In this scenario, some constitutional reforms have been made and others are expected to happen in the short run. This situation has raised a strong debate between those who support the new policies and those who want to guarantee the so-called acquired rights of the citizens and the "status quo". In a discussion where several groups of interests try to make their point, it is difficult for the average citizen to decide on what side to adhere.

My intention with this study is to acquire a better understanding of the facts related with the fiscal reform and with the so called " labor cost ", and to express my conclusions in an impartial basis. To establish a mean of comparison I will use the US tax system.

The work will be developed in the following sequence:

I - Tax system theory

II - Legal environment of Brazil and United States

III - Comparison of the Brazilian revenue with other countries

IV - Brazil’s Value Aggregate Tax (VAT) analysis

V - Labor cost in Brazil

Any government has to raise a certain amount of revenue to offset its liabilities. The basic problem of taxation is to define the appropriate set of tax instruments that produces this result and that can be administered at the lowest cost.

However, in a given economy any set of tax instruments is associated with a consumption pattern for each individual. In other words these choices will affect the distribution of society’s welfare and the distribution implications must be balanced against the efficiency costs of taxation.

Thus, it seems more relevant to study how taxes affect the way in which total income is distributed among people. Given information on what proportion of people’s income is from capital, land and labor, changes in the factor distribution can be translated into changes in the size distribution. For example, a tax that lowers the relative return on capital tends to hurt those at the top of the income distribution because a relatively high proportion of the incomes of the rich is from capital.

An important issue to be considered is that the overall tax incidence depends on how both the sources and uses of income are affected. For instance a tax imposed in a good could affect the uses side or how the money is spent, increasing the price for the consumers. It can similarly affect the sources side if the demand for the good decreases the producer’s receives diminish.

We are now going to describe the kinds of taxes that could be levied in order to rise the needed revenue for the government.

A uniform tax system, which could be thought to produce the fewer distortion of the relative price of goods, is in general not optimal. This fact could be explained by two means. First, as the elasticity of demand among goods differs greatly, the goods with high elasticity factor would suffer a greater decrease on consumption while in those with high inelastic behavior the effect would be minimized. Secondly, with a uniform tax on all commodities the relative price of leisure would decrease, causing an inefficiently large consumption of leisure.

So, the optimal tax pattern should take in account the demand elasticity and the relative substitutability or complementary of those goods with leisure (like for example bicycles, rollers, tennis rackets, etc.). But, if taxpayers have different endowments, then the optimal commodity tax structure must consider not only its efficiency cost, but also its effect on the distribution of welfare. Not surprisingly, in this case the optimal tax on luxury goods is higher than otherwise and the optimal tax on necessary goods is lower than otherwise.

The lump sum tax can be defined as a certain amount that must be paid regardless of the taxpayer’s behavior. Consequently, this tax does not depend on consumption and no taxpayer can avoid paying it. As the lump sum tax represents a diminishing in the tax payer income by a certain value, it does not affect relative prices in the economy.

An important result from this tax is that the revenue yield equals its equivalent variation. Better saying, the total collected is the product of the number of taxpayers times the value of the lump sum tax.

On the other hand taxes "ad valorem ", as they affect the consumption pattern tend to achieve a revenue lower than expected considering the before tax situation. In this case as the government needs a certain amount of revenue the rate has to be increased. This characterizes an excess burden.

Lump sum taxes are not used because most people would consider unfair for everyone to pay the same tax regardless of their economic circumstances. A way of producing more equitable results would be by basing the value to be paid on the personal income. However this procedure could drive people to adjust their working and saving decisions accordingly to their eventual tax burden.

Like the lump sum tax, an income tax represents a diminishing of the income received. However, as income tax affects the people decisions on how much time spent at work or in leisure it also affects the final income, and consequently is not equivalent to a lump sum tax.

There is a general consensus in the society about the equalization of the after tax distribution of income. But as income taxes distort work decisions the final amount of income available is reduced. The optimal income tax problem is to find the best rate that maximizes social welfare, subjected to the constraint that a given amount of revenue must be collected.

An important consideration to be undertaken refers to the definition of income. Public finance economists generally define income as " money value of the net increase to an individual power to consume during a period ". This is equal to the amount actually consumed during the period plus net additions to wealth. The definition includes items ordinarily thought of as income; wages and salaries, business, profits, rents, royalties, dividends and interests. However the criteria also includes certain unconventional items like: employer contribution to retirement and pension plans, social security benefits, aid to families with dependents, income in kind (goods, services, etc.), capital gains etc.

