## wpiea2021240-print-pdf

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### I. Overview — key findings and tax system snapshot
- Overall national (federal plus state and municipal) tax revenue to GDP (excluding social security contributions) averaged just under 23 percent over 2000–2015.
- Tax revenue declined to 20.5 percent of GDP pre-COVID (2019).
- Comparator benchmarks: 19 percent (average for other emerging market economies and Latin America) and 25 percent (OECD).
- Taxpayers spend over 1500 hours a year complying with tax obligations (World Bank Doing Business, 2020).
- Substantial subnational taxing authority and domestic tax competition ("fiscal war") have limited overall tax revenue potential.
- Cumulative indirect taxes levied largely at origin distort allocative efficiency, burden exports, productive investment, and formal employment.

### I. Structure and rates — composition and distributional features
- Indirect taxes constitute about half of the general government tax burden (including social security contributions) and are predominantly regressive.
- Social security contributions account for about 22 percent of the total tax burden (5.6 percent of GDP for the general government in 2019).
- Personal income tax:
  - Dual income tax system: progressive schedule for labor income; lower average effective rates for capital income; dividend income is tax exempt.
  - Up to 80 percent of the population are exempt from PIT.
  - Personal exemption equals 52 percent of GDP per capita.
  - Footnote: average income of the bottom 80 percent of households in Q1 2021 = R$1374 per month; personal exemption = R$1903.99.
- Capital and corporate taxation:
  - Capital income (except dividends) taxed at rates between 15 and 22.5 percent.
  - Corporate statutory tax rate: 34 percent (45 percent in the financial sector), composed of IRPJ 15 percent; 10 percent surcharge on taxable income over BRL 240,000 (USD 48,000); CSLL 9 percent (20 percent in the financial sector).
  - Loss-carryforward deductibility limited to 30 percent of profits.
  - METR under the standard regime estimated at 36.9 percent (Mintz and others, 2020).
- Indirect and local taxes (selected rates and features):
  - IPI rates vary from 0 to 365 percent for some products.
  - PIS/PASEP and COFINS mixed rates (examples: 1.65 plus 7.6 percent; 0.65 plus 3 percent).
  - Import duties generally 10 to 20 percent.
  - ICMS minimum rate of 12 percent in principle.
  - ISS ranges from 2 to 5 percent.
  - IPTU (São Paulo) between 1-1.5 percent.
  - ITCMD up to 8 percent.
- Labor and payroll taxation:
  - Labor tax wedge sometimes exceeds 36 percent.
  - Formal workers contributing to RGPS pay up to 14 percent of salary; employers pay another 20 percent.
  - FGTS contribution: 8 percent.

### II. Tax expenditures — definitions, reporting, and magnitudes
- Definition and methodology:
  - TEs defined as forgone government revenue from differential tax treatment (allowances, exemptions, rate relief, credits). Tax deferrals are not considered TEs.
  - Brazil uses a revenue-forgone approach; RFB has published an annual tax expenditure report since 1989.
- Legal and reporting framework:
  - Fiscal Responsibility Law (FRL) Article 14 requires TE to be proven not to affect targets or be accompanied by compensatory tax measures.
  - PLDO Annex IV.11 and Annex IV.12 used for reporting and compensatory measures.
  - Subnational reporting heterogeneous; central government documents do not systematically cover state TEs.
- Quantified magnitudes:
  - Federal tax expenditures reported at 4.2 percent of GDP; adding subnational estimates brings national total to 5.4 percent of GDP in 2019.
  - 2019 federal subsidies including implicit credit subsidies and explicit financial subsidies amounted to 4.8 percent of GDP (note: analysis here concerns implicit subsidies via TEs only).
  - At federal level there are at least 207 different categories of tax expenditures (DGT PLOA 2021).
  - Simples Nacional accounts for about 25 percent of all quantified federal tax expenditures.
- Composition:
  - Most federal TEs attributable to indirect tax exemptions; exemptions and reductions in liability of IPI/PIS/COFINS are the single largest contributor.
  - Significant implicit outlays due to regional incentives and free trade zones (e.g., Manaus Free Trade Zone) and zero-rating or exemption of basic food items.

### II. Governance, evaluation, and institutional developments
- Evaluation capacity and new bodies:
  - No systematic monitoring or cost-benefit evaluation historically.
  - New bodies from 2019: Council for Monitoring and Evaluation of Public Policies (CMAP) and Committee for Monitoring and Evaluation of the Subsidies of the Union (CMAS), coordinated by SECAP.
  - CMAS/CMAP have published over a dozen reports.
- Constraints:
  - Lack of protocol for anonymized administrative taxpayer data exchange from RFB.
  - Limited financial and human resources to process data.
  - No clear mechanism to translate recommendations into policy changes.

### III. Systemic implications and analytical points
- TEs increase complexity, erode revenue, and affect fairness, efficiency, effectiveness, and transparency.
- TEs are often used as implicit subsidies that weaken fiscal rules and can circumvent spending ceilings.
- Cumulative taxation promotes vertical integration, harms investment by burdening capital goods, and distorts competitiveness.
- Legislative-institutional constraints (legislature can overturn vetoes) reduce executive ability to contain TE growth.

### IV. Business support programs and special regimes — evidence and impacts
- Programs (Simples Nacional, payroll tax exemptions, Manaus Free Zone) channel large fiscal resources to businesses but have little impact on productivity, investment, or employment (World Bank, 2017).
- Simplified regimes:
  - Simples Nacional eligibility threshold: BRL 4.8 million (about USD 951,928); progressive rates 4 to 33 percent of turnover.
  - Simples federal fiscal cost: 1.05 percent of GDP (not including subnational ICMS and ISS exemptions).
  - Over 5 million registered in 2021; nearly 80 percent of formal firms.
  - Presumptive profit regime threshold ceiling: BRL 78 million (USD 15 million); presumptive taxable profit percentages 1.6 to 32 percent; implied effective tax rate on turnover between 0.54 and 10.88 percent.
  - MEI eligibility revenue cap: BRL 81,000; nearly 12 million taxpayers in 2021; owners pay fixed fee equivalent to 5 percent of the minimum wage.
  - Evidence of behavioral responses: firms bunch below thresholds and reduce reported/real revenue by 10 to 25 percent to exploit Simples.
  - Presumptive profit regime not counted as a TE by RFB despite economic similarity to Simples.
- Payroll tax exemptions:
  - Introduced in 2011 replacing 20 percent employer payroll tax with 1.5 – 2.5 percent turnover tax for opting firms.
  - Peak coverage in 2015: 56 sectors; forgone revenue cost 0.4 percent of GDP; reduced to 0.13 percent of GDP in 2019.
  - No strong evidence of positive effects on aggregate compensation or employment creation (Ministério da Fazenda, 2018).
- Manaus Free Zone and regional incentives:
  - Combined SUDAM and ZFM cost: about 0.45 percent of GDP in 2019.
  - Little evidence of productivity, regional development, investment, or job creation impacts; anecdotal inefficiency and arguments about foreign investor retention.
- R&D and production incentives:
  - Lei da Informática (1991) reduces IPI on ICT capital inputs; limited success in producing internationally competitive ICT.
  - Lei do Bem (2005) allows up to 200 percent deduction of R&D expenses; positive impact at lower fiscal cost but limited reach.

### V. Personal income tax TEs, deductions, and distributional impacts
- Personal income tax exemptions and deductions total nearly 1 percent of GDP, driven by pensions, severance payments, medical expenses, and savings vehicles.
- Pensions account for 10 percent of all federal recorded TEs.
- Health deductions uncapped: fiscal cost 0.23 percent of GDP; 86 percent of forgiven revenue accrues to the richest decile.
- Education deduction limited to a nominal value; regressive in practice.
- PROUNI forgone revenue: 0.04 percent of GDP annually.
- Personal exemption: BRL 1,904 per month (1.8 times the national minimum salary); not classified as a TE.
- Dividend income exempt since 1995.
- JCP (Interest on Net Equity): deductible up to 50 percent of profits or accumulated earnings multiplied by TJLP currently set at 4.61 percent; JCP subject to 15 percent IRRF at source.

### VI. Subnational tax expenditures, fiscal war, and governance
- Subnational tax expenditures represent at least 1.2 percent of national GDP in forgone revenue (IMF, 2019).
- Total subnational tax revenues around 10 percent of GDP.
- In 2020 subnational TEs corresponded to an average of 19 percent of each state’s actual tax collection.
- Consequences of fiscal war:
  - States and municipalities grant incentives (ICMS, ISS) to attract investment; triangular transactions can disguise benefits.
  - CONSEFAZ estimates forgone revenue due to fiscal war could be as large as 4 percent of national GDP.
- Governance and legal features:
  - Complementary Law 24/75 requires unanimous CONFAZ vote for state incentives; unanimity hinders reforms.
  - Complementary Law 160/2017 provided amnesty and committed to gradual reduction of fiscal war TEs by 2022 and 2032, but implementation has struggled.
  - Subnational transparency and ex-post cost-benefit assessment typically lacking.

