Brazil has made great improvements in fiscal governance in the last decade and a half. Most of the institutional changes took place during the President Cardoso’s two terms in office (1995-2002), although some initiatives preceded his administrations. Since President Lula’s inauguration in 2003, there has not been a significant change in mechanisms of fiscal governance. In fact, Lula’s administration has been mostly an autopilot in fiscal and tax matters. The three major institutional innovations in fiscal governance mostly resulted from crisis. Changes include: a budget reform associated with a major scandal (known as escândalo dos anões do orçamento); the privatization of banks and utilities and new fiscal federalism measures in the wake of the states’ debt crisis; and the Fiscal Responsibility Law (FRL)—following the Asian and Russian crises. The crises provided a window of opportunity for reforms in the three cases. In the case of tax reform, however, the impact of the crisis was radically different—it inhibited reforms.

There is a recurrent reform agenda in tax policy that has never been implemented despite the Executive’s enormous preponderance in Congress. Ironically, these include proposals that were presented by the government itself. This status quo bias in tax policies is thus associated with differences in risk aversion across the issue areas but also with the incentives in the country’s policymaking process. The executive derives utility from fiscal stability and inflation control because of electoral incentives and of credibility gains in international markets. This endogenous perspective allows us to understand fiscal and tax reform initiatives as generating political benefits for incumbent politicians. However, fiscal stability was attained at the cost of systemic inefficiency associated with highly regressive and distortionary taxes, especially consumers’ taxes. Tax reform initiatives—such as uniformed state VAT legislation all over the country and converting turnover and cascading taxes (PIS/PASEP, COFINS) into a single federal tax—were therefore discontinued by policymakers because of the perceived risks of a fall in revenue due to fiscal uncertainty; and also due to the political costs involved, leading the government to choose a line of least effort.

Therefore, the international crisis led risk-averse incumbent policymakers to prefer an inefficient tax system that was capable of generating high levels of revenue to a streamlined and more efficient system—the issue of efficiency lost importance in the context of crisis. Other examples of “non-reforms” that caused great impact were the massive expansion of tax revenue associated with hikes in existing social contributions and also the introduction of new contributions and, to a lesser extent, of new taxes.

Part of the country’s fiscal adjustment was made possible by a massive increase in tax revenues since the mid-1980s—during a time of already high taxes. The tax taken as percent of GDP rose 12 percentage points (from 25 to 37 percent) between 1993 and 2005. This makes Brazil an outlier among developing countries in terms of its ability to extract resources from society (Lora, 2007). In Latin America, Brazil’s tax has been twice the Latin America average (see Figure 1). The increase in taxation was due to the introduction of new taxes and increased rates of existing taxes, particularly federal taxes and the so-called social contributions, which are cascading taxes. The tax burden in Brazil (34.41 percent in 2008) is greater than developed countries such as Japan (17.6 percent), USA (26.9 percent), Switzerland (29.4 percent), and Canada (32.2 percent), Ireland (28.3 percent), Spain (33 percent); and several developing countries such as Mexico (20.4 percent) and Turkey (23.5 percent). Tax revenue increased 11 percent last July beating all previous record in Brazil.

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Needless to say, the negative impact of this tax burden affects Brazil’s investment and productivity sectors. However, rather than complaining with this tremendous tax burden, business and national Brazilian industry seem somewhat satisfied. In fact, the last time business sector decisively complained against high taxes in Brazil was in December 2007 when the government proposal to extend the CPMF (the tax of financial transactions) was defeated in the Senate. This defeat was an upset result because the executive’s majority coalition was not able to obtain the necessary majority of 49 votes in the Senate, but just 45 votes. This episode might represent a signal and a remarkable mobilization of several different sectors in the society (media, interest groups, business sectors, etc.) and opposition players that the leverage of the federal government to keep increasing the tax burden was running out.

In sum, while there has been an extensive reorganization of fiscal federalism in the country since the mid-1990s, much less change can be observed in the area of taxation. The federal government has managed to recentralize fiscal authority, curbing the autonomy of the states by resorting to numerical rules. By contrast, while expanding massively the extractive capacity of the Brazilian state, incumbent policymakers choose not to revamp the tax system and kept an inefficient system that has been capable of generating high levels of revenue.

With the 2010 presidential election rapidly approaching, it is surprising that the issue of tax reform has a very low profile in the agendas of the principal candidates. What is more perplexing is that there is very few information about tax policy proposals in their official platform of govern. For instance, the program of the main opposition candidate, Jose Serra, PSDB, is very critical of the fact that “Brazil has highest tax burden in the developing world.” During his campaign, for example, Serra has actually posed for pictures in front of a “taxmeter” in downtown São Paulo installed by São Paulo Commerce Association. However, he does not say much of his plans to address the problem of reducing the tax taken or to make the current system more efficient. The issue is approached in a single sentence in his campaign platform. Similarly, the governing candidate, Dilma Rousseff, PT, supports the idea of tax reform; however, she is very vague by proposing a broad simplification of taxes and a reduction in investment taxation in her campaign platform. The lack of a clear agenda or strategy of tax reform might be a sign that the current status quo, which has been generating generous and massive revenue to the national government, will prevail.

Why is tax reform virtually a non-issue in Brazil lately? One potential reason that might explain the current passivity of the business with regard to high taxes has to do with the role played by the National Development Bank (BNDES) providing relatively easy loans pumping money into the national economy during the financial crises. According to The Economist (August 05, 2010), “BNDES’s rate of new lending now far exceeds that of the World Bank.” Behind these massive loans for manufacturing and infrastructure national industries is a mechanism of subsidies from the national treasure that in fact pays the difference (about $6 billion a year) between the rate BNDES lends (6 percent) and the yield on the ten-year government bonds of 12 percent. In other words, there would be a clear gains-from-trade mechanism in this process by allowing the executive to have access to greater revenues via a distortionary tax system in exchange for subsidized public loans to the national business sector. In addition to BNDES loans, it should be borne in mind that the economy is booming. It is expected to grow about 7 percent this year. Massive expansion of consumer credit has led to a surge in manufacturing and services. Business climate is very positive and citizens are highly optimistic and in such a context they are not concerned about inefficiencies in the tax system. The currency over appreciation has led to massive imports in consumer goods by Brazilian consumers who have also spent massively abroad.

References:

Lora, E. (2007) “Trends and outcomes in of tax reforms”, in Lora, E. The state of state reform in Latin America, Washington, D.C., IADB-Stanford University Press.

Melo, Marcus; Pereira, Carlos; and Souza, Saulo. (2010) “The Political Economy of Fiscal Reform in Brazil: The Rationale for the Suboptimal Equilibrium” Inter-American Development Bank, IDB-WP-117.

The Economist, Magazine, August 05, 2010.