Tax reform, the politics of imperfection – 12/24/2023 – Marcus Melo

Minister Fernando Haddad stated that the approved Tax Reform is not perfect because it is part of a collective effort. For President Lula, it was due to almighty God and the art of negotiation. In reality, there are other reasons that explain why it was approved and why it is imperfect.

I remind Machiavelli about the fate of reforms that impose concentrated costs on specific sectors and diffuse benefits for the whole society: “There is nothing more difficult, dangerous and with a more uncertain outcome than starting to introduce new laws, because the introducer has enemies as everyone those who take advantage of the old ones and as weak defenders those who would profit from the new ones”.

With anti-reform sectors mobilized and reformists disorganized, the result is a pro-status quo bias. Machiavelli also argued that “armed prophets”, who combined ardor and coercion, always triumphed. But in democracies, this option is ruled out. How was the reform approved, if there are multiple actors with veto power?

The issue has already been explored in the literature. Reforms of this type become politically viable by 1) compensating the losers; and 2) the impact of the change differs over time. The result of the reform depends on the calibration of these two aspects. But, in the case of the approved tax reform, it clearly failed. So let’s see.

To compensate the losing states, sectors and companies, billion-dollar funds and reduced rates were created: R$570 billion over 14 years (2029 to 2042) and another R$60 billion annually from 2043 onwards will make up the Regional Development Fund (FNDR) . All outside the primary expenditure limit of the fiscal framework. The automobile sector will have R$160 billion between 1925 and 1932, which will also not be included in the calculation of primary expenses.

The rates will be 60% for 13 sectors of the economy, such as agribusiness; 40% for health, public transport and others; 30% for independent professionals. For others, it will be reset. The result of these compensations is a very high standard rate for the new VAT.

Changes to the rules are also deferred over time and will only come into full force after ten years. Compensation for the losers will extend for an incredible two decades.

The struggle to guarantee privileged treatment will intensify next semester, when complementary laws will be voted on.

With so many trade-offs and such a length of time, transition costs will represent a disproportionate share of future benefits. The advance is Lampedusian: it will only be felt by future generations. It is as if there was a great collusion in which benefiting rentier sectors charge a hefty toll for the change.

LINK PRESENT: Did you like this text? Subscribers can access five free accesses from any link per day. Just click the blue F below.