### VII. Reform options, scenarios, and estimated yields (selected table entries and exact figures)
- Scope identified: as much as 4.46 percent of GDP (total including subnational and broader TE definition) could be recouped at the national level in the medium-term; total based on federal TE report: 2.66; total federal without reforming TEs excluded by Constitutional Amendment: 1.21.
- Key reform measures, estimated yields, and timelines (exact values preserved):
  - Elimination of pension income exemption from IRPF: 0.31 (% of GDP) — 2022.
  - Elimination of education and health expenditure deductions on IRPF: 0.28 — 2022.
  - Elimination of preferential tax treatment of savings vehicles: 0.11 — 2022.
  - Elimination of payroll tax exemption: 0.13 — 2022.
  - Integration of Lei da Informática resources into Lei do Bem: 0.08 — 2022.
  - Simples Nacional Threshold and Rate Reform: 0.77 — 2023.
  - Elimination of PIS/COFINS zero-rating on basic food items: 0.23 — 2023.
  - Elimination of PIS/COFINS tax credit on medicine and pharmaceutical products: 0.17 — 2023.
  - Manaus Free Zone and SUDAM/SUDENE Reform: 0.45 — 2024.
  - Automatic expiration of other benefits (mainly semiconductors and automotive sectors): 0.13 — 2029.
  - Repeal of existing ACE on distributions: 0.23 — 2022.
  - Thin capitalization provisions for unrelated parties not in low-tax jurisdictions: 0.17 — 2022.
  - Elimination of presumptive profit regime along with AMT: 0.16 — 2023.
  - Harmonization of IPI rates, incl. removal of preferential rates: 0.04 — 2023.
  - Elimination of subnational tax expenditures, including for ICMS on basic food items: 1.20 — 2024.
- Note: Excluding customs and IPI exemptions from Manaus Free Zone reform would cut projected revenue by half.

### VIII. EC 109/2021 exclusions and implications
- EC 109/2021 excludes six sizeable programs from targeted TE rationalization: Simples Nacional; non-profit organizations; regional development programs in the North, Northeast and Center-West; the Manaus Free Trade Zone; basic food items; and PROUNI.
- These excluded programs accounted for "just over 2 percent of GDP" in forgone revenue.
- Implication: reducing federal TEs to "2 percent of GDP" would require near complete elimination of other federal tax incentives not covered by EC exceptions.

### IX. Policy design principles, transition, and coordination
- Guiding principles for reform:
  - Clear strategic long-term vision, transparent communication on distributional impacts, bundling reforms, time-bound transitions, cross-level coordination, and ex-post evaluation.
- Transition features:
  - Temporary arrangements, sunset provisions, and grandfathering useful but should be time-limited.
  - Temporary Alternative Minimum Tax (AMT) suggested to mitigate short-run revenue loss and encourage voluntary transition from simplified regimes.
- Coordination across levels:
  - Compensatory transfers to net-losing subnational governments and legal consistency across bases to avoid judicial disputes.

### X. Tax policy recommendations and priorities (Brazil-specific)
- Integrate TE rationalization into broader tax reform packages; prioritize repeal of TEs changeable by ordinary or supplemental law while bundling major reforms to build political consensus.
- Medium-term reforms:
  - Consolidate indirect taxes toward a unified broad-based destination VAT with full refunds for intermediate goods and zero-rating for exports.
  - Reduce payroll costs and tax expenditures; make labor and capital income taxation more progressive.
  - Rationalize Simples Nacional: drastically reduce eligibility threshold, increase minimum rate to at least 5-6 percent on turnover, eliminate presumptive profit regime, exclude liberal professionals, separate social security contributions from Simples.
  - Consider ACE for new equity increases, limit interest deductibility (OECD-style cap as reference), and redesign R&D support toward Lei do Bem and direct subsidies/refunds.
  - Eliminate most IRPF deductions and capital income exemptions (education, health, pension exemptions, preferential savings vehicles) to improve progressivity.
  - Compensate low-income households for VAT uniformization via expanded direct transfers leveraging Cadastro Único/Bolsa Família (PBF) network or targeted refundable credits.
- Revenue mobilization:
  - Aim to recoup at least 2 percent of GDP in federal TE reductions in the medium-term, while recognizing constitutional and political constraints around excluded programs.
  - Use base-broadening (property, inheritance, capital gains) to finance reductions in employer social security contributions and improve progressivity.
- Administrative and sequencing recommendations:
  - Phase in VAT unification gradually to mitigate inflationary shocks.
  - Pair CIT reductions with measures to mitigate debt bias and avoid raising marginal cost of capital for equity-financed firms.
  - Ensure transparency, ex-ante and ex-post evaluation of TEs, and protocols for data sharing (RFB) to support monitoring and impact assessment.

*Source: wpiea2021240-print-pdf (excerpted content provided).*

### REFERENCES _____________________________________________________________________________________

### REFERENCES — wpiea2021240-print-pdf

### I. Overview of Brazil's tax system — key findings
- Brazil historically prioritized revenue collection; overall national (federal plus state and municipal) tax revenue to GDP (excluding social security contributions) averaged just under 23 percent over 2000–2015.
- Tax revenue declined to 20.5 percent of GDP pre-COVID (2019).
- Comparator benchmarks: 19 percent (average for other emerging market economies and Latin America) and 25 percent (OECD).
- The tax system is highly complex with large compliance burdens:
  - Taxpayers spend over 1500 hours a year complying with tax obligations, over half for subnational taxes (World Bank Doing Business, 2020).
- Cumulative indirect taxes, largely levied at origin rather than destination, distort allocative efficiency, burden exports, productive investment, and formal employment, and have limited potential GDP growth.
- Substantial taxing authority at subnational level has fostered domestic tax competition ("fiscal war"), limiting overall tax revenue potential.

### I. Overview — structure and rates
- Tax structure composition and regressivity:
  - About half of the general government tax burden (including social security contributions) comes from indirect taxes, which are predominantly regressive.
  - Social security contributions account for about 22 percent of the total tax burden (5.6 percent of GDP for the general government in 2019).
- Personal income tax:
  - Dual income tax system: progressive schedule for labor income, lower average effective rates for capital income; dividend income is tax exempt.
  - Due to bracket creep (non-indexation since at least 2015), the PIT burden now falls disproportionately on the middle class; up to 80 percent of the population are exempt.
  - Personal exemption equals 52 percent of GDP per capita (above OECD average).
  - Footnote data: average income of the bottom 80 percent of households in Q1 2021 was R$1374 per month, below current personal exemption of R$1903.99.
- Capital and corporate taxation:
  - Capital income (except dividends) taxed at rates between 15 and 22.5 percent.
  - Corporate statutory tax rate: 34 percent (45 percent in the financial sector), composed of:
    - IRPJ at 15 percent;
    - 10 percent surcharge on taxable income over BRL 240,000 (USD 48,000);
    - CSLL at 9 percent (increased CSLL rate of 20 percent applies in the financial sector).
  - Loss-carryforward deductibility limited to 30 percent of profits.
  - Estimated marginal effective tax rate (METR) under the standard regime: 36.9 percent (Mintz and others, 2020), with non-refundable VAT on capital inputs as main driver.
- Indirect and local taxes:
  - IPI (Imposto sobre Produtos Industrializados) rates vary from 0 to 365 percent for some products; IPI also levied on imports; higher rates on specific products (e.g., tobacco).
  - Two federal social contributions on sales: PIS/PASEP and COFINS with mixed cumulative and non-cumulative rates (examples: 1.65 plus 7.6 percent; 0.65 plus 3 percent), different by corporate regime.
  - Import duties generally 10 to 20 percent.
  - ICMS (state VAT-type tax) minimum rate of 12 percent in principle, but with many state-specific exceptions; revenues shared between origin and destination states.
  - Municipal services tax (ISS) ranges from 2 to 5 percent.
  - Other federal/local taxes: IOF on certain financial operations; CIDE on certain activities; IPTU (municipal property tax) e.g., São Paulo between 1-1.5 percent; ITBI; ITCMD up to 8 percent; IPVA.
- Labor and payroll taxation:
  - Heavy payroll taxes discourage formal employment; labor tax wedge sometimes exceeds 36 percent (Figure 2).
  - Formal workers contributing to RGPS pay up to 14 percent of salary (capped) and employers pay another 20 percent.
  - FGTS contribution: 8 percent.
  - Various smaller payroll-based taxes (e.g., salário educação) and sector-specific earmarked taxes.

