Search

 

Cablegate: Lula's Plan to Recover Cpmf Revenues As Expected

VZCZCXRO9014
PP RUEHRG
DE RUEHSO #0012/01 0101618
ZNR UUUUU ZZH
P 101618Z JAN 08 ZFF6
FM AMCONSUL SAO PAULO
TO RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RUEHC/SECSTATE WASHDC PRIORITY 7810
INFO RUEHAC/AMEMBASSY ASUNCION PRIORITY 3260
RUEHBR/AMEMBASSY BRASILIA PRIORITY 8953
RUEHBU/AMEMBASSY BUENOS AIRES PRIORITY 3017
RUEHLP/AMEMBASSY LA PAZ PRIORITY 3664
RUEHMN/AMEMBASSY MONTEVIDEO PRIORITY 2574
RUEHSG/AMEMBASSY SANTIAGO PRIORITY 2271
RUEHRG/AMCONSUL RECIFE PRIORITY 3952
RUEHRI/AMCONSUL RIO DE JANEIRO PRIORITY 8526
RUEHRC/DEPT OF AGRICULTURE WASHDC PRIORITY
RUEHC/DEPT OF LABOR WASHDC PRIORITY
RHEHNSC/NSC WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 05 SAO PAULO 000012

SIPDIS

SENSITIVE
SIPDIS

STATE FOR WHA/BSC, WHA/EPSC
STATE PASS USTR FOR KATE DUCKWORTH
STATE PASS FED BOARD OF GOVERNORS FOR ROBITAILLE
STATE PASS EXIMBANK
STATE PASS OPIC FOR DEMROSE, NRIVERA, CMERVENNE
NSC FOR TOMASULO
TREASURY FOR JHOEK
USDOC FOR 4332/ITA/MAC/WH/OLAC
UDSOC ALSO FOR 3134/USFCS

E.O. 12958: N/A
TAGS: ECON EFIN PREL BR
SUBJECT: LULA'S PLAN TO RECOVER CPMF REVENUES AS EXPECTED
BUT NOT WITHOUT OPPOSITION

REF: A. SAO PAULO 1005
B. SAO PAULO 0832

1. (SBU) SUMMARY: The Brazilian government announced on
January 2 three ways for compensating for lost revenues after
losing the battle to renew the Provisional Financial
Transactions Tax (CPMF) in December. As expected, the GOB
announced a mix of tax hikes and potential cuts in government
spending to cover the shortfall from the lost CPMF revenue
(R$40 billion or approximately USD 23 billion at the current
exchange rate). While the tax hikes have been announced in
the form of increases to another financial transactions tax,
the IOF (Financial Operations Tax), and increases in the CSLL
(Corporate Profits Tax), the GOB is holding off on defining
cuts in spending until February when Congress reviews the
2008 budget. The tax hikes are not expected to hurt Brazil's
prospects for strong economic growth in 2008, but might hit
some consumers harder than others and has the potential to
slow the exploding growth in credit. The political
opposition is attacking the Lula Administration for
backtracking on its December promise not to raise taxes by
specifically calling into question the constitutionality of
the two tax hikes and by threatening to stop negotiating
comprehensive tax reform. One potentially positive impact of
the increase in the IOF tax is a likely slowing of credit
growth, which would alleviate some of the Brazilian Central
Bank's fears of growing inflation. As for spending cuts,
Post is not convinced the GOB will follow-through on all the
spending cuts, nor would these cuts be necessary. The
forecast for robust economic growth in 2008 will likely mean
higher tax receipts. In addition, it appears that the GOB
has underestimated the additional revenues it will receive
from increasing the IOF tax. END SUMMARY.

