Tax Reform – 06/10/2023 – Marcos Lisboa

Maria manages the family factory, which earns BRL 100 million a year. Many partners work in the enterprise. The business was founded by his great-grandfather and the heirs are more than 30. Taking out the costs of material, rent, equipment and outsourced services, R$ 12 million a year remains to pay employees and distribute profits to shareholders.

Salaries and charges add up to R$ 6 million per year. That leaves R$6 million in profits per year to be distributed among the partners, which amounts to just over R$10,500 per month for each one, net of income tax.

A distant cousin, Antônio, is a successful liberal professional, who earns BRL 30 million a year. The office and the team that advises him cost BRL 6 million. He pays just over R$ 3 million with Income Tax, leaving R$ 20 million to spend as he pleases.

In present-day Brazil, Antônio pays, proportionately, far less tribute than his distant cousin, despite earning much more. Maria and her partners are taxed at 34% of their profit. Antônio, on the other hand, is under the presumed profit regime and has a rate below 15%.

The tax system in Brazil allows even greater distortions than this example. Buying metal structures and precast parts to build a building involves paying taxes that do not generate credit for the buyer. In many cases it is cheaper to make a building with the more archaic masonry methods.

The result is a country where producers choose less efficient production techniques due to tax distortions. Our low growth in recent decades is not the result of chance.

There are special rules per type of product, such as onion bulbs or thoroughbred horses, as long as they are not of the English type. The list of special cases seems endless, as exemplified by the ICMS reform proposal proposed by the São Paulo government in 2020, Law 17,293, which was accompanied by decrees, such as 65,255, which systematized the endless exceptions that should be reviewed.

Lobbies, however, are stronger than the common good. The exceptions remain in effect. Perfume has a taxation rule. Cologne water has another one.

In many cases, companies can deduct from what they owe the tax authorities what was spent to enable the production of what they sell. Is marketing necessary for business? It depends. In some cases, the tax authorities think so. In general, decides not to.

Many business leaders are getting tense with the tax reform. Will the load increase or decrease?

Accounting is not easy. There is such a “tax residue”; tax obligations embedded in the price of goods and services that are purchased. Some suppliers are in the “cumulative regime”, others in the “non-cumulative”. There are expenses that allow a reduction in taxes to be paid, but not all. Which ones?

The changing rules, and their creative interpretations, result in gigantic tax litigation in Brazil, more than 250 times greater, as a proportion of GDP, than in OECD countries, or in other Latin American countries, according to a study by Insper.

But what is the rate actually paid by companies? Well, it’s not good to know. There are taxes paid directly by the business. But there are also those embedded in the prices of purchases of equipment and services.

The profusion of rules on taxation, by type of product and service, on what can be deducted or not, results in a chaotic tax collection system.

Depending on the business, more or less tax is paid for the same income received. Economists, lawyers and consultants usually pay less taxes than machinery and equipment producers.

The tax reform under discussion in the Chamber of Deputies institutes a simple regime, which is a first step towards correcting our distortions. All businesses now pay the same rate on added value, which is, essentially, employee payroll and shareholder profits.

All other expenses may be deductible from taxes to be paid, including marketing or third-party services.

There is no reason why those who make money from litigation should be less burdened than those who produce cars or food. Merchants and producers should pay the same tax rate on their added value, as well as economists and lawyers.

The tax reform, by introducing a single rate on all consumption decisions, reduces income inequality. Currently, services, demanded in greater proportion by the richest, are less taxed than goods, which represent most of the consumption of the poorest families.

The vast majority of cities, over 98%, will receive more resources, as the new tax will be allocated to where people live, no longer to where goods and services are produced.

The reform provides other benefits for the most vulnerable.

Public policy is much more effective in transferring income and taking care of the poorest than trying to redistribute income through taxation on consumption. The Ministry of Finance estimated that taxing the basic food basket and using the additional revenue to increase Bolsa Família has a 12 times greater impact on reducing income inequality than the current regime, which favors agribusiness sectors.

The next step is to ensure that profits and wages are progressively taxed. Those who earn more should pay a higher rate. Theme of the next stage of tax reform, which deals with Income Tax.

Large companies may have small partners, such as pension funds, which manage the resources to pay for the retirement of those who worked on the factory floor. Low-income companies may have partners who are among the richest 1% of the country.

Confusing company size with shareholder wealth helps perpetuate our income inequality. The gray areas of our taxation rules help those who make a living from litigation, but hurt the country.

Tax reform is a sandy topic, full of subtleties and details that may go unnoticed. Each lower tax rate for any sector that is incorporated into legislation, each exception to the rule, means a privilege that has been preserved.