### II. Current tax expenditures — definitions, reporting, and quantified magnitudes
- Definition and methodological approach:
  - Tax expenditures (TEs) defined as forgone government revenue from differential tax treatment (allowances, exemptions, rate relief, credits, tax deferrals). Tax deferrals are not considered TEs (Redonda and Neubig, 2018).
  - Brazil uses a revenue-forgone approach; methodology generally in line with international best practice (Kraan, 2004). Annual reports define benchmarks and include expiration dates where applicable.
- Reporting framework and legal context:
  - RFB has published an annual tax expenditure report since 1989 (Art. 165 §6 of the Constitution).
  - Fiscal Responsibility Law (FRL) Article 14: any tax expenditure should either be proven not to affect targets set in the LDO or be accompanied by a compensatory tax measure. PLDO Annex IV.11 and Annex IV.12 used for reporting and compensatory measures.
  - Despite legal rules, no hard limits exist; compensatory system has had only partial effect in containing growth of central government TEs. Legislative ability to overturn executive vetoes reduces executive binding power.
- Subnational reporting gaps:
  - Central government documents do not systematically cover state tax expenditures; states report in their LDOs with heterogeneous methodologies and most do not conduct ex-post estimations. (IDB study: only 6 states out of 27 do not provide information on tax expenditures in their LDOs.)
- Quantified magnitudes and international comparison:
  - Federal tax expenditures reported at 4.2 percent of GDP (Figure 3); adding subnational estimates brings national total to 5.4 percent of GDP in 2019.
  - Note: 2019 federal subsidies including implicit credit subsidies and explicit financial subsidies amounted to 4.8 percent of GDP; analysis here concerns implicit subsidies via TEs only.
  - International comparisons are complicated by methodological differences, but Brazil’s TEs are high relative to G20 peers and other emerging markets.
- Proliferation and composition:
  - At federal level there are at least 207 different categories of tax expenditures (DGT PLOA 2021).
  - Most federal TEs are attributable to indirect tax exemptions; exemptions and reductions in liability of IPI/PIS/COFINS are the single largest contributor to forgone revenue at the federal level.
  - Simples Nacional (simplified tax regime for smaller firms) accounts for about 25 percent of all quantified federal tax expenditures.
  - Significant implicit outlays due to regional incentives and free trade zones (e.g., Manaus Free Trade Zone) and zero-rating or exemption of basic food items.

### II. Current tax expenditures — governance, evaluation, and institutional developments
- Evaluation capacity and recent institutional changes:
  - No systematic monitoring or cost-benefit evaluation of TEs historically.
  - New bodies created in 2019:
    - Council for Monitoring and Evaluation of Public Policies (CMAP), coordinated by SECAP.
    - Committee for Monitoring and Evaluation of the Subsidies of the Union (CMAS) charged with selecting tax expenditure programs for detailed cost-benefit analyses.
  - Achievements and constraints:
    - CMAS/CMAP have published over a dozen reports.
    - Constraints: lack of a protocol for anonymized administrative taxpayer data exchange from RFB; limited financial and human resources to process data; no clear mechanism to translate recommendations into policy changes.

### III. Systemic implications and analysis points highlighted in the source
- TEs exacerbate complexity, erode revenue collection, and have consequences for fairness, efficiency, effectiveness, and transparency of the tax and fiscal systems.
- TEs are often used to pursue objectives that could otherwise be pursued through public spending, creating implicit subsidies and weakening fiscal rules (e.g., spending ceiling circumvention).
- Cumulative taxation (multiple layers of taxes on production and services):
  - Promotes vertical integration, harms investments due to burden on capital goods, distorts domestic and foreign competitiveness (Varsano, 2001, cited in Afonso and others, 2013: 8).
- Legislative-institutional constraints reduce executive ability to contain TE growth (legislature can overturn vetoes).

### IV. Key statistics and exact figures cited
- Average national tax revenue to GDP (2000–2015): just under 23 percent.
- Tax revenue pre-COVID (2019): 20.5 percent of GDP.
- Comparator averages: 19 percent (emerging markets & Latin America), 25 percent (OECD).
- Tax compliance time: over 1500 hours per year.
- Personal exemption: 52 percent of GDP per capita.
- Up to 80 percent of the population exempted from PIT.
- Footnote: bottom 80 percent average income Q1 2021 = R$1374 per month; personal exemption = R$1903.99.
- Capital income rates: between 15 and 22.5 percent; dividends tax exempt.
- Corporate statutory tax rate: 34 percent (45 percent in financial sector).
- Corporate tax components: IRPJ 15 percent; 10 percent surcharge over BRL 240,000 (USD 48,000); CSLL 9 percent (20 percent in financial sector).
- Loss-carryforward deductibility limit: 30 percent of profits.
- METR estimate: 36.9 percent.
- Social security contributions share: about 22 percent of total tax burden; 5.6 percent of GDP for general government in 2019.
- Worker contributions to RGPS: up to 14 percent; employer contribution: 20 percent; FGTS: 8 percent.
- Federal tax expenditure categories: at least 207 (DGT PLOA 2021).
- Federal TEs reported: 4.2 percent of GDP (Figure 3); national total including subnational estimates: 5.4 percent of GDP in 2019.
- Federal subsidies (including implicit credit and explicit financial subsidies) in 2019: 4.8 percent of GDP.
- Simples Nacional accounts for about 25 percent of quantified federal tax expenditures.
- IPI rates: variable by product, ranging 0 to 365 percent for some products.
- Import duties: generally 10 to 20 percent.
- ICMS minimum rate: 12 percent in principle.
- ISS range: 2 to 5 percent.
- IPTU example (São Paulo): between 1-1.5 percent.
- ITCMD can reach up to 8 percent.

*References as provided in the source PDF.*

### 18.      When adding IRPJ (corporate income tax - CIT), payroll tax, and indirect tax

### 18.      When adding IRPJ (corporate income tax - CIT), payroll tax, and indirect tax expenditures, programs aimed at supporting businesses receive overall the most fiscal resources, but have had little impact on productivity, investment, or employment (World Bank, 2017).

### Overview: purpose, history, and general effects
- Programs include a simplified tax regime for smaller companies, payroll tax exemptions, and the Manaus Free Zone; some date to the 1960s while others emerged in the 2014-2016 recession.
- Common intent: granting tax relief to businesses to foster economic development, create jobs, and reduce poverty and inequality.
- Empirical findings: scant evidence of increases in sustainable investment, cost-effective job creation, or reduction of informality.
- Observed adverse effects: new avenues of tax avoidance by more sophisticated and wealthier professionals and firms; creation of a non-level business environment favoring less efficient incumbent firms; erosion of the revenue base.

### Simplified tax regimes for SMEs (Simples Nacional and presumptive regimes)
- Two optional regimes exist depending on turnover threshold: Simples Nacional (up to BRL 4.8 million; about USD 951,928) and a presumptive profit regime for companies with higher annual turnover below BRL 78 million (USD 15 million).
- Presumptive profit regime: taxable profits calculated on a “presumed” percentage of gross revenue ranging from 1.6 to 32 percent by sector, implying an effective tax rate on turnover between 0.54 and 10.88 percent.
- Simples Nacional:
  - Replaces IPRJ, CSLL, PIS, COFINS, IPI, ICMS, ISS and social security contributions with a single tax on reported turnover.
  - Progressive rates ranging from 4 to 33 percent of turnover.
  - Federal fiscal cost of Simples alone amounts to 1.05 percent of GDP (not including exemption of subnational ICMS and ISS taxes).
  - Over 5 million registered in 2021, nearly 80 percent of the formal firms in the country.
  - In some states, Simples concentrates almost 90 percent of all companies.
- Presumptive profit regime is not counted as a tax expenditure (TE) by RFB despite economic similarity to Simples, leading to understatement of true revenue forgone from simplified corporate regimes.
- MEI (micro-entrepreneurs, variant of Simples):
  - For yearly revenues below BRL 81,000 and at most one employee.
  - Owners pay a fixed fee equivalent to 5 percent of the minimum wage to cover social security contributions and ICMS or ISS, and are exempt from all other federal taxes.
  - Nearly 12 million taxpayers in 2021.
  - Evidence of abuse: over 330,000 formal employees identified as turning entrepreneurs and joining MEI while working for the same company between 2010 and 2014.

### International comparators and design lessons
- Turnover tax regimes are common in developing countries but typically much less generous than Brazil’s.
- Table (excerpted findings): Brazil’s maximum participation threshold ~951,928 USD (BRL 4.8 million), among the most generous globally.
- Consequences of high threshold: forgoes more revenue and creates inefficiency by keeping many taxpayers outside the general tax system.
- Examples of forgone-revenue magnitudes in other countries’ SME TEs: Canada (0.2 percent of GDP), Chile, Mexico, South Africa (0.1 percent each), India and Argentina (< 0.1 percent).

### Evaluations: effects on formalization, employment, and distribution
- Simples evaluations:
  - Not cost-efficient at generating employment; may be regressive.
  - Fiscal cost often outweighs benefits in additional wages or employment.
  - Discontinuity in average effective tax rates at the Simples eligibility threshold: about 6 percentage points.
  - Firms respond by bunching below the threshold and reducing reported and real revenue by 10 to 25 percent to benefit from Simples.
  - Incidence may be regressive because a non-trivial share of beneficiaries are high-income self-employed professionals.
  - Finance and real estate sectors have been excluded over time to curb excessive breaks, though leakage persists.
- MEI effects:
  - Increased social protection for informal micro-business owners.
  - Generated suboptimal labor reallocation and disguised formal employment; MEI-to-Simples graduation facing substantially higher tax burden discourages firm growth.

### Payroll tax exemptions (desoneração da folha de pagamento)
- Introduced in 2011 to replace a 20 percent employer payroll tax with a 1.5 – 2.5 percent tax on turnover for opting firms.
- Initially targeted selected labor-intensive sectors, then expanded.
- Peak coverage in 2015: 56 sectors at a forgone revenue cost of 0.4 percent of GDP.
- Reduced to 0.13 percent of GDP in 2019 after sector removals in 2018.
- Evidence from Ministério da Fazenda (former MOE; 2018): no strong evidence of real positive effects on aggregate compensation of employees or employment creation.
- Conclusion: costly and ineffective at lowering unit labor costs and generating employment; jobs maintained come at high fiscal cost and could be more efficiently achieved through direct public job intervention.

