Framework approval does not guarantee fiscal results – 06/07/2023 – Market

The simple approval of the new fiscal framework will not be enough to guarantee fiscal results consistent with the sustainability of the public debt, and the high dependence on new revenues could undermine the credibility of the rule, warns the IFI (Institution Fiscal Independent) of the Senate in a technical note released this Wednesday (7).

The agency prepared a series of simulations for the next ten years, with the aim of analyzing the behavior of revenues and expenses under the rules approved by the Chamber of Deputies.

In 5 of the 6 scenarios outlined, the fiscal target is not met in the initial years of validity. In 4 of them, convergence to the center of the target only occurs at the turn of the decade. Only with a strong increase in collections are the fiscal policy targets successfully achieved in the analyzed period.

The IFI study is released at the time the Federal Senate begins to analyze the proposal. The text must go through the CAE (Commission on Economic Affairs) and then by the plenary. The rapporteur is Senator Omar Aziz (PSD-AM).

The new fiscal framework combines an expenditure limit that is more flexible than the current expenditure ceiling and a primary result target, obtained from the difference between revenues and expenditures.

The annual expenditure cap is corrected for inflation plus an actual increase equal to 70% of the 12-month revenue growth through June of the previous year. The percentage of real advance in spending should be between 0.6% and 2.5%, which in practice works as a floor and a ceiling.

The fiscal target is stipulated at each beginning of the term and must be pursued in the management years. Minister Fernando Haddad (Finance) indicated his intention to eliminate the deficit in 2024 and reach a surplus of 1% of GDP (Gross Domestic Product) in 2026. There will also be a margin of tolerance of 0.25 percentage points for more or less .

The IFI technical note, signed by director Vilma Pinto and analyst Alexandre Andrade, takes the rules validated by the Chamber as a starting point and assumes a positive fiscal target of 1.5% of GDP between 2027 and 2033.

The attribution of this hypothesis is necessary to be able to analyze the behavior of public accounts in the coming years. The choice was made based on the estimate of the primary result required to stabilize the public debt.

Economists also adopted as a premise the full compliance with the 2024 objective (zero deficit).

Under these pre-established conditions, IFI developed six scenarios. One of them is more optimistic, with annual revenue growth of 6.5%, equivalent to the average observed in the period from 2000 to 2009 —coincident with the rise in commodities prices. This would mean an expenditure growth of 2.5% above inflation in all years.

In four other intermediate scenarios, collections have an annual expansion of between 2% and 4.1% in real terms, which would impose a more moderate pace in the evolution of expenditures, but also a greater challenge in achieving fiscal targets.

There is still a pessimistic scenario, with an expansion of only 0.9% in revenue per year, which would put an annual increase in expenses at the bottom of the rule.

“With the exception of the most optimistic scenario, in all the others the target for the primary result is not met in the first years of the rule’s effectiveness”, says the IFI.

According to the agency, 3 of the 4 intermediate scenarios show the overrun of the fiscal target already in 2025, the first year evaluated in the exercise. A fourth simulation indicates that the target is reached in 2025 thanks to the lower limit of the tolerance band, but there is non-compliance in the years 2026 and 2027.

Still in the group of intermediate hypotheses, the government eventually manages to reach its goals only at the turn of the decade. The moment of arrival varies between 2028 and 2032, that is, in a next government.

Under the pessimistic perspective, the government frustrates the fiscal target in all the years analyzed.

The optimistic scenario, with strong annual revenue growth, is the only one in which the target is met throughout the period.

The agency recognizes that the simulations have limitations, such as the risk of not reaching zero deficit in 2024, which would further affect the results ahead. But the IFI points out that the numbers show the main challenges that the government will have in case of approval of the new rule.

For the agency, the scenarios demonstrate, with data, that the rule is very dependent on new revenue whose materialization is uncertain. “The excessive weight placed on revenues to meet the primary result targets could affect the credibility of the new fiscal regime”, warns the IFI.

“The exercise is important to demonstrate that the simple application of the rule will not be enough to allow the obtaining of fiscal results consistent with the sustainability of the public debt, being necessary an additional effort so that the real growth of the primary revenues is high.”

According to the agency, only structuring reforms, such as taxation, or productivity gains will be able to promote the necessary boost in tax collection for the framework to remain standing in the future.