Brazilian Tax System Dysfunctions (and a tax reform agenda) Bernard Appy

Transcription

1 Brazilian Tax System Dysfunctions (and a tax reform agenda) Bernard Appy November 2017

2 Introduction What s a good tax system? 2 The features of a good tax system are well estabished Simplicity for the taxpayers Neutrality, as not to interfere with the efficient allocation of resources Transparency, so that taxpayers can ascertain what they are paying Equity, both horizontal and vertical A good tax system must also leave little space for tax evasion

3 Introduction Brazilian tax system Dysfunctions 3 The Brazilian tax system has none of those features This leads to several outcomes: Lower productivity Distortions in resource allocation Unproductive work Legal uncertainty (reduces investment) Higher investment cost Distributive distortions Similiar situations are taxed in different ways High income individuals are little taxed Lack of transparency, harming the political responsibility

4 4 General Issues: Litigation and Compliance Costs

5 Litigation Brazilian issues 5 The level of litigation on tax issues in Brazil is certainly one of the highest (if not the highest) in the world The amount under litigation reaches R$ 4 trillion (2/3 of GDP) - R$ 1.5 trillion to R$ 2 trillion are irrecoverable Consequences High cost for taxpayers and for the tax administration Legal uncertainty Reasons for the high litigation Complexity Too many tax issues in the Constitution Ineffective process of solving disputes regarding the interpretation of tax legislation

6 Litigation Estimate of the amount under litigation 6 Amount under Litigation (estimate - R$ billion) Federal Government 3,080 Federal Debt Roster (a) 1,800 Administrative Courts (CARF and DRJs) (b) 780 Other judicial litigation 500 States and Municipalities 1,000 States and Municipalities Debt Rosters 700 Administrative Courts 300 Total 4,080 % of GDP 66% Source: (a) Meirelles (2016); (b) RFB; other: lawyers' estimate. (a) Nov 2016; (b) Feb 2016; other: 2016.

7 Compliance costs Brazilian problems 7 According to the World Bank, Brazil has the highest tax compliance costs in the world Brazil: 1,958 hours / Bolivia (2nd place): 1,025 hours / Median : 206 hours - Although the methodology may be questionable, the result shows that there are problems Reasons Complexity (e.g. tax substitution) High level of tax autonomy of states and municipalities High cost for businesses and for the tax administration Compliance cost is higher for small companies subject to the normal tax system

8 8 Taxes on Goods and Services

9 Taxes on goods and services Introduction (VAT model) 9 The distortions most harmful to productivity are those related to taxes on goods and services Those problems wouldn t exist if Brazil adopted a good VAT VAT operation Non-cumulative VAT Turnover Tax rate Debit Credit Amount due (A) (B) (C= A*B) (D) (C-D) Stage % Stage % Final sale % Total tax 40

10 Taxes on goods and services Tax base fragmentation 10 In Brazil there are four general taxes on goods and services, leading to sectoral differences Most of the countries have only one VAT A good VAT has a broad base of goods and services Taxes usually beared by the economic sectors PIS/Cofins IPI ICMS ISS Non-cumul. Cumul. Manufacturing Commerce Services Farming Building

11 Taxes on goods and services Capital misallocation (sectoral effects) 11 The tax structure has strong impacts on resource allocation (capital misallocation) E.g.: taxation of different forms of building - Value added on the construction site: ISS (5% at most) + cumulative PIS/Cofins (3,65%) - Value added on the manufacturing industry: ICMS (12%) + non-cumulative PIS/Cofins (9,75%) + IPI (some cases) All four taxes have many effective tax rates, tax breaks and tax regimes High level of distortion of relative prices Most modern VATs have only one rate (and the old ones few rates) and the best have no tax breaks

12 Taxes on goods and services Capital misallocation (geographic and other) 12 Tax war and regional tax breaks lead to regional capital misallocation Ilegal tax breaks lead to legal uncertainty The main reason for the States tax war is that (part of) the tax is due in the state of origin Cumulative taxes lead to artificial vertical integration, and impair exports and investments Purely cumulative taxes (ISS) Restrictions on input tax credits (ICMS, PIS/Cofins) Restrictions on unutilised input tax credits refunding A good VAT adopts the destination principle, has no restrictions on input tax credits and quickly refunds unutilised tax credits

13 Taxes on goods and services Regulatory goals 13 Brazilian taxes on goods and services have many regulatory goals (social, regional and sectoral) General taxes on goods and services are not good tools to attain regulatory goals Using these taxes for regulation brings complexity, distortions, fraud and litigation Other means (especially budget allocation) are more efficient An excise tax can be used to tax goods and services with negative externalities The best VATs are not used as regulatory tools

14 Taxes on goods and services Selectivity (basic food basket) Expenditure with the basic food basket (R$/month) < ,245 1,245-2,490 2,490-4,150 4,150-6,225 6,225-10,375 > 10,375 Family Income (R$/month) Source: IBGE. Data for 2008/2009.