The criteria has two basic appeal; a sense of justice as people with equal incomes should pay equal taxes and efficiency as it treats all form of income the same, and so, does not distort the pattern of economic activity. Nevertheless, the full implementation of this criteria present some difficulties:

• The income must be measured net of the expenses of earning it
• Unrealized capital gains are not easily measured
• The imputed income from durable goods is not directly observable
• It is difficult to measure the value of in kind values
• It is either cultural and political difficult to implement a system like that

Moreover, some students of the subject argue that the criterion does not necessarily guarantee either fair or efficient outcomes. It is also important to add that the cost of running a tax system is ignored in most theoretical analyses. However, administrative and compliance costs affect the choice of tax base, tax rates and the amount of tax evasion.

Finally, once equity issues are required to be limited only on commodity taxes policy is inappropriate. On the other hand, commodity taxes, which vary with the circumstance of the buyer, are conceivable but usually impractical. Personal income taxes, though, are flexible enough that the average tax rate may vary by individual (although not without cost), thus allowing the pursuit of redistribution goals.

1. 7% or 12 % for essential goods
2. 7% on goods from South and Southeast to North , Northeast and Middle-East regions.
3. 12% on merchandises among others states. The difference between the normal and the reduced tax on interstates operations is transferred to the buyer state.
4. 25% on non essential products.
5. 17% or 18% on the lasting cases.

NOTES:

The Federal Government has to transfer:

Comparing the legal frame it can be verified that:

• The personal Income Tax has almost the same system in both countries. The tax is withheld out of the personal paycheck during the year. Eventually, an annual tax return will be filled determining the difference to be paid or to be refunded
• In Brazil the state level is not allowed to levy income taxes
• States and local levels establish the sales taxes in the US and they are applied at the retail prices. In Brazil the sales taxes are applied over the value aggregate (VAT), and they exist at the state and federal levels
• The Brazilian Federal Constitution defines the legal apportionment of some part of the Federal Revenue among states and local governments. The same way, some apportionment from states to municipalities is defined in the constitution
• In Brazil the states are forbidden to establish different taxes on sales. The same value has to be approved by the Senate for all the country

Table 3 shows that the weight of indirect taxes is very high and that sales tax are the greater source of revenue. It is important to point out that the Social Insurance Contribution is accounted as a direct tax. This high level of indirect taxes has according to some authors historical reasons, and is attributed to a natural tendency to evade the income tax. The consumer perception of the indirect tax, as sales taxes, is greatly minimizes and the evasion decreases.

Another factor that presumably tends to reinforce the collection of this tax is the system of Value Added Tax, where each level of production or trade receives a credit on the purchase. Thus, the firm that is buying the merchandise will require the receipt of the collection to use this value as a fiscal credit.

However, as indirect taxes are based mainly on consumption, they tend to be regressive affecting negatively the welfare of poor people. It is said that it is easier to levy a tax of 20% on sales than 2% on incomes. This capacity of political influence is amazing in a country with 74 million of active workers and where only 5 million are subjected to income tax collection.

Table 4, bellow presents the comparison of the Brazilian revenue with those of developed countries. It is difficult to define the optimum tax level as every country has its particularities and different degrees of development. However, a case could be made if we think on where the amount of investments should be stronger. In a country where we already have an infrastructure and where the need is mainly to the maintenance, or in a country with a scarcity basic resources (roads, sewage, ports, etc.)?

Our understanding is that the later situation is the more likely to happen and, in this case, Brazil should have a greater amount of resources to provide these investments. As the Brazilian revenues is situated at the lower level, 28.01% of the GDP in the table, we can conclude that the tax burden in the country is not as perverse as usually said.

Another aspect to be underlined in the table is that Brazil presents a high level of sales taxes and the lowest on income tax. This fact outline the extensive burden on low-income population through the sales taxes mechanism, although staples and some other basic goods are exempt of taxation.