2. (U) On January 2, Finance Minister Guido Mantega and
Planning Minister Paulo Bernardo announced three measures
aimed to partly compensate for the revenue losses from the
end of the Provisional Financial Transactions tax (CPMF) in
December (Ref A). The R$30 billion package is in line with
market expectations, and includes R$20 billion in spending
cuts and R$10 billion in tax hikes on two taxes, the
Financial Operations Tax (IOF) and the Tax on Corporate Net
Profits (CSLL). (Note: Technically speaking, the spending
cuts the GOB plans to make are reductions in expenditure
growth; the GOB's overall spending is still expected to be
higher in 2008 than 2007. Other economic contacts indicate
that these taxes will generate significantly more than R$10
billion. End Note.) As an explanation for raising the IOF
tax, Mantega stated that increases in the IOF would slow down
the rate of credit growth and provide a small hedge against
inflation. (Note: The overall credit market in Brazil grew
by some 25 percent in 2007 and individual credit grew by more
than 32 percent. End Note.) Concerning cuts to government
spending, Minister Mantega again reaffirmed that the GOB will
not make cuts to Bolsa Familia and to the Program for Growth
Acceleration (PAC) without specifying which programs would
receive spending cuts.

IOF-Financial Operations Tax Increased
--------------------------------------

3. (U) The GOB issued a decree effective January 4 to
increase the IOF which is a tax on a variety of financial
transactions including credit, foreign exchange, and
insurance and stock purchases. The decree increases the IOF
by a fixed 0.38 percent on all financial operations

SAO PAULO 00000012 002.2 OF 005


previously taxed under the CPMF (currency exchange operations
for exports, foreign exchange from service revenues, goods
and services and spending abroad using credit cards). In
addition to the 0.38 percent, the GOB doubled the rate
applied to personal credit transactions to approximately
three percent per year or 0.0082 percent calculated on a
daily basis. Originally the IOF accounted for about 1.3
percent of federal revenues (approximately R$8 billion). The
IOF is not applied to foreign portfolio investments; however,
repatriation of profits by Brazilian firms abroad is subject
to IOF, as well as foreign direct investment in Brazil.
Personal mortgages continue exempt from IOF, but mortgages
for investment properties are subject to the three percent
plus 0.38 percent surcharge.

4. (U) Under the decree, corporations pay IOF on more
financial transactions including 0.38 percent on operations
involving the export of goods and services and the import of
services. Furthermore, the government created a specific tax
rate for imported products that the GOB suspects have an
unfair advantage in the domestic market, such as textiles,
machine parts, and apparel, among others. The GOB also
expanded the breadth of financial transactions covered by the
IOF (adding an additional fixed 0.38 percentage point
increase to the 1.5 percent levied) on corporate credit
transactions to include the Brazilian development bank
(BNDES) loans, financing for machinery and equipment, loans
for rural exporters and rural producers, and on government
transfers and financing of employment generation programs.

Corporate Profits Tax Increased
-------------------------------

5. (SBU) The GOB also notified Congress of a provisional
measure to increase the CSLL from nine percent to 15 percent
for financial institutions, which the GOB estimates would
bring in an additional R$2 billion. Minister Mantega said
that GOB chose financial institutions (including investment
banks, finance companies, mortgage associations, credit card
companies, leasing companies, stock markets, and insurance
and capitalization companies) over other industries because
the banking sector is the most profitable sector in Brazil.
The GOB must wait 90 days to begin collecting the additional
tax, and Congress has 120 days to vote on the bill.
Vice-President of Economic Research at Itau Corretora
Mauricio Oreng told Econoff that Brazilian banks should be
able to absorb the additional tax because the banking
industry was extremely profitable in 2007. Several economic
interlocutors, however, say that banks would likely pass on
the increase to consumers rather than lower their profits.

Effect on Companies and the Economy
-----------------------------------

6. (SBU) Overall, economic interlocutors told Econoff that
they don't believe the tax hike will have a significant
negative impact on economic growth. Oreng said he expects
GDP growth above five percent unless the Brazilian Central
Bank raises interest rates, which he sees as a growing
possibility due to creeping inflation. Although the IOF
increases are designed to replace the previous CPMF tax, many
industries are still better off than under CPMF, according to
local financial analysts. Industries with long production
chains felt the largest impact under the CPMF tax (Ref A)
because of its cascading effect on all stages of production.
The IOF, on the other hand, is less of a drain on the

SAO PAULO 00000012 003.2 OF 005


competitiveness of these industries because the tax is
applied to a smaller base of transactions.