15 Tax Regimes for SMEs 15

16 Tax regimes for SMEs Distortions 16 Brazil has three special tax regimes for SMEs (very high limits) Presumed profit (annual turnover < R$ 78 million) SIMPLES (annual turnover < R$ 3.6 million) MEI individual microentrepreneur (< R$ 60 thousand) Unnaceptable impacts on income distribution Partners taxation much lower than employees Favors companies with high margins Negative impacts on productivity Inefficient economic organization Maintains small unproductive businesses Low impact on labor formalization There are reasons for a simplified tax regime for small businesses, but the Brazilian model leads to too many distortions

17 Tax regimes for SMEs Example for a service provider 17 Tax burden for a service provider (R$/month) 1 Employee 2 Business Partner Pres. Profit Simples 3 A. Value of the service 30,000 30,000 30,000 B. Taxes paid by the company 9,788 4,518 2,463 Taxes except payroll 4 2,856 3,480 2,463 Payroll (except FGTS) 5,316 1,038 FGTS 1,617 C. Taxes paid by the individual 5, Payroll Withholding income tax 4, D. Net personal income (A-B-C) 15,109 24,508 26,563 E. Total taxes (B+C) 14,891 5,492 3,437 Notes: (1) Only taxes and salaries are considered as costs for the business. (2) Normal tax system (assuming the company has no profit). (3) Anex III Complementary Law 123/2006. (4) ISS payment on a fixed amount, according to the legislation of São Paulo City.

18 Tax regimes for SMEs Distortions resulting from the taxation of turnover 18 Tax burden compared to the normal system Retailer - margin 50% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Turnover (R$ per month\0 Simples Pres. Profit Normal System

19 Tax regimes for SMEs Distortions resulting from the taxation of turnover % 120% 100% 80% 60% 40% 20% Tax burden compared to the normal system Retailer - margin 25% 0% Turnover (R$ per month) Simples Pres. Profit Normal System

20 Payroll Taxes 20

21 Payroll taxes Distortions 21 High tax burden on payroll harms low income workers formalization, possibly with a negative impact on productivity The problem is made worse by non-contributive benefits similar to contributive benefits and to a multiplicity of systems of social security financing - Rural workers / SIMPLES / MEI / etc. This leads to allocative and distributive distortions Employers payroll taxes above the social security ceiling is one of the main reasons why high income service providers become business partners ( pejotização )

22 Payroll taxes Example for a typical company 22 Minimum Maximum Total 42.3% 50.8% Employers' payroll taxes (whole salary) 26.3% 31.8% INSS (social security) 20.0% Seguro Acid. Trabalho (work accidents insurance) 0.5% 6.0% Salário Educação (education allowance) "S" System Sebrae (SMEs support service) Incra (land reform) 2.5% 2.5% 0.6% 0.2% FGTS (whole salary) Payroll taxes for a typical company 8.0% Employees' taxes (limit = social security ceiling) 8.0% 11.0%

23 Income Taxes 23

24 Income taxes Introduction 24 When designing income taxes many issues must be taken into account Allocative effects (lack of neutrality) Distributive effects Effects on savings and labor supply International tax competition It s important to distinguish labor income from capital income Ideally capital income should be adjusted for inflation The main distortions in the taxation of labor income in Brazil are due to the special tax regimes for SMEs

25 Income taxes Taxation of capital income 25 The Brazilian system of capital income taxation has positive and negative features Positive No lock-in effect due to the exemption on dividend distribution Closer treatment of debt and equity through the JCP system (deduction of notional initerest on part of the distributed profit) Negative Lack of neutrality leading to many possibilities of arbitrage (e.g. financial investments, rents, capital gains) Too many tax base reduction options (e.g. goodwil deduction in M&A) Foreign affiliates taxation (worlwide taxation on accrual basis)

26 Income taxes Personal income taxation 26 The Brazilian system for taxing personal income leads to distributive distortions, but there are many innacurate findings PIT taxpayers profile (2015) Income Brackets (minimum wages) Number of Taxpayers (thousands) Total (A) Total 27,519 2,585 1, % Up to 10 21, % , % % More than % Business owners 1 2, % Up to 10 1, % % % More than % Source: RFB. (1) Receivers of profits and dividends and SME partners. Income (R$ billion) Definitive Taxed Exempt (B) Withholding (B)/(A)