Through the analyses of the taxes revenues from Brazil (1991 to 1996) and United States (1992) some important observations could be made (tables 5,6 and 7):

• The US revenue of 1992 presented a total amount of 38.46% of the GDP. Almost 8% of this amount is classified as "charges and miscellaneous. Although the Brazilian government also have some extra fiscal receipts (dividends, shares of companies, profits of state owned companies, etc.), these values barely adds to the total revenue. This happens due to the bad situation of state owned companies that very seldom provide rents for the government. So if we compare a revenue of 38.48% of US with a total of 30% in Brazil again the "excess burden" of the later, could be questioned
• At the federal level the revenue in Brazil represents 7.54% of GDP while in the US 14.56% (excluding for both the social insurance fund). This result confirms the struggling situation of the Brazilian federal government as an agent capable of fostering the development. This indicator also shows a clear need to alleviate the government from activities not directly related with its basic functions
• The Social Insurance in Brazil represents 35 % of GDP against a total of 25 % in US. The commitment of the Brazilian government with this item is extremely high and is another factor to stress the urgency of a reform in the system
• An issue that has also to be solved is the high level of payroll expenses in the Brazilian government. The salaries and pensions in the Public sector consume 60% of the net revenue at the federal level. 70% - 80% in several mayor states and over 100% of net revenues in other states. In this sense, any action that could be done to promote a reduction of expenditure had necessary to deal with the public sector wage bill
• According to the Word Bank report of February 17, 1988 the public employment in Brazil at the national level was 9% of total employment. That rate is coherent with the predicted for the country by the Bank. This number increases to 12% when we add employees from public enterprises. However the public payroll related expenses reaches 12% of Brazilian` s GDP, which is high relative to comparable countries
• The Brazilian stabilization program has been conducted under a strong exchange rate and a strict monetary policy. This policy and a loose fiscal stance led to a high interest rate and to an increasing inflow of rent seeking capital from abroad. This capital had to be sterilized with a loss because of the differential between domestic and foreign interest rates. The result was a worsening of the fiscal deficit and an increase on the domestic debt.
• "The annual cost of pensions, public and private, is about 12% of GDP and the Insurance Program (INSS) is running a cash deficit estimating to R$4.2 billion in 1997. About 3 million retired civil servants get half of the total benefits while there are more than three times as many beneficiaries in the general system. Moreover, about one third of the benefits go to early retirees below the age of 55 and these are almost all ex public servants". ( World Bank)
• Contribution rates are lower for civil servants and they receive a pension equal to the full last salary while in the private sector the limit is 10 minimum wages (R$ 1,200.00 at the end of 1997)

THE BEGINNER RETAILER

The taxes he had to add to the product are:

ICMS - 18.00 %

PIS/PASEP - 0.65 %

COFINS - 2.00 %

GROSS TAX - 18.00% + 0.65% + 2.00%

GROSS TAX - 20.65%

PRICE = 144.78

ICMS = 144.78 x 18%= 26.06

COFINS = 144.78 x 2% = 2.89

PIS = 144.78 x 0.65%= 0.94

PRICE – TAXES = 114.88 units.

PRICE = COST + TAXES x PRICE + MARGIN x COST

Or

(1 – TAXES) x PRICE = COST x (1 + MARGIN)

Or

PRICE = COST (1 + MARGIN) / (1 – TAXES)

And, in our example:

PRICE = (100 + 20 %) / (1 - 18% - 2% - 0.65%)

PRICE = 120 / (0.7935) = 151.22 units

The final price will be composed of:

PRICE = 151.22

ICMS = 151.22 x 18 % = 27.21

COFINS = 3.03

PIS = 0.98

PRICE – TAXES = 120.00

PRICE 1 = price with tax through inside

PRICE 2 = price over the added value

PRICE 1 / PRICE 2 = 151.22 / 144.78 = 1.0448

• There are a total of 6.45 units of taxation obtained by applying the rate over itself on a cumulative sequence.
• As the added value, or gross margin the trader has put over his cost, did not vary and its equal to 20 units the taxation over it varies not proportionally.

PRICE 2 = 151.22 units

ICMS = 18 % x 151.22 units = 27.22

PRICE 2 = (27.22 + 124)

COFINS = 2 % x (27.22 + 124) = (0.54 + 2.48)

PRICE = ((INDUSTRY PRICE + 15%) +20) / (1 –20.65 %)

PRICE = (100 + 15 + 20) / 0.7935

PRICE = 170.13 units

Through this table we can identify some important facts:

• The COFINS and PIS taxes are applied over the gross revenue of each process and, in this example, they have reached 7.16 units or 4.21 % of the final price instead of 2.65 %.

• This mechanism is surely a hidden way to increase taxes without presenting this increase to the "general public"
• The tables on the appendix shows the total amount of sales taxes beard by each specific sector of activities
• The sales taxes on industrialized goods are really high (mainly those that also have the IPI). But to lower them and maintain the revenue rate an offset should happen, probably by increasing the income tax. The previous sections had already presented some comments about the personal income tax. The analyses had showed that there is enough space both to increase the income tax and also to broaden its basis.

