Cablegate: Tax Reform: Gob Passes Its Latest Legislative Test

This record is a partial extract of the original cable. The full text of the original cable is not available.




E.O. 12958: N/A
SUBJECT: Tax Reform: GoB Passes Its Latest Legislative Test

1. SUMMARY: Lula's administration has recorded its latest
key legislative win, with the Chamber of Deputies' 378-53
approval of the GoB tax-reform bill on September 4. In so
doing, the GoB was compelled to make some relatively minor
extra concessions to Brazil's governors. All observers
predict the bill will undergo further major re-working in
the Senate; there is little hope for final passage before
mid-November at best. The GoB may consider detaching and
submitting separately the bill's two elements that it wants
approved by October: extension of the "temporary" CPMF levy
and of the `DRU' (long-standing federal-government authority
to de-link 20 percent of its revenues from required
earmarks.) END SUMMARY.

2. The September 4 vote was the first of the Chamber's two
required floor votes on the tax-reform bill. Dozens of
amendments remain to be voted on to complete the first-round
process, which should be finalized by the middle of the week
of September 8. Thereafter, five Chamber sessions with a
quorum must take place before the second-round vote may
occur. Thus, that vote could occur in the September 17-24
timeframe. Provided the bill gets the necessary three-
fifths majority again, it will proceed to the Senate Justice
Committee for routine determination of its
constitutionality, and thence to the Senate floor for the
required pair of plenary votes there. A notional timetable
in the September 5 `Estado de Sao Paulo' forecast the Senate
committee reporting out the bill in late October, and the
second-round Senate floor vote occurring in mid-November.

3. The Chamber floor vote came at 3 a.m. September 4, in an
extraordinary session convened by Speaker Cunha, after
sixteen hours of turbulent negotiations. The GoB had been
adamant about holding a vote in the Chamber's September 3
session and hoped to pass the bill quickly that afternoon.
But resistance from governors -- particularly Aecio Neves
(PSDB-Minas Gerais) -- raised the prospect of the GoB's
losing the vote outright, and impelled Lula's team to make
further concessions to the governors. These negotiations
delayed the voting until the early hours of Thursday, at
which point the GoB submitted its revised bill. With the
governors' and mayors' backing, that bill passed with an
impressive 70 votes to spare.

4. GoB leaders immediately pointed out that the final
result had featured near-impeccable voting discipline
throughout the government's alliance base. In fact, the PT-
led coalition, even without any opposition support,
delivered more than enough votes to pass the bill,
suggesting that the government's late-night courting of the
powerful PSDB governors had been unnecessary. This vote
thus contrasted favorably with the pension-reform bill's key
recent victory in the Chamber, which would not have been won
without votes of parties outside the GoB coalition.
Moreover, the solid support this time from the PMDB party
(70 of 77 PMDB deputies supported Lula's bill) is seen as
proof that Lula's intensified courtship of the PMDB has
borne fruit. The opposition PSDB party vote split down the
middle (24 yea, 26 nay), while PFL deputies opposed en masse
and walked out when they saw they were going to lose.

5. The GoB's last-minute concessions to the governors
consisted of: adding a further billion Reals (for a total of
6.7 billion) to the fund for compensating states' revenue
losses on exports due to the Kandir law; adding two billion
Reals (making a total of eight billion) to the prospective
new compensation mechanism for ensuring states against
revenue decreases arising from the eventual reform of the
ICMS tax; and ceding to governors the control over resources
from the new regional development fund already promised as
part of the same tax reform. Numerous `retail' deals with
individual states were evidently also made, notably with Rio
state after Finance Minister Palocci met with Rio governor
Rosinha Mattheus.

6. The GoB had previously agreed to concede one-quarter
(approximately 2.2 billion Reals annually) of Brazil's
national CIDE (fuel) tax to states and municipalities. But
it has held firm in its rejection of governors' demands for
a comparable share of the CPMF (financial transactions)
levy, which totals over twenty billion Reals annually.

7. Other main elements of the tax-reform bill were left
unaffected by the last-minute September 4 horse-trading.
Chief amongst these:

-- The ICMS tax is to be phased into a national, VAT-like
tax with five basic rates, imposed at point of sale rather
than of production. Transitional time-frame, mechanisms for
defining rates and categories, and limits or ceilings to the
rates, remain almost entirely undefined;

-- To do away with Brazil's `fiscal wars,' whereby states
use tax lures for new industry, all fiscal incentives of
this type are supposed to discontinue after September 30;

-- New tax relief on capital goods;

-- Introduction of a progressive inheritance-tax rate (up to
a maximum of 15%, vs. the present uniform four percent.)

8. The bill contains two other main elements central to GoB
fiscal authority: the extension after December 31 of
Brazil's `temporary' CPMF (financial services levy) and of
the `DRU' (a mechanism giving the GoB freedom to allocate
twenty percent of its tax revenues away from earmarked
purposes.) By most traditional juridical interpretation, if
Congress does not by September 30 approve these extensions,
the GoB's authority in both areas will lapse on January 1,
2004. Precedent suggests that the GoB would find some way
round this supposed constitutional constraint, but a growing
number of voices is urging that it detach and submit
separately for early passage this component of its tax-
reform bill.

9. COMMENT: The Chamber's approval of the tax-reform bill
preserves the legislative momentum of Lula's fiscal reforms.
With respect to substantive content, however, that bill has
become decidedly under-whelming. Enthusiasm for it has
waned in the private-sector and perhaps especially amongst
the ranks of Brazil's governors and mayors (Septel). A
common assumption now is that its main result may be just a
further increase in Brazil's tax burden. The near-universal
forecast is that it is liable to undergo major further
recasting before final passage through the Chamber -- let
alone when it reaches the Senate, where over twenty sitting
members are former governors.


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