According to Cervantes, “the best gravy is hunger”. So does it follow that a crisis is necessary to grease the wheels of reform? Not judging from China’s example, where one reform after another has been successfully completed and each one has acted as a stepping stone for the next. Perhaps both eating and implementing reforms is simply a question of getting started.
The Chinese have undertaken two important tax reforms over the last 15 years. In the 90s, a VAT tax was introduced to replace the previous “tax farming” scheme and in early 2007, another tax reform unified tax on earnings for all types of businesses – domestic and foreign, large and small.
In Brazil, simplifying taxes is even more important than in China. The Finance Ministry is making promises about presenting Congress with a project that will reform the tax system.
Complaints about the high tax burden in Brazil are generalized. The additional costs of an employee to his firm run at 102 percent over his salary. Whilst a payroll tax is normal, existing in almost every country, in Brazil the rates are very high, with payroll taxes covering days not worked (such as holidays and sick leave) and even a contribution destined for agrarian reform.
Other significant distortions in the Brazilian system relate to indirect taxes on goods and services. Many taxes are cumulative and there are multiple tax agencies, tax rates and bases for calculation. According to the Instituto Brasileiro de Planejamento Tributário (Brazilian Institute for Tax Planning), there are 62 taxes in Brazil and 3200 tax codes – including laws, provisional measures, decrees, regulations and instructions.
In addition to income tax, the Union controls taxes and contributions such as PIS, Cofins, IPI, CPMF and a fuel tax. Cumulative and non-cumulative regimes are piled on top of one another, negatively impacting on both neutrality and efficiency. The States control the ICMs, with serious distortions resulting from a mixed system for sharing taxes. At the same time, an onerous tax war affects a group of States, without imposing costs for those that concede benefits. The municipalities collect the ISS (a tax on services), but less than 3 percent of Brazilian municipalities are efficient in collecting taxes. As a majority of cities survive on the basis of transfers, a reform could distribute the weight of the tax burden more fairly.
The high cost of complying with tax obligations is an incentive to fraud and tax evasion, whilst tax complexities hamper investment. The reform to be discussed in Congress plans for substituting all of the taxes on goods and services with two uniform taxes on added value: one state and one federal. The States would be able to set tax rates according to nationally defined parameters. For inter-state operations, the tax would be charged in the State of origin, but appropriated in the State of destination.
Clearly, the new system could simplify and diminish the costs of tax obligations, thus reducing the informal market and broadening the base of taxpayers, facilitating productive investments and eliminating distortions in foreign trade. The opportunity to carry forward the reform grew with the recently introduced electronic tax form. The new data bases create the conditions to calibrate tax rates and accurately estimate the impact of changes in each federal entity. By eliminating loopholes for fraud and putting an end to the tax wars, the new regime would make a reduction in the tax rate feasible.
However, too much optimism merits some caution. Consider the argument that a tax reform is a game in which everyone wins. Certainly, increased efficiency could promote economic growth and, at least in theory, it would be possible to construct a system of compensation between winners and losers. Compensation between Federal entities would be possible. But a system of compensation between sectors would not make sense when the objective is to make tax rates uniform. Therefore, some interests will be hurt and tempted to impede reform. And on announcing tax breaks for sectors that suffer damage due to the appreciation of the real, the Finance Minister goes against the grain of the reform proposed by his secretary.
Lula’s first term totaled over R$ 30 billion in tax reductions for specific sectors, which was almost equivalent to the annual total revenue of the tax on financial transactions (R$ 32 billion for 2006). The tax exemptions are inefficient and damage the principle of neutrality which should guide the future tax reform. It seems a bad idea to create interests that are bound to resist tax simplification.