Sector-differentiated tax exemptions in investment networks

Abstract

We analyze sector-differentiated subsidies in production and investment net works. Our work expands Liu’s (2019) model of industrial policy in production networks to include the investment goods network of the economy. We show how Liu’s main theoretical results must be modified when two distinct networks connect the economy’s sectors. Then, we present two applications of this theory to Brazil. Our first finding is that incorporating the investment network leads to changes in the position of sectors that produce investment goods and services in the sectoral priority ranking for incentives. For our second application, we analyze the impact of sector-differentiated federal tax exemptions in Brazil in 2019, estimated at R$ 265 billion, or 3.6% of Brazil’s GDP. We calculate that the impact of these subsidies on aggregate income was nearly zero. However, in a counterfactual scenario where sub sidies are redistributed among sectors based on the theory-derived ranking, income increases by up to 1.7% within the investment-augmented production network.