22/02/2003

Letter From Brasilia

The President, the Vice President, Ministers and Leaders in Congress met the Governors of the 27 States of Brazil on February 21-22 of 2003 and agreed that the pension reform and the tax reform are priorities to ensure economic growth. They have, thus, entered into a commitment to send proposals to Congress dealing with these issues.

Knowing that the debate of such reforms ought to involve society as a whole, they have decided to publicize the following points of agreement reached during their meeting:

1. The tax system shall promote justice and increase the efficiency and competitiveness of the economy, by eliminating tax biases against exports, and stimulating production and investment. Hence, it is necessary to streamline the existing system and fight fraud and tax evasion.
2. The reform shall be revenue neutral for all member of the federation (Union, states, etc.). It will not seek to raise tax rates, but rather to broaden the tax basis, and improve tax administration—insofar helping to reduce the burden on those who pay taxes and the most fragile sectors of the economy.
3. The Constitution will define a new VAT, which will be the same across the country, eliminating the 27 existing (state) legislations and reducing the number of statutory rates. The transition rules will be defined by a Federal law requiring qualified (50%) majority.
4. The social security tax paid by firms for the financing of the social security (seguridade social) will be levied in part on the turnover of firms, rather than on the wage bill. This shall help increase formal employment. The transition will also be gradual.
5. Cascading taxes should be eliminated gradually, based on the experience with the PIS (a cumulative tax that has been levied on value added since this January). This will require extensive adjustment on the existing tax administration structure and shall, therefore, be pursued carefully.
6. Taxes ought to become less regressive, allowing for, inter alia, a reduction in the taxation of essential goods, and a review on the scale of direct taxes.
7. Every state and municipality shall engage on an educative campaign against tax fraud and evasion.
8. Regional Development policies shall be reviewed and newly defined, with a view to inter alia overcome existing tax conflicts between states.
9. Municipalities shall be empowered to be the locus of social services.
10. Existing work done by Congress shall be considered in future discussions and by proposals to be submitted to the Legislative Houses.

With respect to the pension reform, there was agreement on the following facts

1. It is urgent to reorganize social security to ensure the present and future generations will have their rights protected, and to maintain the distributive and contributive (actuarial) aspects of the system.
2. The problems in the general scheme and the scheme for public servants are distinct.
3. The general scheme is progressive and reaches 21 million people, of which 2/3 receive the minimum pension.
4. The general scheme is roughly in balance (80% in the whole, 97% when considering only urban benefits and contributions)
5. The scheme for public servants is typically not in balance: this is the case for the Union, States and Muncipalities. This imbalance has a perverse effect on other social policies, as well as on the ability of the government to finance public investment.
6. The deficit typically exceeds 50% of the aggregate size of benefit outlays.
7. The imbalance is likely to increase in the next 10 years if current policies are kept unchanged. In some states the situation is already critical.
8. The main cause for the imbalance is the set of rules for access to benefits.

In view of this situation, it was decided to:

1. Reaffirm that rights will be respected
2. Preserve the thrust of existing rules of the general regime
3. Attempt a gradual raise of the ceiling of the general scheme, preferably to reflect GDP growth (e.g., productivity gains), as well as to promote a gradual raise in the floor, in line with efforts to raise the minimum wage.

With respect to the scheme for public servants it was decided to

1. Prepare reforms, including Constitutional Amendments, to address the existing imbalance and, therefore, fulfill the mandate of Article 40 of the Constitution.
2. Review the retirement age, and the minimum period in the public service entitling the employee to a pension under the scheme for public servants, as well as new rules for survivor pensions
3. Find ways to charge retirees and establish a minimum contribution rate for all schemes
4. Support the passage of PL-9 that deals with complementary, pre funded schemes for entrants in the public service
5. Support the establishment of ceilings for public servant pay
6. Prepare all required studies (actuarial, as well as on the distributive aspects of the schemes) in 30 days, to contribute to the technical base to be submitted to Congress.

Brasilia, February 22, 2003.