TAXATION IN BRAZIL
TAX COMPLIANCE COSTS: A NEW FIELD FOR RESEARCH
Conventional tax analysis has ignored an important criterion for evaluating the quality of tax collection models used around the world. Taxation studies begin with theoretical assumptions which are usually unsupported by economic reality, such as the presence of perfect competition, economic rationality, the absence of evasion, and negligible tax compliance costs. At the same time, analysts largely ignore the economic, cultural, ethical, moral, and operational environments in which tax collection takes place. An inevitable consequence is a conflict between intentions and results.169 Theoretical models are essential components in the construction of sound tax models. However, a disturbing fact is the failure of economists to realize that there is an abyss between their logical constructs and the reality of applied economics. Economists become prisoners to pure science, and the more innocent believe they can extend their “monoparadigmatic” prescriptions to reality170.
“The broadly based neutral VAT found in textbooks is quite different from the VAT prevailing in most developing countries, and this difference results largely from administrative constraints: in developing countries tax administration is tax policy.
Multiple VAT rates, zero-rating with refunds and numerous exemptions of specified goods can be accommodated only at high administrative and compliance costs”.171
A recent study conducted in Brazil by Aldo V. Bertolucci172 fills a significant gap in the study of taxation, and inaugurated in Brazil a new area of study and research– the analysis of tax compliance costs – which is also relatively new in the world. One of its most important mentors is Professor Cedric Sandford of the University of Bath, England. This field of tax study first appeared in 1988 at the International Fiscal Association Conference in Rio de Janeiro, followed by two congresses on the Cost of Compliance at Oxford (1994) and Sydney (2000).
According to Professor Cedric Sandford,173 politicians, tax administrators, and
169 Vito Tanzi, a former Director of the IMF Fiscal Department once expressed his surprise at noticing that many tax experts study tax models and theory, but very few dedicate their efforts to tax administration, implicitly assuming it to be a trivial problem. Such mistake, according to him, may turn a good tax model into a harmful system if in practice its application produces different results than were originally intended. See [BIRD and JANTSCHER, 1992].
170 A Brazilian economist, Antonio Maria da Silveira referred to this phenomenon as “Senior’s indeterminacy”. To construct theoretical models and try to apply them without due consideration to the complete environmental determinants of where they are to be applied is to incur in a “ricardian vice”, a term, according to him, coined by Joseph Schumpeter to describe the “habit of piling up a heavy load of practical conclusions over a fragile foundation…seemingly simple, attractive and also convincing”. See [COUTINHO, 2007] pp.169-184; [SILVEIRA, 1991, 1993].
171 [SHOUP, 1990], p.xiv; [JANTSCHER, 1990] p.178; and [SANDFORD and GODWIN, 1990].
172 [BERTOLUCCI, 2001, 2005].
173 [SANDFORD et alii, 1989], quoted by [BERTOLUCCI, 2001], p.30. On page 54, Bertolucci refers to Vito Tanzi’s opinion of the IMF, who “manifests surprise concerning the imbalance between the economists’ interest, on the one hand, for taxes and their repercussions on the economy, and on the other, their concern over the tax administration: many books have been written on the first subject,
economists have neglected the administrative and operational costs of taxation.
These costs should be taken into consideration in tax policy analysis, in addition to the usual considerations regarding equity, neutrality, and simplicity. In retrospect, Professor Sandford stated, “following Adam Smith, no one else referred to compliance costs (with the honored exception of McCulloch in his Treatise on Taxation, published in 1845), until 1935, when the first attempt was made to measure them. However, the author stated that it was not until the end of the 20th Century that the topic was given importance, at the Rio de Janeiro conference in 1988.”174
At the Oxford Congress in 1994, Professor Cedric Sandford listed reasons for the growing interest in tax costs:175
1. Compliance and administrative costs are high and they reduce international competitiveness;
2. Compliance costs have undesirable redistributive effects, are highly regressive, and severely burden small businesses;
3. High compliance costs create resentment and stimulate tax avoidance;
4. The high costs generated by the creation of VATs in several countries have led to protests and dissatisfaction on the part of small business;
5. The importance of deregulation in order to unburden small business;
6. The need to begin considering the taxpayer as a client and treating taxpayers in a friendlier manner;
7. In the early 1980s, some governments reduced their administrative costs, shifting them onto the taxpayer and increasing compliance costs; they soon discovered that the social tax cost had increased in their economy as a whole.
Certainly, research in this area will open new horizons in tax studies, broadening the list of critical variants used in evaluating, reforming, and planning tax systems throughout the world. These fields of study and research will at once enrich the debate and partially divert the focus of economic policymakers’ attention from where it is today, biased by the formalistic approach of economists, toward a position of greater equilibrium between theoretical-conceptual considerations and practical-operational experience. Economists must talk to tax administrators, and vice-versa.
Aldo Bertolucci has surveyed stock companies in Brazil, and gathered valuable information on their compliance costs.
Bertolucci says, that “compliance costs of taxation correspond to the resources
but almost nothing has been written about how to administer the receipt and control of revenue and of taxpayers”.
