Tax reform and macroeconomic stabilization – 07/22/2023 – Samuel Pessôa

I have written that the tax reform (RT) has several parallels with the Real Plan. It’s worth organizing the ideas. At the outset, it is important to emphasize the main difference: there will be no immediate impact on poverty reduction. However, the approval of RT will bring an immediate improvement in the growth perspective, which should generate some reduction in risk perception.

I see four similarities with the Real Plan.

The first is the allocative effect. To live with chronic and rising inflation, companies had to have hypertrophied financial departments. Additionally, on every corner of the cities there was a bank branch. If it weren’t for the distortion, in this case inflation, these resources could be used in productive activities.

Inflation produces a misallocation of production factors. The same is true of tax complexity. In this case, we have hypertrophy of accounting departments in companies, and in every corner of our cities there are tax law offices, in addition to a good portion of the Judiciary being used in tax litigation. The misallocation is aggravated by investments made exclusively as a result of tax arbitrage. Trucks going up and down the Brazilian roads without need.

The second similarity is the way the distortion evolves. When inflation is low, the deleterious effects are small, everyone adapts and there are even some who win. With hyperinflation, almost everyone loses (the exception is banks). There is a point at which a majority coalition is formed that sustains stabilization. The same is true of tax complexity. From one level it becomes almost impossible to do business. Even those who have a special regime start to accept the RT, as the systemic gains more than compensate for their localized loss with the reform.

The third similarity is the need for a transition that respects the status quo. The current situation is dire, but it works. The new has to be created from the old without major ruptures. Exactly like China adopted the market economy at the turn of the 1970s to the 1980s. In Real, the transition was very fast, with two currencies. On RT, the transition will be long.

The design of the PEC 45 transition encloses a veritable Columbus egg. Tax has two ends: the payer and the receiver. From the point of view of productive efficiency and the reduction of disputes, the end that matters is the tax payer. PEC 45 provides for two transitions with different deadlines. The transition from the federative division (the receiving end) is longer, which increases the chance that governors will accept the RT.

The fourth similarity is the impact on transparency. Chronic and rising inflation makes the price system very noisy. People lose track of the relative prices of goods and services. Tax complexity has the same impact. Relative prices no longer indicate social costs and begin to reflect the tax policies of the Union, states and municipalities.

But the worst thing is that the tax complexity prevents the citizen from knowing the cost of the Brazilian State — and at this point the RT goes beyond stabilization. Tax transparency must be, together with greater efficiency, the great gain of RT. Through this channel, we should expect that the explanation, for the citizen, of the cost of maintaining the State will generate pressure to increase the efficiency of the public sector.

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