Framework will require considerable fiscal effort – 04/24/2023 – Why? Economês in good Portuguese

The Ministry of Finance has recently introduced its proposed fiscal rule, which will replace the spending cap. The bill was finally delivered to Congress last week. In general terms, the idea is, in a few years, to generate primary surpluses – that is, to make the government collect more than it spends, not counting the payment of interest on the public debt. This year we will have a substantial primary deficit: the government’s optimistic projection is that it will remain at 1% of GDP. The framework promises to turn this picture around and make sure that in 2026 we reach a surplus equivalent to 1% of GDP. This is a considerable fiscal effort.

Generating primary surpluses is crucial for consistently lowering interest rates. In this way, the stability of the country’s public debt in the long term is signaled, reducing the chance of scenarios in which a default occurs or in which creditors’ income is eroded by high inflation. If debt risk decreases, the government no longer needs to pay such a high premium for creditors to be willing to continue financing its debt.

In addition, fiscal balance also reduces the chances of the government resorting to high inflation to close the hole in public accounts in the future. As a result, inflation expectations remain anchored, which helps to keep inflation under control.

Thus, the emphasis on primary surpluses is a very positive point of the framework. The problem is in the details.

To generate surpluses, the government needs to control expenditures and/or expand revenue. On the expenditure side, the framework proposes to limit expenditure growth, which cannot be greater than 70% of revenue growth in each year. In addition, there is a floor of 0.6% for this expenditure growth. Unless the economy expands considerably (and there is no indication that it will), this rule alone will not be nearly enough to generate the intended surpluses.

It will be essential, therefore, that the government actively seek to increase tax collection, as already indicated by Minister Fernando Haddad. Tax reform is often placed as a fundamental piece for the framework to stop standing.

We are far from having details of the government’s proposal, but we have some indications: a simpler tax system, with the unification of several taxes, and similar rates for the most varied products. While there is potential to make the Brazilian economy more productive, the reform will certainly produce winners and losers. Some sectors may suffer tax increases. Some state and municipal governments may lose revenue.

So we can expect resistance from groups that are eventually harmed. Even uncertainty about the impacts of a change can mobilize certain agents to position themselves in the opposite way. Therefore, approving a tax reform, even if it brings huge net benefits to the economy, will not be an easy task.

In this sense, last week’s episode, in which the government gave up taxing purchases below US$ 50 abroad, is a very negative sign. The battles ahead, against well-organized groups, will be much more complicated.

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