Do Taxes Lower Employment in the Third World? Evidence from Personal Service Firms in Pre-Debt-Crisis Brazil

Abstract

In most nations, developed and undeveloped alike, employers' associations advocate tax cuts as a strategy for increasing employment. The literature on public finance and Third World taxation has been sceptical of these claims, although a small literature within economics favouring tax cuts does exist. Neither side provides compelling empirical evidence for or against tax relief as a tool to generate employment. The present paper provides such evidence for Brazilian restaurants, hotels and barber/beauty shops in the period 1940–1980. After controls are introduced for the size of potential markets and the impact of other non-tax costs, tax rates have virtually no effect on employment. This is because many Third World firms are characterized by a constellation of forces that theoretically minimize the link between taxation and employment. Third World governments that seek to increase employment in strategic industries would be better off using their funds to create programmes designed to stimulate employment proactively.