Experts doubt Brazil will reform its cumbersome tax system anytime soon.
BY LATIN AMERICA ADVISOR
At her inauguration Jan. 1, Brazil's new president, Dilma Rousseff, said simplifying the country's byzantine tax system was an 'urgent' priority of her administration. How much of an impediment to business is Brazil's tax code? What types of reforms are needed? What are Rousseff's chances of getting a reform through the country's Congress?
Joel Korn, chairman of Foreign Investors Group and managing partner of Performa Partners in São Paulo: Brazil's tax system is cumbersome and represents a constraint to the country's economic activities. It encompasses a large number of taxes and contributions, introduced in the last two decades to strengthen the government's budget. As a result, the overall tax burden has grown to approximately 38 percent of GDP. Aside from a high-cost tax compliance structure to manage the complexities of the system, taxes imposed on company's payroll, capital investments and exports represent an important component of the 'Brazil Cost' of doing business and a major competitive disadvantage for the private sector. Moreover, the proliferation of tax legislation among states and municipalities has prompted an unhealthy 'tax war,' leading to inefficiencies in economic activities, as well as in higher costs related to a prolonged period for recovery of tax credits. Recognizing the need to preserve adequate revenues at the federal, state and municipal levels, the tax reform should be neutral-or close to it-while ensuring that it is equitable and simpler to administer. The system's architecture should stimulate the competitiveness of economic activity, induce less 'informality' and tax evasion and ultimately broaden the base of taxpayers. Specifically, there is an urgent need to reduce excessive labor costs by curtailing a significant part of the payroll taxes, eliminate taxes currently imposed on exports and capital investments, consolidate several indirect taxes along with a reduction in the number of tax brackets, place more emphasis on consumer taxes and harmonize state and municipal tax legislation. A major challenge for the authorities is the development of accurate data to support alternative sources of revenue compensation, especially for states and municipalities. While it is virtually a consensus within the government, political leaderships and business circles that a tax reform is overdue, it will be a challenge, given the vested interests of governors and congressmen. Rhetoric is good, but when it gets to details on how to implement it, then the forces against any potential loss in revenues are surmounting. The window of opportunity is now, at the start of a new administration.
Rafael Amiel, director of Latin America Economics at IHS Global Insight in Eddystone, Pa.: Brazil's overcomplicated tax system imposes clear hurdles to business development. The government's tax take, at around 35 percent of GDP, is by far the highest in the region, which averages less than 20 percent. It is a major constraint for small businesses that cannot afford legal and accounting advice; to some extent, cumbersome tax legislation fuels the underground economy. Tax reform is a priority. However, it seems unlikely to happen in the short-term as narrowing the fiscal gap is an even more important priority. The government plans to eliminate the deficit by 2013-2014, and while most of its strategy is based on lowering interest payments on debt, a reduction in revenue is not in the equation. Politically, a tax reform will also be difficult to achieve as it involves consensus not only in Congress. Interests of individual states are also at play, and consensus at this level is not an easy task.
Paulo Vieira da Cunha, partner and head of research for emerging markets at Tandem Global Partners in New York: Reforming the tax code has been an 'urgent' priority of the last three administrations, stretching back to the second term of Fernando Henrique Cardoso, without any tangible progress thus far. Cardoso stitched together an ambitious and eventually successful political plan. Congress would approve the Fiscal Responsibility Law and the reform of the publicly sponsored private social security system. In exchange, Congress would get more money for discretionary public spending. How? By increasing taxes, of course. In this way, the tax load in Brazil increased from 20.4 percent of GDP in 1998 to likely 35 percent of GDP in 2010. Of course, in this process the tax system became not only more efficient (i.e. punitive) but also more complex. Because new taxes would not be distributed equally, states and municipalities introduced their own complications with the result that, today, by all admissions the system is unwieldy. Even if you want to pay all the taxes you may not know how to. And of course this is a major business impediment, with the typical Brazilian twist. It discriminates against new entrants while favoring long-established large enterprises. This is why the common advice to foreigners is not to open branches or even subsidiaries. Instead, the safest route is through acquisitions. The first and easiest step of the tax reform is the unification of the 27 different quasi-VAT regimes, one for each state. Congress has been considering this legislation for the past 10 years. It is the easiest but it is not easy. A single tax regime would eliminate cross-jurisdictional tax incentives; it would call for a unified and transparent revenue-sharing agreement between the Federation and the states and, the most difficult part; it would presuppose an agreement to tax products at destination not origin. All this can be done with political will. Lula almost did it in 2005 but in the end refused to spend his political capital for the reform. Dilma Rousseff could do it. In the campaign she said she would do it; however, she gave up the idea in her first week in office.
Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter.