Tax evasion a way of life in Brazil

By Kenneth Rapoza

With high tax rates besieging workers and companies alike, rampant smuggling and tax evasion has become the norm in Brazil.

It's a jungle out there, say Brazil's business owners. Stringent labor laws, high interest rates and heavy taxes have led to rampant smuggling and tax evasion, some of it tied to international organized crime.

The result is a growing civil-disobedience movement among the country's business class and years of falling incomes and underdevelopment in a nation that rivals China for foreign investment capital.

"The market has become totally predatory," said Sergio Garcia Ozorio of Brazil's small-business association. Mr. Ozorio once owned a construction-materials company and cheated the system himself. "The informal economy is growing simply because there's not enough jobs to go around, and high taxes lead companies and individuals to do whatever they can to survive," he said.

For example, payroll taxes in Brazil consume an average 42 percent of an employee's income, compared with about 24 percent in the United States, and corporate taxes average 23 percent, compared with an average 14 percent in the United States.

Sales taxes vary widely by state and type of purchase. In Sao Paulo state for cigarettes, it's 72 percent. Beer is taxed at 56 percent. For soap, add 42 percent. And the tax on a new car is 44 percent.

Tax receipts for 2003 were the equivalent of 35.6 percent of the country's gross domestic product, rising from the equivalent of $154 billion in 2002 to $174.3 billion in 2003, breaking a seven-year growth record. Roughly $50 billion a year is thought to be lost to tax evasion.

Businesses here pay more taxes than their counterparts elsewhere. And the "informal economy" is growing because of it.

The informal economy consists of workers earning money tax-free, often as street vendors called "camelos" illegally selling everything from toothbrushes to pocket computers, as well as legitimate businesses that report lower sales figures to avoid taxes.

The informal economy has grown so large that it has become one of the chief barriers to development, according to a study made public in June by McKinsey & Company, an international consulting firm with offices in Sao Paulo. Per-capita income over the past 20 years has grown a nominal 0.5 percent even in boom times, though this doesn't include the "informal economy."

Thirty-three percent of the population lives on less than $2 per day, according to United Nations Development Program data this year, and about 45 percent are malnourished, according to May data in a study on malnutrition and household debt by the Brazilian Institute for Demographics.

Companies working within the legal system produce twice as much as those operating informally, according to McKinsey. They are responsible for the best-paying jobs, and their employees have legal rights. Yet they are increasingly losing out to competitors that pay smaller, tax-free salaries.

"Informality is growing like a cancer," said Emerson Kapaz, president of the Brazilian Institute for Ethical Competition, set up by businesses trying to counter tax evasion and patent violations. Mr. Kapaz said the formal sector has come to accept the tax-evading practices of their competitors, hurting Brazil's legal economy and aiding corruption.

"It's not exactly the Boston Tea Party, but a large part of the population has no means to survive or to compete unless they work illegally," Mr. Kapaz said.

"What are the consequences? Companies are up to their neck in taxes, facing unethical competition. If we do nothing, we are headed for a society where organized crime has more power than the state, and citizens are prisoners of a parallel economy that barely serves their needs. We are mobilizing to put an end to this."

Though the informal economy makes statistics unreliable, it is believed to provide 40 percent of Brazil's income, double the rate of 133 countries studied in the World Bank's "Doing Business 2004" report. Half of the nonrural labor market works under the table, and 90 percent of farm laborers are paid tax-free, according to last month's McKinsey report.

An estimated 15 percent of small businesses pay taxes regularly. Between 1992 and 2002, 87 percent of the jobs created in metropolitan regions were informal—that is, employers did not file the equivalent of a W-2 form.

From a competitive standpoint, 53 percent of music and software CDs sold in the country are pirated copies, compared with 5 percent in 1997. An estimated 80 percent of retail food sales in Brazil and a quarter of soft drinks sold in Brazil involve companies that under-report sales. An estimated 60 percent of clothing stores in Brazil avoid taxes.

"I'm competing against clothing makers who pay zero taxes and can sell for less," said Inez Striquer Medri, a small manufacturer of clothing who employs 22 persons.

