what are the effects on the economy

Treated as a priority by the government of Luiz Inácio Lula da Silva (PT), a tax reform on consumption could result in an increase in economic activity in all sectors, in addition to increasing exports, imports and household income and consumption , and reduce social inequality.

This is the conclusion of a study carried out by professors Edson Paulo Domingues and Debora Freire Cardoso, from the Federal University of Minas Gerais (UFMG), at the request of the Fiscal Citizenship Center (CCiF). The work, presented shortly before the 2022 elections, simulates the macroeconomic impacts of the proposed amendment to the Constitution (PEC) 45/2019.

The text of PEC 45 is inspired by a proposal by Bernard Appy, founder of CCiF, who today holds the position of special secretary for tax reform at the Ministry of Finance, chosen by Minister Fernando Haddad.

Haddad has reiterated that the government is working to approve a reform in consumption taxes in the first half of the year, which he defined as a priority in November, before being appointed to the Ministry of Finance.

Although this provision is praised by specialists, there are doubts about the government’s ability to win the support of three-fifths of Congress in such a short time, given the historical resistance of sectors that fear damages with the reform – the case of services, whose representatives returned to expressed concern in recent days.

The minister, however, says he sees a favorable environment both in the Chamber and in the Senate. “Tax reform could have already been voted on, and it wasn’t. And it can be voted on, Congress is mature. Obviously we have deputies and senators who are taking office now, but there is, in both Houses, a very favorable environment”, said Haddad , this Tuesday (31), after a meeting at the Brazilian Federation of Banks (Febraban).

“This has a very strong impact on economic growth. It will improve the life of companies, it will improve the life of the industry, it will give more transparency to the tax system, it will allow us to move forward in the second half of the year to discuss the regressivity of the tax system , which penalizes the poorest families”, added Haddad, referring to the income tax reform that he announced two weeks ago, at the World Economic Forum, in Davos (Switzerland).

According to the Secretary of Economic Policies of the Treasury, Guilherme Mello, the government is working “to present in the coming months” the reform of taxes on consumption. “[A reforma] it will simplify, guarantee more agility, guarantee an improvement in the productivity and competitiveness of our companies”, he told CNN Brasil this Tuesday.

“We are also working on a reform of income taxation, aiming, in addition to simplification, at a better distribution of income. Nowadays, the Brazilian tax system is regressive, that is, the very rich pay little and workers pay a lot”, he added. Mello.

What does the tax reform of PEC 45 foresee

In general terms, PEC 45 provides for the unification of five taxes on consumption (IPI, PIS, Cofins, ICMS and ISS) into a single tax, which would be called Tax on Goods and Services (IBS). Presented in 2019 in the Chamber of Deputies, the text has been stalled since it passed through the House’s Constitution, Justice and Citizenship Commission (CCJC), in May of that year.

To assess the effects of approval of the text on the country’s economy, researchers from UFMG simulated four different scenarios based on data from the national accounts of the Brazilian Institute of Geography and Statistics (IBGE) for 2015. In the first, called the standard, they projected an IBS rate that keeps the tax burden unchanged, estimated at 26.3%.

In the second scenario, treated as a base, a selective tax on tobacco, beverages and fossil fuels was included, with a new readjustment of the IBS rate in order to guarantee the maintenance of the tax burden. In this context, the incidence of the new tax would correspond to 24.2%.

The other two simulations start from the second scenario, but analyze the macroeconomic effects of the reform added to an increase in capital productivity through indirect means, such as the reduction of administrative costs and tax litigation, in addition to the correction of geographic distortions in the allocation of capital.

Based on a study by economist Bráulio Borges, a researcher at the Brazilian Institute of Economics (Ibre), of the Getulio Vargas Foundation (FGV), the researchers created a scenario, considered conservative, that supports a 12% growth in potential GDP in 15 years. The latter, optimistic, predicts a 20% increase in GDP in the long term.

The calculations were made before the entry into force of Complementary Law 194/2022, which instituted the ICMS ceiling on fuels, electricity and telecommunications, in addition to temporarily zeroing PIS and Cofins for gasoline and ethanol. But the researcher Debora Freire Cardoso considers that the results of the study should not change, since the changes in LC 194 should not be maintained in the long term.

Federal taxes on fuels should have been resumed on January 1, but a provisional measure by Lula extended the exemption until the end of February for gasoline and ethanol, and until December for diesel oil, biodiesel and natural gas.