### Manaus Free Zone (ZFM) and regional development incentives
- Created in the 1960s to foster development in Amazonas after decline of the rubber industry.
- Main incentives: near complete exemption of customs duties on manufacturing inputs, exemption of IPI, PIS, COFINS and ICMS on manufactured goods; overlap with SUDAM grants additional IRPJ/CSLL exemptions.
- Combined SUDAM and ZFM cost: about 0.45 percent of GDP in 2019.
- Comparable costs: South Africa SEZ ~0.3 percent; Argentinian SEZ in Tierra del Fuego ~0.5 percent.
- Evidence on effectiveness: little analysis of impact on productivity growth, regional development, investment, and job creation; anecdotal evidence suggests inefficiency and that equivalent cash transfers might deliver more benefit.
- Counterargument: supporters claim mostly foreign investors would exit without incentives; jobs account for about one fifth of the population of the city of Manaus.

### R&D and local production incentives
- Lei da Informática (1991): reduces IPI on capital inputs to ICT production to promote local content and R&D; beneficiaries have not produced internationally competitive ICT products; program endures by preserving domestic ICT/electronics hub in Southeast.
- Lei do Bem (2005): allows companies under standard IRPJ regime to deduct up to 200 percent of R&D expenses from taxable income under IRPJ/CSLL.
  - Positive impact at lower fiscal cost than Lei da Informática, but limited reach: design excludes firms filing under the presumptive profit regime, favoring incumbent, older, larger firms and leaving out young start-ups.
- Multiple other small-cost TEs promote rural exports and local production of medicine, automotive vehicles, and petrochemicals.

### IRPJ deductions that resemble tax expenditures: Interest on Net Equity (JCP) and ACE discussion
- Interest on Net Equity (“juros sobre capital próprio”):
  - Companies can pay out earnings as JCP, deductible (unlike standard dividends).
  - Amount limited to 50 percent of profits or accumulated earnings, multiplied by the long-term interest rate (TJLP), currently set at 4.61 percent.
  - JCP deductible for both IRPJ and CSLL and subject to 15 percent IRRF at source.
  - The allowance in theory reduces cost of equity and eases debt bias, encouraging neutrality in investment and financing.
  - In practice, bulk of beneficiaries have used this allowance to issue fully deductible dividends with an actual return lower than the TJLP, yielding lower effective tax rates at the individual level.
- Standard ACE (as defined in theory) differs by giving allowance irrespective of profit distribution.
- Immediate expensing for capital machinery purchases available for some manufacturing firms with high numbers of working shifts; not considered a TE by RFB.

### Personal income tax (IRPF) exemptions and deductions
- Personal income tax exemptions and deductions (including capital income received by individuals) account for nearly 1 percent of GDP, driven primarily by:
  - Treatment of pensions, severance payments, medical expenses, and savings vehicles.
- Exempt or non-taxable income covers:
  - Pension income of individuals 65 or older (eligible for double the standard personal exemption on IRPF).
  - Retirement income due to work accident/disability.
  - Severance pay.
- Pensions alone account for 10 percent of all federal recorded TEs.
- Pension-related design produces “EEE” treatment for pension income below twice the standard personal exemption.
- Exemptions favoring savings vehicles include accrued capital gains in closed-end funds and through real estate and agrobusiness credit notes, likely benefiting wealthier individuals.

### Deductions for personal education and health; distributional impacts
- Most personal education and health expenditures are deductible from IRPF.
  - Health deductions are uncapped and cost 0.23 percent of GDP; claimed almost exclusively by the richest quintile; 86 percent of the forgone revenue accrues to the richest decile.
  - Education deduction is limited to a nominal value periodically reviewed; financing private school attendance reaches a small sliver of population and is regressive.
- PROUNI: forgone revenue of 0.04 percent of GDP annually via IRPJ, CSLL, PIS and COFINS exemptions to private higher education institutions granting scholarships; scholarships already exceed vacancies in public universities.

### Other personal income tax features and reform notes
- Personal exemption: BRL 1,904 per month (1.8 times the national minimum salary); not classified as a TE.
- Dividend income has been exempt from withholding or individual income taxes since 1995.
  - Corporate profits distributed as dividends are effectively taxed at corporate level at the 34 percent statutory rate for non-financial corporates.
  - Distributional concerns and the JCP allowance usage have driven calls for reform.
- Recent government income tax reform proposal included a 20 percent dividend tax with a BRL 20,000 per month exemption, described as a de facto new tax expenditure nullifying redistributive and revenue-raising capacity of the reform.

### Key quantitative figures (as stated)
- Simples Nacional eligibility threshold: BRL 4.8 million (about USD 951,928).
- Presumptive profit regime threshold ceiling: BRL 78 million (USD 15 million).
- Presumptive percentages for taxable profits: 1.6 to 32 percent; implied effective tax rate on turnover between 0.54 and 10.88 percent.
- Simples effective turnover rates: 4 to 33 percent of turnover.
- Federal fiscal cost of Simples alone: 1.05 percent of GDP.
- Simples registrants in 2021: over 5 million; nearly 80 percent of formal firms.
- MEI eligibility revenue cap: BRL 81,000; nearly 12 million taxpayers in 2021.
- MEI: owners pay a fixed fee equivalent to 5 percent of the minimum wage for social security and ICMS/ISS coverage.
- Reported firm revenue reduction to exploit Simples threshold: 10 to 25 percent.
- Payroll tax replacement rate: 1.5 – 2.5 percent turnover tax replacing 20 percent payroll tax.
- Payroll tax exemption peak coverage (2015): 56 sectors; forgone revenue cost 0.4 percent of GDP; reduced to 0.13 percent of GDP in 2019.
- Combined SUDAM and ZFM cost: about 0.45 percent of GDP in 2019.
- TJLP (long-term interest rate) currently set at 4.61 percent.
- JCP subject to 15 percent IRRF at source.
- Personal income tax exemptions and deductions total: nearly 1 percent of GDP.
- Pensions account for 10 percent of all federal recorded TEs.
- Health deduction fiscal cost: 0.23 percent of GDP; 86 percent of forgiven revenue to richest decile.
- PROUNI forgone revenue: 0.04 percent of GDP annually.
- Personal exemption: BRL 1,904 per month (1.8 times the national minimum salary).
- Proposed dividend tax in reform: 20 percent with BRL 20,000 per month exemption.

*Source: wpiea2021240-print-pdf - 18.      When adding IRPJ (corporate income tax - CIT), payroll tax, and indirect tax expenditures (https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021240-print-pdf.pdf).*

### 31.      Tax relief for the consumption of basic food items accounts for at least 0.64

### 31.      Tax relief for the consumption of basic food items accounts for at least 0.64 percent of GDP in forgone revenue federally

### Federal tax relief for basic food consumption
- Tax relief (zero-rating) of PIS and COFINS over imports or domestic sales of various types of food considered to be of first necessity (desoneração da cesta básica) was first introduced in 2004 and the list was expanded in 2013.
- Federal tax relief for basic food items accounts for at least 0.64 percent of GDP in forgone revenue.
- The policy is intended to lower the tax burden on consumption of basic food items by lower income households, but:
  - According to SECAP (2019c), in 2018 the richest income decile benefited over 4 times as much from this TE in absolute terms as the poorest decile.
  - Many items predominantly consumed by richer households are included (examples in source: wines, cheeses, foie gras, filet mignon, salmon).
- Zero-rating of IPI on production of most of these items is effectively preferential tax treatment but is not counted as a tax expenditure under RFB’s approach due to IPI benchmark design.
- Inputs used in the agricultural industry benefit from PIS/COFINS zero-rating; rural firms exporting agricultural products are exempt from social security contributions.
- Preferential ICMS rates (and sometimes exemptions) for the sale of such items are likewise not covered in federal TE quantification.
- Implication: quantification of federal tax expenditures associated with preferential tax treatment of basic food items likely vastly underestimates the true fiscal cost.

### Tax relief for medicines
- Tax relief associated with purchases of medicine account for 0.2 percent of GDP and rising.
- Policy introduced in 2000 warrants tax credits in the amount of PIS and COFINS tax otherwise due to firms manufacturing or importing certain pharmaceutical products (de facto zero-rating).
- About 65 percent of all medicine sold in Brazil was covered by this TE as of 2017.
- The associated fiscal cost has risen in recent years.
- Distributional impact:
  - The policy is highly regressive, with the richest household quintile benefiting from nearly 44 percent of all revenue forgone.
  - Direct public purchases of medicine for health clinics are also regressive but tend to more effectively increase access to basic medicine for the lowest income deciles than the equivalent tax expenditure.