"Informal businesses operate with a lot of uncertainties. They don't have access to credit. They don't keep records of sales, so they have nowhere to run if a buyer decides not to pay them," she said.

Then Mrs. Striquer Medri admitted she avoids taxes whenever possible and actively colludes with a brand-name clothing retailer to hide sales records. "If I sell 100 pairs of jeans, I discount 50 percent on the contract. Instead of paying 5,000 reals in taxes, I just pay 2,500 reals."

Rua 25 de Marco in Sao Paulo is packed with camelos. They set up shop right outside small businesses. Vendors don't talk on the record.

"They're afraid. Everyone is making money under the table here. Some are selling fake goods," said Antonio Nogueira.

Mr. Nogueira, a tall, paunchy, balding man with a mustache, is running for City Council in a Sao Paulo neighborhood called Jabaquara. He was talking to vendors and handing out a business card saying "I need you" in Portuguese.

"Some of these people are my voters. Informality doesn't hurt anybody," he said.

On a side street crossing Avenida Paulista in downtown Sao Paulo, a vendor offers DVDs of the movies "Shrek 2" and "The Day After Tomorrow" at $8. How they managed to get pirated copies of movies not even sold here yet on the legitimate market is hard to know, and they won't tell.

Authorities got involved in a physical dispute with street vendors on Rua 25 de Marco on Thursday. Since the Sao Paulo government increased the powers of tax police and monitors July 2, tension has been high there. Sweeps to check on street merchants and shops are planned for the rest of the month to discourage the sale of pirated goods.

Last month, federal police arrested Chinese businessman Law Kin Chong, 43, who owns 600 stores in the city, accusing him of earning $150 million per year, tax-free. Mr. Chong, who had reportedly paid off police and court authorities for two decades, was caught after he tried to buy protection from a piracy-monitoring authority.

An investigation in Rio de Janeiro led to the arrest in March of Antonio Carlos Chebabe, owner of Chebabe Petroleum Distributors, for reported ties to Ubigas Petroleum, a firm created by organized crime for tax-evasion purposes, according to federal police records. Nearly $3.2 billion is lost each year in gasoline-tax evasion.

The magnitude of the problem makes it difficult for some companies to speak openly. "Informality can be dangerous and criminal," said an executive of a supermarket chain whose main competition is from tax-evading minimarkets.

Viviane Pizzol, owner of a minimarket in Parana state, said: "Everyone evades taxes. Everyone." She flipped through pages of bills and taxes she pays each month. She blamed employment laws for contributing to the informal hiring of workers.

High interest rates are another problem, she said. With annual interest rates at 16 percent, Mrs. Pizzol has taken out only one loan in the 20 years she has been in business.

"We need major changes, or the small middle-class business owner won't be able to handle the burdens of staying in business. I have 15 families that count on me to stay open."

Brazil finds itself in a Catch-22.

The cycle looks something like this: High taxes hurt business. Few tax evaders are punished, leading to social acceptance of tax evasion. While the informal sector manages to sell cheaper, the formal economy sells less. Lower profits stifle investments and hiring in the formal economy. With fewer formal jobs available, consumer spending drops, causing law-abiding companies to commit tax fraud in order to survive.

As the formal market weakens, government tax receipts fall, and it raises taxes to pay for services and debts. Boom and bust cycles become common.

Brazil's policy-makers are focused on fiscal austerity. Although the country is applauded by international bankers for its policies, economic growth over the past decade averaged 2.4 percent per year, compared with about 7 percent and 10 percent in India and China, respectively.

The McKinsey report blames the informal economy for the numbers. The informal sectors of India and China are tiny compared with Brazil's. The report estimates that if Brazil reduced its informal sector, per capita income could grow by 7 percent annually.

Although the federal government has no specific plan to deal with the informal sector, the Brazilian Congress recently passed a law giving tax breaks, lower interest rates and other benefits to small businesses.

Silvano Gianni, president of the Small Business Association in Brasilia, the capital, said that when the law takes effect, it is expected to reduce tax evasion by many companies.

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