IN 1967 THE BRAZILIAN STATES abolished the heterogeneous turnover taxes that they had levied for 30 years and replaced them with a unified sales tax of the value-added type. The reform was designed to overcome the defects of turnover taxation and to secure a greater degree of tax coordination among the states of the Federation.
The transformation of the state turnover levies into value-added taxes (VAT) was part of a comprehensive tax reform effort in the 1960s that sought to improve and modernize the entire Brazilian tax structure. Over the years, the antiquated and inelastic tax system had constituted an increasingly less efficient and more burdensome instrument of government finance. One of the major objectives of the tax reform was to remove some of the economic distortions that were magnifying the pressure of the tax system on the economy out of all proportion to actual yields.
At the state level, the emphasis was on eliminating the distortions in the allocation of economic resources caused by the turnover taxes. In the search for an alternative form of sales taxation, the choice fell upon a value-added measure, rather than a single-stage tax. There were several reasons for this choice. It reflected, to a large extent, the appeal of the VAT as neutral with respect to methods of production. The case for adopting the value-added method of collection, which spreads the tax over the various stages of production and distribution, was reinforced by the expectation that serious enforcement difficulties would arise if a single-stage tax were to be used to raise the large amount of revenue required by the state governments. Another important factor was the implicit decision to achieve an interstate allocation of the tax base governed essentially by criteria of origin rather than of destination, as would have been true, for instance, if a retail sales tax had been chosen. The current trend toward centralization of power in the hands of the Federal Government simultaneously played a part in the selection of a measure that would require a high degree of interstate coordination and leave only limited scope for independent state policies.
The Brazilian experience is of interest both as a case study of the VAT in a developing country and as an illustration of the problems posed by interstate tax coordination in the special setting of a federation characterized by huge regional disparities. The purpose of this study is to describe, analyze, and evaluate the Brazilian tax against the background provided by these broader issues.
Miss Guerard, economist in the Tax Policy Division of the Fiscal Affairs Department, is a graduate of Bryn Mawr College and of Columbia University. This paper is adapted from the author’s unpublished doctoral dissertation, submitted to Columbia University in 1972. The study developed out of the author’s participation in the Brazilian Development Assistance Program of the University of California at Berkeley during 1967-70. The author wishes to acknowledge her indebtedness to Professor Carl S. Shoup for his many helpful comments.
Ministry of Finance, Secretaria da Receita Federal and Conselho Técnico de Economía e Finanças.
Ministry of Finance, Secretaria da Receita Federal.
Ministry of Finance, Conselho Técnico de Economia e Finanças, and State Treasury balance sheets.
In addition, 80 per cent of the proceeds of a rural land tax, levied by the Federal Government, is returned to the municipal governments, but the revenue is quite small.
The higher rate prevailed in the State of Amazonas, where the tax was levied only on the first sale.
Fundação Getúlio Vargas, Comissão de Reforma do Ministério da Fazenda, Reforma Tributária Nacional (Rio de Janeiro, 1966).
In effect, producers in low-tax states enjoy a degree of protection in local markets because of the tax differential, as well as some subsidization of their exports to other states in the Federation.
Reforma Tributaria Nacional (cited in footnote 6), p. 49 (in Portuguese).
In this connection, a recommendation by the Canadian Royal Commission to shift the federal sales tax in Canada from a manufacturers’ to a retail levy, to be combined with the existing provincial retail sales tax, encountered a major obstacle: the fear of public reaction to the 15 to 18 per cent rate that would have been necessary to raise the required amount of revenue. See John F. Due, Indirect Taxation in Developing Economies: The Role and Structure of Customs Duties, Excises, and Sales Taxes (Baltimore, 1970), p. 124.
The argument that conditions in retailing do not permit the use of a retail sales tax does not apply as strongly to a VAT extended through the retail stage, since with the VAT the largest potential for evasion and fraud is the retailer’s margin—the tax on earlier stages having already been collected from the production and wholesale sectors.
The tax harmonization program of the European Economic Community (EEC) calls for the removal of fiscal frontiers and for a move to the origin principle in trade within the Community, but this step has been left for a later stage. Meanwhile, the EEC countries continue to apply the destination principle in their trade with countries both inside and outside the Community.
See Clara K. Sullivan, The Tax on Value Added (Columbia University Press, 1965), Chapters 1 and 4, for an excellent review of this topic and the various theories of business taxation that have been offered in support of this viewpoint.
See, for example, Carl S. Shoup, Public Finance (Chicago, 1969), pp. 250–51; Due, op. cit., pp. 124-25 and passim.
A detailed analysis of the characteristics of the VAT and its three basic variants—the gross product type, the income type, and the consumption type—can be found in Shoup, op. cit., pp. 250-66, and Sullivan, op. cit., Chapters 1 and 5. A succinct examination of its main features also appears in the Richardson Report, Report of the Committee on Turnover Taxation (Cmnd. 2300, London, March 1964).
Until 1968, the French VAT stopped at the wholesale level. Separate taxes were levied on retail sales (by local governments) and on services.
This is the so-called invoice, or tax-credit, method of computation. The other possible methods of computing a VAT are described in the basic reference works by Sullivan and Shoup, cited in footnotes 12 and 13.
