Letter IEDI n. 1078—Principles for Reforming the Brazilian Tax System
This Letter IEDI lists a set of principles to be observed in a tax reform in Brazil, which can be carried out over time, in stages, as long as it follows a coherent trajectory so that the efforts are synergistic and constructive and do not lose effectiveness.
To this end, the IEDI carried out studies on various tax topics, contrasting the characteristics and trends of our system with the international experience, especially that of OECD countries.
Our objective is to contribute to the effort of reflection and elaboration of proposals for a wide-ranging reform in the country. It should address the main problems of our tax system, in addition to the distortions of taxes on goods and services, and also be consistent with international trends.
This is an attempt to build convergences between what Brazilian society and its productive sector crave, such as greater efficiency and social justice, what experts consider most technically adequate and what seems to be possible from a political point of view.
From the identification of the needs and the possibilities of change in our tax system and the similarities and differences with the international experience—which allows a richer and deeper discussion about the distortions of our own system—the following items were systematized:
1. Promote the adjustment of public accounts also through collection and not only via the necessary rationalization of State expenses. This must be achieved by reorganizing our tax system and not by simply raising existing taxes and, thus, increasing the total tax burden, which is already very high in Brazil. According to a study by the Tax Citizenship Center (CCiF), a reform such as that provided for in PEC-45 would lead to a 20.2% increase in Brazil's potential GDP by 2035. This growth, in turn, would lead to an expansion in tax collection by the Union, States and Municipalities of about R$ 750 billion in the period.
2. Combat the fragmentation of the tax base on goods and services in Brazil—which today is composed of various taxes administered autonomously by the different units of the three federated entities—through the adoption of a national Value Added Tax (VAT), as seen in almost all OECD countries. While in the OECD, VAT and selective taxes total 86% of the value levied on goods and services, in Brazil the sum of quasi-VATs (ICMS and IPI) plus selective taxes does not reach 56% of the total collected. On the other hand, about 31% of the Brazilian tax revenue comes from cumulative sales taxes (such as ISS and partly PIS/Cofins), which reach 4.1% of GDP, without any parallel among OECD countries.
3. Ensure the following characteristics to Brazilian VAT: (i) simplification of the tax system by reducing the cost of providing taxes and the legal uncertainty, (ii) elimination of cascading taxes and of accumulation of taxpayers' credits, through their prompt return, (iii) complete export exemption and (iv) elimination—through comprehensive taxation at destination, and with horizontal rates— of dysfunctional incentives to ways of carrying out activities that end up adding systemic costs.
4. Replace the exemption of basic consumer basket items and of other products and services by a VAT refund mechanism for the lower income strata of the population and establish a value range not affected by VAT for housing and services such as health, education and public transport, expanding the access of the lower income population. OECD studies recommend caution with distributive policies by differentiating rates, as they do not usually achieve the desired progressive effects. This conclusion guided a set of reforms that limited the use of special rates in many countries in the years 2015–2017, although this is not a widespread trend.
5. Provide for Selective Taxes (ST) in the process of implementation of a Brazilian VAT, for extra-fiscal or regulatory purposes. In the last decade, there has been growing interest in the OECD about the use of ST to influence consumer behavior and boost environmental sustainability and the efficiency of the public health system, among other objectives related to economic and social development.
6. Seek to expand the VAT base on digital businesses, as is the case in OECD countries. International experience indicates that a broad-based VAT levied at destination is perfectly suited for the taxation of intangible goods and services and the digital supply of non-residents. Many countries have implemented simplified VAT registration and collection systems for the provision of these goods and services.
7. Improve the distribution of collection on the various tax bases, making it possible, over time, to reduce the burden on sales of goods and services. In comparison to the OECD, Brazil surcharges goods and services and undercharges income. The weight of taxes on goods and services in the total collection of Brazil is 1/4 higher than the OECD average and the share of income tax is 1/3 lower.
