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Anyone who claims that bank transactions hold no correlation with taxpaying capacity (and therefore contain no economic substance) commits an impropriety. Such a person does not perceive, or obscures the fact, that he or she is reasoning based on an income paradigm, or more precisely, a paradigm of net earnings or increased net worth.

We must underscore this elementary mistake. Though increased net income could be chosen as an ideal tax base, it would be abusive to consider it the exclusive indicator of taxpaying capacity. On the other hand, though bank transactions may not always represent income or increased net worth (albeit this is often the case), this does not mean that bank transactions do not indicate taxpaying capacity.

A good example is a loan. Accounting shows that funds leaving the lender’s net worth to enter the borrower’s net worth only to once again return to the lender do not trigger a definitive change in the respective net worths of lender and borrower. On the other hand, payment for the loan (interest) decreases the net worth of the borrower, and materially increases the net worth of the lender. So it is fair that income tax should not be levied against the value of the loan, but rather only against the net income from interest, earned by the lender. The borrower, who pays the interest, would be permitted to deduct the interest as a cost or expense.

Now, this logical routine, which is valid within the mental universe of income tax, cannot exclude other dimensions of the phenomenon.

Obviously, the loan has economic substance; it is a manifestation of credit, a quantifiable economic asset. It also indicates the taxpaying capacity of its holder.

This asset, the foundation of financial leverage, can be used, spent, invested, made profitable, multiplied, renewed, “rolled”, and exploited economically. It is not income, so it would be absurd to tax it at high income tax rates, of between 15 and 27.5. But it constitutes a bank transaction, utilization of capital, which is indisputably an economic act. In fact, it is already subject to Brazil’s IOF tax [Tax on Financial Transactions], with a low rate, and until 2007 to the CPMF [Provisional Contribution on Financial Transactions], both of which would be replaced by the proposed bank transaction tax.

Now let us take the common case of a middle class wage earner whose only income is his monthly salary deposited into a bank account. Under normal conditions, this citizen will not play around with his money, needlessly withdrawing it and re-depositing it into the same bank account, over and over again, knowing he would be charged the tax repeatedly and pointlessly. If he makes a loan, the funds will leave the account and return to it, just once. Normally funds will be withdrawn only once, for consumption, leisure, charity, equipment, maintenance or increased productive capacity, or for savings and investments.

Funds withdrawn for financial investment will not be subject to the proposed tax, as the comments in the section below will make clear. Under the current system, the remainder, after allowed deductions and on amounts exceeding the exemption limits, would be subject to income tax, at rates of between 15 and 27.5%, and until 2007 to the CPMF – in addition to other indirect taxes included in the prices of products and services consumed.

Under the proposed Federal Single Tax system, the funds would be subject to the bank transaction tax, the rate for which would be nearly 10 times less than the income tax rate, in addition to indirect taxes included in the prices of goods and services consumed, which presumably would be less than what they are today. Currently, half or more of taxes included in the prices of products and services are pocketed by sellers, and not passed on to the Treasury. These become illegitimate income appropriated by criminal businessmen and disloyal competitors.

Because it is intended, in principle, to keep the tax burden unchanged, and since that revenue does not rain down from the sky, but does curtail the economy’s disposable income, clearly there is no magic. Any tax that ceases to flow from one place will have to emerge from other sources. And since tax avoidance is very high in Brazil, we should expect that the universally applied bank transaction tax would produce a healthy redistribution of tax incidence, and a subsequent easing of fiscal pressure. Reduction of taxes included in product prices will tend to occur as soon as business owners cease to act as tax depositories and as soon as tax evaders, now subjected to the inescapable bank transaction tax, are included in the taxpayer universe.

The case of a self-employed professional, whose earnings takes the form of numerous checks in small denominations, part of which will be used to pay suppliers, will differ little, if at all, from the case of the wage earner. In both cases,

the taxpayer will feel unjustly taxed on that portion of his gross earnings that are paid out as costs, such as checks paid to third party suppliers. Those taxpayers whose business structure involves large bank transaction volumes that do not represent earnings will be hurt; namely, those enterprises, whether individual or corporate, that manipulate third-party funds, involving high costs and minimal margins. These enterprises would suffer – and perhaps even become impracticable – under this type of tax.

It might be fair, albeit not simple, to avoid this effect. On the other hand, this effect would not necessarily be a bad thing, insofar as it would discourage a whole range of speculative businesses that are devoid of true economic usefulness, since they involve using assets in order to seek profits in the intermediation game.

Adoption of the tax base comprised of bank transactions is perfectly compatible with building adjustment mechanisms capable of making the tax’s incidence fairer and better tailored to the diversity of individual circumstances. But, we should make clear that any adjustment or individualization of the tax presupposes that paper tax returns and interfacing with the federal revenue agency will survive. In other words, they would exclude the primary advantages of the tax, which are simplicity and low compliance cost.

Perhaps it is preferable to be taxed in a less sophisticated manner, thus avoiding auditing procedures of fiscal obligations, than to be taxed in a fine-tuned system while having to accept a lasting and costly relationship of dependency with the federal revenue agencies. The authors of the Federal Single Tax amendment place their bets that preference will be given to simplicity, low operational costs, abolition of the paper-ridden declaratory system, and elimination of all subjectivity in taxation procedures.