Brazilian tax reform: cashback as a mechanism to reduce tax regressivity

In furtherance of a series of articles by VRMA Advogados outlining the recent Brazilian tax reform, one may remember that on July 6 2023, the Lower House of Representatives approved Constitutional Amendment Bill (PEC) No. 45/2019 (PEC 45). The tax reform focuses on goods and services taxation, especially on the replacement of consumption taxes with a dual VAT (CBS – federal VAT, and IBS – states and municipalities VAT). Some specialists say that it has the political strength to be definitively approved soon.

From a global perspective, this reformist phenomenon can be seen as a maturation of consumption taxation models, as a result of the quest to keep up with technological innovations, but also to try to solve the insufficiencies of past models. Comparisons can be made with other developing countries, such as India, which in 2016 approved a goods and services tax model that intended to simplify consumption taxation through the reduction of tax types.

This article will analyse an issue that is debated globally when consumption taxation is discussed, tax regressivity. Beyond that, the cashback mechanism will be discussed as a tool to deal with this issue, and its capacity to boost the domestic consumer market.

The Brazilian tax system was built up on a decentralised basis, with milestones in 1891 and 1965.

The 1891 Constitution adopted, without major modifications, the composition of the tax system existing at the end of the Empire. However, in view of the adoption of the federative regime, it provided the states and municipalities with revenues that would allow them financial autonomy.

The tax reform of 1965 modernised sales tax, replacing it with a tax on the circulation of goods, which was levied on added value. Taxes and rates were increased, with an emphasis on federal taxes. Today, several taxes affect consumption, in a fragmented and decentralised way.

Thus, a range of taxes is levied on the consumption of goods and services, although none does so exclusively. Inputs, production, sales, transport, the sale of goods and the provision of services are taxed in a fragmented manner. The system is said to be fragmented in relation to the distribution of tax powers among the federal entities, as well as fragmented in the sense that there is almost no concern regarding the global tax burden of this indirect taxation.

The tax system, therefore, aims to tax final consumption, but focuses on the intermediate stages of the formation of goods and services.

This taxation system does not reflect the real economic features of consumers (or does it, but too roughly) but is based on practical criteria for public administration. This is because the taxation of consumption has the peculiarity of indirectly reaching the consumed income of taxpayers (since the tax is commonly included in the price of goods and services consumed).

Comparing indirect taxation (consumption taxes) to direct income taxation, the latter can be seen as allowing a more equitable distribution of the tax burden, as it is easier to take into account taxpayers’ ability to pay. This is because direct taxes are charged on economic proxies which are subjective; they are proxies of the taxpayer, while indirect taxes are charged on facts which are objectively proxies of ability to pay, with no subjective consideration of the taxpayer.

Indirect taxation, in general, aims to tax consumption in several stages, which makes taxation based on consumer characteristics hard to be applied. This results in a regressive system, where consumers with less ability to pay spend a greater proportion of their income in consumption and, thus, a greater portion of their income is subject to consumption taxes.

In light of the above scenario, from which undesirable economic effects such as regressivity arise, one must take into consideration the proposals to build a more appropriate consumption taxation system, in particular the tax refund mechanisms for those on a low income that are set forth in PEC 45.

PEC 45, in short, seeks to simplify and rationalise taxation on the production and sale of goods and services, consolidating the taxes in CBS and IBS. The original text of PEC 45 proposes a partial refund of the tax collected from low-income taxpayers through income transfer mechanisms. The revised wording features modifications, allowing for the refund of IBS and social contributions, and changing the wording to focus the actions on the aim to “reduce income inequality” of "individuals" rather than "low-income taxpayers". This is a significant change to the wording, although seeking the same goal.

The tax refund will probably be implemented by means of the Brazilian tax ID number of the consumer under the Cadastro de Pessoas Físicas (the Natural Persons Register), linking the issued invoices to such register. The rate of the tax to be reimbursed would be determined based on the consumer's income in relation to the rate of progressive income tax. If the income tax rate is lower than the standard rate of VAT, then the difference would be refunded. In this context, it would be important to track the consumers eligible for a tax refund and to control the income consumed.

Despite these possible complexities, it appears that Brazil already has some institutions and mechanisms able to deal with this control, such as the so-called Cadastro Único (a register which gathers socioeconomic information about taxpayers) and electronic invoicing (a system for registering invoices used nationwide).

Practical examples that come close to the aforementioned model can be cited. In Brazil itself, there is the Nota Fiscal Gaúcha programme that refunds a portion of the current tax on consumption (up to a limit of BRL 400.00, or $82, per year) when it is paid to families with income of up to three minimum wages. One can also mention the very similar programmes implemented respectively in Bolivia and Argentina, the so-called Régimen de Reintegro en Efectivo del Impuesto al Valor Agregado and the Régimen de Reintegro a Sectores Vulnerados.

As shown, PEC 45 has presented an alternative to deal with regressivity. This alternative is, to some extent, innovative and therefore will require multisectoral efforts, necessitating the action of tax administration and social assistance bodies.

However, despite these difficulties, the initiative is appreciated, because markets with less regressivity are more efficient markets. In practical terms, this enhanced efficiency has great potential to generate a greater economic capacity of taxpayers, and consequently a possible increase in monetary flows, which can positively impact the domestic consumer market as a whole.

When the issue is analysed from the perspective of an economy that is heating up again, with a population of over 210 million people, the conclusion is that a decrease in regressivity could represent a great opportunity for the expansion of the services and retail sectors.