### Other noteworthy federal tax expenditures and implicit preferences
- Non-profit entities engaged in social assistance, health or education benefit from full exemption under the Constitution (art. 195 § 7) of social security contributions, IRPJ/CSLL, as well as PIS/COFINS.
  - These tax expenditures account for nearly 0.4 percent of GDP in forgone revenue.
  - They are normally difficult to change (except for social security contributions where benefit to the individual taxpayer is more clearly linked).
- Companies can claim tax relief related to worker benefits such as medical, dental, and pharmaceutical assistance, and food provision.
- Numerous exclusions from the definition of taxable rural property and low valuations de facto imply preferential treatment of rural property owners with respect to the ITR (forgone tax revenue not estimated).
  - Illustrative fact: the amount of urban property tax collected by the city of São Paulo alone annually is larger than the total ITR collection in the whole of Brazil.

### Subnational tax expenditures and magnitude
- Subnational tax expenditures represent at least 1.2 percent of national GDP in forgone revenue (IMF, 2019).
- Total subnational tax revenues are in the order of 10 percent of GDP.
- In 2020, subnational tax expenditures corresponded to an average of 19 percent of each state’s actual tax collection, though with substantial variation across states.
- Reasons estimates likely understate the true aggregate magnitude:
  - Partial conceptual coverage of ICMS tax expenditures by LDOs in some states.
  - Lack of information on the magnitude of tax expenditures associated with ISS and municipal taxes such as IPTU, ITCMD, and IPVA.
- According to CONSEFAZ estimates, forgone revenue due to the fiscal war could be as large as 4 percent of national GDP.

### Fiscal war, ICMS, ISS, and subnational competition
- The leading cause of ICMS and ISS tax expenditures is tax competition between Brazilian states and municipalities (“fiscal war”).
  - States and municipalities compete to attract investment by granting fiscal benefits; mechanisms such as “triangular transactions” disguise fiscal benefits as financial incentives/long-term loans.
- Kandir Law (1996) introduced tax credit mechanisms and destination principle for exports but also distorted the ICMS incentive model since the cost of incentives can be borne by different states downstream.
- More developed states often benefit most from the fiscal war due to greater financial capacity, larger consumer markets, and better infrastructure.
- Subnational tax relief for the cesta básica varies by state and CONFAZ agreement:
  - Agreement 128/94 authorizes a reduced 7 percent rate on domestic sales of basic food goods.
  - Agreement 161/94 authorizes six states (GO, PE, MT, TO, AC, MS) to exempt such goods for distribution to low-income households.
  - More recent agreements have authorized a further 11 states to exempt sales of basic food items to the general public.
  - On average between 2010 and 2020, there were 177 CONFAZ agreements per year recognizing new ICMS tax expenditures for some states and goods.
- Municipal ISS waivers granted by economically underprivileged municipalities can produce perverse outcomes: companies register in smaller cities to benefit from waivers but operate in larger cities, depriving both cities of appropriate tax and development outcomes.
- Lack of coordination over ITCMD and IPVA rates incentivizes a race to the bottom due to taxpayer mobility.
  - Example controversy: in São Paulo, residents with qualifying disabilities grew only 2 percent since 2016, while vehicles benefiting from the exemption grew nearly 140 percent over the same period (UOL, 2021).
- Prolific urban property tax exemptions and rate discounts erode the IPTU revenue base despite inelasticity of immovable property.

### Governance, transparency, and recent legal reforms at subnational level
- Complementary Law 24/75 established CONFAZ and requires unanimous vote of CONFAZ for states to grant tax incentives (via agreements/convênios).
  - Objective: guarantee reciprocity in ICMS tax credits for interstate transactions.
- Incentives continued to be granted irregularly as recently as 2017, sometimes in disregard of CONFAZ regulations, with formal clearance ex-post.
- Subnational governments are technically covered by Art. 165 of the Constitution and Art. 14 of the Fiscal Responsibility Law, but in practice they are not binding.
- Lack of transparency: no ex-ante or ex-post cost-benefit assessment typically accompanies subnational TEs.
- Complementary Law 160/2017 aimed to regularize ICMS tax expenditures by granting an amnesty for previously irregular TEs and committed to gradual reduction of fiscal war TEs for commercial and industrial purposes by 2022 and 2032, respectively.
- Governance challenges:
  - The unanimity requirement for CONFAZ decisions hinders new regulations because at least one state often opposes measures.
  - CONFAZ has created a working group to promote studies and norms relating to concession of fiscal incentives by states.
  - Some states have initiated improvements in treatment and fiscal accounting of tax expenditures (examples in source: LC 231/2020 of Paraná; Estudo de Benefícios Fiscais of Rio Grande do Sul).

### Scope for revenue mobilization and preferred reform path
- There is scope to increase subnational tax revenue, but a comprehensive reform at the national level would be preferable.
  - Historically states are overly indebted and have required federal bailouts (most recently cited: 2014).
  - Local tax expenditures erode subnational revenue mobilization capacity and exacerbate federal public finance imbalance.
  - New federal tax exemptions reduce constitutional transfers to subnational governments.
- Constitutional Amendment 109/2021 (Art. 167, X) may empower the federal government to halt concession or expansion of tax incentives by states or municipalities whose current expenditure to revenue ratio exceeds 95 percent in a 12-month period (untried in practice).
- A more durable solution would integrate ICMS, ISS, IPI, PIS and COFINS into a single or dual VAT, with nationally coordinated tax relief and compensatory transfers to net losing states phased-out over time.

### Comprehensive reform options and targeted measures
- IMF staff recommend broad tax reform focusing on ease-of-doing-business and progressivity while maintaining current aggregate revenue levels:
  - Simplification of indirect taxes, reduction of payroll costs and tax expenditures, and more progressive labor and capital income taxation.
  - Rationalizing tax expenditures can broaden the base—sustaining revenue levels and raising productivity while reducing statutory rates.
- Medium-term reform: consolidate complex system of indirect taxes at federal and state levels toward a unified broad-based VAT with full refund for VAT on intermediate goods and zero-rating for exports.
  - Borges (2020) estimates a comprehensive indirect tax reform at the national level could result in a 24 percent increase in potential GDP in 15 years, mostly due to increased factor productivity.
- Eliminating preferential tax treatment of basic consumption goods along with offsetting transfer mechanisms to low-income households is estimated to revert the regressive character of indirect taxes for the lowest two quintiles of the population (Thiago and Mendes, 2019).

### Ongoing proposals, transition features, and targets for federal tax expenditures
- At least four different tax reform proposals have been tabled in Congress since 2019: PEC 45/19 (Lower House), PEC 110/19 (Senate), PL 3887/20 (ordinary law), and PL 2337/2021 (ordinary law on income taxes).
  - The House’s proposal envisions a tax system transition of 10 years, with 50 years of gradual replacement of revenue from origin to destination states.
  - The Senate’s proposal envisions a transition in 6 years, with revenue replacement over 15 years.
  - The government’s first phase proposal (ordinary bill) seeks to simplify federal PIS/COFINS into a non-cumulative federal VAT (CBS) with immediate application in 6 months.
- Constitutional Amendment (EC) 109/2021 mandates:
  - The executive branch to present within six months a plan for the gradual reduction of tax incentives toward 2 percent of GDP until September 2029 (to be implemented through future legislation).
  - In the first year, the reduction should be of at least 10 percent nominally.
- The FRL and successive LDO requirements have reduced the number of new federal tax expenditures and increased the share with clear expirations; LDOs since 2019 require novel federal TEs to have an expiration date of at most 5 years and be accompanied by preferably quantitative goals and a designated agency for monitoring.

*Source: Excerpt from IMF Working Paper content unit "wpiea2021240-print-pdf" (provided text).*

### 43.      Notably, EC 109/2021 excludes six sizeable programs from the targeted tax

### wpiea2021240-print-pdf - 43.      Notably, EC 109/2021 excludes six sizeable programs from the targeted tax

### Exclusions and fiscal impact
- EC 109/2021 excludes six sizeable programs from the targeted tax expenditure rationalization: Simples Nacional; non-profit organizations; regional development programs in the North, Northeast and Center-West; the Manaus Free Trade Zone; basic food items; and programs supporting scholarships for university students (PROUNI).
- These excluded programs already accounted for "just over 2 percent of GDP" in forgone revenue.
- Implication: an overall reduction of federal tax expenditures to "2 percent of GDP" would in practice entail the near complete elimination of all other tax incentives not covered by the EC exceptions.

### Guiding principles in reform design and implementation
- Successful tax reforms entail:
  - A clear strategic vision of broad, long-term tax reform objectives.
  - Transparent communication over distributional/equity impacts and linkage of tax and benefit systems.
  - Bundling reforms into comprehensive packages where feasible.
  - Time-bound transitional arrangements and incentives to opt into the new system when feasible.
  - Coordination across levels of government to mitigate fiscal spillovers in federal systems.
  - Proper timing of reforms and ex-post periodic evaluation and adjustment of policies.

### Integrating tax expenditure rationalization with broader reform packages
- Rationale:
  - Bundling tax expenditure rationalization into broader reform packages facilitates addressing efficiency, equity, and revenue simultaneously.
  - Simultaneous measures make it easier to mitigate distributional costs for groups adversely affected by specific eliminations.
- Examples of offsetting measures discussed:
  - Using VAT base-broadening revenues to compensate poorer households via increased direct benefits.
  - Offsetting VAT base-broadening by reducing PIT rates in lowest brackets or increasing personal exemption thresholds.
  - Pairing statutory CIT rate reductions with higher capital income taxes at the personal shareholder level or removing CIT deductions/special regimes.
  - Using increases in recurrent property taxes to finance reductions in employee social security contributions.

