Long before the COVID-19 pandemic spread across the globe, Latin America’s largest country had already been experiencing structural economic and social difficulties. Despite its paradisiacal landscapes, rich culture, and warm population, Brazil has in recent years reached the position of one of the most unequal countries in the world. In 2020, according to the United Nations Development Program, the country ranked 8th for worst economic inequality. Among several institutional weaknesses, one significant cause for this issue is the nation’s obsolete, complex, inefficient, and unfair tax system, which drives foreign investments away from the country and does not adequately redistribute the wealth to its neediest population.
The Brazilian tax system, introduced by the 1988 Federal Constitution and the 1966 Brazilian National Tax Code, is characterized by the division of powers between the federal state and municipality levels to collect taxes on different matters. This tripartition of powers results in a huge number of regulations enacted by each of these governmental instances, and thus in a very complex tax environment that just confuses both taxpayers and tax authorities.
Three major factors exemplify the extent to which Brazilian taxation is a current headache. First, the Brazilian taxpayer spends an excessive amount of time and money to comply with constantly changing tax rules, as well as fulfilling ancillary obligations. In the country, people spend 1,501 hours a year on average attempting to comply with tax obligations, causing Brazil to rank last in efficiency according to the Organization for Economic Cooperation and Development. By comparison, the USA falls in 25th place, averaging 175 hours a year.
Second, this complexity causes an enormous degree of litigation between taxpayers and the tax authority. This raises the costs of companies, produces legal uncertainty and resultively removes investments from the country. According to a new study by the Brazilian research institution Insper, the amount involved in tax actions in Brazil reached R$ 5.4 trillion in 2020, representing 75% of the national GDP. In other numbers, in 2018, out of the 80.1 million cases in Brazil, 31.4 million of the cases were tax foreclosures. In this line, in 2018, the congestion rate reached 91.7%; that is, for every 100 tax foreclosures actions that were processed in the previous year, only 8 were remanded.
Third, it precisely refers to the context brought at the beginning: the current taxation only accentuates social inequality instead of reducing it. The country has a lower tax on income and wealth, whereas there is a predominance of taxes on consumption. While Brazilian taxation on income and wealth represents only 22% of the total collection, in the USA it is 60%; in Denmark, 67%; and in the average of the countries of the OECD, it is 40%.
Given this situation, in recent years, new articulations for developing a new Brazilian tax model have become more intense. Today, three tax reform proposals are under discussion in Brazilian legislative houses, the House of Representatives and Senate. In summary, the projects aim to simplify the taxation on national consumption through a unified value-added tax, cutting the multiplicity of taxes of the type apportioned among the government levels.
The Impacts of New Legislation
In a conversation with the HPR, Bernard Appy, economist president of Centro de Cidadania Fiscal (Center for Tax Citizenship) expressed his belief that “a good tax system is the one that manages to collect as much as possible, minimally harming economic growth and having the best possible distributional impact.” He explained that the Brazilian system, in contrast to this ideal scenario, is surrounded by distortions both in productivity and in the distribution of resources. Therefore, with regard to economic efficiency, his proposal, No. 45/2019, aims to improve taxation for goods and services, substituting five current taxes on consumption for one new unified federal “tax on goods and services.” Appy argues that there are some necessary points for a well-designed tax on goods and services. First, the tax must be on consumption, explaining the common presence of VATs in international models. He also highlights that the tax must have a broad tax base, for both all kinds of goods and services.
According to Appy, an efficient VAT should also tax the destination of the goods or services. This logic is completely inverted in Brazil where these taxes are predominantly levied at the origin, not at the destination. He explains that “taxation at destination means between different jurisdictions, whether between countries or between states, the tax should belong to the destination’s jurisdiction.” An efficient VAT must also present clear and homogeneous rules, very few different tax rates, and contain no tax benefits or any other kind of an exception to the rules.
He understands that, contrary to this, taxation on consumption in Brazil today has a totally fragmented base since there are five different taxes on consumption divided among the government levels. Moreover, Brazil opted for a separation between taxation on consumption of goods and provision of services; the latter in Brazil is less taxed. Brazil’s model perpetuates social inequality since those who consume the most services are the richest and not the poorest social classes.
Furthermore, the current system is surrounded by exceptions to the rules, several tax incentives and different tax rates for each type of consumption. According to Appy, the presence of many fiscal benefits also generates distortions because Brazilian taxpayers companies often choose to set their productive structure in certain states just due to the amount of fiscal benefits that the region can offer, even if it complicates logistics. “From the economic point of view, for businesses to take the goods to the consumer, there are much more expenses on work and capital,” he adds.
Appy’s tax reform proposal establishes a national VAT of centralized collection in the federal government, with homogeneous rules, a uniform tax rate, no tax benefits or any other exception. According to a study at the request of CcIF, by the consultancy agency LCA Consultores, the correction of the Brazilian tax system ending these distortions has the capacity to raise the Brazilian GDP by up to 20 percentage points in the next 15 years.
Finally, the economist refuted one of the greatest fears concerning the reform, which is that government levels may lose their fiscal autonomy. For Appy, the autonomy of the states in setting the tax rate will be preserved, because the rate can be increased by the state, so long as it is applied integrally and with no distinctions for all goods and services in the region. With regards to the autonomy of the state to manage its collection, he understands that there will really be no more. However, Appy assures that the concentrated collection will be more transparent to the Brazilian taxpayer, who today does not generally have any notion of how much tax is embedded in the goods and services he consumes.
