Brazil’s House Backs Tax Reform, Sending Local Markets Rallying

Daniel Carvalho and Vinícius Andrade
·3 min read
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(Bloomberg) -- Brazil’s lower house approved a proposal to overhaul the country’s labyrinthine tax rules, fueling a rally in the local stock and currency markets.

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Lawmakers voted 375-113 to advance the bill in a second round of voting that took place in the early hours of Friday. The reform, which has eluded Brazilian politicians for decades, is among the priorities of President Luiz Inacio Lula da Silva’s administration.

The benchmark Ibovespa equity index gained 1.2% in early afternoon trade as the bill’s approval added to prospects of interest rate cuts and cheap valuations. The Brazilian real strengthened 1.1%, the second-best performer among emerging-market currencies.

Local assets could benefit from a “positive agenda” in congress, and chances are high that both the tax reform as well as a proposal to shore up fiscal accounts are approved by lawmakers by the end of the year, said Eduardo Miszputen, Citigroup Inc.’s markets head for Brazil. Domestic equities went from being “extremely cheap” to just “cheap” after the recent rally, and still have room for additional gains, he added.

Yet the plan still has many hurdles to clear. As a proposed constitutional amendment, it must win two votes in the Senate as well, and may have to return to the lower house in the second half of the year if senators make changes to the bill, as Speaker Arthur Lira expects.

Brazilian leaders and lawmakers have attempted to rewrite the country’s tax code numerous times only to fail to build the consensus between various political parties and economic interests. Lira, Finance Minister Fernando Haddad and congressman Aguinaldo Ribeiro — the legislation’s rapporteur in the lower house — negotiated changes to the bill throughout the week in an effort to secure its passage.

Lula and his economic team see the current legislation as crucial to their broader efforts to shore up Brazil’s public finances. Lawmakers this week may also approve the government’s fiscal framework proposal, which will replace a so-called spending cap law.

The leftist leader entered the final days of voting before the legislature begins its mid-year break without a solid base in congress, although support for major economic agenda items is broader, even including some members of opposition parties.

Right-wing former President Jair Bolsonaro and other opposition figures sought to turn allies against the tax reform proposal this week, calling on lawmakers to vote against it. Yet 20 of his party’s 95 representatives backed the bill.

Read More: Five Key Points in Brazil’s Effort to Overhaul Its Tax Code

Long Road Ahead

The tax reform will take years to fully implement if it becomes law. The current proposal says that the new structure will begin in 2026, but a full transition won’t be completed until 2033.

The plan consolidates five existing consumption levies into two new value added taxes, or VATs. One VAT would be administered by the federal government, while another would collect revenues for states and municipalities. The plan includes funds to compensate states that are likely to lose revenue from the overhaul.

The bill provides for a zero tax rate on basic food basket items, although the list will be defined only later. It also creates a levy on goods and services considered harmful to health and the environment, including cigarettes and alcoholic beverages.

There will be a standard tax rate, along with a separate treatment for certain goods and services related to health care, medicines and basic menstrual health care products, education, public transportation, rural production and national artistic, cultural, journalistic and audiovisual productions.

A specific rate for products and services like fuels and lubricants, real estate, financial services, insurance, cooperatives, hotel services, amusement parks and theme parks, restaurants and regional aviation will be set. The constitutional amendment maintains a favored tax regime for biofuels in order to ensure lower rates than those levied on fossil fuels.

The bill also creates a cash-back system for poor families. A later proposal will define who would be eligible.

(Recasts story with market reaction.)

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