### Temporary arrangements and administrative transition
- Temporary arrangements can:
  - Smooth administrative transitions and mitigate sudden revenue losses when incentives cannot be lifted immediately.
  - Balance tax stability for incumbents with equal treatment of market entrants.
- Sunset provisions and grandfathering:
  - Useful to respect existing contracts and investment decisions, but create uneven playing fields and potential distortions and compliance risks.
  - Should be temporary; renegotiation or reasonable, time-bound incentives for new investors may be needed.

### Coordination across levels of government and legal hurdles
- Consider trade-offs between decentralization and a coherent national tax distribution.
- Possible measures:
  - Allow subnational tax discretion within bands to maintain links across levels.
  - Establish institutional settings for tax reform evaluation across levels and mechanisms for inter-regional compensation if reforms have heterogeneous regional impacts.
- Legal considerations:
  - Some tax expenditures may expire automatically; others require legislative repeal or constitutional amendment.
  - Ensure changes are immediately consistent across all legal bases to mitigate judicial disputes.

### Limitations of tax expenditure eliminations for revenue mobilization
- Not all tax expenditures are viable revenue sources:
  - Some are difficult to eliminate due to social objectives (e.g., income tax exemptions for non-profit organizations) or international agreements (e.g., customs exemptions).
  - Behavioral responses may yield lower revenues than TE estimates suggest.
- Other revenue options not classified as tax expenditures can be important (example: lowering the threshold for the top PIT rate).
- Recommendation: complement proposed TE eliminations with non-TE revenue mobilization options.

### Cross-country lessons informing Brazilian strategy (high-level takeaways)
- Successful examples emphasize:
  - Comprehensive packages, phased implementation, grandfathering with limits, temporary compensations to subnational governments, and strong communications to manage uncertainty.
  - Risks include short-term economic disruption, delayed revenue realization, and political pushback if measures are not bundled or compensated appropriately.

### Concrete recommendations and Brazil-specific proposals
- Recommendation: integrate tax expenditure rationalization into broader tax reform packages and prioritize repeal of TEs that can be changed more easily (ordinary or supplemental law) while bundling major reforms to build political consensus.
- Government proposals summarized:
  - First phase: unification of PIS and COFINS into a federal VAT (CBS) at a non-cumulative "12 percent" rate.
    - Of the total "1.2 percent of GDP" in PIS/COFINS tax expenditures, only "0.3 percent" would be removed (pertaining to medicines, infrastructure, ships and aircraft, and others).
    - Exemptions, zero rates and tax credits associated with Simples Nacional, the Manaus Free Zone, the basic food basket, and public transport would remain.
    - Financial sector to be taxed on a cumulative basis at a "5.8 percent" rate.
    - IPI reform delayed to a later stage; eventual aim to turn IPI into a true excise tax focused on production and imports of externality-generating goods.
  - Second phase: draft income tax reform proposals (Congress rapporteur’s first draft):
    - Gradual reduction of the statutory IRPJ rate from "34" to "21½ percent" over two years.
    - Increase of the personal exemption threshold by "31 percent" and "13 percent" increases for every other bracket threshold in the IRPF schedule.
    - Estimated revenue loss from these measures tallying "just under ½ percent of GDP", partially offset (according to RFB estimates) by:
      - Reintroduction of dividend taxation at a "20 percent" rate.
      - Elimination of the interest on net equity (JCP) deduction from IRPJ.
      - Taxation of capital gains in closed-end investment funds on an accrual basis.
    - A net revenue loss in the order of "0.36 percent of GDP" was still expected to materialize given the large CIT rate cut (the original cut proposed by government to only "29 percent" would have been fully revenue neutral).
    - No major changes were foreseen for key tax expenditures associated with PIT deductions, simplified tax regimes for SMEs, or payroll tax contributions at the time of writing.

*Source: wpiea2021240-print-pdf - 43.*

### 52.      Both of these bills can be used to phase out the majority of current federal tax

### wpiea2021240-print-pdf - 52.      Both of these bills can be used to phase out the majority of current federal tax

### Federal tax-expenditure phase-out and legislative prospects
- Both bills affect only federal taxes and require a simple majority of both chambers of Congress to pass; they are in practice less likely to face strong opposition than constitutional amendment proposals and are most likely to be approved in the short-term.
- Congress and the government can use reviews of these measures to incorporate more ambitious withdrawal of federal tax expenditures, because doing so later will be much more difficult without the “carrot” of simplifying tax reform to balance interest groups.
- Unless all identified federal tax expenditures except a handful of large special categories identified in EC 109 are removed, the 2 percent of GDP target ceiling in eight years is unlikely to be achieved.
- A more reasonable alternative involves rationalization of excluded categories (Simples, the basic consumption basket, and ZFM/regional development programs) and other tax relief considered part of the benchmark system and excluded from the RFB’s TE report (e.g., CIT cost of capital deductibility provisions, presumptive profit regime, and IPI preferential rates).
- Implementing Supplemental Law 160/2017 (gradual elimination of “fiscal war” subnational tax expenditures) is necessary for integrated national VAT discussions but has struggled to take hold.
- Repealing laws granting open-ended tax relief by incorporating rationalization within current government draft bills has the advantage of avoiding reliance on expiring legal provisions, which would yield only minor potential gains of 0.2 percent of GDP for the next eight years and face strong political incentives for extension.

### Income tax reform: move toward a dual income tax model
- Converging to a true dual income tax model would increase neutrality across income sources while preserving progressivity, addressing asymmetries between sources of capital income and choice of incorporation, and reducing exemptions benefiting high-income households that impede PIT redistributive power.
- Authorities’ latest draft bill proposals include:
  - proposing a reduction of 5 percent in the statutory CIT rate over two years;
  - introducing dividend taxation; and
  - increasing the personal exemption for PIT.
- Some design features merit reconsideration, and additional measures could add value within review of the current bill.

### Corporate tax integration, dividend tax design, and distributional impacts
- Under the proposed 20 percent dividend tax and a lower statutory CIT rate of 21½-29 percent, firms would face an integrated CIT rate for distributed profits of 37.2-43.2 percent, higher than the OECD average.
- Previously, firms could distribute profits at a 15 percent rate using the JCP deduction.
- The integrated rate would be substantially higher than the top marginal PIT rate of 27.5 percent, which the government has not proposed to increase.
- Recommendation: The CIT rate could be further reduced by at least another 5 percentage points in the medium-term to better align with PIT rates.
- Concerns with the proposed dividend tax:
  - The proposed 20 percent dividend tax, combined with elimination of the JCP (de facto dividend deductibility), will likely induce dividend lock-in, leading firms to retain earnings or convert capital returns into labor remuneration, eroding projected tax base and revenue yield.
  - Increasing the marginal cost of capital for equity-financed investment risks discouraging future aggregate investment (including FDI), particularly for young or high-tech firms with intangible assets.
  - A dividend tax rate below the 15 percent rate applied to interest and other capital income—e.g., 10 percent—would avoid similar distortions and partially offset debt bias from JCP removal.
  - The redistributional effectiveness is weakened by the large exemption threshold (BRL 20,000 per month, nearly six times GDP per capita on an annualized basis).
- International treaty consideration:
  - Most bilateral double taxation treaties with Brazil foresee up to 15 percent withholding tax at source; a domestic dividend tax rate above 15 percent would entail loss of taxation rights or need to renegotiate treaties.

### Cost of capital, ACE, and interest deductibility
- To neutralize debt bias and render CIT neutral for marginal investment decisions while mitigating short-run revenue costs, consider:
  - Introducing an incremental allowance for corporate equity (ACE) similar to Belgium’s notional return on equity, applied only to new equity increases relative to a base year and initially at a fraction of JCP’s revenue cost.
  - Limiting interest deductibility beyond transfer pricing rules, expanding regulations to debt service between unrelated domestic and foreign non-low-tax parties.
- OECD standard practice caps deductible interest to 30 percent of EBITDA; Brazil’s relatively high credit costs may warrant a higher ratio (e.g., 40 percent). Financial institutions would typically be excluded.
- Revenue cost of ACE in the financial sector can be limited by providing it only for equity in excess of minimum regulatory capital requirements.
- Targeted accelerated depreciation allowances and redesign of R&D tax incentives (eliminate Lei de Informática and integrate resources into Lei do Bem) could lower investment costs and boost productivity.
- Consider immediate cash refunds for R&D expenditures (direct subsidies) or allowing firms to carry associated losses forward to benefit younger not-yet-profitable firms.

