Defying Lula, Senate president insists on reducing taxes on municipal payrolls

Rodrigo Pacheco, the president of the Brazilian Senate, defied the federal government this week by modifying a provisional decree signed by President Luiz Inácio Lula da Silva which proposed the gradual end of payroll tax relief for small municipalities. 

With Mr. Pacheco’s decision, municipalities with more than 156,200 inhabitants will continue to pay only 8 percent in payroll taxes instead of 20 percent, which would be the normal rate.

The issue has been an intense struggle between the Executive and Legislative branches. Congress approved the tax relief in August last year, but President Lula vetoed it. In reaction, lawmakers overturned the veto shortly after. To try to overcome the standstill, President Lula issued a provisional decree in December proposing, among other things, a gradual tax increase for these municipalities. 

Members of Congress accused the government’s measure of being unconstitutional. In February 2024, the Lula administration agreed to draft a new provisional decree, removing payroll tax exemptions for companies operating in 17 economic sectors — which were also part of the negotiations — so that the matter could be discussed through an ordinary bill, but maintained the increase in taxes for municipalities.

The rate would rise to 14 percent in April 2024 and then 2 percent annually until it reached 20 percent in 2027. The Confederation of Municipalities (CNM) said such a change would reduce the relief in municipalities’ expenses previously estimated at around BRL 11 billion to just BRL 4 billion.

After several meetings with government leaders, Mr. Pacheco decided to maintain Congress’ original intention of sustaining the tax reduction for municipalities. Pressure from city halls in an election year weighed on the decision of the leader of the Upper Chamber.

Finance Minister Fernando Haddad argues there is no room for such a tax waiver in the 2024 budget. Committed to regulating the recently approved tax reform, his economic team would not have an alternative to compensate for the measure at a time when the federal government is already struggling to find new ways to increase revenue.

Mr. Pacheco says he made this decision because municipalities would have to start paying higher rates on their payrolls on Monday, but that the discussion with the federal government remains open.

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