Institutional resistance to tax reform – 03/21/2023 – What tax is this

In order to indirectly tax the income spent by the consumer of goods and services, the tax system currently in force has failed. Proof of this is that, in Brazil, there is a common sense that it is the entrepreneur (and not the consumer) who pays the indirect tax. And, strictly speaking, this perception is not wrong. This is because, due to the model adopted here, indirect taxation affects the assets of suppliers and not consumers.

However, this encumbrance on suppliers’ assets throughout the entire production chain can be passed on indiscriminately in the price of goods and services, without many criteria of clarity, almost as if it were a simple cost. Precisely for this reason, a large part of the population is not aware that it pays (or how much) tax it pays, when doing, eg, shopping at the supermarket; or when contracting a service, whatever it may be.

This lack of transparency also brings another major problem: as indirect taxation is regressive (that is, the poorest pay more in proportion to their income than the richest), Brazil has tried to neutralize this by exempting certain essential goods and services.

However, as in the current model the supplier of goods and the provider of services are the taxpayers of indirect taxes, these exemptions for certain goods or services that aim to combat the aforementioned regression are likely to be used by companies, as a cost reducer, so that these tax benefits often do not adequately relieve low-income consumers, making our system even more unfair.

In addition to this fiscal illusionism, the segmentation of consumption taxation brings economic and behavioral distortions to the agents affected, directly and indirectly, by the asymmetry of the tax burden. There is a break in economic neutrality, as certain sectors benefit from favored tax regimes, while, on the other hand, several sectors end up being more severely burdened, to “close the public accounts” of tax benefits granted to others. Thus, while some are benefited, the tax burden in general tends to rise on those who are not benefited, in order to maintain the financial balance of the State.

This establishes an institutional phenomenon that is called by some scholars “capture of the State” by interest groups. The most favored are naturally against any tax reform proposal that would neutralize this scenario. In the words of economists, such as the Brazilian exponent Marcos Lisboa, this is one of the biggest factors for failure in the economic advancement of a country.

It should also be noted that the many exception rules end up making the tax system as a whole much more complex. Thus, in addition to the breach of economic neutrality, a huge cost of compliance is generated for the entire business community.

Even in the face of this inefficiency and injustice, the scenario described entails strong institutional resistance to carrying out a tax reform that will simplify indirect taxation as a whole, in order to unify the base of incidence of taxation on consumption (as proposed with the Tax on Goods and Services – IBS, by PECs 45 and 110, both from 2019).

Behavioral economics can explain such institutional resistance very well. This is a bias called by scholars the “possession effect”. As the Nobel Prize in Economics Richard Thaler explains, the economic being is much more averse to losses than open to potential gains.

Thus, for example, the service sector —currently less burdened by the tax system— has difficulties in seeing the long-term benefits that a simpler IBS in its structure could provide. This, just because of the increase in the immediate tax burden that the proposed standardization would bring.

To refute the bias of interest groups that resist tax reform, both in the public area (such as some municipalities and states) and in the private sphere (agribusiness segment or the services sector, for example), we can adopt for our tax policy the same rationale extracted from the maxim said by economist Milton Friedman, about fighting inflation: “Inflation is like alcoholism, in both cases, when you start drinking or when you start printing a lot of money, the good effects come first , the bad ones come later.”

The same will happen with the tax reform, from the perspective of the sectors currently benefiting from the economic distortions of our current system: the tax benefits granted in an exacerbated way until then generated good immediate effects, but ephemeral and with terrible consequences in the long term.

The remedy (the tax reform) could have a negative effect in the short term (increased burden for some segments hitherto benefited). But, in the long term, the new, more neutral and transparent model will have a valuable economic return for these sectors: greater efficiency, enabling greater economic development, with consequent attraction of capital and income generation in the country.

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