This project seeks to assess the impact of distortions that affect firms’ decision to integrate vertically on their incentives to invest and on their productivity. The study focuses on a specific distortion: cascading taxes. Cascading taxes are business taxes that are levied at every stage of production, with no deduction for the taxes paid at earlier stages (e.g. on intermediate inputs). Since firms that decide to produce their inputs instead of outsourcing them do not have to pay taxes on their intermediates, cascading taxes give an incentive to firms to integrate vertically. Cascading taxes are very common in Low-Income Countries (LICs), yet there is very little empirical research on the topic, and virtually no estimate of the magnitude of the distortions that these taxes impose (Keen, 2013).
The researcher exploits a set of tax reforms in Brazil to provide direct empirical evidence that distortions that induce firms to integrate vertically translate into productivity losses. Over the last 15 years, the Brazilian government converted some of its turnover taxes into value-added taxes. Turnover taxes create cascading effects and tend to disproportionately hit industries whose inputs account for a large share of final production. Indeed, the author documents a sharp and persistent reduction in the level of vertical integration from 2003 onwards, mostly concentrated in sectors in which intermediate inputs are relatively more important.
The author plans to guide the empirical analysis by developing a simplified version of the model of Antràs and Helpman (2004) and test its predictions in a differences-in-differences framework. By comparing the response to the Brazilian fiscal reforms across firms that were more and less affected by them, the researcher will be able to quantify how distortions to firm organization affect both their incentives to invest and their productivity. Vertical integration, investment and productivity will be precisely measured by detailed firm, plant and product level data that includes information on transfers internal to firm, plant-level investment and product level price and quantities.
This study has clear and important policy implications for LICs. As of 2013, 22 out of 35 LICs still have some form of cascading tax in place (World Bank, 2013). Although distortive, cascading taxes have administrative advantages over more complicated arrangements like VATs or net profit taxes. Understanding the full cost of the distortions introduced by these taxes is important to inform the debate around the opportunity to abolish them in LICs that still have them.
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