The ICM was not charged on imports originally. The value of imports, nevertheless, was automatically included in the importer’s tax base upon resale in the domestic market, so that the exemption was effective only for goods imported directly by the final consumer. Imports have now (in principle) been made subject to the tax, but registered ICM taxpayers may import raw materials and supplies in suspension of tax for further processing. Capital goods are generally exempt (see the section, Industrial machinery and equipment).
Self-deliveries are taxable in all the European VAT systems. In the Brazilian tax, the position is not to tax them, thereby avoiding difficult valuation problems. Credit is denied, of course, on tax paid on purchases of raw materials and other goods set aside for private use, or utilized for purposes not connected directly with an enterprise’s ordinary business.
In transactions between dependent firms, the actual point of collection and accurate valuation do not make any difference to the final total VAT bill. The Brazilian approach to integrated business concerns, however, is motivated by considerations of interstate allocation of revenue. For the valuation rules, see the section, Taxable price.
The Brazilian states, having operated turnover taxes for 30 years, were experienced in the handling of large numbers of small taxpayers. It was not deemed necessary, as a result, to grant an exemption for small enterprises, as was done under the VAT in several European countries. In the retail sector, however, small firms are assessed under a forfait (estimate) system, which was already a feature of the earlier turnover levy (see p. 152).
It is 5 per cent on most services, 10 per cent for entertainment services (Federal Complementary Act No. 34, Art. 9, January 30, 1967).
All the European value-added levies tax services to some extent. In the EEC, it was decided that the member countries would be required to tax at least those services that are likely, as business inputs, to have a significant impact on the price of goods and other services. The inclusion of personal services remains optional and varies from country to country. The list of activities subject to the separate Brazilian service tax is as comprehensive as that of the services included in the scope of the VAT by most European countries. Furthermore, there are no socially minded exemptions: both health and education services are within the scope of the tax.
Financial institutions are normally excluded from the scope of the VAT because of the technical difficulties involved in defining the tax base when the tax-credit method is used.
In the European VAT systems, the treatment of transactions relating to immovable property varies widely. Arrangements are usually made to allow for the transfer of some tax credits to the business purchasers of buildings.
The credit against the minerals tax, which is normally levied at the rate of 7 per cent, is prorated between the ICM and the federal sales tax on manufacturers, with 90 per cent of the payment allowed as credit against the ICM. This corresponds to the percentage of the revenue from the minerals tax that is returned by the Federal Government to the state of origin.
For further discussion of the treatment of manufactured exports, see the sections, Exemptions and rate concessions and Tax credits.
Many of these rate concessions were granted partly because of federal government pressures. The exemption of agricultural exports in São Paulo also had an impact on the policy of neighboring states. The cotton export trade in Paraná, for instance, was faced with a major upheaval after the exemption of cotton exports in São Paulo. Paraná eventually cut its tax on cotton exports by 50 per cent.
See the section, Tax credits.
These schemes provide for a tax credit for approved investments in the northeastern and Amazon areas of up to 25 per cent (formerly, up to 50 per cent) of a firm’s federal corporate income-tax liability.
Credit is allowed, however, for the minerals tax; see the section, Other exclusions.
Interstate Covenant No. 7/71, May 5, 1971. The agreement provides for refunds “in cash or securities.” The prior-stage tax-credit provision is to be put into effect gradually, with only 30 per cent of the prior-stage tax eligible for offsetting against other liabilities or refunds in the first year, 40 per cent in 1972, 70 per cent in 1973, and 100 per cent by 1974.
A case in point is the problem that was faced, in this connection, by the castor-oil industries in the States of Pernambuco and Bahia, which work mostly for the export market. They were denied credit on their purchases of castor beans. The State of São Paulo allowed full credit. As a result, the major firms began to close down their northeastern plants and to concentrate their operations in São Paulo, until Pernambuco took the step of exempting castor beans from the tax and Bahia granted them a rate reduction of 50 per cent. Castor beans were finally declared exempt from the tax throughout the country by an interstate covenant signed in January 1970.
“O Produto Agrícola Segundo Tipos de Pagamento aos Fatores,” Revista do Banco Nacional de Desenvolvimento Económico (1966), pp. 43-59.
Undervaluation through administrative use of a deliberately low price base for agricultural products is likely to be much more significant, in fact, but a great deal of the loss would be recouped at the processing stage.
Fundação Instituto Brasileiro de Estatística (IBGE), Produção Industrial. 1966 (Rio de Janeiro, 1969).
In the agricultural sector, the adoption of the ICM in 1967 coincided with a period of bumper crops, which at least temporarily may have created the supply conditions for some backward shifting of the tax. In real terms, farm prices after taxes fell considerably in 1967.
The substantial increase for the western region is due mostly to the fact that it was decided to provide revenues for the Federal District by allocating to it all the proceeds from the compensating tax on wheat imports (a federal monopoly), regardless of the port of entry. This has provided the major source of income for the capital, exceeding by far what could be levied on value added in the District itself.
This point is made in Shoup, op. cit., p. 217. The argument is that low-income households do not normally buy products in a form or at a location that embodies expensive marketing services. It would seem to have particular validity in less developed countries, where the basic needs of low-income groups are met in a very rudimentary fashion, while the middle and upper classes are becoming accustomed to a standard of living that embodies all the trimmings associated with the distribution system of the developed economies—credit, advertising, etc.