8. Promote greater alignment of the applicable tax rates on the different types of income, both from capital and from work, not only for reasons of equity, but also of economic efficiency. It would help, for example, to combat the phenomenon of “pejotization”, that is, the transfiguration of labor income into capital income due to the combination of simplified taxation regimes (Simple and Presumed Profit) for small and micro enterprises (which reduce the IRPJ, taxes on companies' earnings) with the exemption of dividends distributed to shareholders (see sections 8 and 9).
9. Better balance the burden of profit and dividend taxes between enterprises and individuals. This is a way to reduce corporate taxation. The combined tax rate on profits and dividends for individuals is only 6.8% in Brazil compared to 18.2% in the OECD average; for companies it can reach 34% versus 23.8%, respectively. A greater balance can be achieved with charges on dividends at the level of individuals in Brazil, with a mechanism to mitigate double taxation and/or integration with corporate taxes, as is the case in most OECD countries. This would also combat tax planning and evasion strategies, which are less accessible at the level of individuals.
10. Follow the worldwide trend of reduction of corporate income tax, which in Brazil includes the IRPJ itself and the Social Contribution on Net Profit (CSLL). In OECD countries, over a decade, the average revenue collected via IRPJ-like taxes decreased from 3.6% of GDP in 2006 to 2.9% in 2016. As a result, companies began to account for 1/3 of the total income tax collection, while the taxation of personal income started to correspond to 2/3 of the total.
11. Ensure that the taxation, in Brazil, of profits of Brazilian multinational companies abroad is similar to international IRPJ standards, even if by maintaining the reduction of 9 percentage points, as currently applied. In the OECD, the average statutory rate on corporate profits is 23.8%, while in Brazil it reaches 34% (IRPJ + CSLL) and Brazilian companies with operations abroad must pay the difference to the Federal Revenue as taxes on their profits earned in external markets, which undermines their competitiveness (see section 8).
12. Review the IRPF (income tax paid by individuals) deductions and exemptions, which tend to favor the highest income brackets of the Brazilian population, avoiding specific approaches and prioritizing a broader reform that simultaneously seeks to rescue aspects of equity and provide more consistent treatment to the different types of income. In Brazil, individuals with gross income above 10 minimum wages take 40% of the total deductions with education and 56% with medical expenses.
13. Reject the use of CPMF-type financial transaction taxes, which is a cumulative and distorting tax unparalleled in the rest of the world, to deal with the tax challenges of the digital economy. Such a tax can aggravate the problem arising from the asymmetry of charges on domestic companies and foreign digital companies. Given the global performance of these firms, the country must avoid becoming an eccentric case of taxing these activities and should be part of the solutions negotiated at the international level.
14. Reduce, over time and within the fiscal possibility, the burden of social contributions to employers and make the tax wedge on wages more progressive. As far as fiscal possibilities are concerned, we should aim not to completely eliminate employers' payroll taxes—needed to maintain the possibility of retirement for those with lower salaries—but to reduce them to OECD levels. According to CNI estimates, payroll charges paid by OECD companies add up to an average of 14.6% while in Brazil they reach 28.8% (see section 10).
15. Increase the progressiveness of taxes on inheritances and donations in Brazil, through a wide range of exemptions, and promote greater homogenization in the national territory, avoiding disparate rates in certain states. International experience suggests that the collection power of this type of tax is low and that Brazil is not far from the average of OECD countries (0.13% of GDP).
16. Eliminate exceptions to the general rules of the tax system, using, when meritorious, budget expenditures for the constitution of specific incentives, thus ensuring greater transparency in public spending or investment and less complexity in the tax system.
17. Readjust the limits for qualifying to the Simples Nacional tax scheme (set lower limits based on estimates of added value or cash flow, and not the company's sales), recalibrate its rates and establish a more consistent mechanism of integration between individuals' and corporations' income taxes. Today, the Simples Nacional scheme accounts for about ¼ of the total federal tax expenditure, it enables the process of “pejotização” and has a revenue ceiling for qualification well above international standards. In none of the OECD countries is there a regime as comprehensive as the Simples Nacional.