For decades one government after another has tried to overhaul Brazil’s unwieldy tax system to no avail. Time and again vying state governments, entrenched business interests, and shifting alliances in congress have been the downfall of tax reforms. Now, just half a year into the third term of President Luiz Inácio Lula da Silva, it looks like a deal is finally in the making.
The tax reform drafted as a constitutional amendment, known as a PEC, was approved by the chamber of deputies on 6 July, and senate president Rodrigo Pacheco pledged to get it approved before year-end. The proposal obtained 382 and 375 votes in two rounds of voting in the lower house, well above the 308 votes needed. The approval marks a major victory for the Lula administration and helps bolster investor confidence.
The PEC essentially consolidates five different federal, state, and local taxes into two value-added taxes (VAT), one for the federal government called the Contribuição sobre Bens e Serviços (CBS) and one for the states and municipalities called the Imposto sobre Bens e Serviços (IBS). It grants preferential tax rates for priority goods and services such as basic foods, health services, education, medicines, and public transport. Higher rates would apply to alcoholic beverages and tobacco.
Simplification
The objective is to simplify what has been a complicated web of taxes that makes bookkeeping time-consuming and costly for companies and acts as a disincentive to investments. According to the World Bank’s Cost of Doing Business Index, it takes a typical company in São Paulo 1,501 hours to file taxes each year, compared with 317 hours in the rest of Latin America and 159 hours in countries of the Organisation for Economic Co-operation and Development (OECD). Total taxes amount to 65% in Brazil, compared with 47% in Latin American and 40% in OECD countries.
The current tax system is also a disadvantage to domestic businesses, especially in industry, because a good is taxed several times at each stage of production. Imported meat for example pays cumulative taxes of 1.2%, while domestically produced meat has a cumulative tax burden on added value of 13.6%, according to the Confederação Nacional das Indústrias (CNI), a business lobby. Under the new VAT, there will be no cumulative tax burden, making Brazilian products more competitive, particularly exports.
Currently investments are subject to the municipal service tax ISS and, if companies qualify for an exemption, they can’t recover their refund for 48 months. Under the reform, investments would not be taxed. By establishing a fixed tax rate across the nation, legislators also want to end the common practice of tax wars between state governments to attract businesses.
To help offset regional differences and promote economic development in poorer states, a fund will be financed by the national treasury with gradually increasing amounts starting with R$8bn (US$1.7bn) in 2029 and reaching R$40bn in 2032.
Pork barrel
Following a few setbacks in congress, the government seemed to have got its ducks in a row for the tax reform, prompting Lula to hold a series of meetings with legislative leaders to improve relations. To further grease the wheels of the congressional machinery, Lula opened the floodgates of discretionary spending for legislators. Unlike his predecessor Jair Bolsonaro (2019-2023), who handed over a big pot of cash (the so-called secret budget) for legislators to divvy up as they saw fit, Lula only approves legislators’ requests to fund projects in their constituencies (earmarks called ‘emendas parlamentares’) once he is assured support on specific legislation by key parties.
In the two days leading up to the vote on the tax PEC in the lower house, the Lula administration rubberstamped R$7.5bn in earmarks, roughly as much as during the previous six months since he took office. The bulk of the funds went to Bolsonaro’s Partido Liberal (PL), followed by the Partido Social Democrático (PSD), and the Partido Progressista (PP).
All three form part of the so-called Centrão, a group of political parties that lack strong ideological convictions and usually vote for whoever offers most pork barrel spending. As a result of all the efforts, 109 deputies that form part of the opposition in congress voted for the proposal.
- Ministerial favours
In a further effort to broaden his support base in congress, Lula also held out the possibility of granting ministerial posts to the PP, the party of lower house chief Arthur Lira, and to the Republicanos, another Centrão party.
Industry and business entities celebrated the approval as an historic victory for Brazil. “In Brazil we’ll finally have a modern tax system that will stop being an expensive nuisance day by day for taxpayers, whoever they may be,” said Robson Andrade, head of the CNI business lobby.
Finance Minister Fernando Haddad said the tax reform would bring far-reaching and lasting efficiencies to the economy, and he likened its impact to that of the Plano Real, which ended hyperinflation in 1994.
Looming pitfalls
Yet there are a series of potential pitfalls that could water down the bill and undermine its overall benefits. For one, the level of the new VAT has yet to be determined. Were it to be set too high, the more simple form of taxation than previously could continue to disfavour Brazil’s industry in comparison with other nations. Various members of the economic team have suggested that the rate would be below 30%, and Haddad spoke of a rate closer to 25% – above the OECD average of 19.2%.
As the senate begins discussions after the end of the summer recess, there will certainly be lobbying efforts by certain industries and sectors pushing for exemptions along the lines of those obtained for health services and farm products.
Already, governors played a wild card with a last-minute amendment to the house bill that gives states the right to create a levy on raw materials and semi-processed goods, potentially opening up a door to new tax wars that could throw off balance the delicate agreement among Brazil’s 27 states.
The good news is that the rapporteur of the reform in the senate, Eduardo Braga of the Movimento Democrático Brasileiro (MDB), already spoke out against the amendment, suggesting he would likely remove it. In addition, the senate’s constitution and justice committee (CCJ) may well find it unconstitutional as states aren’t authorised to create new levies.
The objective, said Braga, was for the senate to vote on the text by the end of October. Then it would go back for a second and final vote in the lower house before receiving the president’s signature so that the law could go into effect on 1 January 2024. Given the long transition times stipulated in the bill, the new tax structure wouldn’t be fully in place until 2033 – long enough for subsequent governments and legislatures to revisit Brazil’s tax saga.
