An analysis of Tax Reform – 07/10/2023 – Why? Economês in good Portuguese

If you pile up the legislation that regulates the ICMS with that of the Cofins, it makes a book substantially thicker than Dom Quixote (the two volumes, of course). Thicker, and much less interesting. In a single state, ICMS has 15 rates and thousands of special tax regimes. Multiply that monster by 26 and see what a mess it is for a nationwide company. Maybe it’s better for her to stay quiet in a lonely state, wasting opportunities to grow and gain efficiency.

Many of these and other inefficiencies are about to disappear. A good –albeit imperfect– Tax Reform has just been approved by the House and is going to be voted by the Senate. A reform that has been discussed and matured for more than a decade and was finally able to garner support from state governments.

The birth of a national VAT –the IBS (Tax on Goods and Services)– and a system of contributions also based on added value, the CBS (Social Contribution on Goods and Services) took a while, but seems irreversible, for the benefit of society.

Just the economy of being able to do without an army of tax specialists, with a master’s degree in ICMS in Pará, a postdoctoral degree in ICMS in São Paulo and a doctorate in ICMS in Minas and Bahia, is already a tremendous gain. The unification of the legislation of the various ICMS (state) and ISS (municipal) is also quite a gain in terms of legal uncertainty for companies and efficiency in combating tax evasion and the practice affectionately called “tax planning”.

Simplicity matters and the laws regulating ICMS and ISS date from the second half of the 1960s, a time of great verticalization of production. They are rarely up to date…

To make clear the benefits of the reform: simplification of the Kafkaesque tangle, change in the incidence of revenues to added value and taxation that will occur at the destination and not at the source (which will occur gradually, over decades). ICMS and ISS merge into IBS, jointly administered by the states.

Why is value-added taxation higher than that levied on billing? Because it allows the decision to take part in activities involving production outside the company to depend only on how much more efficient it is than doing it inside. Billing tax distorts choices to do everything in (thus paying tax only once, in the limit case).

Current ICMS is about added value, but quite confusing. The credit generated at each stage of production is physical and not financial. A strange concept, dictating that at each stage of the process, only expenses with goods directly used in production –whatever that means– generate credits to be deducted. For example, expenses with electricity and outsourced services do not generate credits. Does not make sense.

Does the service sector lose out, will it pay more taxes? Possibly, but it is not a truth set in stone. Many companies sell services to others, services that focus on some stage of the other company’s production process. The providers, today, do not receive any credit. But that changes with the reform. What about services to final consumers? These yes will probably pay more taxes. But the macroeconomic balance, with a sector that is currently highly taxed being less burdened after the reform, and another currently undertaxed paying a higher rate, is healthy.

Finally, by gradually passing the charge on to the destination, the reform contributes to an increase in the overall efficiency of the economy: exemptions no longer dictate where something is produced. States can continue to compete for companies, which is not a bad thing. What’s bad is competition that leads to a race to the bottom in revenue. A workforce with better human capital, public safety, better roads, become the margins of competition. The taxpayer wins. Twice!

In short: if it is not dehydrated in the next rounds, we will have approved a beautiful Tax Reform in a few months.

This column was written in collaboration with the Why?

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