Pension Fund Taxes to Erode Brazil's Savings and Growth

 

By: Terry Wade and Adriana Arai
 The Wall Street Journal, November 9, 2001


Taxing people twice may help Brazil balance its books, but it also could stymie long-term economic growth.

Brazil's Supreme Court on Thursday issued a ruling that paves the way for the federal government to impose a range of taxes on pension funds, including capital gains. The levies will come in addition to the income and sales taxes pensioners already pay when they pull money out of their retirement accounts.

Economists say the decision will provide the federal government with much-needed cash but diminish the country's already low savings rate, discouraging the formation of capital needed to finance economic expansion. Less local savings, in turn, will push up external borrowing needs over the long haul.

"This court decision is going to erode what is an already low savings rate for Brazil," said Walter Molano, Latin America economist with BCP Securities in Connecticut. "Eventually a move like this will manifest itself in a larger current account deficit."

The high court banned the tax-exempt status of Embrapa, a pension fund run by the government's agricultural research institute. The decision is expected to set a precedent that will hit all other pension funds in Latin America's largest nation.

The ruling capped a five-year legal battle by the fund. Now, the country's major pension funds are expected to retroactively pay 12 billion reals ($1=BRR2.55) in taxes and about BRR700 million annually.

Key members of Abrapp, the association of 270 company-run pension funds that represents the bulk of Brazil's retirement investments, say they expect to eventually be hit by the ruling. Abrapp's members have BRR136 billion in assets.

To encourage pension funds to settle out of court on disputes over past tax liabilities, Social security Minister Roberto Brant said the government is offering a 50% discount on back taxes. That would still give the government BRR6 billion in windfall revenue in coming months and help it meet a BRR40 billion primary budget surplus target set by the International Monetary Fund for 2002.

So far, the equities market hasn't reacted negatively to the Thursday decision, according to traders.

That's because most pension funds had provisioned for taxes prior to the issuance of the ruling. The BRR35 billion Previ fund of state-run Banco do Brasil SA (E.BDB), which is Latin America's largest pension fund, had set aside BRR2.0 billion ahead of the ruling.

But pension funds say that longer-term, the decision will cut the amount of voluntary contributions retirees make to their accounts as the ruling makes investing less attractive.

"This will really hurt savings levels and savers, no other country taxes pension funds the way we will be taxed," said an advisor to Petros, the pension fund of oil giant Petroleo Brasileiro SA (PBR). Petros has BRR8.0 billion in assets.

Currently, Brazil has one of the lowest saving rates in Latin America at about 16% of gross domestic product, compared with the regional average of 19%.

Fewer people investing spells bad news for a market already suffering from declining liquidity as local blue chips continue to list American Depositary Receipts in New York.

The ruling also runs counter to efforts being made by other branches of government and investor groups to further develop the country's equity market and increase its role as a source of capital.

Last week, President Fernando Henrique Cardoso kicked off a rally on the local stock market by sanctioning a new corporate law that gives 80% tag-along rights to minority shareholders. Through a presidential decree, he also gave greater oversight powers to the country's securities regulator.

Also, to boost sagging trading volumes and give investors more choices, Brazil's main stock exchange will start offering futures on individual stocks Nov. 19. A new one-share, one-vote Novo Mercado exchange, meanwhile, is slated to launch when market conditions improve enough to allow a group of local firms to hold initial public offerings. A new Bovespa mutual fund index is also being planned.

 


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