Modern systems of firm taxation often coexist with exemptions or presumptive tax regimes. As a result, only a subset of firms in the economy is subject to the ‘regular’ tax system, which typically includes a combination of value-added, payroll, and corporate income taxes. Other firms are either exempt from these taxes or subject to special tax regimes based on a presumptive tax base, usually turnover. The common rationale for such a ‘two-tier tax system’ is that modern taxes have desirable properties but may impose high compliance costs for taxpayers and administrative costs for tax authorities. Therefore, exemptions or presumptive taxes are often aimed at small and medium enterprises, where these costs can be particularly significant. Firms can often choose whether to participate in the regular or presumptive tax regime. This paper examines the key effects of a two-tier tax system on firms, using administrative data on firm-to-firm trade from São Paulo, Brazil. Our results show that the presence of a two-tier tax system (i) affects firms’ input choices, creating (partial) segmentation in firm-to-firm trade along the supply chain, (ii) slows down firm growth around the eligibility threshold, and (iii) impacts competition.