Brazil achieves historic tax reform

Several countries in Latin America have recently sought tax reforms – with mixed results. The change to the tax system now underway in Brazil is not perfect. But it shows that comprehensive improvements in the business environment are possible in Latin America if there is political consensus.

by Alexander Busch, Latin America correspondent for Handelsblatt and Neue Zürcher Zeitung

 

In Chile, Congress rejected a comprehensive tax reform in March, triggering a new crisis between the government and the legislature. President Gabriel Boric has now called for a bipartisan consensus to get the law through parliament after all.

In Colombia, the government succeeded in passing a reform in December 2022 – after the previous attempt two years ago had led to severe social unrest. In Brazil, the government introduced a comprehensive tax reform last week, which was approved by a large majority in the Chamber of Deputies.

This is remarkable. After all, Brazilian governments have been trying to reform for several decades. But now the opposition and the government, as well as the states, have pulled together.

Unlike the reforms in Chile and Colombia, the main aim in Brazil is not to increase tax revenues. In Brazil, the chaotic and inefficient tax system is to be completely changed. Industrial companies in particular will benefit from this.

Thereafter, five taxes currently levied at source will be combined into two value-added taxes. As a result, the current tax levies on production at source will be gradually abolished by 2033 and shifted to consumption.

This avoids cascading taxes that companies have to pay on each new production step. They are partly responsible for Brazil being an expensive country in relation to average income.

At the same time, the tax system is becoming more transparent. Tax competition between states is shifting from the tax system to state budgets. In the future, companies will no longer be given tax breaks to locate in the state or city. If mayors or governors want to attract businesses with financial incentives, they will have to show the subsidies in their budgets. Then they have to justify to their voters why, for example, a carmaker should be subsidized with millions when at the same time there is no money for hospitals and schools.

The Ministry of Finance expects growth to increase by 12 to 20 percent over the next 15 years. Previously, numerous entrepreneurs, economists and financial investors from all political camps had defended the reform – despite its shortcomings.

Because the decisive factor now will be how the long-term implementation succeeds. The reform now goes to the Senate for a vote. Numerous industries have already been able to secure reduced VAT rates. However, the level of the VAT will only be determined over time. Tax increases will begin with minimal rates to estimate the tax base. Then, by 2033, existing taxes will be phased out.

Almost 40 percent of state tax revenues are affected by the reform. A second phase of the tax reform, in which higher incomes, property and dividends are taxed, is planned. It would be necessary to make Brazil’s tax system fairer. In few countries in the world are the differences in income and wealth as great as in Brazil.

Nevertheless, the reform is a huge step forward for Brazil’s economy and state. The renowned economist Samuel Pessôa believes that it could trigger a similar growth spurt as the “Plano Real” economic reform almost 30 years ago. In 1994, the currency reform succeeded in curbing decades of hyperinflation in Brazil and stabilizing the currency. The reform gave Brazil an economic and investment boom in the mid-1990s.

The reform initiated in Brazil gives hope for Latin America: It shows that comprehensive improvements in the framework conditions for business are possible in the region.

Brazilian Reais
© Pixabay/joelfotos

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