* Industry group cuts forecast to 1.5 percent output drop
* Tax breaks, industrial stimulus fall short as demand cools
* Carmakers counting on growth in world's No. 4 car market
By Brad Haynes and Alberto Alerigi
SAO PAULO, Dec 7 (Reuters) - Brazilian car production is likely to fall this year for the first time in a decade, the national automakers' association said on Friday, as tighter credit and cooling demand overwhelm government efforts to boost the sector.
The downbeat forecast spells more bad news for Brazil's struggling economy, which is the world's No. 4 car market and a key source of growth for U.S. and European auto companies such as General Motors Co and Volkswagen AG.
Industry group Anfavea said it was revising its 2012 output forecast to a 1.5 percent drop, down from a prior outlook for 2 percent growth. Brazil's auto output last declined in 2002, by 2.4 percent; it has averaged 9 percent growth since then.
Anfavea said it anticipated 4.5 percent output growth for 2013, although analysts have warned of a painful hangover when a critical tax break for cars expires at the end of this year.
President Dilma Rousseff has cut taxes and made other efforts to stimulate the auto industry, which contributes a fifth of Brazil's industrial output. The disappointing result is likely to reinforce concerns that her efforts so far have been insufficient, and that broader changes, such as an overhaul of the tax code, are needed to revive the economy.
Cars in Brazil often retail for double what U.S. consumers pay, primarily because of steep import tariffs and a thicket of overlapping taxes that can make up 50 percent of a vehicle's final cost.
Carmakers aren't the only ones facing struggles. Brazil's economy as a whole posted much-weaker-than-expected economic growth in the third quarter, expanding half as fast as economists expected.
And while Brazil's growing middle class has doubled the size of its car market over the past 10 years, investment in public infrastructure has not kept pace. Cities from Sao Paulo to Salvador are strangled with traffic jams, discouraging would-be drivers and costing the economy billions every year.
RESCUE FALLS FLAT
In May, Rousseff announced an "emergency" tax break for the auto industry, reducing the price to consumers by about 7 percent for about three months at first. Payroll tax cuts have also eased operating costs for Brazilian manufacturers and kept unemployment near historic lows.
The government has since extended incentives for carmakers through the end of the year, but Finance Minister Guido Mantega warned the latest extension was probably the last one.
After a rush of new demand, however, the measures have delivered diminishing returns, leading to blockbuster promotions on the eve of the tax breaks' anticipated expiration but little overall boost in recent months.
Dealerships sold 9 percent fewer vehicles in November than a year earlier, before the tax breaks, Anfavea reported on Friday.
Brazil is the world's fourth-biggest car market, with 70 percent of new cars coming from Italy's Fiat SpA, Volkswagen and U.S.-based General Motors Co and Ford Motor Co.
With sales in Europe plunging and a U.S. recovery still in doubt, Brazil and other major emerging markets have taken center stage in the global auto industry's search for new growth.