Brazil: A Debate Out of Focus

The debate on postponing the tax on financial transactions (CPMF) is out of focus. In the current scenario, we do not recommend the elimination of such tax. The key issue should not revolve around whether the tax should be renewed or not but on how to control and consciously allocate public spending.

A drawback of the CPMF is that it triggers double taxation. A positive aspect is that the tax has low costs of collection. Indeed, this type of tax tends to be progressive because the rich usually make more financial transactions than the poor. All in all, its costs are greater than the benefits, and in an ideal tax structure the CPMF could participate with a small rate of 0.08%. However, the CPMF is not the only ‘ugly duck’ of our fiscal structure. Indeed, the structure is a ‘real monster’ and it does not help to embellish it without attacking its original causes.

The key aspect is that Brazil’s vulnerability is linked to the increase in public expenditure. For decades, public spending was financed by the inflation tax. After the Real Plan, spending started to be covered by debt and increasing taxation. The Fiscal Responsability Law, approved in 2000, imposed discipline to the state finances. The law, however, did not constraint the Federal government. In turn, expenses (excluding interest) have increased by 0.58% of GDP per year, in the last five years (as displayed in the chart). There are two strong reasons as to why the increase in government spending will be preserved. First, the government has already announced an increase in current expenses for 2008. Second, social security spending shows a steady structural upward trend. Reforms have been set aside (or even posed as a minor goal) and the new economic team is arguing for more spending to be allocated in infra-structure without spending cuts in other areas.

The tax burden in Brazil increased from 25% in 1990 to 36% in 2006. Nobody denies the negative aspects of such burden, which chokes the private sector. But returning to the former inflationary public deficit financing would be even worst. Given the amount of expenses, it may not be feasible to substitute the CPMF revenues (estimated in R$ 36bn or US$18 bn for 2007) for an increase in indebtedness or for another type of tax. The first option (greater indebtedness) challenges the current macro stability and tends to increase the debt (that so far has displayed a declining trend). The second choice (increase another type of tax) has a high probability of exchanging one bad tax to a worse one. In brief, there is no alternative besides the CPMF renewal at the same tax rate. The formal arguments that the tax was originally created as a temporary one and that the government has other sources of revenues to substitute for the CPMF are arguments without any economic rationality and ignore current budgetary constraints.

In order to decrease the tax burden without risking the macro stability we need to start a serious debate on the size and efficient allocation of public spending. Should Brazil spend more in education and health care or in retirement, that already respond for 12.5% of GDP? Should it allocate more resources to non-profit organizations or invest in infra-structure? Should it increase the spending with public sector employees or improve their efficiency? Should Brazil grant free college education for those who can afford to pay or invest more on research? In this debate it is imperative to include the ‘invisible subsidies’ that are not formally in the budget but increase public debt and therefore interest expenses.

A good example of a hidden expense is the financing extended by the Brazilian Development Bank (BNDES) to some private companies at a subsidized rate, known as long term interest rate (TJLP). Between June 2006 and 2007, the average balance of these financial operations reached R$ 111 bn (US$56bn). In the same period, the short term interest rate (Selic), equivalent to the Federal Funds rate, was 5.86% above of the long term interest rate (TJLP). In other words, in twelve months these transactions transferred R$ 6.6 bn (US$3.25 bn) to the borrowers. This amount corresponds to 70% of the total spending allocated to the Bolsa Familia (a social, minimum income program) for the whole year.

What is reason for such a subsidy, especially considering that we have a fairly developed capital markets where large companies can raise similar amounts of money? Primary offers of shares in the Sao Paulo Stock Exchange have reached R$32 bn (US$ 16bn) in 2007, until July. Such amount is greater than the amount of BNDES loans extended in the same period. Why should the government subsidize some companies and not others, which add similar or more value to the economy? Why some are protected and insulated from markets, while others have to follow the strict governance rules required by the stock exchange? Why do Brazilian citizens have to pay for the subsidies granted by the BNDES when similar resources can be extended by private investors under competitive conditions?

Unfortunately, nobody is interested on transparency or in any serious discussion regarding controlling and allocating public spending. For the special interest groups, the best is to leave everything the way it is. In the absence of transparency and in the world of fairy tale, the best is to renew the CPMF for three more years. It is worse eliminating it than keeping it.

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Originally published by Valor Economico and translated to English by RGE monitor.

One Response to "Brazil: A Debate Out of Focus"

  1. Lellis   September 13, 2007 at 5:05 am

    Prof. Haddad, The recognition of what you call invisible subsidies has never been properly discussed in Brazil, and the reason for that is the political power of those special interest groups that you mention. Giving names, I would put in first place FIESP. This group has for years and years played a role that has been most damaging to the efficiency of the Brazilian economy. This tipe of pressure groups have dominated the political process, although they like to look like they are opposition, and are the main obstacle to any serious effort of a tax reform.