Selective Tax and ICMS: Analysis of the Unconstitutional Cascade Incidence in the Tax Reform

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Selective Tax and ICMS: Analysis of the Unconstitutional Cascade Incidence in the Tax Reform

The recent Tax Reform, through Constitutional Amendment (EC) No. 132/2023, introduced the Selective Tax (IS) into the Brazilian fiscal scenario. The original proposal for this new tax, popularly known as the “sin tax,” was to discourage the consumption of goods and services considered harmful to health or the environment, with the aim of mitigating so-called negative externalities. However, a more in-depth analysis of its structure reveals a potential problem of unconstitutionality: the possible cascade incidence of the Selective Tax on the calculation basis of the Tax on Operations related to the Circulation of Goods and on the Provision of Interstate and Intermunicipal Transportation and Communication Services (ICMS). This interaction raises serious concerns regarding the tax burden, the complexity of the system, and the violation of fundamental constitutional principles.

The Purpose of the Selective Tax in the Tax Reform

The Selective Tax was conceived as an instrument of fiscal policy to intervene in consumer behavior, directing it towards healthier and more sustainable choices. That is, it aims to:

• Discourage consumption: Raise the final price of products such as cigarettes, alcoholic beverages, and other items that generate social or environmental costs, reducing their demand.
• Mitigation of Negative Externalities: Negative externalities are costs generated by the production or consumption of a good that are not internalized in its price, being borne by society (e.g., pollution, public health expenses resulting from smoking). The IS seeks, in theory, to compensate for these costs.
• Collection: Although its main focus is regulatory, the IS also generates revenue for the State.

The Tax Reform, which brought significant changes to the system of taxes on consumption, seeks to simplify and rationalize taxation in Brazil. However, the way the Selective Tax may interact with the ICMS threatens one of the pillars of this reform: the search for a simpler and more transparent system.

The Question of Cascade Incidence and Unconstitutionality

The central concern lies in the possibility of the value of the Selective Tax being included in the calculation basis of the ICMS. If this occurs, we will be facing an undesirable cascade incidence, that is, the taxation of one tax on another, generating a multiplier effect on the final price of products.

What is Cascade Incidence?

Cascade incidence occurs when a tax is calculated on a basis that already includes the value of another tax. In the context of the IS and ICMS, it would mean that the ICMS, which is a tax on value added, would be charged not only on the value of the product itself, but also on the value of the IS already embedded in it. This mechanism distorts relative prices, disproportionately burdens the final consumer, and goes against the principles of non-cumulativeness and ability to pay.

Precedents and Constitutional Guarantees

Brazilian jurisprudence, especially that of the Supreme Federal Court (STF), has already consolidated the understanding that the inclusion of the ICMS in the calculation basis of the IPI is not permitted, nor is the inclusion of the IPI in the calculation basis of the ICMS. These decisions were fundamental to avoid double taxation and cumulativeness that so penalized the economy and taxpayers. The main arguments that support this prohibition are:

• Nature of Taxes: The ICMS is a tax on the consumption of goods and services, while the IPI (and, by analogy, the Selective Tax) has an extra-fiscal character, seeking to influence behaviors. The calculation basis of each must reflect this nature.
• Non-cumulativeness: The principle of non-cumulativeness (provided for the ICMS and IPI) aims to prevent taxes from being charged multiple times in the production chain. The cascade incidence of the IS on the ICMS would violate this principle.
• Ability to Pay: Excessive taxation, resulting from the cascade, can violate the principle of ability to pay, causing the taxpayer to bear a disproportionate fiscal burden.

The STF’s decision in Theme 69 of General Repercussion, which determined the exclusion of the ICMS from the calculation basis of the PIS/Cofins, reinforced the interpretation that the value of the tax cannot serve as a basis for another tax, unless there is an express constitutional provision and tax logic that justifies it, which does not seem to be the case for the Selective Tax in the ICMS.

The Impacts of Cascade Incidence

The implementation of the cascade incidence of the IS on the ICMS would bring significant negative consequences:

• Increase in the Tax Burden: The final price of products burdened by the IS would be even higher, harming the consumer’s purchasing power.
• Economic Distortion: It would increase the disproportion in the prices of goods and services, affecting the competitiveness of companies and the efficient allocation of resources in the economy.
• Complexity and Litigation: The inclusion of the IS in the ICMS basis would add a layer of complexity to the already intricate Brazilian tax system, generating legal uncertainties and, inevitably, an exponential increase in litigation between taxpayers and the tax authorities.
• Distortion of Purpose: Instead of mitigating externalities, cascade taxation would end up creating new distortions, compromising one of the primary objectives of the Tax Reform: the search for a simpler and more transparent system.

Solutions to Avoid Unconstitutionality

To avoid the unconstitutionality and the harmful effects of cascade incidence, it is crucial that infra-constitutional legislation and the interpretation of the rules clearly provide for the exclusion of the Selective Tax from the calculation basis of the ICMS. Some approaches to this include:

• Clear Legislation: The complementary laws that will regulate the Selective Tax and the ICMS must expressly establish that the IS does not form part of the calculation basis of the ICMS.
• Constitutional Interpretation: The interpretation of the rules must be guided by the constitutional principles of non-cumulativeness, ability to pay, and the objective of simplifying the Tax Reform.
• Analogy with the IPI: Using the analogy with the IPI, which is a tax with an extra-fiscal character similar to the IS, and the consolidated understanding of the STF on the mutual exclusion of bases, can be a robust legal path.

The Search for an Efficient and Fair Tax System

The Tax Reform in Brazil is an important step to modernize the fiscal system, making it more efficient and fair. However, the implementation of the Selective Tax, if not carefully planned to avoid cascade incidence on the ICMS, can generate more problems than solutions.

It is essential that legislators and tax authorities act in a way that ensures that the Selective Tax fulfills its regulatory role without generating undue distortions and additional burdens. Transparency, simplicity, and non-cumulativeness must be the pillars that guide the detailed regulation of these taxes, ensuring that the Brazilian tax system does not become even more complex and litigious.

The legal and business community will be attentive to the developments in the regulation of the Selective Tax, seeking to ensure that constitutional principles are respected and that the reform fully achieves its objectives, without creating new obstacles to the country’s economic development.