BRASILIA, 11 Feb (Reuters) – The expansion of Income Tax exemption for the middle class, which practically halved the number of Brazilian taxpayers, is reinforcing the favorable economic winds and helping to ensure President Luiz Inácio Lula da Silva’s advantage in the first polls, on the eve of the dispute for re-election.
The measure, one of his main campaign promises in 2022, reflects an effort to broaden the left-wing leader’s appeal beyond his traditional base of low-income voters.
It should give more impetus to an economy that, although not expanding strongly, has systematically surprised upwards, amid policies that have increased Brazilians’ disposable income.
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Unemployment is at historic lows, average income has reached a record and inflation — including food inflation — has cooled down enough for interest rates to start falling next month, as the Central Bank has already signaled.
The situation has helped to reinforce support for Lula, who is ahead of his opponents with a margin of four to seven percentage points in recent polls that simulate second-round scenarios for the October election.
Added to this more favorable situation is the new IR exemption for monthly salaries of up to R$5,000, in force since the January payroll and which has started to be felt in the pockets of Brazilians in recent days.
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PILATES, TRAVEL PLANS
Publicist Vitória Santos, 30 years old, said that she was anxiously awaiting the approximately R$300 additional material that had just materialized in her monthly paycheck, an amount that she intends to use to help pay for pilates classes.
‘It’s a significant amount, which ends up making a difference’, stated Santos. ‘For some people, it’s the monthly electricity bill, the internet bill, help planning a trip or paying for a gym membership.’
As the extra income will be channeled to workers who are more likely to spend than save, the government expects the measure to inject around R$28 billion into the economy this year.
However, many economists are skeptical about the policy’s long-term benefits, arguing that Brazil should broaden its tax base to deal with rapidly expanding public debt.
‘It’s a bad policy economically, but it generates votes’, said Fabio Kanczuk, former director of the Central Bank and current director of macroeconomics at Asa.
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He questioned the convenience of tax relief for the middle class, with little practical result in reducing inequality in the country, as opposed to measures that could generate growth and boost productivity.
Kanczuk stated that the stimulus tends to quickly convert into consumption, including through the expansion of credit, as banks anticipate greater household income. He projects a 0.2 percentage point boost to economic growth this year, with a similar effect on inflation.
FLAT TAX BASE
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With the IR exemption expanded, around 11.3 million of the 25.4 million Brazilians who paid income tax last year — approximately 44% — stopped paying the tax, the Federal Revenue estimated to Reuters. Another 5.7 million had a tax reduction, as discounts were extended to incomes of up to R$7,350 per month.
The shrinking base exposes how public revenues in Latin America’s largest economy continue to be anchored in a model that taxes the consumption of goods and services proportionally much more than income.
It also reflects the priority that Lula began to give to Brazilians with more resources after having initially directed public spending to programs that mainly benefited the poorest, including income transfers under Bolsa Família, assistance to the elderly and people with disabilities via the Continuous Payment Benefit (BPC), subsidies for cooking gas and financial aid for low-income high school students.
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In recent years, the Brazilian middle class has moved sharply to the right, with a significant portion supporting former president Jair Bolsonaro, attracted by his law and order agenda, conservative social values and reduced burdens for entrepreneurs.
Over the last year, sources from the Ministry of Finance said that, to also reach middle-income families, the Lula government calibrated policies, such as the expansion of subsidized housing financing to cover families with a monthly income of up to R$12 thousand and for the purchase of properties valued at up to R$500 thousand.
Senator Flávio Bolsonaro, son of Lula’s predecessor and seen as his main opponent at this time, has signaled an economic agenda in favor of tax cuts and a smaller role for the State.
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BOOST SPENDING
Until last year, the government did not charge income tax on monthly salaries of up to R$3,036, the equivalent of two minimum wages.
The reform that came into force extended total tax relief to those earning just above three minimum wages, with Brazilians earning up to 4.5 minimum wages also now receiving partial discounts.
This ceiling includes workers like Emerson Marinho, 51 years old, a postal worker at Correios, whose deduction in the last paycheck fell by R$110.
‘It’s extra money I put into buying food. I have two children, and it’s two weeks’ worth of food that I’ll have to inject into fruits and vegetables. So yes, it does make a difference,’ said Marinho.
To compensate for the loss of revenue, the government instituted a minimum tax on monthly income above R$50,000 and a 10% withholding tax on corporate dividends sent abroad.
The change in the tax burden should reduce income inequality in Brazil by 1.1%, according to a study by the Budget and Financial Inspection Consultancy of the Chamber of Deputies.
The tax exemption is the most visible boost to confidence at the beginning of the year, but Lula is also reaping the effects of a more favorable economic scenario as he enters the final year of his term.
In addition to the prospect of falling interest rates with more moderate inflation and a strong job market, the external environment has also played in favor. Policies adopted by US President Donald Trump weakened the dollar, strengthened emerging market currencies and redirected part of capital flows, benefiting economies such as Brazil.
Bruno Funchal, CEO of Bradesco Asset Management and former secretary of the National Treasury, warned, however, that public spending that stimulates consumption is part of an ‘unsustainable’ growth model that, by raising fiscal distrust, ended up pushing basic interest rates to the highest level in almost 20 years.
He argued that Brazil should instead reduce its debt and encourage long-term investment at lower interest rates, but acknowledged that an abrupt change of course was unlikely in the run-up to the October election.
‘In elections, in general, the tendency is not to show a bitter medicine that will have to be done,’ he stated.
