Tax Hike and Political Gridlock
The IOF decree, issued in late May, targeted corporate credit, foreign exchange, and private pension transactions as part of Lula’s strategy to raise critical revenue—approximately 12 billion reais ($2.16 billion) in 2025 and over twice that in 2026—to avoid constitutionally mandated budget freezes
Congress swiftly rebuffed the decree, passing a motion in June that nullified it. This marked the first time in over 30 years that a presidential decree was overturned, eliciting a historic rebuke of the executive’s fiscal authority .
In response, the government invoked the Supreme Court, arguing that Congress had overstepped its constitutional bounds and jeopardized legal certainty by reversing a decree within executive competence
Supreme Court Intervention
Ahead of its final ruling, the Supreme Court temporarily suspended both the decree and Congress’s annulment order while brokering institutional dialogue—including a mediation hearing on July 15 between Lula’s government and congressional leaders .
Justice Moraes emphasized the need for harmony between Brazil’s branches of government—a principle he saw as key to preserving democratic stability without governing overreach.
Financial Impact and Government Response
The Executive Branch estimates the blockage of the forfait portion of the tax hike will cost the treasury 450 million reais ($81 million) in 2025 and 3.5 billion reais in 2026. Finance Minister Fernando Haddad welcomed the court’s near-complete vindication, pledging to explore alternative measures to plug the remaining fiscal gap and expressing confidence in achieving a “good primary result” for the year.
Constitutional Debate
The crux of the dispute hinges on whether the IOF qualifies as an extra-fiscal (regulatory) tax, which the executive may alter via decree, or whether Lula’s use of it as a revenue-generating tool exceeded constitutional limits. Critics argue that expanding the IOF base—applying it to transactions not previously taxed—constitutes substantive tax policy, which should be legislated, not decreed
Supporters maintain the changes align with regulatory intent, aiming to standardize tax treatment and correct distortions among credit operators. They assert Congress’s repeal was an unconstitutional intrusion into executive prerogative under Article 153 of the Constitution and its supporting statutes
Broader Political Implications
-
Executive-Legislative Tensions: The showdown underscores Lula’s fragile support in Congress, where fiscal reforms have stalled amid deep legislative fragmentation
-
Fiscal Strategy: With IOF revenues partially preserved, the government confronts new pressure to identify revenue alternatives or reduce spending to meet the primary surplus goals set for 2026 .
-
Institutional Precedent: The court’s partial ruling and mediation process set a benchmark for future executive-legislative conflict, affirming the Supreme Court’s role in arbitrating constitutional disputes.
What Lies Ahead
-
Legislative Dialogue: Lula has pledged renewed engagement with legislators following the court’s decision to align future proposals with congressional input Fiscal Recalibration: The government is expected to propose substitutes or reforms—possibly extending beyond IOF—to fill the revenue shortfall caused by the court’s rejection of the forfait tax.
-
Legal Abeyance: Pending challenges by lawmakers and opposition parties—such as PSOL—could continue to unfold, especially if new fiscal measures prompt renewed constitutional scrutiny