Meanwhile, governors have been raising the standard ICMS rate to compensate for the loss of revenue caused by the tax cap. And an agreement between the states and the Union, mediated by the Federal Supreme Court (STF), gave back to the states the autonomy to define the state tax rates on ethanol, diesel, biodiesel, LPG (cooking gas) and natural gas, although still under a roof. Gasoline, in turn, will still be the subject of new discussions – the governors are pressing for annulment of the ICMS ceiling on this fuel.

“This change in ICMS is momentary; it’s a short-term change that we know is very difficult to maintain,” she says. “The tendency is that this modification will not be maintained and, consequently, this should not interfere with the results that we project, because they are structural results. A temporary modification is not capable of modifying the structure”, says Debora.

Macroeconomic results of the tax reform provided for in PEC 45

See below the estimated impact of PEC 45 on a series of economic variables, considering the maintenance of the general tax burden. The “standard” scenario does not foresee the existence of selective taxes. The others (“base”, “conservative” and “optimistic”) include excise taxes:

In the scenarios that do not consider the productivity effect a priori, there is a forecast of growth of 3.99% (standard scenario) to 4.14% (baseline) in GDP, due to the benefits of allocative efficiency that the tax reform should generate, in addition to the effect on investment and capital stock growth.

All macroeconomic variables considered (household consumption, investments, exports and imports) would have a positive variation in both scenarios. “It is worth highlighting the large increase in investment in the standard and base scenarios (over 16%), which shows how much the distortions of the current tax system impact capital accumulation in the Brazilian economy”, says an excerpt from the technical note.

With the incorporation of the effect of long-term productivity, there is a relevant increase in household consumption (12.55% in the conservative scenario and 24.2% in the optimistic one), in exports (11.7% and 17.4%) and in investments (20.3% and 25%).

One of the most relevant impacts in simulations with productivity gains is that of the so-called well-being of families, monetarily evaluated and equivalent to the gain generated by the change in prices and income resulting from the reform. In simulations without the productivity effect, this gain would be between R$ 112.9 billion and R$ 126.9 billion.

In the other scenarios, it would reach BRL 559 billion (conservative) or even BRL 1.01 trillion (optimistic), which would also end up generating a significant increase in consumption. “The final result on household consumption is positive as the income effect offsets the effect on prices, which is reflected in the increase in real household consumption in all scenarios,” says the study.

There is an important increase, in all scenarios, in exports, as there is no prediction of incidence of IBS on this type of operation, which would result in a drop in production costs. Imports, in turn, would grow due to increased domestic activity.

In the segmentation by sector of the economy, industry would benefit the most, as it is the activity most dependent on investments in fixed assets and because it currently has higher rates than those on goods and services. But all macrosectors would also benefit from the reform, according to the simulations.

Impact of tax reform on activity in each sector

Impact of tax reform on the input cost index in each sector

In addition, the study showed that the tax reform proposed in PEC 45 can reduce income and consumption inequality, as it especially benefits families in the lower wage brackets.

“This result stems essentially from the fact that, in the current system, the consumption basket of higher-income families (more intensive in services) is less taxed than the consumption basket of poorer families (more intensive in goods)”, they say. the authors.

The simulations do not take into account the personalized exemption model, which appears in PEC 45 and according to which lower-income families would be entitled to a refund of part of the tax paid. If it comes into force, the system would tend to make the impact of the tax reform even more progressive.

Impact of tax reform on household welfare

Equivalent change in % of income per household

In parallel with PEC 45, PEC 110 has been pending in the Senate since 2019, which had a favorable admissibility report presented at the House Constitution and Justice Committee (CCJ) in early 2022.

The main difference from PEC 110 is the prediction of a “dual” value-added tax (VAT) model, that is, composed of two taxes: one of federal jurisdiction (the Contribution on Goods and Services, CBS) and one of responsibility states and municipalities (the Tax on Goods and Services, IBS).

Researcher Debora Freire Cardoso points out that, from the point of view of macroeconomic impacts, the approval of PEC 110 instead of 45 would result in very similar effects.

“From a political point of view, there is a big difference to do this in a dual or unified way. This has been discussed in relation to the autonomy of federal entities. From the perspective of macroeconomic impacts, it changes little, because we measure the impacts based on a structure of the total economy, at the national level. Basically, we are capturing the tax change via sectors and not via regions”, he explains.