Study shows that just 13% of ICMS tax cuts are passed on to consumers
A study by Fundação Getulio Vargas’ Sao Paulo Law School found that, on average, just 13% of reductions in Tax on Circulation of Goods and Services (ICMS) rates for 79 food products were passed on to consumers in the form of lower prices. The study, called “A Flat-Rate Tax on Consumption,” coordinated by Leonel Cesarino Pessôa, a professor on the Professional Master’s Program at the FGV Sao Paulo Law School, and Maurício Canêdo Pinheiro, a professor of economics at Rio de Janeiro State University, looked at products in the states of Bahia, Rio de Janeiro, Minas Gerais and Sao Paulo between 1994 and 2021.
The data disprove an assumption that is very common in debates on tax policy – that tax reductions are passed on to consumers in the form of lower prices. “Many members of the public believe that tax rate reductions necessarily mean lower prices, as if companies automatically pass on the entire reduction. Even some tax policymakers believe that a tax reduction will lead to lower prices and therefore increased demand for that good and an increase in employment,” the report states.
Can cutting tax rates reduce inequality?
The study also concludes that the use of differentiated tax rates is not an efficient way to reduce inequalities, because the benefits are not directed exclusively to the poorest people. Everyone, including the richest, ends up benefiting from price reductions. Thus, other, more targeted tax policy instruments can be much more efficient at achieving the proposed objective.
In addition, a non-specific tax mechanism can cause other effects that are not in line with government policy as a whole. For example, reduced gasoline tax rates may not be in tune with environmental concerns.
Many people believe that lowering tax rates automatically means lower prices, but this pass-through process involves other factors, such as market structure and supply and demand elasticities for the product in question.
Furthermore, differentiated rates make the system much more complex, impairing its productivity and efficiency. This can reduce domestic economic output, harming everyone, including the poorest people.
Lastly (and this is an argument that is particularly pertinent to Brazil), the existence of differentiated tax rates stimulates lobbying. Some groups argue that they are in a very special situation, so they deserve different treatment.