How to tackle the ‘Custo Brasil’
The so-called ‘Custo Brasil’ describes several factors that make Brazil a relatively expensive place to do business. In this special report, we will cover three important growth bottlenecks that are primarily cause this Custo Brasil: the tax system and red tape, lack of good infrastructure and human capital constraints. Furthermore, we discuss what could be done and what we expect that will be done to solve these challenges.
Tax system and red tape
According to the 2013-2014 Global Competitiveness Report of the World Economic Forum, tax regulations are one of the most problematic factors for doing business in Brazil. The World Bank’s Doing Business report also clearly reveals Brazil’s weakness in this respect, as Brazil comes as a dismal number 159 (out of 189 countries) when it comes to the difficulty of paying taxes. Brazil’s tax system is very complicated and fragmented, as not only the federal and state, but also the municipal governments have the authority to collect. In particular the corporate and indirect taxation systems are extremely complicated. There are for example four different sorts of de facto value added taxes. Both tax collection and tax reporting regulations are thereby extensive.
As a result, local mid-sized companies have to spend 2,600 hours a years to comply with tax regulations, according to the Doing Business report. There is no country in the world where tax regulation is so burdensome (for OECD high income countries the average is 175 hours, while the average for Latin America and the Caribbean is 369 hours). The complicatedness of the tax system not only results in a lot of work, but also in uncertainty.
Most of the time, Brazilian tax officials tend to issue infraction notices as soon as they see potential mistakes, instead of discussing issues directly with a firm. At the same time, the government has passed several tax amnesties which lowered the interest and fines to be paid and allowed companies to pay in instalments. Partially as a result of the complicated tax system, tax evasion is also widespread in Brazil, which often puts companies and individuals who do pay taxes at a competitive disadvantage.
Meanwhile, tax rates are relatively high. The overall taxes are equal to approximately 36% of GDP, which is above the Latin America and emerging market average. According to the World Bank, the total tax bill of companies is equal to 69.3% of profits, against 47% in Latin America and Caribbean as a whole and 43% in the OECD. Both profit taxes and, in particular, labor taxes are relatively high in Brazil.
Worse, companies do not get a lot in return for paying these relatively high taxes, as the quality of institutions and public service delivery is rather poor in Brazil. The judicial system is for example very slow. According to the World Bank Doing Business indicators Brazil is number 135 (out of 170 countries) when it comes to resolving insolvency, as it takes on average 4 years to deal with an insolvency. Red tape is thereby an important issue. According to the Global Competitiveness Report, dealing with an inefficient government bureaucracy is the fourth largest problem for businesses in Brazil. Of all the 148 countries included in the report, Brazil has the second worst score for the burden of government regulation. Brazil’s score for wastefulness of government spending is also dismal and the country has very strict labor laws. All these factors add to the cost of doing business, discourage investment and explain Brazil’s relatively low ranking on the World Bank’s Doing Business ranking (see also figure 1).
The Brazilian government has taken some efforts to reduce the burden of the tax system. The government has tried to modernize the tax compliance system through the introduction of a new system, the SPED (Sistema Público de Escrituração Digital). This system should allow much of the control to be processed automatically. The government also intends to overhaul state-based VAT taxes on interstate transactions. This should lower the overall tax burden and result in a flat VAT for the whole of the country. Overall, the tax environment may improve somewhat, but, at least in the near future, we expect Brazil to continue to be a country with a difficult tax system and a lot of bureaucracy, also as it generally takes a lot of time in Brazil to implement comprehensive reforms (see also this Economic Report)). We also expect Brazil to be a high tax country.
The relatively low level of public service delivery is also very much visible in the field of infrastructure. In fact, inadequate supply of infrastructure is the biggest problem for business according to the 2013-2014 Global Competitiveness Report. While Brazil invested a lot in infrastructure in the 1970s, which for example resulted in the construction of many hydro dams that still are Brazil’s primary generators of electricity, investment fell sharply when the country ran into deep macroeconomic problems during the 1980s and has remained low ever after. In 2012, investment in infrastructure was 2.2% of GDP, of which only 0.7% of GDP was invested in transport infrastructure. What is more, investment in infrastructure is also affected by the poor planning and execution track-record of the government.
Years of underinvestment have thus resulted in a very low level of infrastructure provision. According to the McKinsey Global Institute (MGI), the value of Brazil´s infrastructure stock was a meagre 16% of GDP and far below the value of the infrastructure stock of other Emerging Markets. For example, India had a stock of 58% of GDP, China a stock of 76% of GDP, and South Africa even 87% of GDP. Advanced economies also have much higher investment stocks than Brazil (see figure 2) .
Meanwhile, the pick-up growth that Brazil experienced in the first decade of this century has made the problems more acute, as it has resulted in a strong increase of demand for infrastructure. For example, air traffic in Brazil increased by 171% in the past decade and its airports are overburdened. The same applies to Brazil’s ports. Moreover, the quality of the road and railway network in Brazil is also low. For example, only 6% of Brazil’s roads are paved.
The infrastructural problems also have a regulatory dimension, as customs procedures are a burden for international trade. According to the FGV institute, getting a container into Brazil requires 100 forms and 900 pieces of information. All this limits Brazil’s ability to reap the benefits from participating in the global economy, as infrastructural bottlenecks result in delays and high costs. According to the World Bank it costs USD 2215 per container to export and USD 2775 to import in Brazil. In China this costs just USD 500 (export) and USD 545 (import) and in Chile only USD 795 (both).
