Changes to income tax could reduce inequality in Brazil, experts say.

Bruno de Freitas Moura, reporter for Agência Brasil - The bill (PL) that provides for income tax exemption for those earning up to R$ 5 and taxation for people who receive more than R$ 50 per month, if approved by the National Congress, brings Brazil closer to the tax system of more egalitarian countries, such as France and Germany. This assessment comes from Clara Zanon Brenck, professor of economics at the Federal University of Minas Gerais (UFMG).

"More egalitarian countries, such as the most developed in Europe, tend to tax in a more progressive way. By making this change, Brazil will move closer to those countries," he told Agência Brasil.

Last Tuesday (18), President Luiz Inácio Lula da Silva submitted the PL to Congress. In addition to exempting workers who earn up to R$5 per month from income tax, the text creates tax discounts for the range between R$5 and R$7.

Conversely, the proposal creates a tax bracket for individuals with annual incomes exceeding R$ 600 – an average of R$ 50 per month. This tax on the wealthiest provides what experts call fiscal neutrality; in other words, what the government will forgo in revenue from lower-income individuals will be offset by taxing the rich.

According to the Ministry of Finance's calculations, 10 million Brazilians will stop paying income tax, representing a projected tax waiver of R$ 25,84 billion.

This amount will be offset by tax collection from 141,3 people. The income base for these taxpayers will include currently exempt income, such as dividends (distribution of company profits).  

According to the Treasury, nine out of ten Brazilians who pay income tax will have total or partial exemption. Of those who file income tax returns, more than 26 million (65%) will pay nothing. Taxation on high incomes will affect 0,13% of taxpayers and 0,06% of the population.  

Tax justice Economist Clara Brenck explains that tax fairness is the idea that “those who earn more will pay more in proportion to their income.”

She explains that if someone earns R$5 and pays R$500 in income tax, that represents 10% of their income. If someone who earns R$500 pays R$50, that also represents 10%, and this is a case of tax injustice.

“You have people paying the same amount of tax, regardless of their income,” points out the professor, who is also a researcher at the Center for Research in Macroeconomics of Inequalities (Made) at the School of Administration, Economics and Accounting (FEA) at the University of São Paulo (USP).

According to her, alongside income distribution policies, tax justice is a "very important" element in reducing inequality in a country.

Top-level charge - According to the professor, the proposed changes are moving towards reducing inequality, but they are still not enough. Made's calculations indicate greater effectiveness if the tax rate for the wealthy were closer to 15%. This would ensure that the wealthiest and the majority of the population who pay taxes would feel the same effective tax burden in their pockets – what a person actually pays in taxes in the end.

In defending the proposal, Finance Minister Fernando Haddad has demonstrated that the effective tax rate for the middle class is around 10%.

“The great merit of this proposal is that it opens an avenue for us to discuss tax justice,” Haddad said on Thursday (20), in an interview with the Bom Dia, Ministro program, broadcast by Canal Gov, from Empresa Brasil de Comunicação (EBC).

Professor Brenck believes it's appropriate to set a minimum income of R$50 per month as the target of progressive taxation, but she believes they aren't necessarily the super-rich. "We can't call them super-rich," she says, before adding: "It's more than fair that these people start paying more and progressively increasing it."

Another factor preventing greater equality, says the UFMG professor, is indirect taxation, which forces consumers to pay taxes when purchasing products and services. This results in low-income people paying, proportionally, more taxes than the wealthy.

Clara Brenck states that the first part of the tax reform, which unified taxes and had its regulations sanctioned at the beginning of this year, did not solve the problem because the two issues were treated separately.

"From the moment you separate the indirect reform from the income reform, you maintain the proportion of the indirect reform in the total tax burden, and that's the problem," he assesses.

"We had to change the composition of how much [of revenue] comes from direct income tax and how much comes from indirect income tax. By implementing the two reforms separately, you can't change the proportions," he adds.

The economist also advocates adjusting the value of the income brackets subject to taxation for inflation over time. "To continue reaching the income brackets we want. What we call the super-rich today will be different in 10 years."  

Income inequality In Brazil, the income of the richest 10% is 14,4 times higher than that of the poorest 40%, according to the Brazilian Institute of Geography and Statistics (IBGE). Efforts to reduce inequality are one of the government's key objectives in convincing Congress to approve the bill.

"We are among the ten worst income distributions in the world. That's what we have to explain to society. Brazil is among the ten countries with the worst income distribution in the world," Haddad stated on Bom Dia, Ministro.

"There are many wealthy people who agree with social justice. Just because someone has a wealthy income doesn't mean they won't vote for a fair project. You can be sure that many people there [represented in Congress], business owners, farmers, will vote for this project because they know it's fair," he hopes.

Processing - The text submitted by the government to Congress will come into effect if it is approved by the Chamber of Deputies and the Senate. In this case, the text may be subject to amendments by lawmakers.

The Speaker of the House, Hugo Motta (Republicans-PB), said that Congress will have the sensitivity to consider the social impact of the proposal, but did not rule out changes to improve the measures.

João Leme, an analyst at Tendências Consultoria, told Agência Brasil that the bill "can be considered an advance in terms of tax justice" and correct some distortions inherent in Brazilian dynamics, such as the fact that the wealthiest strata have most of their income exempt, as in the case of dividends.

But he warns that there is a risk that Congress will not approve the part that deals with taxation of the richest.

"There's a risk that these fiscal counterbalance mechanisms could end up being diluted or eliminated during the legislative process, which would make the measure a shot in the foot, given that the fiscal cost wouldn't be properly equalized, increasing fiscal uncertainty, damaging expectations, and complicating the government's fragile political and economic balance," he analyzes. "The expectation is that the government's coordination teams will push for the maintenance of these counterbalances."

Extremes of the social pyramid - Researcher Marcos Hecksher, from the Institute of Applied Economic Research (Ipea), an agency linked to the Ministry of Planning and Budget, believes that the most important and challenging part of the bill is to make those who earn more than R$50 per month on average start paying more taxes.

For him, making taxation more progressive, without so many exemptions and tax breaks for the wealthiest, is essential for reducing inequalities, in a way "that allows the country to fulfill one of its fundamental objectives established in Article 3 of the 1988 Federal Constitution, which is to reduce social and regional inequalities."

Hecksher, an expert on income inequality, warns that the government's proposal directly benefits "those in the middle of the income distribution, not those at the bottom." He therefore draws attention to the portion of government budgets dedicated to income transfer programs, such as Bolsa Família.

“The reduction in income inequality achieved from 2001 to 2014 was largely concentrated on increased public spending aimed at the poorest,” he says.