US embassy cable - 03BRASILIA2889

UNCLAS SECTION 01 OF 02 BRASILIA 002889 
 
SIPDIS 
 
NSC FOR WALLACE 
TREASURY FOR SSEGAL 
PLS PASS FED BOARD OF GOVERNORS FOR WILSON, ROBATAILLE 
USDA FOR FAS/FAA/ITP 
USDOC FOR 4322/ITA/IEP/WH/OLAC-SC 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, EIND, EINV, PGOV, BR 
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. 
 
HRINAK