27 France Ireland USA Canada Denmark Belguim Korea Portugal Israel Australia Germany Norway Italy Sweden UK Japan Austria Netherlands Luxemburg Finland Spain Mexico Chile Switzerland Slovenia Greece Iceland Poland Turkey New Zealand Hungary Czech Republic Brazil Slovakia Estonia Income taxes Taxation of distributed profits 27 70% Tax burden on distributed profits (nominal) 60% 50% 40% 30% 20% 10% 0%

28 France Turkey Canada USA Australia Denmark Mexico Ireland Norway Korea Chile Belgium Germany Israel UK Austria Brazil Japan Netherlands Portugal Italy Luxemburg Finland Iceland Sweden Spain Slovenia New Zealand Switzerland Poland Czech Republic Hungary Greece Slovakia Estonia Income taxes Taxation of distributed profits 28 80% 70% 60% 50% 40% 30% 20% 10% 0% Tax burden on distributed profits (adjusted for inflation) Hypothesis: real profit = 10% of net Worth. Adjusted using the average inflation.

29 A Tax Reform Agenda 29

30 Tax reform agenda Overview 30 In our view, a tax reform agenda in Brazil would need to take into account at least the following changes Reform of the goods and services tax, leading to a model based on a good VAT Revision of the capital income taxation system Reform of the payroll taxes based on a clear separation of contributive and non-contributive social security benefits Reform of the simplified tax regimes for SMEs The main goal is to eliminate the multiple tax systems that exist today in Brazil, leading to a unified tax system

31 Tax reform agenda Taxes on goods and services 31 Centro de Cidadania Fiscal (CCiF) has developed a proposal for reforming the Brazilian goods and services taxation system Progressive substitution of five current taxes (PIS, Cofins, IPI, ICMS e ISS) for one Goods and Services Tax (IBS) based on the best international practices for the VAT/GST design Unified and centralized collection, sharing the revenue among the federal government, the states and municipalities Two-year test period with a tax rate of 1% Eight-year progressive transition One rate for all goods and services (no regulatory goals) Tax administration shared among the federal government, states and municipalities

32 Tax rate Tax reform agenda Taxes on goods and services - transition 32 20% 15% 10% Test Transition 5% 0% Years PIS/Cofins ICMS ISS IPI IBS

33 Tax reform agenda Taxes on goods and services 33 Other features of the proposal States and municipalities could change the tax rate related to their share of the tax Revenue distribution according to the destination principle (consumption) Transition for the revenue distribution among states and municipalities would take 50 years (during the first 20 years, only the real increase of revenue would be distributed according to the destination principle) Replace the current system of revenue sharing and earmarking for specific tax rates, that can be individually managed In adition, there would be an excise tax focused on goods and services with negative externalities (tobacco, alcohol etc.)

34 Tax reform agenda Capital income taxation 34 Changes should focus on neutrality and dealing with international tax competition Two options: changes maintaining the current system or a broader reform of income taxes Changes in the current system CIT: reduction of tax rates and broadening of the tax base Elimination of the goodwill deduction in M&A Adoption of a single model of taxation for financial investments Revision of the taxation system for foreign affiliates of Brazilian companies Possible review of exemption for dividend distribution

35 Tax reform agenda Capital income taxation 35 Broader reform Differentiate the taxation of saved income and consumed income (expenditure tax) Based on an investment account integrated with the PIT Low rate for all forms of capital income Progressive tax rate on consumed income Transition from the current system is complex

36 Tax reform agenda Payroll taxes 36 Changes in payroll taxes should be linked to changes in social security benefits Introduction of a universal non-contributive social benefit for all individual over 65 (Elderly Basic Income EBI) Initial value = minimum wage, but not linked to the MW Partial reduction of payroll taxes up to value of EBI Payroll taxes should be explicitly linked to social security benefits (and actuarially balanced) Elimination of other taxes on payroll Payroll tax base should be limited to the social security ceiling Only one system for financing social security Changes require higher taxes on other bases

37 Tax reform agenda Payroll taxes 37 Payroll Tax (example) Tax rate Value Retirement Other Contrib Salary 1,500 Elderly Basic Income % 90 Difference % 10% 180 Total tax 18.0% 270 Social Security Benefit (example) years of contribution Elderly Basic Income Contributive benefit Total 900 1,050 1,200 1,500

38 Tax reform agenda Simplified tax regimes for SMEs 38 Reform should eliminate the distortions that favor high margin business and lead to a low taxation of high income individuals Taxes on turnover should be replaced by a simplified taxation of added value Payroll tax normal system Taxation, via PIT, of distributed profits not taxed in the business (or adoption of a passthrough system) With a very simple model, the tax administration could compute the amount due and inform the taxpayer Taxpayer responsibility: issuing electronic invoice for all transactions

39 Brazilian Tax System Dysfunctions (and a tax reform agenda) Bernard Appy November 2017