Will Brazil raise taxes in 2017?

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Despite President Michel Temer’s growing challenges regarding the ever-present threat of the Lava-Jato corruption scandal, Brazil’s much lauded fiscal adjustment continues to progress. Having passed legislation creating a federal spending ceiling in December, Temer now has his sights set on approving a large pension reform measure sometime in the first half of this year.

Nonetheless, due to the nature of this specific fiscal adjustment, companies operating in Brazil should be concerned about the potential of meaningful increases to their tax burden in 2017.

Deficit targeting and the need for new tax revenue 

The end goal of Brazil’s federal spending ceiling and pension reform measures is to place the country’s debt-to-GDP ratio on a sustainable path, while also helping to drive higher business confidence in the market and thus generate renewed economic growth.

Due to the mechanisms being applied (a freeze of federal spending in real terms for 20 years, and a phased-in adjustment of pension obligations), Brazil’s fiscal adjustment will be a gradual one. Therefore, to hold itself accountable and generate greater business confidence in the short-term, the Brazilian government has set itself a series of deficit targets. 

In its recently released yearly budget for 2017 (which includes expenditure and revenue estimates), the Brazilian government is targeting a deficit of 2% of GDP, following a shortfall of approximately 2.5% of GDP in 2016. The issue, however, is that the revenue estimate for 2017 made by Brasilia is overly optimistic. Because of one-off revenue measures realized in 2016 that will not be repeated in 2017 (asset sales and revenue from the repatriation of capital held abroad), and due to the downside risk to headline economic growth (lower economic growth reduces government tax revenue), the government is likely to fall short of its revenue targets.

Indeed, this is exactly what occurred in both 2015 and 2016, when the government was forced to cut expenditure and adjust its deficit target on several occasions as it realized tax receipts were falling short. Nonetheless, after cutting investment expenditures by 50.1% * over the past two years, and with a rigid federal budget that provides little room for reductions in other spending categories, the government would be left with little recourse this year but to resort to raising taxes or creating new revenue measures.

Possible new tax measures

The budget shortfall for Brazil in 2017 anticipated by FSG is above $R55 billion, meaning simple marginal tax hikes would likely be inefficient to close the gap. In that case, the government may very well be obliged to reintroduce the CPFM levy (Provisional Contribution on Financial Transaction), a tax placed on financial transaction that was last utilized by the Fernando Henrique Cardoso government. While the tax falls on all banking transactions, the ultimate effect would be to raise prices for consumer products, which in turn would further hinder a recovery in private consumption that FSG anticipates to be weak (FSG forecasts real private consumption growth of 0.2% in 2017 and 1.8% in 2018).

Signposts to watch 

For executives updating their scenarios around their anticipated tax burden in Brazil for 2017, key signposts to watch involve factors that will ultimately affect the federal government’s total revenue during the 2017 fiscal year.

  • GDP forecast revisions: Downward revisions to the 2017 forecast in the first half of the year would push the government to subsequently revise down its revenue targets, and thus either adjust its deficit target (negative for business confidence) or raise new tax revenue. The budget as it stands today assumed growth in 2016 at 1.6%, FSG is currently forecasting growth at just 0.8%
  • Revenue from second round of capital repatriation: The government has announced that it intends to pursue a second round of permitted capital repatriation, however, the expected revenue (R$ 13.2 billion) is much lower than during the first round. If the captured funds surprise to the upside, this mechanism could relieve some of the government’s immediate funding pressures
  • Monthly government deficit reports: Watch the government’s monthly reports on income and compare against expected revenue – significant underperformance would signal an earlier need for the government to either adjust its deficit target (negative for business confidence) or raise new tax revenue 

While FSG’s base case is for the government in the very least to raise tax rates on existing revenue measures, multinationals can look to offset these negative effects by pursuing opportunities presented by economic relief measures being introduced by the Temer administration. Such opportunities include demand created by the government’s announced new infrastructure tenders, and eased financing conditions for companies and consumers driven by Temer’s recently announced package of microeconomic policy measures. 

*This figure represents an estimate based off available federal budget statistics released through November 2016

***Deficit for 2016

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