Impasse in income tax reform: Lira and government do not agree on taxing the richest

The government and the Chamber of Deputies are not reaching an agreement in discussions on the second part of the tax reform, which changes the Income Tax. The main points of divergence are on the taxation of wealthier taxpayers and the situation of states and municipalities, which fear losing revenue.

Four meetings of the Special Committee on Amendments to Income Tax Legislation, created in early May, have already been held. The last one was last Tuesday (17) and one of the few consensuses between the economic team and the rapporteur, former Speaker of the Chamber Arthur Lira (PP-AL), is in relation to increasing the exemption limit: R$5,000.

The government's proposal – bill 1.087/2025 – was presented on March 18. The goal is to reduce the tax burden for those who earn less and increase taxes for those who earn more. The Executive says that, with this, it seeks tax justice.

The path to approval in the National Congress is proving to be a stage of intense negotiations, with the project's rapporteur and government representatives – such as the Secretary of Economic Reforms, Marcos Barbosa Pinto, and the Special Secretary of the Federal Revenue, Robinson Barreirinhas – diverging on crucial points.

The outlook is challenging, say political analysts Erich Decat and Izael Pereira, from the Warren Rena brokerage firm. According to them, the government's proposal presents significant obstacles:

• the methodology of taxation;
• the fiscal impact on subnational entities;
• operational complexity; and
• the way in which the regulation will be detailed.

The differences point to likely changes in the text of the reform. Taxation of dividends is one of the most sensitive points and with the greatest potential for change, according to experts at Warren Rena.

Another point of concern is the effects of the changes on states and municipalities. The government's bill is seen by many states as " a kindness on someone else's plate " since it affects their revenue.

The Constitution determines that all income tax withheld at source from state and municipal employees belongs to the respective states and municipalities. With the expansion of the tax-exempt bracket, regional governments will immediately lose a large part of this revenue.

Furthermore, almost half of the total income tax revenue is passed on to states and municipalities – and if the tax waiver is not properly compensated, this slice of the “pie” is at risk of shrinking. Income tax revenue is shared with states and municipalities through regional funds:

• 21.5% of the resources go to the State and Federal District Participation Fund (FPE);
• 25.5% for the Municipal Participation Fund (FPM); and
• 3% for financing programs in the North, Northeast and Central-West regions.

Exemption of R$5,000 is a consensus amid impasses

Amid the discussions, one point stands out as an unrestricted consensus between the government and Congress: the exemption from Income Tax for those who earn up to R$5,000 per month. Lira is emphatic in saying that this is "the only convergence of the entire Congress". "No one disputes the exemption of R$5,000", he says.

The project also foresees the application of discounts for incomes between R$5,000 and R$7,000, a "ladder" designed to prevent the taxpayer from having a lower net income when exceeding the exemption limit.

Barbosa Pinto, Secretary of Economic Reforms at the Treasury, highlighted in his speeches to the committee the importance of this correction, which according to him reverses a "secretive increase in taxation on personal income" that lasted for almost 30 years due to the lack of correction of the table values.

The losses, however, will not be fully compensated. The National Association of Federal Revenue Auditors of Brazil (Unafisco) pointed out in March that the minimum exemption limit would be R$5,211.51 if the IR table had been fully adjusted by the IPCA over the last 29 years. In addition, those who earn more than R$7,000 will continue to be taxed according to the old – and outdated – table.

Another point of convergence between the government and the rapporteur of the proposal is the need for legal clarity and detail. Both Barbosa Pinto and Lira agree that the mechanisms for refunding excess tax should be made explicit in the law itself, and not relegated to sub-legal regulations, to guarantee legal certainty to the taxpayer.

The breaking points: where Lira and the government do not understand each other

Despite the consensus, the public hearings of the Special Committee on Income Reform reveal major divergences, which are shaping the debate in Congress. The main points of disagreement are:

• the form of compensation for revenue losses due to the correction in the IR exemption bracket; and
• the situation of states and municipalities in light of changes in IR.

How to compensate for lost revenue?

Arthur Lira's main concern is how to compensate for the loss of revenue resulting from the increase in the income tax exemption bracket for those who earn up to R$5,000 per month, which could benefit 14 million taxpayers. According to him, there is a lot of skepticism in Congress regarding the arguments presented by the government.

The Federal Revenue Service projects a revenue loss of R$25.84 billion in 2026, but estimates that the new measures will provide full compensation. “The project is perfectly balanced from a fiscal point of view,” says Barbosa Pinto.