### SME regimes, Simples, and addressing "pejotização"
- Reform of the standard CIT regime (lucro real) should be accompanied by reform of asymmetric tax treatment of small businesses, self-employed workers, and wage earners.
- Poorly calibrated simplified SME regimes plus high payroll taxes have encouraged incorporation for tax avoidance (pejotização), with examples showing salaries subject to average effective tax rates nearing 50 percent including SSCs, while shareholders under special SME regimes face much lower rates possibly in single digits.
- Possible measures:
  - Drastically reduce the threshold of eligibility for Simples Nacional from its current level.
  - Using an optimal SME threshold model (Wen and Wei, 2019) with assumptions: CIT rate of 34 percent, simplified regime turnover tax rate of 4 percent, average profit margin of 10 percent, and “shadow value” of public funds of 1.3, the recommended threshold for Brazil is USD 191,023 (just short of BRL 1 million).
    - This change would affect about 10 percent of current registered Simples taxpayers, who contribute 63 percent of Simples’ total tax collection.
  - Separate social security contributions from the unified Simples tax so they are actuarially associated with wage costs of each insured worker.
  - Increase the minimum tax rate in the regime to at least 5-6 percent on turnover in the medium-term to reduce incentives to incorporate for tax avoidance.
  - Eliminate the presumptive profit regime (duplicative with Simples) and retain only Simples under a lower threshold to target truly micro and small firms.
  - Exclude liberal professionals from both regimes to mitigate tax avoidance.
  - Absorb self-employed individuals into the standard IRPF regime while lowering compliance costs via administrative measures (e.g., pre-filled tax returns).

### Transition measures: temporary Alternative Minimum Tax (AMT)
- A temporary AMT could mitigate short-run revenue loss and encourage voluntary transition to standard CIT and PIT regimes when curtailing Simples generosity and eliminating presumptive profit regime.
- Design example:
  - Allow companies under presumptive regime to benefit from lower CIT rate only if transitioning to the standard regime, while subjecting every firm simultaneously to an AMT (even under presumptive regime) to incentivize switching.
  - AMT rate could be parametrized to mimic current average tax collection in simplified regimes.
- Timing caveat: AMT-type measures should only be implemented once the pandemic-related crisis abates to avoid burdening firms with exceptional losses.

### Personal income tax (IRPF), deductions, payroll tax, and financing social contributions
- Eliminate most IRPF deductions and capital income exemptions (including regressive deductions for education and health, preferential treatment of capital returns vehicles, and pension income) to improve progressivity.
- Latest proposal taxes accrued capital gains of closed-end investment funds, but most other deductions and exemptions remain unaltered.
- Payroll tax reform options:
  - Allow payroll tax exemption to expire at the end of 2021.
  - To offset payroll cost burden, consider reducing the standard employer’s contribution (currently 20 percent) and compensate via higher PIT rates on higher income earners.
  - Alternative PIT schedule illustrated: thresholds for lower brackets adjusted as government proposed (including increasing personal exemption to BRL 2,500 per month); top bracket threshold remains unaltered in nominal terms; top marginal tax rate increased from 27.5 to 30 percent; all lower marginal rates unchanged. This alternative yields similar relief for individuals around 100 percent of GDP per capita but is more progressive at the top.
  - A similar transition option as for CIT could make firms eligible for a new lower payroll tax rate only if they switch to the standard CIT regime and relinquish special incentives (except R&D).
- Financing reductions in social security contributions:
  - Use more efficient tax bases and shift contribution burdens to higher-income individuals via base broadening of property taxes and inheritance taxes (improved valuation and elimination of exemptions).
  - Rural property tax is federally collected; improvements in subnational own revenues would alleviate federal fiscal pressures.
  - Assess federal capital gains taxes upon asset transfers at death to improve inheritance taxation revenue productivity.
  - Consider regulation of a net wealth tax with a high threshold, as stipulated in the Constitution but never implemented; Paiva and others (2021) estimate a progressive net wealth tax could yield 0.4 percent of GDP based on wealth values declared in PIT returns, but evasion risks could erode the base unless used credibly once or announced as temporary.
  - Re-introduction of the CPMF (tax on financial transactions) is discussed publicly but is ill advised given existing high tax burden on financial sector through IOF and a higher CSLL surcharge of 20 percent.

### Indirect tax simplification and national VAT integration
- Substantial welfare gains exist from integrating indirect taxes into a unified destination-based national VAT and an excise regime on selected externality and rent-generating goods and services (e.g., fuels, electricity, telecommunications, tobacco, alcohol, motor vehicles).
- Integration would eliminate current sectoral and regional tax incentives; destination-based design would neutralize fiscal war between subnational governments.
- Even if states choose their own VAT rates within a band around a reference rate (e.g., 25 percent), destination-based nature would mitigate current distortions; dual VAT resembling the Canadian system is more probable given infra-constitutional feasibility.
- Unification of rates would alter sectoral burdens: manufacturing and retail could see reduced revenue/sales burden, while services and food could bear heavier burdens.
- To mitigate price passthrough and inflationary shock, VAT rate uniformization could be phased in gradually and predictably over several years, possibly as suggested by the House.
- Reform would redistribute fiscal resources in favor of net importing states, which are the least developed in the country.

*Source: https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021240-print-pdf.pdf*

### 62.      An expansion of social transfers would be needed to compensate low-income

### wpiea2021240-print-pdf - 62.      An expansion of social transfers would be needed to compensate low-income

### Social transfers and VAT uniformization
- The new VAT should have a uniform rate applied to all goods and services, removing the vast majority of exemptions and preferential rates, including for food and medicine.
- Zero-rating of the basic consumption basket today in Brazil is described as regressive as a share of consumption spending by households and less effective for redistribution than increased direct transfers to the poorest households.
- Retailers typically absorb declines in VAT rates as added markup, rather than passing through lower prices to final consumers.
- Poorer households often make purchases in informal retailers, which may not charge VAT, reducing the redistributive impact of preferential rates.
- A narrower basic consumption basket with lower or zero rates was considered (SECAP’s proposed partial reform), with SECAP (2019c) recommending excluding some goods (e.g., cheese, milk derivatives, certain types of fish and birds, and coffee derivatives).
- Footnote: No exemptions should be allowed for food sales at the ICMS level for some states to maintain the integrity of the VAT’s chain of credits on input purchases; VAT exemptions should only be allowed when value added is hard to define, such as margin-based financial services and insurance services.

### Compensation mechanisms and targeting
- Individualized refundable tax credits could be considered in theory, but practical limitations exist:
  - Less than 30 million individuals file IRPF each year in a country of over 200 million, and most filers are not among the poorest households.
  - Many of the poorest households may not purchase goods in retailers issuing electronic invoices that would enable such credits.
- Authorities could leverage the Cadastro Único network of registered beneficiaries under Bolsa Família (PBF) to identify households for direct augmented transfers.
- Authorities may consider excluding PBF transfers from the spending ceiling to enable direct cash transfers compensating low-income families for increased tax burden on basic food items.
- International and subnational precedents:
  - Ecuador and Guatemala: personal expenditures deductible from PIT taxable income or VAT creditable, which reduced redistributive capacity and created compliance problems.
  - São Paulo and Rio Grande do Sul: refund plus lottery for ICMS electronic compliance; limited impact due to stigma and data concerns.
  - Canada and Portugal: targeted and capped refundable sales tax credits to low-income taxpayers, contributing to progressive VAT.
  - Uruguay (since 2006) and Thailand (since 2018): use smart cards to refund VAT to low-income individuals with monthly deposits according to household composition.
- Estimated impact: Paiva and others (2021) estimate such a policy shift could reduce inequality by as much as 7 points of the Gini coefficient and virtually eliminate extreme poverty rates in the country.

### Potential revenue yield from tax expenditure rationalization
- An effective reduction in tax expenditures by at least 2 percent of GDP in the medium-term will require ambitious special regime reforms and a broader fiscal reform package.
- Estimates are largely based on the RFB’s annual federal tax expenditure report taking 2019 as a base; other public tax return aggregates used where not covered.
- Examples of data sources and bases:
  - ACE, thin capitalization provisions, and presumptive profit regime estimates based on RFB aggregate statistics (corporate income tax returns aggregates by sector).
  - IPI estimate assumes tax expenditure proportional to that measured in PIS/COFINS.
- Political and constitutional constraints:
  - Some exemptions (e.g., social security contributions by non-profit/social assistance organizations and exemption for rural exporters nearly 0.3 percent of GDP) are prescribed in the Constitution and harder to repeal.
- Table 2 (summarized measures, yields, timelines, balancing measures) — key entries and exact numeric values preserved:
  - Elimination of pension income exemption from IRPF: 0.31 (% of GDP) — 2022 — Ensuring low-income pensions remain under PIT exemption threshold
  - Elimination of education and health expenditure deductions on IRPF: 0.28 — 2022 — Public spending in education and health
  - Elimination of preferential tax treatment of savings vehicles: 0.11 — 2022
  - Elimination of payroll tax exemption: 0.13 — 2022 — Lower payroll tax rate on middle class, but increase top marginal PIT. Transition option for firms
  - Integration of Lei da Informática resources into Lei do Bem: 0.08 — 2022
  - Simples Nacional (SME) Nacional Threshold and Rate Reform: 0.77 — 2023 — Statutory CIT rate reduction
  - Elimination of PIS/COFINS zero-rating on basic food items: 0.23 — 2023 — VAT refund for households under Bolsa Familia / increased social transfers to mitigate poverty impact
  - Elimination of PIS/COFINS tax credit on medicine and pharmaceutical products: 0.17 — 2023 — Expanding low-income access to basic medicine directly through government purchases (post-pandemic)
  - Manaus Free Zone and SUDAM/SUDENE Reform: 0.45 — 2024 — Cost-based incentives and infrastructure/direct public spending in the region
  - Automatic expiration of other benefits (mainly semiconductors and automotive sectors): 0.13 — 2029
  - Repeal of existing ACE on distributions: 0.23 — 2022 — Dividend taxation + standard ACE on new equity only
  - Thin capitalization provisions for unrelated parties not in low-tax jurisdictions: 0.17 — 2022 — Statutory CIT rate reduction
  - Elimination of presumptive profit regime along with AMT: 0.16 — 2023 — Statutory CIT rate reduction
  - Harmonization of IPI rates, incl. removal of preferential rates: 0.04 — 2023 — VAT refund for households under Bolsa Familia
  - Elimination of subnational tax expenditures, including for ICMS on basic food items: 1.20 — 2024 — VAT refund for households under Bolsa Familia
  - Total federal without reforming TEs excluded by Constitutional Ammendment: 1.21
  - Total based on federal tax expenditure report: 2.66
  - Total including subnational and broader tax expenditure definition: 4.46
- Note: Excluding customs and IPI exemptions from Manaus Free Zone reform would cut projected revenue by half.
- As much as 4½ percent of GDP in forgone revenue could be recouped at the national level in the medium-term; introducing balancing packaged measures would neutralize that revenue impact.