Among several topics that have been presented as Brazilian barriers for a more competitive economy, one of the most important is the great amount of social costs that the nominal wages carries. The discussion stays basically on grounds of what is truthfully salary and what is social benefit.

To clarify this discussion we are going first to present the frame of legal benefits that have to be paid with the nominal salary:

13^th salary

Besides these social benefits that add costs in the payroll by the employer, there are some legal guaranties like; a maximum workable week of 44 hours, the rewarded rest, and the maximum period of 6 hours of continuous work, etc.

One of the most discussed subjects is the rewarded resting time. This item in fact have its origin in the old labor system where the worker had to work 30 continuous days, without resting time or weekend. When the resting time was established the legal frame was not changed and the value of the daily wage continued to be defined as the monthly value divided by 30. This situation lead to a rough discussion among specialists about the fairness of considering this time as a paid rest or a cost without production.

We consider this discussion worthless. The salary is an agreement between two parts. The employer knows exactly the workable time he is paying. In the same way the worker knows how much he has to work. Both worthies those times in the marked and agree in a money value basis about it. If the law were changed from the 30 days basis to for instance a 22 days it would be very unlikely that the labor market would adjust the wage by a rate of 22/30. On the contrary, the only expected result would be an increase in the hourly basis.

The table bellow shows that the real wage of the worker is really far greater than the nominal value. This characteristic of the Brazilian market produces an uneven distribution of salaries along the year. More than that the worker perception of a salary is focused only on the monthly value. So they tend in general to underestimate earnings.

The social and fringe benefits, mainly the FGTS, are barely understood as a wage because the earnings are delayed in time.

The market has developed an underground system, where the worker and employer agree on an intermediate wage. The worker gives up some of the social rights, mainly those delayed in time like social insurance, FGTS, etc. The employer agrees to pay in the present a share, normally 50%, of the forgone values that should be collected to the government funds.

There are some proposals to abolish this model through the incorporation of these wage benefits, and letting the worker decide how he uses the money he receives. However a system like that would probably hurt the less skilled worker who rarely would care about any kind of saving for their retirement (either by joining to a pension fund or personal saving). In this case the society would suffer because it would have to support those improvident workers and families.

A way to surpass this possibility would be the adoption of a minimum amount to be collected in the payroll. This amount would correspond to a pension equal to the minimum wage necessary for someone’s basic subsistence. This tax would build a fund to sustain the improvidence.

Another solution proposed is the obligation to affiliation to a private pension funding which a monthly contribution would be withheld in the firm’s payroll. It would be a system like the presently used in Brazil with the only difference that it would be transferred to the private sector.

Both proposals would eliminate at least partially the public intervention and consequently, a series of vices and misleading uses of these funds.

The Social Insurance funding is contributing greatly to the Brazilian fiscal deficit and is a problem that has to be solved in the short run. The bill that intends to change this situation is presently under the congress appreciation and has already been voted in first round. As an amendment to the Constitution it has to pass twice by the 2 houses.

In terms of other rights guaranteed by law we can conclude that:

• The money values paid along the year are and have to be considered as salaries. They can’t understand just as social benefits. Both parts anticipate their values the employer in its cost structure and the employee in its personal budget. Of course to the labor market would be better if these parcels were incorporated to the monthly salary. This would clarify the involved values for both parts and promote a better self-regulation of the market. It would also reduce informal agreements related to those delayed benefits.
• The social insurance is also claimed as a burden on the salary. It really is, but it is a cost that also affects several economies around the world. Even those economies that don’t have a payroll tax will have sooner or later to support their elders through any other kind of taxation
• The lack of enforcement has created an unfair situation where some firms accomplish with the law while others don’t. The excess of regulation is partly responsible for this situation and for a growing underground economy
• The observation of sectors tables on the appendix, shows that the share of labor on the final price varies according with the sector, but in general the participation of labor is not as high as many people claim. It is important to verify on these tables that they deal with gross wages and that the averages includes blue collar wages.
• It is a common practice among workers to require more transportation tickets than they really need. The tickets are sold in the parallel market. If those values, as well as some related to meal supply by employers, were converted at once in salary this practice some say, could end. However it could also be expected that after a few time there would be some unions movements to reestablish the "lost rights". Another problem that could arise would be the lost of the protection the worker now have against a different evolution between those prices and the wages
• The turnover in the Brazilian labor market is 33% higher than in the US. Severance fund (FGTS) is viewed as an incentive to workers to ask to be fired and withdraw the money in the fund

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