Background:

More than 20 years of military rule ended in 1985 and a new constitution was ratified in 1988. The government of Fernando Henrique Cardoso (1995-2002) ended hyperinflation and advanced reforms to liberalise the economy, but public-debt indicators deteriorated amid low economic growth. The current government, under the president, Luiz Inacio Lula da Silva, has been successful in consolidating macroeconomic stability, while stepping up social spending. However, the political environment is obstructing the implementation of deeper reforms needed to accelerate growth.
Political structure: The president executes policy approved by the 513-seat Chamber of Deputies (the lower house) and the 81-seat Senate (the upper house). Constitutional review is by an independent judiciary. Although the president can resort to temporary decrees to push through legislation, the 1988 constitution gives Congress ample capacity to frustrate the executive. A total of 21 political parties are represented in the lower house and party discipline has traditionally been weak.
Policy issues: The Lula government has stuck to fiscal and monetary conservatism and improved the public debt ratios, while stepping up poverty-alleviation programmes. But fiscal problems persist, preventing a steeper decline in interest rates. Public debt remains high at around 41% of GDP and, despite improvements, social security expenditure still appears to be on an unsustainable path. The success of Lula’s plan to raise annual average real GDP growth to 5% (mainly through higher infrastructure investment) will depend on progress in reforms, including streamlining the complex tax system, strengthening the regulatory framework, improving the quality of social spending and tackling labour informality.
Taxation: Brazil has a poorly structured revenue system characterised by heavy tax burdens, a narrow taxable base, complicated levies and widespread tax evasion. Companies, both foreign and domestic, employ tax professionals and devote considerable resources to managing their tax affairs. The corporate and indirect taxation systems are particularly complex and porous; the income tax system is considered to be relatively efficient, with a top rate of 27.5%.
Foreign trade: Strong external demand and a more active export policy have contributed to booming export earnings since 2003, leading the trade surplus to swell and transforming the current account from a deficit of 4.6% of GDP in 2001 to a surplus for several years, albeit steadily declining. Stronger growth in the import bill than in export earnings, coupled with a wider services deficit caused this surplus to shrink to 0.1% of GDP in 2007 and will lead to a deficit in 2008.