The Wall Street Journal-20080128-Americas- Tax-Happy Brazil Hits the Wall
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Americas: Tax-Happy Brazil Hits the Wall
Full Text (923 words)As Luiz Inacio "Lula" da Silva starts the second year of his second term as president of Brazil, he remains popular, with approval ratings of 50%. But those numbers were no help last month when he sunk serious political capital into a bid to renew the national financial- transactions tax. The effort went down in flames in Congress, where elected officials are finally waking up to the fact that the government can't squeeze the public forever.
The death of any tax anywhere in the world is good economic news, but in a country like Brazil it's only slightly less amazing than the fall of the Berlin Wall was to Eastern Europe. As the nearby chart demonstrates, the government's take of the fruits of private-sector production (GDP) is not only extraordinarily large in Brazil. This revenue grab is also highly correlated with the country's chronically anemic economic growth in the post-military-dictatorship period. If Brasilia is beginning to fear that tax hikes carry political costs, an epic shift may be under way.
This is not to say that the lumbering federal bureaucracy is about to convert to Irish-style economic liberalism any time soon. Factor in a constitution stuffed with state privileges and obligations and the power of entrenched interests in a country that remains insular, and expectations for change are best kept low.
However, the pushback against taxes does contradict the argument that Latin America's largest economy is going the socialist way of Cuba-Venezuela satellites like Bolivia, Argentina and Ecuador. Brazil, rather, is inching toward modernity despite the shackles of big government. The pity is the pace.
As disastrous as the tax defeat turned out to be for Lula, there is little mystery about why he pursued it. His side of the aisle is marinated in the same "equality" theory of economics that motivates the U.S. left. This special brand of populism holds that raising taxes on the most productive sectors of the economy is the way to satisfy government's unlimited appetite for more. They have cleverly dubbed this "pay-as-you-go" fiscal conservatism, while posing before television cameras as champions of social fairness. A more cynical view is that this is the school of old-fashioned caudillos, who cling to power by distributing patronage.
In countries where a sizeable part of the electorate is middle class and has more to lose than to gain from tax policies that punish economic aspirations, populist pandering eventually hits a wall. Proof of this is now on display in Europe, where lowering and simplifying taxes is currently in vogue.
Poor countries like Brazil are far more vulnerable to seductive offers from politicians who thrive on public dependency. Even as recently as a decade ago, Brazilian politicians resisting tax hikes were demagogued as elites taking food from the mouths of poor children. Today, however, there is a far better understanding among the public that tax increases on businesses are paid by consumers, not billionaire bankers.
If Brazilians are waking up to the problem it may be because, after years of wealth-destroying hyperinflation, monetary stability finally seems to have taken hold, doing wonders for the earning and saving power of millions. This, together with the global commodity boom, is producing an emerging middle class that is now asserting itself politically.
Dissatisfaction with government is already running high because of a string of corruption scandals that have damaged not only Lula's Workers' Party but also the Social Democrats. Now, the public discussion about taxes is highlighting the fact that the government's propensity to gobble knows no limits. In 2007, the economy grew at 5% while federal tax collection jumped 11.1% in real terms. From 1988- 2007, real GDP grew at an annual rate of 2.5% -- while taxes as a percentage of GDP grew at 4.8% and the tax burden per capita grew at 3.3%.
High rates, though, are not the only problem on the tax agenda. A study last year by the World Bank found that it takes a Brazilian company 2,600 hours to fully comply with the tax system while even in red-tape India it takes only 271 hours. Over half of Brazil's "tax time" is spent on administering a consumption tax that companies have to collect for the government.
The complexity of the tax system is no accident. It serves a political purpose: Every complication in the code produces multiple government jobs and at least as many opportunities to grant special favors for a price. This means that simplifying the code is likely to lower overall corruption -- but it also means that efforts to simplify are likely to meet with significant resistance.
A more fundamental problem is that the Brazilian left still doesn't grasp the concept that lower rates and a less-convoluted tax code would raise the incentive to work and to comply, and therefore would be likely to produce higher government revenues. Fearing a loss of income from the failure to renew the financial transaction tax, the Lula government is now floating another tax idea -- this one raises taxes on the financial sector.
Happily, it too is facing opposition. If nothing else, Brazilians seem to have hit their limit in tax tolerance. Cutting taxes may not be on the horizon yet, but the political class clearly senses that tax hikes are now unpopular and probably costly at the ballot box. The opposition is eager to make taxes an issue in this year's important municipal elections. Lula's critics are already reminding voters that the president has broken his earlier promise not to raise taxes. Anyone for a tea party?
