Brazil’s Massive Tax Changes Set to Roil Already Struggling Consumers

While officials say they’re streamlining the country’s notoriously complex tax system, some say a high VAT will hurt low-income households.

Illustration by The Epoch Times, Shutterstock, Getty Images

Complaints about Brazil’s confusing tax system have spanned decades and multiple administrations.

The latest reforms were approved in December 2023 after nearly five years of debate. They include a value-added tax (VAT) of up to 27.5 percent that will put Brazil alongside Hungary and Sweden as countries with the highest consumption tax rates in the world.

The United States doesn’t have a VAT, but states have a sales and use tax that varies between zero and 9.5 percent.

Brazil’s VAT tax will begin to be phased in by 2026 and is currently anticipated to take full effect over a seven-year period.

The move has drawn mixed reactions from Brazilians, including criticism that a high VAT will deal a harsh blow to those with low incomes. Standard VAT rates of about 20 percent aren’t uncommon in European countries, but those nations don’t have the same level of poverty as Brazil.

Since leftist President Luiz Inácio Lula da Silva took office in January 2023, his administration has struggled to address inflation and high unemployment, and the poverty rate sits near 30 percent.

Among the new tax reform’s critics is Brazilian Sen. Rogerio Marinho, who said, “We are going to offer Brazil the highest value-added tax in the world.”

Brazil’s current levy aims to consolidate five different consumption taxes into a single VAT to “promote greater efficiency and sectoral isonomy,” according to the Policy Center for the New South.

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Supporters of the reform maintain that the VAT won’t directly affect Brazilian taxpayers, but experts argue that those struggling financially will take a hit regardless.

“It’s clear that Brazil missed a great opportunity to reduce its percentage of tax collection on productive activity, which [will] cause several negative economic consequences,” Paulo Ricardo Alecrim, a Brazilian tax attorney and a partner at Alecrim & Costa Advogados, told The Epoch Times.

He said that some of the adverse effects of the current reform include increased consumer prices, a chilling effect on consumption, loss of international competitiveness, and a disproportionate effect on the economically vulnerable.

“Low-income consumers are more affected by a high VAT since they spend a higher proportion of their income on goods and services subject to the tax,” he added.

Effect on Poverty

Mr. Alecrim is far from alone in his concerns over the VAT’s effects on those who are struggling financially. Leading World Bank economist for Brazil Shireen Mahdi also highlighted that point.

She said that while the VAT has the potential to change the Brazilian tax system for the better, the outcome may diminish families’ purchasing power.

Further, she asserted that reducing the standard VAT rate in education and health care could mean no reduction in indirect taxes at the individual level. Both of these sectors constitute a sizable portion of consumption for low-income families.

A supporter of Brazilian presidential candidate Luiz Inácio Lula da Silva hangs a flag with a photo of the candidate on her street stall during the presidential run-off election, in Rio de Janeiro on Oct. 30, 2022. Since President Lula took office, his administration has struggled to address inflation and high unemployment. Mauro Pimentel/AFP via Getty Images

Amid sluggish economic growth in 2024, necessities such as food also have become more expensive.

Between 2007 and 2023, Brazil’s Food and Beverage Price Index increased by 216 percent, according to the Instituto Fome Zero. This far surpassed the Broad Consumer Price Index growth rate of 132 percent over the same period.

So far this year, Brazil’s Broad Consumer Price Index has seen a 3.59 percent increase in food and drink, a 3.1 percent rise in health and personal care items, and a 5.5 percent spike in education costs.

The potential indirect effects of the VAT also weigh heavily on some Brazilians.

Juliana Santos works as a secondary school teacher in the western city of Rio Branco. He worries how the new VAT rate will affect the already struggling education sector.

“They act like these changes won’t affect most people because it’s not an income tax,” she told The Epoch Times.

“Education already comes with expenses many Brazilians struggle to pay. Transportation, items for class, and more. If families pay more in other areas, sending children to school will become harder.”

Currently, more than 21 million families use government welfare subsidies under the Bolsa Familia program. Started in 2003 by President Lula during his first term, the program offers money to qualifying low-income households that are willing to send their children to school and get vaccinations. The average monthly per household payout is R686 ($127).