### Conclusion and policy priorities
- Tax expenditures have increased complexity, opacity, and regressivity in Brazil’s tax system and should be rationalized within comprehensive tax reform.
- The pandemic crisis could provide an environment to introduce sweeping tax reforms addressing horizontal and vertical inequities.
- Any new tax expenditures or deferrals granted during the crisis should have clearly well-defined expirations.
- Key tax expenditure rationalization priorities identified:
  - Reduce regressive personal income tax deductions for education and health expenses, and exemptions for pension income, savings investment funds, and dividend income. Eliminate payroll tax exemptions (including those tied to special CIT regimes for SMEs), possibly combined with reduced employer social security contributions financed by higher top marginal PIT rates and improved use of other tax instruments such as property and inheritance taxes.
  - Substantial rationalization of special regimes for corporates: lower eligibility threshold for Simples Nacional, eliminate presumptive profit regime, curtail liberal professionals’ ability to incorporate for tax avoidance. Partially compensate firms via lower statutory CIT rate and improved investment and cost of capital allowances; consider voluntary transition arrangements and a temporary alternative minimum tax.
  - Remove preferential rates and exemptions associated with PIS, COFINS and IPI to enhance efficiency, simplicity and progressivity; later extend to ICMS and ISS in tandem with creation of a national VAT.
  - Expand social assistance transfers leveraging the existing PBF network to compensate low-income households for increased prices resulting from rate uniformization.

*Italic source: Extracted from the provided PDF content unit.*

### REFERENCES

### REFERENCES

### Major themes covered by the cited literature
- Tax expenditures and fiscal transparency
- ICMS (state value-added tax) incentives, renúncias fiscais, and "guerra fiscal"
- Tax reform proposals for Brazil, including PEC 45/2019 and VAT alternatives
- Tax incentives, special regimes, and their effects on investment and misallocation
- Consumption taxes, VAT, and distributional impacts on low-income individuals
- Formalization, SIMPLES monotax, and informality
- Corporate taxation, allowances for corporate equity, and interest limitation rules
- Revenue mobilization and tax policy in developing and low-income countries
- COVID-19 fiscal and tax administration responses, including "COVID-19 Recovery Contributions"
- Evaluations of specific Brazilian programs (Nota Fiscal Paulista, Zona Franca de Manaus) and tax expenditures reporting

### Representative citations from the section (selected for topic coverage)
- Afonso, J. R.; Silveira, R. F.; Carvalho, C. M. S.; Klintowitz , D.; e Azevedo, F. 2014. “A renúncia Tributária do ICMS no Brasil”. Inter-American Development Bank. Discussion Document number 327. February.
- Afonso, J.R., J. Morais Soares, and K. Pacheco Castro, 2013. “Evaluation of the Structure and Performance of the Brazilian Tax System: White Paper on Taxation in Brazil”, Discussion paper No. IDB-DP-265. August. Inter-American Development Bank.
- Araújo, E. M. and N. L. Paes, 2019. “Desoneração da cesta básica ou expansão do Programa Bolsa Família? Uma simulação por equilíbrio geral computável”, Revista de Economia Contemporânea, 23(1): p. 1-23.
- Auerbach, Alan J., and Joel Slemrod, 1997. “The Economic Effects of the Tax Reform Act of 1986.” Journal of Economic Literature, vol. 35, no. 2, pp. 589–632.
- Azuara Herrera, Oliver, Rodrigo Azuero, Mariano Bosch, and Jesica Torres, 2019. "Special Tax Regimes in Latin America and the Caribbean: Compliance, Social Protection, and Resource Misallocation," IDB Publications (Working Papers) 9511, Inter-American Development Bank.
- Bachas, Pierre, Lucie Gadenne and Anders Jensen, 2020. “Informality, Consumption Taxes and Redistribution”, NBER working paper 27429, June.
- Fenochietto, Ricardo and Juan Carlos Benítez, 2021. “Encouraging Formal Invoicing and Reducing the VAT Impact on Low-Income individuals”, IMF Working Paper No. 2021/040.
- International Monetary Fund (IMF), 2011. “Revenue Mobilization in Developing Countries”, Policy Paper.
- IMF, 2015. “Options for Low Income Countries’ Effective and Efficient Use of Tax Incentives for Investment”. Report to the G-20 Development Working Group.
- IMF, 2016. “Tax policy, leverage and macroeconomic stability”, Policy Paper.
- IMF, 2017. “Brazil: Fiscal Transparency Evaluation”, Country Report No. 17/104.
- IMF, 2019. “Brazil: Technical Assistance Report—Strengthening the Framework for Subnational Borrowing.” Country Report No. 19/302.
- IMF, 2020. “Tax and Customs Administration Responses”, Special Series note on COVID-19.
- IMF, 2021. “COVID-19 Recovery Contributions”, Special Series note on COVID-19.
- Itaú, 2020. “Macro Vision: 10 frequently asked questions about the tax reform”, Macro Research Department report.
- Klemm, A., 2006. “Allowances for Corporate Equity in Practice”, IMF working paper WP/06/259.
- Keen, Michael and Mario Mansour, 2010, “Revenue Mobilization in Sub-Saharan Africa: Challenges from Globalization II – Corporate Taxation,” Development Policy Review, Vol. 28, pp. 573-596.
- Matsumoto, Maurício Massao Soares, 2021. “Essays in Firm Taxation and Job Loss”, Chapter 2. Princeton University, Department of Economics Dissertation. April.
- Mattos, E., Rocha, F., and Toporcov, P, 2013. “Programas de Incentivos Fiscais São Eficazes? Evidência a Partir da Avaliação do Impacto do Programa Nota Fiscal Paulista Sobre a Arrecadação de ICMS” Revista Brasileira de Economia, Rio de Janeiro v. 67 n. 1 / p. 97–120 Jan-Mar.
- Piza, C., 2018. “Out of the Shadows? Revisiting the impact of the Brazilian SIMPLES program on firms’ formalization rates.” Journal of Development Economics, vol. 134, issue C, pp. 125-132.
- Pinto, V. C. 2019. “Os elevados e Descoordenados Benefícios Fiscais do ICMS”. Febrafite. Study. May.
- Pinto, V. C. and M. A. B. L. Gradvohl, 2021. “Renúncias fiscais do ICMS em tempos de pandemia” Febrafite technical note. April.
- Redonda, A. and T. Neubig, 2008. “Assessing Tax Expenditure Reporting in G20 and OECD Economies”, CEP Discussion Note 2018/3.
- SECAP, 2019a–2021. Multiple Boletim Mensal notes on tax deductions, Lei de Informática, Desoneração da Cesta Básica, Desoneração dos Medicamentos, Dedução de Despesas com Educação, and Lei do Bem: Lei nº 11.196/05 (editions and dates as listed).
- Wei, F. and J.F. Wen, 2019. “The Optimal Turnover Threshold and Tax Rate for SMEs”, IMF Working Paper No. 19/98.
- World Bank, 2017. “Business Support Policies in Brazil: Large Spending, Little Impact”, Background Paper to Um Ajuste Justo - Análise da eficiência e equidade do gasto público no Brasil, November.
- World Bank, 2020. "Doing Business 2020: Comparing Business Regulation in 190 Economies”. Washington, DC: World Bank.

### Observations on methodological and institutional coverage
- Both empirical program evaluations (e.g., Nota Fiscal Paulista, SIMPLES) and computable general equilibrium simulations are represented.
- International organizations (IMF, World Bank, OECD, ILO, IDB) provide policy papers, country reports, technical notes, and working papers addressing tax policy, revenue mobilization, and COVID-19 fiscal responses.
- Legal and administrative sources for Brazil are cited, including Receita Federal do Brasil (RFB), Presidency of the Federal Republic of Brazil (TIPI), SECAP Boletim Mensal editions, and state-level analyses (SEFAZ RS).

*References section from the source PDF: wpiea2021240-print-pdf - REFERENCES*

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_Source: https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021240-print-pdf.pdf_