Brazil's VAT Reform: Improving Equity

After decades in the making, Brazil’s landmark VAT reform was approved in 2023. The primary objective of the reform is to eliminate distortions and reduce the complexity of the current consumption tax system while maintaining revenue neutrality. In addition, specific design features were included to alleviate the VAT’s inherent regressivity and improve the equity of the Brazilian tax system. This paper assesses the reform’s expected equity print leveraging a microstatic model based on household data and simulates policy options to further improve distributional outcomes. While the new VAT achieves a fairly equal distribution of the tax burden across most income groups, the poorest still carry a heavier load in terms of their disposable income. Dissecting the impact by policy instrument, the reform’s approved reduced rates aggravate regressivity, while zero rates and the new cashback lower the tax burden for poorer households, under the revenue neutrality assumption. Overall, the combined use of these measures dampens the reform’s equity outcomes somewhat as a higher VAT reference rate is required on all other items to maintain revenue neutrality. The paper also shows that some equity improvements stem from the reform’s implied pivot towards taxing services. Finally, simulations show that focusing on and expanding the cashback could amplify equity gains by raising the poorest disposable income by 25 percent via reductions in their tax liability.