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Brazil Country Update: The Vote Against the Provisional Tax

January 31, 2008

CPMF on Hold

In place since 1997, the provisional tax on financial transactions (CPMF) was considered critical for maintaining public finances. But spending policies are now being reevaluated. On December 12, 2007, Congress, led by a unanimous vote by opposition senators, chose against extending the CPMF, handing President Luiz Inácio Lula da Silva (Lula) one of his most significant political setbacks. Defeat of the CPMF—the most important piece of legislation in the government’s 2007 agenda—slowed momentum for political reform and the prospect of a broader tax reform in 2008.

The CPMF setback represents a 40 billion reais loss ($22 billion)—equivalent to 1.4 percent of GDP—and puts greater pressure on the federal government to reform social security and to reduce government spending, especially funds linked to civil servant benefits. According to the Ministry of Finance, approximately 45 percent of CPMF revenues had been dedicated to federal poverty reduction, with an additional 40 percent allocated to health care and 15 percent to social security administration benefits.

From a political perspective, the CPMF defeat stemmed from a lack of support from government-allied senators along with the Brazilian Social Democracy Party (PSDB). This reinforces one of the government’s central concerns in its second term: creating alliances. Political sensitivity at the state and municipal levels is likely to accompany the decreased revenues as governors struggle to address local impact while preparing for mayoral elections in October. In the Senate, the government’s greatest challenge is to rebuild its shaky parliamentary base.

Outlook and Implications

While Brazil’s fiscal revenues had been growing rapidly alongside strong economic growth, a fiscal shortfall is a possibility in 2008. As result, the government is now being forced to revise and make adjustments to the 2008 budget. The reality of such fiscal challenges may push the government to address long-standing fiscal problems, opening the door for renewed discussions on a more efficient and equitable tax system.

Early last month, the government unveiled an austere fiscal package to compensate for the R$40 billion revenue loss expected from the CPMF withdrawal. The package includes R$20 billion (US$11.3 billion) in spending cuts as well as R$10 billion (US$5.1 billion) in additional revenue from higher taxes on foreign exchange and credit card operations. Financial institutions would incur a 6 percent raise (to 15 percent) in income tax. As planned, the remaining R$10 billion would come from continued above-budget revenue performance.

The loss of the CPMF tax will directly affect the country’s Growth Acceleration Plan (PAC). For example, the R$4 billion expected increase in the health sector is now on hold. With that, new 24-hour emergency room units and hospital facility improvements are also suspended. Cuts are also expected in the Education Development Plan (PDE - Plano de Desenvolvimento da Educação), which initially had a R$12.7 billion budget.