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The “Tax War” Mobilizes Billions and Redefines the Industrial Map of Brazilian States. Understand How This Competition Through Tax Incentives Impacts the Economy, Public Coffers, and the Future of Fiscal Federalism in the Country.
The term “tax war” describes a fierce competition among Brazilian states to attract companies and investments, primarily using the grant of tax benefits, especially the Tax on Circulation of Goods and Services (ICMS). This practice, often on the margins of national agreements, generates billion-dollar disputes and a constant debate about regional development.
With the recent tax reform promising to end this cycle, it is crucial to understand the mechanisms, consequences, and future of this complex rivalry involving Brazilian states and their finances.
What Is the “Tax War” Among Brazilian States and How Does It Work in Practice?
The “tax war” is a predatory competition where Brazilian states manipulate their tax regimes to attract companies. The main battleground is the ICMS, with states offering exemptions, reduced rates, presumptive credits, and tax deferral. Often, these concessions are unilateral, disregarding the need for consensus in the National Council of Fiscal Policy (CONFAZ).
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A new Brazilian shopping center worth R$ 400 million will be built in an area equivalent to more than 4 football fields, featuring 90 stores, 5 cinemas, a supermarket, a college, and parking for 1,700 cars, potentially generating 3,000 jobs.
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Larger than entire cities in Brazil: BYD is building a 4.6 km² complex in Bahia with a capacity for 600,000 vehicles per year, but the discovery of 163 workers in conditions analogous to slavery has shaken the entire project.
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With an investment of R$ 612 million, a capacity to process 1.2 million liters of milk per day, Piracanjuba inaugurates a mega cheese factory that increases national production, reduces dependence on imports, and repositions Brazil on the global dairy map.
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Brazilian city gains industrial hub for 85 companies that is equivalent to 55 football fields.
In addition to the ICMS, Brazilian states employ other “weapons”, such as subsidized financing, land donations, and even the construction of facilities with public resources.
The Escalation of the Dispute
The practice gained momentum after the 1988 Constitution, which granted greater fiscal autonomy to Brazilian states in the management of the ICMS. The competition intensified drastically in the 1990s, driven by the country’s economic opening and increased foreign direct investment, particularly in the automotive sector. For example, between 1996 and 2001, of the 22 new vehicle factories established in the country, only five went to São Paulo, the traditional hub.
The lesser intervention of the federal government in coordinating regional development policies also contributed to Brazilian states seeking to attract investments more autonomously and often in a disjointed manner.
Emblematic Cases: The “Tax War” in Practice and Its Consequences for Brazilian States
One of the most notorious cases was the competition for the Ford plant in the late 1990s. Bahia won the competition against Rio Grande do Sul, offering an extremely advantageous incentive package, including land donations and subsidized financing. However, the closure of the plant in Camaçari (BA) in 2021 raised questions about the long-term effectiveness of these incentives.
Another example is the “Ports War”, where Brazilian states such as Santa Catarina and Espírito Santo offered reduced ICMS on imports, attracting trade flows but causing logistical distortions. The footwear industry also saw plants migrate to the Northeast, and states like Goiás and municipalities like Extrema (MG) became attraction hubs for companies from São Paulo.
A Zero-Sum Game for the Country?
The tax war results in the erosion of the tax bases of Brazilian states, compromising the financing of essential public services such as health and education. It also increases the complexity of the tax system and creates legal instability. Investment decisions can be distorted, prioritizing temporary tax advantages over solid economic factors.
This “race to the bottom” may not increase total investment in the country, merely redistributing it, configuring a zero-sum game. The ICMS revenue loss for Brazilian states is alarming, estimated at R$232.49 billion in 2023 and projected to reach R$273.47 billion in 2025.
The Tax Reform and the Future of the Finances of Brazilian States
The tax reform (Constitutional Amendment No. 132/2023) seeks to end the tax war. Its main change is the unification of five taxes into a dual VAT (federal CBS and state/municipal IBS), with the IBS being charged at the destination of the goods or services, rather than at the origin. This eliminates the main incentive for Brazilian states to grant production benefits.
To deal with the liabilities, the Fund for Compensation of Tax Benefits was created, with a projected contribution of R$160 billion from the Union between 2025 and 2032, an amount that could exceed R$250 billion. Experts see potential in the end of traditional tax war, but warn about the complexity of the transition and the risk of new forms of competition among Brazilian states.
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