Pro-poor tax policy and yardstick competition: a spatial investigation for VAT relief on food in Brazil

Abstract

This paper investigates whether a pro-poor tax policy follows yardstick competition in the value-added tax (VAT) base in Brazilian states. We explore an institutional arrangement that allows lower levels of government to set tax relief (tax cuts and exemptions) for food goods in a so-called basic basket food. Next, we examine the relationship between the VAT and the 'Fund Against Poverty' (FAP) financed by VAT rate increases on cigarettes and gas. Our findings indicate that the state tax function responds positively to the neighbour's redistributive policy. Moreover, we estimate that the degree of spatial tax interaction among states has increased since the establishment of the FAP, suggesting that FAP resources are viewed as a complementary pro-poor policy rather than either a fiscal equalisation (substitute policy) or a possible slackness in the constraint of redistributive policies.