174 [BERTOLUCCI, 2001]
175 [BERTOLUCCI, 2001]
spent by a taxpayer to comply with tax legislation. Tax statements and reports required by federal, state, and municipal governments, filling of forms for federal revenue agencies, inclusions and exclusions defined by tax law, meeting auditing requirements and changes in legislation, lawsuits, as well as administrative and judicial processes…” represent a small portion of the total costs of taxation, because these are merely the monetary costs borne by companies in meeting their tax obligations. Other costs must be added to these, such as public operational and administrative costs borne by the three levels of government (federal, state, and municipal) and by their three branches (executive, legislative, and judiciary). One must also add the opportunity cost of time as well as the psychological costs imposed on the taxpayer, in addition to the imputed costs implied by economic distortions and by the loss of allocative and distributive efficiency introduced by taxes, as ILLUSTRATION 6 indicates.
ILLUSTRATION 6 Costs of Taxation
Source:[BERTOLUCCI, 2001], p.18.
Bertolucci’s findings are dramatic. The average total value of compliance costs to Brazilian stock companies accounts for 0.32 % of their gross income. In smaller companies, with annual sales of up to R$ 100 million, the cost is 1.66 % of their gross income. For all stock companies this cost reaches the equivalent of 0.75 % of GDP. Taking as reference the compliance costs of smaller stock companies alone, they represent 5.82 % of GDP, as can be seen in the TABLE 24.
Cost of taxation
Taxes Distortionary costs Operational Costs
Compliance Cost:
persons and firms
Administrative Cost:
Executive, Legislative and Judiciary branches
Direct Monetary Time Costs Psychological Costs
Temporary Costs Permanent Costs
This study was based on compliance costs for publicly held stock companies that are members of the Brazilian Association of Publicly Held Companies (Abrasca). The breakdown of their compliance costs, according to Bertolucci’s research, is found in ANNEX II. Such publicly held companies are usually large firms and, therefore, Aldo Bertolucci’s findings surely underestimate the overall compliance costs for all of Brazilian companies, given that tax costs are highly regressive in relation to sales volume.
TABLE 24
Compliance Costs for Publicly Held Companies in Brazil
Gross Income (R$ 000,000) Total gross income 154,194 3,736,199 19,631,366 24,610,181 48,131,840
Federal compliance costs 2,025 19,606 76,514 25,325 123,470
External compliance
costs 533 5,669 18,349 8,337 32,888
Total compliance costs 2,558 25,275 94,863 33,662 156,358
Projected cost savings in
case of stable Legislation 2.74% 9.27% 14.72% 27.28% 16.35%
Value-added (FIBGE) 14,240,294 54,215,096 70,918,307 80,764,772 147,362,174 Production Value
(FIBGE ) 49,964,749 150,951,175 183,381,330 141,571,928 341,787,174 Description Up to 100 From 100 to
The size classification used in the survey considered as “small businesses” those companies with annual sales up to R$ 100 million. According to the Federal Revenue, 72% of firms that pay the PIS (a kind of social security contribution), are registered under the Simple method of tax calculation (requiring, therefore, maximum annual sales of R$ 1.2 million), and 21% chose to report profits under the
“presumed profits” option (with maximum annual sales of R$ 24 million). These data indicate that the publicly held stock companies surveyed are large firms, at the
top of the pyramid, and they certainly represent less than 1% of Brazilian companies.176
It can thus be concluded that the overwhelming majority of Brazilian companies incur compliance costs that are higher than the corresponding 5.82 % borne by smaller Brazilian stock companies.
To calculate the overall cost of Brazil’s tax system, the administrative costs of tax collection to the government must be added to compliance costs borne by private firms and families. In centralized countries, which usually have simpler administrative structures, the ratio between public administrative costs and private compliance costs ranges from 1:2 to 1:4. Brazil is a federative republic, and has, therefore, an administrative structure that is more complex, with more decentralized taxation. Thus, the ratio can be conservatively estimated to be 1:3. It is easy to conclude that overall operational tax costs in Brazil are at least 7% of GDP.
Nevertheless, these estimates should be interpreted cautiously due to the lack of detailed empirical studies on the subject.
It is worth noting that international research indicates a strongly regressive relationship between corporate gross sales and operational tax costs. The Annals of the International Fiscal Association Congress held in Rio de Janeiro in 1988, point to this phenomenon as one of the most significant conclusions of research done in Canada and the United Kingdom. This is a source of great competitive disadvantage for smaller companies.177
Thus, despite that fact that operational tax costs in relation to average gross sales of domestic companies should be at levels between 1 and 2% of GDP, for most micro, small, and medium businesses – which account for 97% of Brazilian companies – operational tax costs and obligations take a hefty slice of production costs, over 7% of their value-added.
176 See testimony of Federal Revenue Service Secretary Everardo Maciel before the Special Committee on Cumulative Taxation on April 2, 2002. In that same public hearing, the secretary stated that the top five hundred Brazilian corporations account for 60% of all federal tax revenue, and that the top 2,500 corporations account for 80% of all federal tax revenue. Thus, it is clearly demonstrated that publicly held companies in Brazil represent a small portion at the highest percentile of gross revenue among Brazilian companies.
177 See [BERTOLUCCI, 2001] p.29. In Canada, the costs borne by small employers in collecting withheld income tax and social security taxes are 3.36% of gross income, whereas the costs for large employers represent 0.064%. In the United Kingdom, VAT collection costs are 0.78% of taxable income for small companies, compared to 0.003% for large companies. [HALL and RABUSHKA, 1995] mention that in the US during the 1993 fiscal year, income tax revenue reached US$ 625 billion, while compliance and administrative costs to raise that revenue reached US$ 385 billion, or 61% of that value.
ARGENTINA’S USE OF THE BANK TRANSACTION TAX (1984-1992)