The government insists on the fiscal neutrality of the project, stating that the exemption and benefits for lower incomes will be fully financed by the taxation of high incomes, including profits and dividends.

The Achilles heel of the proposal presented by the government is how states and municipalities will be affected by the changes in taxation. Arthur Lira is categorical on this point, stating that this is a fundamental issue that needs to be resolved and essential for the project to be put to a vote.

The rapporteur is actively seeking alternatives to mitigate this impact. The mayors, represented by Paulo Ziulkoski, president of the National Confederation of Municipalities (CNM), and Michele Roncalio, president of the Brazilian Association of Finance Departments of the Capital Cities (Abrasf), have already raised their voices, pointing out significant losses in Income Tax withheld at source from their payrolls and in the Municipal Participation Fund (FPM).

Estimates of losses for municipalities vary drastically: from R$4.85 billion, according to Abrasf, to R$20 billion annually, depending on the source and scope of the analysis.

Robinson Barreirinhas, from the Federal Revenue Service, presents a complex counterargument. He admits a reduction in withholding tax for municipalities. However, he argues that the overall effect will be offset by a robust increase in transfers to the State Participation Fund (FPE) and the FPM, driven by other revenue collection measures, such as the taxation of offshore companies and closed funds.

The secretary even claims that, between 2015 and 2022, states and municipalities "made money" due to the Union's inaction in correcting the IR table, justifying the IRS methodology. The agency projects a smaller impact, between R$2 billion and R$3 billion, well below the numbers presented by the municipalities. Lira, however, signals a possible underestimation of this impact.

What about the increase for the richest?

The government's proposal also introduces the Minimum Personal Income Tax (IRPFM). The idea is to apply a rate of up to 10% on annual income exceeding R$600,000. The ceiling would apply to those earning over R$1.2 million.

Lira questions the option for IRPFM instead of direct taxation of profits and dividends. He cited PL 2.337/2021, a proposal to reform Income Tax presented by the government of Jair Bolsonaro (PL). For Lira, the project – which was approved by the Chamber of Deputies, but was not discussed in the Senate – was "more neutral" than the one from the Lula government.

The rapporteur is also concerned about the effectiveness of the IRPFM reduction, which, according to him, would reduce revenue by R$3.6 billion. Lira prefers a more traditional progressive model, where taxation would only be levied on the surplus income, not on the total base.

The aforementioned reduction is a mechanism by which the government intends to add the effective taxation on the company to the taxation of the dividend distributed to the shareholder. If the total exceeds a certain level, the individual will be entitled to a refund.

According to the proposal, this sum will not exceed 34% for non-financial companies, 40% for insurance and capitalization companies and 45% for financial institutions. If the sum exceeds these percentages, the Treasury says that the taxpayer will receive a refund in his/her annual individual tax return.

Barbosa Pinto says that the bill "is not about taxing all dividends," but rather high incomes, in practice, above R$1 million per year. According to him, around 80% of people who receive dividends would continue to be exempt. He argues that taxing dividends can stimulate reinvestment in companies.

Barreirinhas, in turn, argues that the IRPFM is more efficient because it focuses on the total income of the individual, which makes it difficult for taxpayers to divert their source of income and avoid taxation. The IRS sees the reduction as a "safeguard for tax justice", essential to avoid double taxation for partners in companies that already pay high corporate taxes.

Even in other government agencies, there are disagreements regarding the proposal that is being discussed in the Chamber. Experts from the Institute of Applied Economic Research (Ipea), an arm of the Ministry of Planning, consider Bill 1,087 to be "timid" and argue that taxation of profits and dividends is a common and efficient practice in most countries of the Organization for Economic Cooperation and Development (OECD) and Latin America, which contrasts with the Brazilian exemption.

Complexity of the proposal and distrust of IRS data

Another point of discomfort for Lira in relation to the proposal that is being processed in the Chamber is in relation to the operational complexity, especially with regard to the return of excess taxes and the general fiscal impact.

Barbosa Pinto acknowledges the situation, but justifies it as a necessity to guarantee tax justice and suggests that the Federal Revenue Service can simplify the process through pre-filled declarations.

Trust in technical data is a sensitive issue. Lira expresses skepticism about the Finance Ministry's data, claiming that he has not yet received official responses to his analyses.

Marcos Pinto acknowledged the delay, saying it was partly due to the IRS strike, and promised to send detailed data. Barreirinhas reinforced the IRS's commitment to providing technical information, studies and projections.