7. (SBU) Individuals, however, are likely to feel the IOF
hit their wallets more heavily than CPMF did. Credit card
interest rates will be three percentage points higher and if
banks are able to pass on the CSLL to consumers, they will
likely pay more for banking services. The President of the
Sao Paulo Federation of Industries (FIESP) Paulo Skaf told
Econ-Pol Chief that the additional three percentage points
would hit the working class hardest because they use the
Brazilian equivalent of a pay advance called the "cheque
especial" that carries higher interest rates (Ref B). He
expects half of the estimated R$15 billion the GOB collects
this year from IOF would come from the working class.

Industry Reaction
-----------------

8. (SBU) Industry largely disapproved of the GOB's measures.
Skaf said that the measures are unnecessary and that the GOB
should have used the opportunity of strong economic growth to
stimulate credit. He opined that the Senate's rejection of
CPMF reflected the "voice of the people" and that FIESP's
efforts to end CPMF were based on the expectation that the
GOB would not need additional revenue to cover the loss due
to higher economic growth. When Econ-Pol Chief pointed out
Minister Mantega's points regarding the need to raise the IOF
to combat slowly rising inflation, Skaf stated that Mantega's
position had little basis in reality and was merely his
attempt to give an explanation to an unnecessary tax hike.

9. (U) Other industry interlocutors offered various opinions
of the GOB response to the loss of the CPMF. Armando
Monteiro, President of the Brazilian National Confederation
of Industries, told O Globo television that he expects the
tax hikes to mean higher interest rates and bank spreads;
however, he approved of the GOB's announcement to cut
expenditures. The senior advisor for the Commercial
Association of Sao Paulo Sergio Leopoldo told Econ Specialist
that the GOB should stimulate consumption to boost revenues,
rather than dampen credit. He believes consumers will suffer
the brunt of the hikes. The Economic Director for the
Federation of Commerce (Fecomercio) Fernanda Rosa told Econ
Specialist that Fecomercio estimated a two percent reduction
in retail and service sales revenues and she said that the
IOF increase punishes those who need financing for
consumption.

Spending Cuts in February?
--------------------------

10. (SBU) The big uncertainty of the GOB's package of
measures to fill the CPMF gap is spending cuts. The bright
spot in the GOB's announcements in December after its failed
attempt to extend the CPMF (Ref A) was the GOB's announcement
that it would cut expenditure growth for the first time since
2003. The GOB again pledged in its package announced January
2 to cut R$20 billion across the legislative, executive, and
judicial branches, but held off announcing specific cuts
until February when Congress reconvenes and begins its review
of the 2008 budget. For the most part, financial analysts
are optimistic but remain unconvinced until the GOB releases
more details. Nilson Teixeira, Managing Director for
Emerging Markets Research at Credit Suisse, expects the GOB's
will not meet the spending reduction mark, which they

SAO PAULO 00000012 004.2 OF 005


estimate at 0.7 percent of GDP, which could force the GOB to
reduce the primary fiscal surplus. However, if the economy
grows as expected, the GOB should maintain its primary
surplus target. According to Bear Stearns Economist Emy
Shayo, she expects that the spending cuts will come in the
form of lower wage hikes for civil servants and lower levels
of investment spending. Oreng agreed that a likely option
would be a freeze on public sector salary increases initially
announced in 2007. End Comment.)

11. (SBU) Expected robust economic growth in 2008 may
protect the GOB from needing to make significant spending
cuts. Economic growth of five percent or more in 2008 would
have covered the lost tax revenues from the CPMF, according
to economic interlocutors. Skaf told Econ-Pol Chief that
FIESP deemed a tax hike unnecessary because FIESP estimated a
12 percent increase in tax collection based on the projected
economic growth of five percent, which easily would have
covered the R$40 billion gap. Oreng told Econoff that Itau
estimated an additional R$40 billion in tax collection from
these two measures based on economic growth of five percent
and far exceeds the GOB's estimate of R$10 billion.
Likewise, Teixeira told Econoff that Credit Suisse believes
that the government should collect more tax revenues under
the two measures than estimated.

