Taxation, Inequality, and the Illusion of the Social Contract in Brazil

Abstract

Brazil combines high inequality and high tax yield as percentage of the GDP. This situation contradicts the predictions of two central theories of taxation and democratic politics. The first theory predicts that, within a democratic context, high levels of income inequality should lead governments to carry out significant redistribution. The second theory sees the government’s ability to raise tax revenue as dependent on a social contract between the state and its citizens, and predicts a negative relationship between taxation and social polarization. In this paper, we propose that the theory of fiscal illusion (Puviani 1 903; Buchanan 1967) can account for this double puzzle Brazil presents us. We argue that, by heavily relying on the exploitation of fiscal illusion, the Brazilian state has been able to mobilize a huge amount of tax resources without the need of a broad social contract that could lead to more redistribution, effective public services, and growth-enhancing policies. The paper provides some evidence that supports our argument. First, using recent household surveys and a tax-benefit microssimulation model, we show that redistribution by the state is small, and that even the poorest 20% of the households are, on average, net contributors to the fiscal system.Second, we describe some main features of the Brazilian tax system that tend to induce voters-taxpayers to underestimate the cost of government’ activities. For instance, in the past, the inflation tax and debt financing were major instruments and, nowadays, complex and cascading indirect taxation plays a major role as a source of illusion. We then emphasize that the relationship between inequality and redistribution cannot be predicted without an understanding of the way inequality influences state financing: the institutions of taxation matters.