An adjustment on the revenue side – 05/06/2023 – Ana Paula Vescovi

Based on the proposed new fiscal framework, the government presented quite daring targets for carrying out an adjustment in the federal accounts of 2% of GDP by 2026. Its achievement will depend on an increase of 2.3% of GDP in revenues for the Union, or about 4% of GDP in the total tax burden for society.

We have warned of the challenges inherent in this strategy, something that also permeated, to a similar extent, the adjustment carried out between 1998 and 2002, fundamental to sustain the Real Plan. One consequence was the sharp rise in tax incentives over the next ten years, to counteract what interest groups claimed to be losses in competitive equality between sectors and countries.

After 20 years, the Brazilian economy has an even higher tax burden, federal subsidies of 4.5% of GDP, a more rigid public budget, high and rising public debt, lower potential GDP, with less strength from the demographic bonus. Since the 2015/2016 crisis, attempts to increase revenues have not been successful at the federal level, although they are meritorious when trying to fill legal gaps, increase contributory justice or tax activities not yet achieved by the tax authorities.

The government’s flight plan involves the timely recovery of federal revenues, tax reforms, first indirect taxes and then income, and a reduction in benefits.

Specific measures were taken right from the start, in an attempt to restore revenue, after tax cuts that reached 0.7% of GDP last year.

Added to the impacts, the spontaneous denunciation of taxpayers to the Carf (Administrative Council of Tax Appeals), the reencumbrance of PIS/Cofins on fuels and the exclusion of ICMS from the PIS/Cofins credit base tend to reach 0.5% of GDP in annual bases, although with possible reducing effects on other types of revenue, such as those on corporate profits.

In the second round of announcements, the government prepares the taxation of electronic games, changes in the regulation of transfer prices (valuation of goods to avoid tax arbitrage between companies located here and abroad), the accounting of state benefits in the ICMS for calculation purposes of the Income Tax of incentive companies and the taxation of investment funds abroad. We estimate a net collection of around 0.5% of GDP on an annual basis with these measures, already including an estimate for possible taxation of exclusive funds.

In addition to this 1% of GDP, a further 1.3% of GDP (about R$ 130 billion) would be needed for the federal government to meet the target of zeroing the primary result in 2024. due to the slowdown in activity, part of the recovery effort may come only to mitigate this loss.

We do not believe in revenue gains from the reforms or the possible reduction of tax benefits.

In the case of the VAT (Value Added Tax) reform, the possible reduction in benefits would enable a lower rate for the new tax, which will replace five others. We see a good probability of approval, through commitments to tax neutrality. But time will be needed for regulation (complementary laws) and the implementation of new automated collection systems.

We believe in the gradual introduction of a new VAT in Brazil starting in 2025, without confidence that Congress can anticipate revenues, given the difficulties of an economy in cyclical contraction. All this will contribute to important long-term productivity gains, with an impact of up to 20% on GDP in 15 years, according to estimates by the Ministry of Finance.

The approval of the income tax reform will have greater difficulties in mobilizing the base, although it is meritorious for focusing on progressivity. Here, there is a lot of demand for load “equalization” for a small source of funding, with the risk of revenue losses. The taxation of dividends has already been mentioned as a possible source to finance the payroll exemption, as well as the increase in the individual exemption bracket to R$5,000 and the convergence of the corporate tax to international standards.

Finally, the wide space for reducing tax expenditures (fiscal incentives) with the reforms has been emphasized, but there is a lack of political consensus to do so. Reduce the Simples classification amount, deductions on Income Tax, incentives for the Manaus Free Trade Zone, agribusiness, or non-profit institutions, focus on exemptions from the basic basket (where there are even luxury items) or eliminate incentives on fixed-income securities (LCI, LCA, CRI, CRA, infrastructure debentures) are topics that have already been tested and encountered enormous resistance.

On the other hand, the measures in the area of ​​credit announced by the government substantially expand the types of securities subject to such exemptions.

There is, therefore, a high risk of executing the fiscal adjustment flight plan. At the end of the year, there will be the test of the end of exemptions on payroll, provided for by law, with unemployment on an upward curve. It is necessary to note that any increase in the tax burden of this magnitude will raise production costs, reduce the number of viable companies, put pressure on job creation, increase the demand for more public transfers, sovereign guarantees and subsidies of various natures, expanding allocation distortions and, thus reducing potential GDP.

The fiscal adjustment by increasing the tax burden can be a legitimate choice of a society that does not want to give up a greater presence of the State in the economy. But one cannot neglect all the possible impacts of this decision in the long term. It always takes more than one period of government to discover this.