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The tax reform provides for the replacement of five taxes with one VAT.
Item information
- Author, Mariana Schreiber
- Role, from BBC News Brasil in Brasilia
November 9, 2023
After the proposal supported by the government of Luiz Inácio Lula da Silva passed the Senate this Wednesday (8/11), the reform is expected to be approved again in the Chamber in the coming weeks, which would allow it to come into force later this year Year.
According to the chamber’s president, Arthur Lira, the proposal can be put to the vote “at any time” after November 15.
After that, however, a law is still needed that regulates the details of the new system, as well as a test and transition period to calibrate the newly created tax.
If this prediction is confirmed, Brazil will have a value added tax (VAT), a model used in most countries and in almost all developed countries.
In the Brazilian case, the VAT consists of two components: the Goods and Services Tax (CBS), which will replace three federal taxes (IPI, PIS and COFINS), and the Goods and Services Tax (IBS), which will unify ICMS (Federal ) and ISS (municipal).
However, the future tax rate was controversially discussed. Critics of the reform say Brazil’s VAT will increase the tax burden, pointing to economists’ forecasts that the rate could reach 28%, the highest in the world.
“A tax reform that imposes on us the highest VAT in the world, jeopardizes investments and competitiveness and imposes cost pressures that will affect us all is unacceptable!”, Senator Rogério Marinho (PLRN), former Regional Development Minister of Jair Bolsonaro’s government ( PL).
Although it is not yet possible to determine Brazil’s VAT rate, supporters of the reform acknowledge that it will be high by international standards. However, they emphasize that this reflects the fact that Brazil generates a large part of its revenue from production and consumption in contrast to other countries with lower VAT, which collect more on income and property.
The idea, emphasize the supporters of the change, is that the new VAT collects exactly what the five taxes (IPI, PIS, COFINS, ICMS, ISS) currently bring to the three areas of public authority, without thereby increasing the current tax burden to increase.
The goal of maintaining equal revenues is not to embezzle government funds, as these funds are used to finance public services such as schools, hospitals and police operations.
“The reform will be neutral as it will neither reduce revenue nor increase the tax burden. So being neutral means that the new taxes (IBS and CBS) must collect exactly the same amount as today,” summarizes tax specialist Melina Rocha, course leader at York University in Canada.
“Because the future tax rate corresponds to the current tax burden, Brazil already has the highest VAT in the world. However, the new system will bring much more transparency,” he argues.
Melina also explains that the basic VAT rate will also be higher in Brazil due to the discounts granted to some sectors as part of the reform.
For example, health and education services are subject to VAT at 40% of the full tax rate. The basic basket includes some items with full exemption (no VAT is paid) and some items with a reduced rate (40% of the full rate).
In other words, in order for some products and services to have lower taxes, the standard rate that ensures the same tax burden as today must be higher.
How much will the Brazilian VAT be? And what is it like in the world?
According to preliminary forecasts from the Ministry of Finance, the new Brazilian tax could be between 25.45% and 27%, but this calculation will be reviewed after the approval of the text in the Senate, as changes have been made to the text that could lead to an increase in the final price.
A forecast by Institute of Applied Economic Research (Ipea) researcher João Maria Oliveira, also ahead of Senate approval, calculated that Brazil’s VAT could reach 28.4%.
Today Hungary has the highest VAT in the world (27%). Organization for Economic Cooperation and Development (OECD) countries have an average tax rate of 19.2%. Of the organization’s 38 members, made up mostly of rich countries, only the United States does not impose a sales tax.
However, for Melina Rocha, it makes no sense to compare the VAT of different countries without taking into account each country’s tax system as a whole.
“It is not possible to compare the nominal normal tax rate of one country with another, precisely because these other countries have a lower VAT rate, have a much higher income rate,” he argues.
According to a Federal Tax Office report with data from 2020, the average tax burden in OECD countries this year was 33.5% of gross domestic product (GDP), while in Brazil it was 30.9% of GDP.
When analyzing the type of tax, the data shows that the tax burden on income in Brazil was 6.9% of GDP, compared to the OECD average of 10.6%.
When it comes to taxation of goods and consumption, however, the scenario is reversed: the Brazilian burden was 13.5% of GDP, compared to the OECD average of 10.8%.
It is worth explaining that GDP is the calculation of the wealth generated by the country in a certain period of time. When calculating the tax burden in relation to GDP, we essentially analyze the amount of revenue in a year in relation to the wealth generated in the country in the same year.
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Tax simplifications are intended to stimulate the economy
How can VAT stimulate the economy?
Preliminary estimates from various economists indicate great potential for economic growth based on productivity increases due to tax simplification through VAT.
A forecast made in 2020 by Bráulio Borges, senior economist at LCA Consultores and researcher at Fundação Getulio Vargas (FGV), estimated that the introduction of the VAT could increase Brazil’s potential GDP by 20% in 15 years
Simulations by economists Edson Domingues and Débora Freire Cardoso, professors at the Federal University of Minas Gerais (UFMG), predicted a slightly lower increase of 12% for the same period.
“There are different taxes depending on the product, different rates depending on the region, multiplying laws, additional obligations and high compliance costs, which increase costs and lead to inefficient economic decisions,” he continues when discussing the negative effects of the current system enters.
In this article, Pires cites studies showing positive effects of introducing VAT in countries such as Canada and China, such as increased investment, sales, job creation and productivity.
According to Pires, these positive effects are linked to the simplicity of the system and the fact that VAT generates tax credits throughout the production chain, thus avoiding the accumulation of taxes.
In other words, when a company purchases an input from another, VAT is charged on that transaction, but later the company can deduct the amount it paid when purchasing the input from the VAT paid when selling its product . These discounts are socalled tax credits.
The Brazilian system today also results in tax credits for some operations, but the complexity of the system leads to distortions and litigation.
“(The introduction of VAT) relieves the burden on the production chain by ending cumulation, which promotes the aggregation of values in the production chain,” Pires says in the article.
Another positive effect, says the researcher, is that VAT is levied on final consumption.
“(The introduction of VAT) shifts taxation from production to consumption, relieves investment and exports and increases the competitiveness of the economy,” affirms Pires.
Studies also show that tax reform should increase the consumption power of the population, especially the poorest. Because the proposal considered in Congress envisages the creation of a cashback system (tax refund) for Brazilians with lower incomes, something that is already being implemented in other countries that apply VAT, such as Uruguay, Colombia and Canada.
However, Melina Rocha emphasizes that the expected gains from the implementation of the tax reform will take time.
“There are studies that assume an increase in economic growth and income of the population, but this will not occur immediately since the new system will not be fully implemented until 2033 due to the transition period,” he emphasizes.
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The government expressed its approval of the reform in parliament
During the test phase, the Brazilian VAT rate will be set
It is not yet possible to say with certainty what the Brazilian VAT rate will be, since it depends on the final text of the reform approved in Congress, the regulations adopted thereafter and also practical aspects such as possible tax losses evasion.
Therefore, the Treasury Department’s initial forecast estimated a possible range between 25.45% and 27%.
In order to calculate exactly what the rate will be, there will be a test phase in 2026 in which a CBS (federal sales tax) of 0.9% and a CBS (state sales tax) of 0.1% will be levied.
At this time, the other five taxes remain in effect, but a discount is applied to the income from the CBS and IBS tax to avoid double taxation.
Based on what is collected with these reduced rates in the test phase, it will be possible to calibrate the new tax rate.
However, there will still be a transition period during which the Brazilian VAT will be gradually introduced in place of the current taxes until it comes into full force in 2032.