Latin America Advisor

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How Much Will Brazil’s Tax Reform Spur the Economy?

Reais Brazil’s Congress last month approved a landmark reform of the country’s consumption taxes.

Brazil’s Congress approved a landmark overhaul of the country’s byzantine tax system in December, marking a major victory for President Luiz Inácio Lula da Silva, who said the reform will “facilitate investment.” The overhaul includes a merging of five consumption taxes into two value-added taxes. What are the most important parts of the reform? What are the main benefits and drawbacks of the reform? How will it affect investment in Brazil, and what industries will be most affected?

Manuel Orozco, director for sovereign and international public finance ratings at S&P Global: “Following the approval of Brazil’s revenue-neutral tax reform, we upgraded our long-term sovereign ratings on the country to ‘BB’ from ‘BB-’. In our opinion, the tax reform extends Brazil’s track record over the last seven years of pragmatic policy implementation that will continue to anchor its macro stability. Among the reform’s key merits are a substantial reduction of consumption tax codes and their consolidation into a dual-VAT system. These changes will help tax governance for all levels of government in Brazil, as well as substantially simplify tax compliance and the noncumulative features in the Brazilian tax system. That said, the implementation will be very gradual, and most of the structural benefits will only be felt over the long term. The full implementation of the dual-VAT will be in 2033, and the transition period to tax from origin to destiny will last 50 years. As a result, to unlock stronger levels of investment in the short-term, the Brazilian government will need to continue to address its very weak fiscal situation. Consolidating Brazil’s fiscal deficits will translate into higher levels of available financing for the private sector and will allow the central bank to continue to ease its monetary policy, both necessary conditions for investment.”

Allison Fedirka, principal at Allonia Group and director of analysis at Geopolitical Futures: “The most important part of Lula’s tax reform is that it is being done in conjunction with the government’s latest fiscal reforms. These changes help create a more predictable behavior for the Brazilian government, more predictable spending patterns and decrease the possibility of extreme measures. They also work toward creating a less complex operating environment for consumers and business. A clear revenue-sharing scheme with state and local governments also helps simplify and solidify government finances and funding for public-private projects. Overall, these moves help create a sense of stability, a key characteristic for attracting investment. The major drawback facing the reforms is the uncertainty and timing regarding implementation. While both legislative chambers strongly approved the big-picture tax reform, additional legislation is needed for follow through and implementation. This will take time and additional political negotiations. Even if all stays on schedule, the changes will not start occurring until 2029 at the earliest, meaning it will be years—possibly close to a decade—before the Brazilian economy reaps the benefits of these changes. Lastly, there will be some level of opposition to the reform. On the business side, companies falling under the category of ‘bad for the environment or health’—such as alcohol or tobacco—will feel the strongest impacts given that they can be subject to much higher tax rates. There’s also potential for low-income families to oppose the system since it will require them to pay taxes upfront and get relief through cashback programs after the fact.”

Maria Paula Bertran, associate professor of economic law at the University of São Paulo: “There are potential risks for the implementation of the new tax reform. Brazil’s complex and onerous tax system has been associated with a high risk of corruption and bribery in tax administration. The implementation of the new tax laws may lead to challenges in navigating bureaucracy, as well as understanding and complying with the revised regulations, and also adapting to changes in tax administration. The slow responsiveness of Brazilian courts and tax authorities to taxpayer inquiries will probably pose challenges during the implementation phase, which can take several years to be solid in terms of understanding. These risks are intertwined with Brazil’s complex legal and bureaucratic framework, and they have the potential to affect investment, economic productivity and the overall business environment in the country. In the short run, the tax reform may represent higher risks for investors instead of creating a better environment. And the ‘short run’ may mean quite a few years.”

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