States, municipalities to face losses with cap on sales tax

The cap for sales tax ICMS rates on certain items, as proposed by the Chambers of Deputies and approved on Wednesday, may reduce inflation projections in the short term by 1 to 1.5 percentage points, while generating revenue losses for states and municipalities of R$65 billion to R$70 billion per year, especially as of 2023, economists estimate.

The current measure goes against what is done in most parts of the world, say some specialists, especially when it comes to fossil fuels, which usually suffer higher taxation.

Deputies approved a bill defining fuel, electricity, natural gas, communications and public transportation as essential goods and services, implying that they would have a 17%-18% cap for ICMS collection. Today, states usually apply rates as high as 30% on these items, especially fuel and energy.

The eventual impact of the measure on prices will depend on the rate charged by each state, but the governing coalition expects a reduction in gasoline, gas cylinders and electricity bills before the October election. “It is the latest attempt by Brasília to ease inflation after another bill to reduce the ICMS tax on diesel prices did not yield the expected results,” said Roberto Secemski, Brazil economist at Barclays.

On Tuesday, even before the decision at the Chamber of Deputies, J.P. Morgan added the possibility of the bill’s approval to its scenario and reduced its projection for benchmark inflation index IPCA in 2022 to 8.7% from 9.1%. “Considering an 80% pass-through to final consumers, we estimate that the gasoline tax cut reduces this year’s IPCA by about 40 basis points [0.4 percentage point]. For energy, we assume a 100% pass-through, as this price is controlled at the consumer level, which would reduce this year’s IPCA by about 30 basis points,” wrote economists Vinicius Moreira and Cassiana Fernandez.

The justification for the project among politicians is that states and municipalities have fiscal space and “surplus” cash. Ítalo Franca, an economist at Santander, notes, however, that the revenue of the states has risen by cyclical factors, such as high oil prices and high inflation. “When the disinflation process comes, revenue tends to fall,” he said.

In addition, expenses are normalizing, increases for civil servants have already been granted, but if inflation remains high, the pressure for increases ahead is likely to continue. “This can cause problems for the states’ accounts. In the broader picture, this revenue tends to fall. If the government wants to reduce taxes, I think it is positive, the tax overhaul is one of the focal points, but they cannot let mandatory expenses grow,” the economist said. “We contract a problem for one, two years from now. We are postponing it.”

Felipe Salto — Foto: Wenderson Araujo/Valor

Felipe Salto — Foto: Wenderson Araujo/Valor

If the states get into a tight spot further down the road, however, the problem returns to the federal government, notes the economist, as they need to enter government support schemes. Felipe Salto, secretary of Finance of São Paulo, said that the bill may reduce by R$0.10 to R$0.12 fuel prices in the pump, but the reduction will be rapidly offset by the effect of high oil prices driven by the war in Ukraine. According to him, the state will lose R$8.6 billion a year with the measure.

Fuels, electric energy, and telecommunications represent 31.7% of the states’ total ICMS collection, according to data from the National Council of Finance Policy (Confaz) organized by economist Sergio Gobetti, a specialist in public accounts.

“There is a high chance of litigation of this issue,” Citi comments in a report. “As this is an election year, it is not yet clear whether states would raise taxes on other goods to offset the negative impact of this bill on tax revenues.”

Although, in theory, there is fiscal space for the measure, Gabriel Leal de Barros, chief economist at Ryo Asset, says the ICMS is a tax with many problems and the focus of Congress should be on more structural solutions, such as the approval of the dual value-added tax – a single value-added tax encompassing the federal collections and another for state and municipal collections. Mr. Gobetti says that with the creation of the Tax on Goods and Services (IBS) in the model of a VAT, the tax overhaul is the best solution to standardize the tax burden on goods and services and end some distortions that exist in the ICMS.

Source: Valor International

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