The Brazilian Tax Authority’s Concerns
Diego Diniz Ribeiro, a longtime administrative judge at the Brazilian Administrative Court of Tax Appeals and current partner at the law firm Daniel & Diniz Advocacia Tributária, commented to the HPR on the impacts of the Tax Reform idealized by Appy.
For Ribeiro, the biggest problem of the Brazilian tax system for the tax authorities is the lack of rationalization that results in an inefficient tax collection for the government. According to Ribeiro, in recent years there has been a significant increase in tax liabilities — the payment amount for company obligations or debts to the tax authorities, for example.
He said he is skeptical about the possibility that the reform under review will actually boost the national economy, given that “Brazil has built its own model of taxation and federalism” that cannot be changed radically by importing a VAT model following international parameters.
Moreover, Ribeiro criticized the reform stating that “there will be a tendency for states to be dependent on the federal government”, which clearly undermines the autonomy of states. Not to mention that the standardization of tax rates to only one rate and the end of benefits will not be beneficial to Brazil, a country of continental extension, as there must be at least a differentiation for poorer states and regions considering the country’s vast inequalities.
Thus, he casts doubts on whether Appy’s reform model can reduce social disparities, and states that “simplification will not necessarily mean achieving tax justice in Brazil.”
The lawyer is also concerned about the proposed transition period in Appy’s reform. According to the reform text, the transition from the current regime to the new one would last ten years, eight of pure transition and two more of testing. The justification is to adapt taxpayers to the new rules, as well as to avoid the devaluation and reduction of investments in the country. Ribeiro understands that this transitional period is too long, and that it would be difficult for both the taxpayer and the tax authorities to handle both regimes in parallel until the old one is totally extinguished.
The Taxpayers’ Concerns
In a conversation with the HPR, Carlos Henrique Bechara, a Brazilian tax lawyer, partner at the law firm Pinheiro Neto Advogados, also commented that the Brazilian tax system is concentrated on the taxation on consumption as a significant source of national revenue. Though under many conditions taxation on consumption may be useful, he argues that it is actually unfair in Brazil. He understands that the new VAT will not solve the country’s socioeconomic inequalities; instead, he insisted that only greater taxation on income and wealth would make it possible to reduce the social chasm.
He praised, however, the efforts of the proposals in trying to bring a more modern and daring tax to the country. “We need to think of VAT in Brazil because it is the tax that foreign investors are used to,” he adds. As mentioned, the five consumption taxes today cause awkwardness on the part of companies and investors entering Brazil, and this already generates an initial barrier.
“This complexity makes the Brazilian market less internationally competitive and perpetuates distortions in the logic of capital and labor,” Bechara stated. As stated before, Brazilian taxes on consumption are collected at the place of origin. Thus, Brazil suffers from a traditional “fiscal war” between the states to attract companies to settle, granting the corporations exaggerated tax benefits, which ends up not compensating for the more expensive cost of logistics.
Bechara is also skeptical about the single rate advocated in Appy’s reform proposal. He cast serious doubt on how this rate may be a sustainable pair to offset the collection of states. Instead, he believes the rate can become much higher over time and may even overtax the taxpayer in future.
Nevertheless, Bechara emphasized that unfortunately this is not the best time to discuss tax reform in the country. “We should not tinker with it now amidst the pandemic with thousands of people losing their lives, their jobs, their source of income,” he says. Now, Brazilian government must focus on “giving subsidies, renegotiating taxpayer’s tax debts, it must focus on helping merchants and businesspeople.” He commented that the reform should be considered after this moment of crisis, and it should also be revisited considering the recession and its next steps arising from the 2020-2021 pandemic.
Looking Towards the Future
The 2019 reform project devised by Appy is still under discussion in the National Congress and its voting is expected to be postponed more and more according to the unfolding of the COVID-19 crisis in Brazil. In general, Appy and Ribeiro are more optimistic about the tax system in future. Appy believes that the need for change is much more mature today; there is much greater support from state governments to simplify taxation on consumption, besides the support from the business sector, as long as there is an appropriate transition period for them to adapt. For this reason, he said he is “very optimistic that in fifteen years from now we will have a much better tax system than the current one.”
Ribeiro hopes to find a fairer system in the future in which the amounts collected are well invested to distribute appropriately to society, but he is not confident in the full potential of the reform proposal that exists today.
Bechara, however, is pessimistic about Brazil’s uncertain future in this field, given that this matter has been discussed for years, but an actual implementation has never occurred. He reaffirms the need for a new tax system, but believes that this may not happen due to the lack of support from the municipalities for the current proposal. “A reform is absolutely necessary”, but he understands that the current pandemic circumstance calls for the conversation to be deferred to a more stable period.
Indeed, improving the national tax system, albeit based on other proposals, seems to be one of the most important achievements towards a more efficient income distribution regime. However, with the current pandemic, it is unlikely that a new reform will be voted on or implemented in the country anytime soon.
Image Credit: “Dinheiro” by Jeso Carneiro is licensed under CC BY-SA 2.0
