President Rousseff's tax reform will likely be approved by Congress, but piecemeal and within the next two years.
Since taking office in January 2011, President Dilma Rousseff has repeatedly vowed to make Brazil's tax regime simpler and less onerous. She has also promised to reduce the tax burden on industrial investment. Rousseff is promising piecemeal reforms rather than a radical overhaul of tax policy. This stems from a belief that such reform will be more agreeable to Congress, which is scheduled to discuss the bill in the second half of 2011.
At the moment, tax compliance is time consuming, costly and very complex. According to the World Bank, companies take 2,600 hours per year to prepare, file and pay taxes in Brazil, compared to 384.7 hours in Latin America and 199.3 hours in the OECD. Numerous payroll taxes and mandatory pension fund contributions are equivalent to 38 percent of employees' gross wages. In addition to a hefty corporate income tax, company tax bills are further inflated by federal, state and municipal sales and valued-added taxes. The government understands that the tax burden needs to be reduced, but support from Congress, states and municipalities has proved elusive. The former Lula administration, for example, made two failed attempts at tax reform.
The proposed tax changes comprise at least three areas. First, payroll taxes will be reduced as social security contributions will decline from the current 20% of gross salary to 14%. Secondly, the ICMS tax, a tax on all goods and services, will be harmonized across different states. At present, this tax is levied at the discretion of states. The government is proposing a fixed 4% rate applicable nationwide, to discourage the fiscal competition between states who try to outdo each other by offering tax holidays. Lastly, the reform envisages tax exemptions for domestic industries and exporters.
There is a strong probability that the Rousseff government will succeed in passing this legislation in Congress, although this will require negotiations with Rousseff's coalition partners. Several factors are supportive of Rousseff 's reform efforts. Tax revenue over recent years has been robust, which provides room for tax reduction without endangering government revenues. The significant appreciation of the currency and the danger that this prices Brazilian companies out of foreign markets is acting as an additional incentive for a reduction in corporate taxation. Very few, including the labor unions, dispute that tax reform would boost productivity, generate jobs and assist economic growth. This puts the government in a strong position to get the bill through Congress.
This commentary was provided by specialist intelligence company Exclusive Analysis.