Tax Reform in Brazil: Small Achievements and Great Challenges

Brazil’s tax burden had fluctuated at around one fourth of GDP in the previous twenty years leading to 1990. The fiscal adjustment necessary to attain a stable macroeconomic scenario came from increases in revenue, not from expenditures cuts as was the case in most of the countries in Latin America. Few imagined that at the end of the nineties, the tax burden would reach 32 percent of GDP. The problem is that the increase in collection came from the introduction of inefficient and distortionary indirect taxes. This paper first traces the historical roots of Brazil's tax system. It argues as resources were transferred to sub-national levels of the government, the state devised exotic taxations schemes, which would not be shared with lower-level governments. The public outcry over the collage of inefficient taxes that extract over 30% is reaching critical levels. In a simple consistency model, this paper shows that only by introducing a value added tax, an excise tax, and a retail sales tax with very broad bases is it possible to eliminate all existent indirect and cascading taxes and still have acceptable levels of the tax rates. The paper concludes by highlighting the additional difficulties that the Brazilian fiscal federalism imposes on successful tax reforms.