Legal Challenges Ahead?
-----------------------

12. (U) The GOB's two tax measures may face legal challenges
under the Brazilian Constitution. Opposition congressmen
have initiated an inquiry into the GOB's decree and
specialists including Mailson da Nobrega, former Finance
Minister, say the IOF was not designed nor constitutionally
mandated to be a revenue generating mechanism, as the GOB's
decree explicitly intends it to be used. Under the
Constitution of 1988, the IOF is restricted to credit and
exchange regulation for use in inflation or balance of
payments crises. Local press criticized the increase of the
CSLL for similar legal irregularities. In addition, a
Constitutional Amendment from 2003 prohibits the GOB from
using provisional measures to assign differentiated tax
rates. Press reports indicate that some law firms are
encouraging their financial institution clients to fight the
increase to the CSLL as discriminatory against their
industry. Oreng, for his part, told Econoff that he doesn't
expect the financial sector to submit claims and assumes they
will pass on the additional tax to consumers.

13. (SBU) COMMENT: The IOF and CSLL tax increases are likely
to dampen the rapid rate of credit growth in Brazil, but are
unlikely to change the prospects for continued credit
expansion this year on the order of 20 percent in Brazil.
The increase in the cost of credit should help soothe the
Central Bank's fears that the Brazilian economy is beginning
to overheat. From a macroeconomic perspective, the GOB's
rhetoric to cut spending is a positive sign; however, Post
remains unconvinced that the GOB will successful trim
spending by R$20 billion. The risk exists, though minimal,
that the GOB may eat into the primary surplus despite the
GOB's repeated statements to the contrary. The primary
surplus has been the GOB's key policy anchor since 2003 and
any adjustment would represent a change in policy and would
have implications for Brazil's fiscal accounts. Furthermore,
covering the CPMF revenue gap has distracted the GOB from
working on ways to tackle the growing inflation problem.

SAO PAULO 00000012 005.2 OF 005


Brazil closed out 2007 with inflation nearly two percentage
points higher than at the end of 2006 and runs the risk that
the Central Bank will decide to raise interest rates. The
political ramifications of the GOB's announcement, however,
are the most disconcerting. The Lula Administration
backtracked on a deal it made with the opposition in order to
get the de-earmarking measure (DRU) passed in December (Ref
A). In doing so, the GOB has likely closed off any remaining
possibility for working with the opposition to institute a
comprehensive tax reform, as some analysts hoped following
the CPMF defeat. END COMMENT.

14. (U) This cable has been coordinated with the U.S.
Treasury Attache in Sao Paulo and Embassy Brasilia.
WHITE

© Scoop Media

 
 
 
 
 
World Headlines

 

Werewolf: Gordon Campbell On North Korea, Neo-Nazism, And Milo

With a bit of luck the planet won’t be devastated by nuclear war in the next few days. US President Donald Trump will have begun to fixate on some other way to gratify his self-esteem – maybe by invading Venezuela or starting a war with Iran. More>>

Victory Declared: New Stabilisation Funding From NZ As Mosul Is Retaken

New Zealand has congratulated the Iraqi government on the successful liberation of Mosul from ISIS after a long and hard-fought campaign. More>>

Gordon Campbell: On The Current US Moves Against North Korea

If Martians visited early last week, they’d probably be scratching their heads as to why North Korea was being treated as a potential trigger for global conflict... More>>

ALSO:

Gordon Campbell: On The Lessons From Corbyn’s Campaign

Leaving partisan politics aside – and ignoring Jeremy Corbyn’s sensational election campaign for a moment – it has to be said that Britain is now really up shit creek... More>>

ALSO:

Another US Court: Fourth Circuit Rules Muslim Ban Discriminatory

ACLU: Step by step, point by point, the court laid out what has been clear from the start: The president promised to ban Muslims from the United States, and his executive orders are an attempt to do just that. More>>

ALSO: