Horizontal and vertical tax competition in Brazil: empirical evidence for tax interaction in the cigarette and gasoline market

Abstract

This paper investigates the effect of federal taxes on tax policy on the part of States (vertical competition) for cigarette and gasoline allowing for the effect of neighbor’s States tax policy (horizontal competition). In order to estimate this effect consistently, we consider spatial econometrics in an annual panel data for 26 States in Brazil for the period 1995-2007. Our results suggest that there might be vertical competition in the cigarette market. An increase in federal tax – IPI – of 1% leads to a statistically significant increase of state’s sales tax for cigarette between 3.2% and 1.2% depending on the model considered. On the other hand, for the gasoline market, our estimations point to horizontal competition. An increase in 1% of neighbor’s Sales tax – ICMS – is associated with an increase in its correspondent tax rate of 0.27% in one of our models.