Brazil’s New VAT System: Simplifying Consumption Taxes Without Losing Public Revenue

Brazil’s VAT reform replaces five complex consumption taxes with a unified dual VAT to simplify taxation, eliminate cascading, and preserve revenues, but its success depends heavily on improved compliance and strong tax administration. The IMF-led analysis finds revenue neutrality is achievable in theory, yet fragile in practice, with compliance gaps posing the biggest risk.

Brazil’s historic value-added tax (VAT) reform, studied by researchers from the International Monetary Fund (IMF) in close collaboration with Brazil’s Federal Revenue Authority (Receita Federal do Brasil) and the Ministry of Finance, marks a decisive break with one of the world’s most complex consumption tax systems. Approved through a constitutional amendment in December 2023 and detailed in subsequent legislation, the reform replaces five overlapping federal, state, and municipal taxes with a dual VAT and a selective excise tax. The central political promise is clear: simplify taxation, remove distortions, and do so without losing revenue for governments at any level.

Why Brazil’s Old System Was a Problem

Before the reform, Brazil’s consumption taxes were exceptionally high and uneven. Combined rates often exceeded 34 percent and could rise above 40 percent on manufactured goods, while many basic items and services were lightly taxed or exempt. Taxes were charged multiple times along production chains because firms could not fully deduct taxes paid on inputs, a problem known as cascading. On top of this, states and municipalities applied hundreds of different rates, competed with each other using tax incentives, and interpreted rules differently. The result was high prices, distorted business decisions, enormous compliance costs, and long-lasting tax disputes. Indirect taxes came to represent about 12.5 percent of GDP and more than 40 percent of total public revenues, placing a heavy and often regressive burden on consumers.

What the New VAT Changes

The reform introduces a destination-based dual VAT with a single national tax base and harmonized rules. The federal component, called CBS, will replace PIS/COFINS by 2027, while the subnational component, IBS, will gradually replace ICMS and ISS between 2029 and 2033. A new selective excise tax will apply only to products considered harmful to health or the environment. The reference VAT rate is currently estimated at 28 percent, lower than typical effective rates under the old system, but it will be adjusted over time to ensure that total revenues remain unchanged.

A crucial improvement is full crediting of taxes paid on business inputs, which should eliminate cascading and make production more efficient. To make this work in practice, Brazil plans to use a generalized split payment system that automatically allocates VAT payments and credits through digital payment platforms. To protect low-income households, the reform also introduces a cashback scheme that refunds part of the VAT paid on essential goods and services, using existing social protection systems.

Can Revenue Neutrality Really Be Achieved?

Using an adapted IMF revenue model and detailed Brazilian data, the researchers estimate future VAT revenues under different assumptions. Their baseline result is cautiously optimistic: revenue neutrality can be achieved, but only under strong conditions. If tax compliance improves significantly, informality does not worsen, and small firms do not massively change tax regimes, the new VAT would raise about 12.8 percent of GDP, broadly matching past consumption tax revenues after accounting for cashback refunds.

The reform shifts the tax burden across sectors. Manufacturing and utilities benefit from lower effective rates and full input credits, while services contribute more because the tax base is broader and exemptions are fewer. However, much of the VAT paid on services is refunded within supply chains, limiting the impact on final consumers. Cashback payments are relatively modest, estimated at around 0.13 percent of GDP, and are concentrated on electricity, gas, water, telecommunications, and manufactured goods consumed by poorer households.

Risks, Administration, and the Road Ahead

The biggest threat to revenue neutrality is tax compliance. Brazil’s current compliance gaps are high, and reducing them to the levels assumed in the baseline would require exceptional administrative performance. If compliance does not improve, revenues could fall short by more than 1 percent of GDP. Other risks come from small firms migrating out of simplified tax regimes to benefit from input credits, which would increase refunds and reduce net revenues. Informality matters too, but even large reductions in informal activity generate relatively small revenue gains.

The paper’s main conclusion is that success depends less on tax rates and more on administration. Brazil will need strong coordination between federal, state, and municipal tax authorities, fast and reliable VAT refunds, and a risk-based approach to fighting fraud and evasion. If these challenges are met, the VAT reform can simplify taxation, boost productivity, and support long-term growth. Over time, the authors suggest, Brazil may also rethink its heavy reliance on consumption taxes so that the economic gains from this reform are shared more clearly with consumers.