Tax reform in production networks

Abstract

This paper studies the effects of a tax reform that eliminates heterogeneity of tax rates and cumulative taxation in a production networks model calibrated for Brazil. In modern economies, industries are highly connected through input-output linkages and changes in tax costs are not confined within industries. The tax reform shocks propagate through the production network, which may amplify the results of the reform. Therefore, it is essential to consider the production networks in the tax reform analysis. Our results indicate that the tax reform generates gains of 0.93% of welfare and 2.15% of real GDP. In addition, the gains are amplified by the production network since real GDP growth is approximately 50% higher than in an economy without input-output linkages. We are also interested in how tax reform changes connections between sectors. In this sense, our results indicate that important suppliers from sectors that face higher reduction in tax costs become more relevant in the network. In addition, the reform tends to distance sectors from final demand, especially when we eliminate cumulative taxation.