(Bloomberg) -- Brazil’s President Luiz Inacio Lula da Silva and governors are discussing a solution for an abrupt decline in state governments’ revenue, following a series of tax breaks spearheaded by the previous administration to ease inflation pressures. 

Lula received all 27 governors in the presidential palace on Friday, saying the tax issue was “in everybody’s minds and needed to be discussed.” 

The so-called ICMS is a value-added tax charged by states that accounted for up to 85% of their revenue. Former President Jair Bolsonaro, worried about the impact of inflation on his reelection bid last year, pushed for lower levies on fuel, electricity and public transportation, among other items. 

While the federal government and many states voluntarily lowered taxes, in some cases completely scrapping them, congress also passed a law limiting ICMS at about 17%. That drastically reduces income for states such as Rio de Janeiro, which imposed a 32% ICMS tax on gasoline sales before the new rule.

Debt Service at Risk

“It’s clear that our goal is to recover ICMS revenue,” Rio de Janeiro Governor Claudio Castro told reporters at the end of the meeting, saying his state has lost about 10 billion reais ($2 billion) in income a year, putting its ability to service debt at risk.

Last year’s tax breaks didn’t have an immediate impact on state budgets because public revenue was turbocharged by inflation that ran above 10% until July. With consumer prices increasing less than 6% a year now, government income is also taking a hit and governors are sounding the alarm bells. 

The law capping ICMS did not establish ways for states to make up for loss of revenue. Governors have been in talks with the top court to discuss whether the cap is constitutional, and Lula decided to form a group led by Finance chief Fernando Haddad to follow the discussions, Institutional Relations Minister Alexadre Padilha said after the meeting.

Read More: Brazil’s Gasoline Tax Cut Is Mostly Benefiting the Middle Class

BNDES Financing

In another attempt to help states, Lula told governors that Brazil’s development bank BNDES is ready finance key infrastructure projects in states.

The president asked governors to present a list of priority public works in their states, especially in the housing, health, education and infrastructure sectors. The government intends to help states conclude such projects with BNDES financing, public-private partnerships and concessions.

“The role of BNDES will again be that of a development bank, and the money it raises needs to be shared with small and medium-sized companies and state governments as well,” he said.


--With assistance from Bruna Lessa and Beatriz Reis.

(Updates with additional Lula’s comments on financing of public works in second-to-last paragraph.)

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