Public schools in Brazil are free, but complaints of underfunding and a lack of quality in education are widespread, as evidenced by the dismal completion rates for public school attendees. According to a 2020 report, more than half of Brazilian adults age 25 or older never completed secondary school. This trend is especially prevalent in the Northeast, where three out of every five adults never finished high school.

The analysis also showed that the transition from primary to secondary education is where the dropout rates increase, with the percentage of young people withdrawing from school nearly doubling at the age of 15.

Students leave school after eating lunch at Municipal Burle Marx School in Rio de Janeiro on April 4, 2024. A 2020 report showed that 60 percent of Brazilian adults aged 25 or older never completed secondary school. Pablo Porciuncula/AFP via Getty Images

Child Fund Brazil underscores this point, noting the problem is worse among rural populations.

“Often due to a lack of structure or public policies, even getting to school can be a problem,” the organization states on its website.

“This isn’t the first time the government has tried changing Brazil’s taxes. The end result is always the same,” Ms. Santos said. “[It] never seems to help the poor.”

A U.N. Development Programme report also touched on the ineffectiveness of previous Brazilian attempts to implement a VAT.

“Since redemocratization, several reforms have made their way through the National Congress calling for a modern value-added tax (VAT) system to replace outdated and inefficient taxes,” the report states.

“However, none has been politically successful, either because of conflicts within the federal government over revenue redistribution or because of opposition from social and congressional interest groups.”

Exemption Challenges

Mr. Alecrim said service providers will be most affected by VAT reform. Currently, companies pay a maximum tax rate of 5 percent.

“These types of companies typically have expenses that don’t necessarily depend on a production chain, where one can obtain a discount through the deduction of tax already paid in previous stages, since the Brazilian VAT will be non-cumulative,” he said.

Additionally, Mr. Alecrim noted that although there’s concern over an increased tax burden on consumption, the consolidated VAT has a built-in cap.

“The text of the tax reform provides a lock for the collection of consumption taxes, meaning a limit that cannot be exceeded,” he said. “Thus, the new Brazilian VAT cannot have a tax burden higher than the currently existing one.”

But that doesn’t guarantee a lower tax burden either. Generally, high VAT rates can be harmful to new and marginal business activities, create administrative complexities, drive inflation, and undermine export incentives, according to an analysis conducted by the U.S.-based Tax Foundation.

People walk in the Saara market in downtown Rio de Janeiro on Dec. 8, 2020. The country's poverty rate is at 27 percent. Mauro Pimentel/AFP via Getty Images

Some claim that a VAT that is managed correctly can create incentives for businesses to control costs and create a stable revenue base. However, some evidence shows that high VATs have encouraged tax evasion in countries that also struggle with income inequality, such as Morocco.

One report noted that 80 percent of Morocco’s VAT is paid by just 1.6 percent of companies, while only 46 percent of companies submit a corporate tax return. Within this group, 33 percent demonstrate taxable profits.

Analysts anticipate similar challenges in Brazil.

“Great effort is needed to battle private interests and detrimental lobbies that seek to claim exemptions from the headline VAT rate,” the Morocco-based Policy Center for the New South stated.

“This includes inhibiting further changes to the already extensive list of sectors receiving preferential treatment.”

Mr. Alecrim said some industries might hope to avoid the new VAT through exemption, which could be a challenge for Brazil.

“As a rule, the granting of tax benefits [or] subsidies will be prohibited,” he said. “However, some sectors and products will have differentiated tax treatment.”

He said there will be VAT exemptions for goods and services such as medical devices, medicines, some food products, and cars acquired by people with qualifying disabilities and professional drivers.

“Tax incentives in the Manaus Free Trade Zone will also be preserved, which will be the only region in the country authorized to have tax, financial, and economic subsidies,” he said.

Maintaining tax incentives through the government-mandated Free Trade Areas is critical for Manaus, which is a key manufacturing hub and the state’s main supplier of jobs because of the undeveloped remoteness of Amazonas.

Brazilian legislators are now eyeing additional reforms to personal income and corporate taxes.

Mr. Alecrim said, “Issues such as the revocation of the exemption from income tax on dividends paid to shareholders are already being discussed in the National Congress.”