RIO DE JANEIRO (CN) - Brazil's President Luiz Inacio Lula da Silva on Wednesday signed into law an expansion of the federal income tax exemption for workers earning up to 5,000 reais, or roughly $1,000, a month and the creation of a minimum tax for high-income taxpayers.

The reform, approved unanimously by Brazil's lower house in early October and by the Senate in early November, removes between 15 million and 16 million Brazilians from the tax rolls, according to estimates from the government and the bill's rapporteur. The fiscal impact is expected to reach 31.2 billion reais (about $6 billion) in 2026.

The change fulfills one of Lula's main campaign promises. Until now, the effective exemption applied only to monthly incomes up to 3,036 reais, equivalent to around $607.

"A lot of money in the hands of a few means misery," Lula said during the signing ceremony. "A little money in the hands of many means a distribution of wealth. If you take 10 million reais and give it to one person, it will sit in a bank account earning interest. If you take the same 10 million and spread it across a thousand people, it turns into food, clothing, school supplies - it turns into things that keep the economy running. That is what makes the economy grow."

Under the new rule, workers earning up to 5,000 reais will owe no tax after an automatic deduction applied by Brazil's revenue service.

Those earning between 5,000.01 reais and 7,350 reais will receive a declining deduction calculated under a statutory formula, while incomes above that level remain subject to current rates.

The government says the new law partly reverses years of bracket erosion that have disproportionately affected lower-income taxpayers.

At the ceremony, Finance Minister Fernando Haddad said that both the minimum wage and the income tax brackets went seven years without real increases, which pushed about 20 million Brazilians into the tax system "by simple freezing of the thresholds."

He said social programs and public-sector salaries were also frozen during that period, and that this time the fiscal adjustment was aimed at "the top of the distribution."

According to him, the bill advanced only because Congress agreed to reduce tax benefits the government considers unnecessary.

To offset revenue losses, the law creates a minimum tax on annual incomes above 600,000 reais (about $120,000), with progressive rates reaching 10% for those earning more than 1.2 million reais, equivalent to around $240,000.

The charge applies only when a taxpayer's effective rate falls below that floor, mainly affecting those who receive dividends and business profits currently exempt at the individual level. Capital gains - except those from the stock market - inheritances, donations, savings income and returns from Brazilian fixed-income securities funds and some types of compensation remain outside the minimum tax base.

Financial equalizer or legal quagmire?

In a study published in early November, researchers at the Center for Research on Macroeconomics of Inequality at the University of Sao Paulo found that the law reduces part of the income tax's regressivity by increasing disposable income for workers and raising the effective burden on those who rely on tax-exempt capital income.

According to the researchers, the richest person in Brazil earns as much as the bottom five million people combined, and the country ranks 13th worst in the world in income concentration among the top 1%.

The researchers found that the current income tax structure amplifies this distortion. The effective rate rises up to the 1% threshold but then falls for higher incomes, making the system progressive only up to roughly 39,000 reais a month. Above that point, the higher the income, the lower the share paid in tax.

They estimate the new law would modestly reduce this pattern. Brazil's Gini coefficient would fall by about 0.3%, with the share of income held by the bottom 99% increasing and that of the top 1% decreasing.

The minimum tax reduces regressivity, especially among the richest 0.2% - those earning around 106,000 reais per month - by narrowing the gap between the minimum and maximum effective rates for people at similar income levels.

Still, the researchers said the system remains lighter on very high incomes than on those in intermediate brackets.

Tathiane Piscitelli, a professor of financial law at Fundacao Getulio Vargas, said that despite the pushback from higher-income groups during the public debate over the reform, "that increase only actually affects those earning around 110,000 reais per month."

"It is an improvement to our system, something that has been needed for a long time," Piscitelli said. "Income tax is supposed to be progressive. We had the opposite situation, where those who earned more paid less. So even if this is not the ideal reform, overall it is a major relief."

But Morvan Meirelles Costa Jr., a tax attorney and partner at Meirelles Costa Advogados, said the law contains a central contradiction.

Costa said that because profits accumulated through 2025 may still be distributed tax-free if companies act within the deadlines, high-income taxpayers can anticipate payouts and remain under the old regime.

The "reduction mechanism" that limits the combined effect of corporate tax and the minimum individual rate effectively creates a ceiling that shields the largest fortunes, he said, adding that the reform advances less than promised, as much of its progressivity will depend on future regulations by the revenue service.

Costa said that "the government got the direction partly right but erred in the legislative engineering."

"Without clear regulations and adjustments to harmonize the law with Brazil's corporate legislation, there will be more legal uncertainty than fiscal gain," he said.

He added that the provision that conditions the exemption for accumulated profits on corporate deliberations by the end of 2025 may violate constitutional principles such as non-retroactivity and conflicts with Brazil's corporate and civil statutes, which set different deadlines for approving and paying dividends.

He said the vague requirement to comply with "civil and corporate norms" opens room for divergent interpretations by the tax authority, increasing litigation risk.

"In the short term, the effect will be a rush to distribute accumulated profits," Costa said. "After 2025, dividend taxation will start to operate fully. That may discourage companies from retaining profits and alter reinvestment decisions. Some firms may retain less and distribute more; others may seek alternative structures such as shareholder loans or investment in assets that generate exempt income."

Courthouse News reporter Marilia Marasciulo is based in Brazil.

Source: Courthouse News Service