Recently, the government announced two programs that offer some promise. In August 2012, President Dilma Rousseff launched the Plano Nacional de Logistica Integrada (PNLI), which is meant to result in USD 65bn in investment in roads and railroads, of which USD 40bn is likely to materialize in the coming five years. It should double the capacity of the main highways and entails 10,000km of railway track. Afterwards, a USD 26bn initiative has been released for ports (Programa de Investimento em Logística: Portos) and airports.
Both initiatives have been well received. The terms offered to private investors are attractive. They are based on public private partnership, through which the government intends to deal with its own weak track-record in procurement. In the meantime, some auctions have taken place. The auctions for airport projects were successful, as investors were willing to make high bids to operate Brazil’s most important airports, such as Sao Paulo’s Guarulhos airport and Rio de Janeiro’s Antônio Carlos Jobim airport. Overall, the outlook for infrastructure has thus improved somewhat.
Nonetheless, inadequate provision is likely to remain an issue. First, road, and in particular, railroad and port projects may be less easy to realize than airport projects, due to regulatory issues. So far, auctions for road and rail road projects have been less successful than the airport projects. Second, the amount of investment needed to remove infrastructural bottlenecks is very large. According to MGI, Brazil invested 1.5% of GDP on transport infrastructure in the period 1993-2011.
However, as almost all countries have an infrastructure stock of 70% of GDP, removing the infrastructure constraints on economic growth in Brazil by 2030 would require 4.9% of investment per year in the period 2013-2030. In the medium-term such a high level of investment is unlikely to materialize. At the same time, the extremely low stock of infrastructure investment means that additional investment is likely to have a big impact on the efficiency of the economy.
Human capital has become another constraint of economic growth in Brazil. In the 2013 Talent Shortage Global Survey of the Manpower group, Brazil was the second worst scoring country among the 42 countries surveyed. Some Emerging Markets, such as India and Turkey, had a slightly better score, while others, such as China, Colombia, Mexico, Peru and, in particular, the Czech Republic, had much better scores. According to this survey, 68% of Brazilian employers reported that they were having difficulty filling jobs, against a global average of 35%. According to the OECD (2013b), there is in particular a lack of people with tertiary education: only 10% of the population has a post-secondary degree, against 15% in Mexico and 25% in Chile.
Not so long ago, Brazil had one of the weakest educational systems of all middle-income countries. In 1960, the average years of schooling completed by the adult population was only 1.8 (against 5.3 for Argentina and 3.2 for Peru) and was thus only slightly higher than the average in China, a country that was much poorer at that time. In the past decades, the years of schooling of the Brazilian population has increased strongly. The average years of schooling have risen rapidly to 7.2 years in 2010 (which is still below the 9.3 years seen in Argentina and 8.7 years in Peru).
Figure 3: Math score in 2012 OECD PISA
In fact, the rise in average educational attainment since 1990 has been one of the fastest in the world. According to the 2009 OECD PISA study, “Brazil’s students have gained the equivalent of a full academic year of math skills” between 2000 and 2009. This has also resulted in a better performance, as mean performance in mathematics improved from 356 to 391 points between 2003 and 2012, which makes Brazil the country with the highest performance gains, according to the 2012 OECD PISA study. Expenditure has grown rapidly in the past decades and increased from about 3.5% of GDP in 2000 to almost 6% of GDP in 2010. Given this increase, the education level of the population is likely to continue to grow in the near future.
Nevertheless, Brazil remains in some respects a laggard. According to the 2012 OECD PISA survey, Brazil’s mathematics performance is still relatively low (see figure 3). Furthermore, the efficiency of education spending is not very high, as Brazil spends relatively more on education than Chile, India, Indonesia and Mexico, without having better outcomes. Furthermore, while access to education has improved markedly, the quality of education is often still relatively low. According to the Global Competitiveness Report of the World Economic Forum, the quality of primary and higher education remains low, with Brazil ranking as respectively the 129th and the 121st country out of the 148 countries surveyed. School days are often very short, as schools sometimes have three daily shifts to deal with a shortage of classrooms. Public secondary schools tend to have a much lower quality than private schools, which makes it hard for poor children to obtain access to tertiary education. Spending is thereby skewed towards the university education. According to the OECD (2013c), Brazil spends three times more on a student in tertiary education than on a student in primary education, in many developed countries this ration is less than 1.5.
Brazil’s past track-record of improving the quality of its labor suggest that country should be able to further improve the quality of human capital. According to the OECD (Brazil outlook 2013), improving the skills of secondary students is likely to have a strong impact on productivity. Some features of the existing system, such as the high level of inefficiency and the difference in quality between private education and public education, may be hard to change.
Many of Brazil’s problems are hard to tackle. In particular in the field of tax policy and red tape, it seems unlikely that the situation will improve dramatically in the near future. Recently launched initiatives give some more hope for infrastructure, but given the low level of development of Brazil’s infrastructure, infrastructure is likely to remain an issue. Meanwhile, given its past track-record, some progress could also be expected in the field of education.
- Manpower Group, 2013 Talent Shortage Global Survey
- McKinsey Global Institute (MGI), McKinsey Infrastructure Practice, Infrastructure productivity: How to save $1 trillion a year, January 2013
- OECD, PISA 2009
- OECD, Brazil – Country Note –Results from PISA 2012, 2013a
- OECD, Economic Survey of Brazil 2013, 2013b
- OECD, Education at a Glance 2013, OECD inDiCatOrs, 2013c
- World Bank, Doing Business 2014
- World Economic Forum, 2013-2014 Global Competitiveness Report