Public finance and fiscal policy

Economic Survey of Brazil 2009: Reforming indirect taxes and labour levies


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The following OECD assessment and recommendations summarise chapter 3 of the Economic Survey of Brazil published on 14 July 2009.




Brazil’s indirect tax system is complex, and the authorities are appropriately acting to reform it

The authorities are taking welcome steps to correct important deficiencies in the tax system. Considerable gains can be achieved through policy action in this area in terms of increased welfare and faster economic growth. Draft legislation was submitted to Congress in February 2008 to reform the state-level value-added tax and alleviate the tax burden on enterprise turnover and labour income. Brazil’s indirect tax system is particularly cumbersome to enterprises, due to its fragmentation, complexity and changing provisions. The tax burden on labour income is also heavy, owing to a combination of onerous social security contributions and a multitude of additional levies on enterprise payroll. The reform package, which is well thought-out overall, recognises the need for a careful setting of the new tax rates, because it encompasses the bulk of federal and state-level indirect levies. Revenue losses, which Brazil can ill afford in a period of consolidation of fiscal adjustment and until upward pressures on spending are mitigated, need to be avoided in the course of the reform. But, at close to 36% of GDP in 2008 according to OECD estimates, the country’s tax take is high in relation to emerging market comparators, which makes further hikes inadvisable. The introduction of a trigger mechanism requiring a re-calibration of tax rates if collections rise by a specified amount in real terms is therefore welcome. In any case, the proposal to implement the reform only gradually is sound, as it would allow adjustments to be made, if needed, in terms of rate setting and tax administration.


Reform of the state-level value-added tax is key to eliminating predatory tax competition among the states

The proposed reform of the state-level value-added tax – the ICMS – focuses on reducing the scope for predatory tax competition among the states. In the current regime, the states are free to set ICMS legislation on intra-state transactions; therefore, they have often used the ICMS as an industrial policy instrument by granting tax breaks for investment. Several tax incentives have been ruled illegal by the judiciary, because they have not been sanctioned by an interstate council that has the prerogative to endorse state-level initiatives in this area (CONFAZ). The government proposes to tackle this problem by making rates and bases homogeneous throughout the country and by imposing heavier sanctions for non compliance. The reform proposal also honours the incentives granted before 5 July 2008 and allows for arrangements put in place after that date and until the tax reform is approved by Congress to be maintained, if they are endorsed by the states. While maintenance of the incentives granted prior to July 2008 is understandable on contractual grounds, those granted during Congressional deliberations on the reform should be annulled.


Another consideration is that the ICMS is collected at origin, although special provisions are in place for taxing interstate trade at a lower rate. As a result, exporting states are reluctant to refund credits earned in other jurisdictions. An accumulation of unrefunded credits creates an anti-export bias in the tax system, an issue that remains by and large unresolved. The authorities propose to deal with this problem by gradually shifting most collection to destination and by shortening the time frame for refunding value-added tax credits. Both initiatives are welcome. Nevertheless, it would be desirable to shift all collection to destination, so that no ICMS liable goods and services would be taxed at origin. This would further simplify the tax system.


This shift to collection at destination would result in a significant reallocation of the tax take among the states. The government’s reform proposal addresses this issue by strengthening its regional development policies, including through the establishment of a regional development fund (FNDR). Efforts in this area are welcome, because existing mechanisms for financing regional development focus on the poorer states and therefore fail to address the needs of the poorer areas of the more prosperous parts of the countries. The regional development fund will need to be designed to encourage contestability in the use of development assistance. In addition, the less developed states, which are net importers of ICMS-liable goods, are likely to be the main beneficiaries of the shift in collection location, but they are also likely to face capacity constraints on administering the new ICMS. As a result, there is a role for the federal government in providing technical assistance to the states with weak administrative capacity.

Brazil’s revenue to GDP ratio is comparatively high
In % of GDP

1. Personal income tax collections include revenue from taxes on corporate income/profits in Mexico and Chile.
Source: OECD (Revenue Statistics), SII (for Chile) and SRFB (for Brazil); and OECD calculations.


The tax burden on labour income needs to be alleviated

Previous reform initiatives have reduced the tax burden on enterprise turnover. This is the case of the conversion of federal levies (PIS and Cofins) into value added taxes during 2003-04, although enterprises operating in several sectors, such as services and public utilities, as well as those that pay their taxes under presumptive regimes (e.g. SIMPLES) continue to do so on the basis of turnover, rather than value added. The cascading nature of turnover taxation is particularly detrimental to the competitiveness of Brazilian exports. The government’s current proposal seeks to take reform efforts a step further by reducing the tax burden on labour income through the elimination of Salário-Educação, a federal levy on enterprise payroll, and a reduction in employers’ social security contributions. Developments in this area are particularly welcome, because, as argued in previous Surveys, a high tax burden on labour income encourages informality, especially among low-income workers. But there remain a number of para-fiscal levies on labour income, including the “S” system contributions (to finance sectoral development and labour training programmes) and contributions to INCRA (an agricultural development programme), which cost employers nearly 3.5% of payroll. These contributions could be eliminated over time or, as argued in previous Surveys in the case of the “S” system, they could be converted into user fees, so as to allow for a better match between the services currently provided by the affiliated institutions and market demands. With regard to employers’ social security contributions, the option of reducing these contributions on low paid workers could also be considered. Of course, the cost of foregoing much needed revenue at a time of consolidation of fiscal adjustment needs to be weighed against the impact on collections of increased formality in labour relations.


How to obtain this publication


The complete edition of the Economic Survey of Brazil is available from:

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.


Additional information

For further information please contact the Brazil Desk at the OECD Economics Department at

The OECD Secretariat's report was prepared by Luiz de Mello and Mauro Pisu under the supervision of Peter Jarrett. Research assistance was provided by Anne Legendre.




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