Quantifying the impacts of tax distortions on Misallocation and Productivity

This paper quantifies the impact of tax distortions on resource misallocation and aggregate productivity in Brazil’s manufacturing sector, a country characterized by one of the world’s most complex and fragmented tax systems. Using firm-level administrative data and building upon the framework of Hsieh and Klenow (2009), we distinguish between tax-specific and other distortions, decomposing tax distortions further into within-sector and between-sector components. We find that Brazil’s manufacturing sector operates at only 68% of its potential productivity under the current tax regime. Revenue-neutral reforms that harmonize tax rates within sectors could raise efficiency to 79%, yielding substantial productivity gains. Eliminating tax differences across sectors brings additional, albeit smaller, gains, boosting efficiency to 84%. Overall, our results indicate that tax distortions alone account for approximately half of the observed resource misallocation, and highlight intra-sectoral tax heterogeneity as the most significant contributor to productivity losses.