Lula government maintains focus on raising more and rejects spending cuts

Despite the challenging fiscal scenario, the government of Luiz Inácio Lula da Silva (PT) does not seem willing to review its policy of seeking to balance public accounts exclusively through increased revenue.

Cutting expenses, reviewing spending and administrative reform are taboos within the PT government, which closed 2023 recording the second largest primary deficit in history, of R$234.3 billion, according to an estimate by the Institute for Applied Economic Research (Ipea).

In the assessment of economists interviewed by the People’s Gazette, the lack of attention to the expenditure side is “a big problem” to be faced this year. In addition to the strategy of the head of the Treasury, Fernando Haddad, being completely focused on revenue, the minister is still under pressure from Lula and the PT to open the spending tap even further in the election year.

“The government did not present any plan to alleviate the need for revenue and, on the other hand, it increased expenses with measures such as the adjustment of the minimum wage [acima da inflação]. It is a government focused on populism, because it believes that the expansion of public spending generates jobs and growth”, says Alex Agostini, chief economist at Austin Rating.

“But the government does not take into account the other side of the equation, the consequences of a loose fiscal policy, which are the reduction in the effectiveness of monetary policy, inflation and the reduction of investments, employment and income in the medium term”, adds Agostini.

In the assessment of Gabriel de Barros, chief economist at Ryo Asset, the strategy will bring more difficulties to the government this year, especially given the prospect of reduced economic growth.

“The global economy is slowing down and the price of commodities is cooling down. Brazilian GDP, which already started to fall in the third quarter of 2023, will be weaker. The government will also no longer have the revenue boost it had last year, with the transition PEC that managed to promote economic growth. All of this will compromise revenue”, he states.

Furthermore, economists point out that there is no guarantee of success for Haddad’s efforts throughout the second half of 2023, to approve in Congress a list of measures to increase revenue.

The minister launched a crusade for revenue in the order of R$168 billion to try to eliminate the primary deficit this year, as foreseen in the new fiscal framework. Among the approved projects are the taxation of offshore funds, closed-end funds and sports betting. Ryo Asset’s estimate is that the volume raised with all measures will not be greater than R$70 billion.

“What could make the situation worse? [fiscal] This is a worse performance than expected for revenues arising from the new measures approved over the last year and which are of great importance for the recommended result”, says Felipe Salto, chief economist at Warren Investimentos.

Priority is to increase revenue

In this scenario, the government’s priority continues to be revenue. Haddad’s commitment to the Treasury culminated, at the end of 2023, in the issuance of Provisional Measure 1,202, which revoked the payroll tax exemption in 17 sectors. The initiative was seen as an affront to Congress, which had approved the tax benefit in October and overturned President Luiz Inácio Lula da Silva’s veto two months later.

Under the exemption rule, in force since 2012 and extended until 2027 by Congress, companies can replace the employer social security contribution (CPP), of 20% on employees’ first minimum wage, with rates of 1% to 4.5% on gross revenue.

With the MP, the government tried to reestablish the gradual return of the employer contribution to salaries, in a staggered manner, until 2027. In place of the 17 sectors, it defined 42 economic activities, divided into two groups, with the CPP reduced by 50% or 25 % in the first year.

Furthermore, the MP suspended the discount on social security contributions for small municipalities that had been created by Congress and revoked the tax benefits for the events sector in force since the pandemic.

It caused outrage among businesspeople the fact that the government also limited the use of tax credits obtained by companies that went to court against paying undue taxes. “The government promoted a misappropriation of resources owed to companies. It is absurd, it causes enormous legal uncertainty”, assesses Barros.

Government did not give up on reimbursing the payroll

The crisis contracted with the MP has been negotiated between the government and Congress, in an attempt to find alternatives for the Treasury.

The president of the Senate, Rodrigo Pacheco (PSD-MG), says that there is an agreement with the government so that the part of MP 1,202 that re-encumbers the sheet is revoked, and that the other points are dealt with in another piece. Haddad, however, does not confirm this agreement and does not show signs of having given up on the reinstatement.

According to the Ministry of Finance’s accounts, the payroll tax relief, as approved by Congress, will cost the Treasury R$16 billion. Including the benefit for events, called Perse, the figure goes to R$32 billion, according to Haddad.

A Treasury report described the exemption as expensive and inefficient, and many analysts see it exactly that way. The Tax Citizenship Center (CCiF), a think tank Created in 2015 by experts in taxation and public finance, it proposes a redesign based on a horizontal logic, without choosing benefiting sectors.

Now extraordinary secretary for tax reform at the Ministry of Finance, economist Bernard Appy, who was part of the CCiF, had given clues, at the end of last year, about the proposal being discussed at the Ministry of Finance. The idea, at the time, was to change company payroll taxation as part of the income taxation reform – the second stage of the tax reform, which is yet to be presented.

MP 1,202, however, came earlier, as a reaction to the extension of the payroll tax exemption until 2027 by Congress. The parliamentarians’ logic for renewing it was simple: the benefit would end at the end of 2023 and the government had not presented any proposal to replace it.

“It is curious that the minister presented such an ambitious MP without consulting members of his own ministry”, says the chief economist at Ryo Asset.

Government must insist on the zero deficit discourse

Although economic agents are already pricing in a deficit above at least 0.8% of GDP this year and the possibility of reviewing the fiscal target in March, in the first bimonthly public accounts report, Haddad has insisted on the viability of the zero deficit target.

“Minister Haddad knows the importance of maintaining the zero target and signaling the possible need to use the triggers of the framework itself, in a timely manner and if necessary”, says Salto.

The Federal Court of Auditors (TCU) issued a warning last week, after a judgment on the compliance of the Budget proposal for this year, that the government may have overestimated revenues in the 2024 Budget.

The risk is that the frustration of these expectations will lead to a deficit of up to R$55.3 billion, implying that the fiscal target will not be met. In the TCU’s view, this indicates the “need to review downward the growth of primary expenditure” authorized in the new framework.

Today the fiscal framework allows expenses to grow up to 70% of the increase in revenues, and establishes a minimum level of spending growth: 0.6% per year, even if revenues do not grow as much or even fall.

In the technical unit’s report, which supported the court’s position, the auditors state that “it would be important to limit the growth [real] of primary expenses at a lower rate” than the stipulated 70%.

Pressure from PT is to change the fiscal target

The law determines that the government must contingency expenses – that is, block payments – when it realizes that it will not reach the fiscal target.

But the government and the PT fear the effects of a spending cut in 2024, the municipal election year. Another affliction comes from the fact that a possible overshoot of the framework’s target would lead to the activation of expense containment triggers in 2025 and especially 2026, when the presidential elections take place.

The expense reduction is provided for in the new fiscal framework, as punishment for failure to meet the target. This is why PT leaders are putting so much pressure to review the goal. It would be the easiest way to escape the contingency this year and avoid triggers in future years.

The main concern is the blocking of resources in the New PAC works. “I think the probability of changing the target is relevant, given the pressure, which will return with everything, in fact, from the same actors as always. The spenders on duty”, advocates Salto.

Last year, Haddad managed to convince Lula to maintain the target under the promise of contingency of up to R$23 billion, a value below that calculated by analysts, who pointed out the need for a blockade of R$53 billion.

The expectation of many analysts is that the government will manage the “timing” and manage the Budget with some contingency. “The government will buy time, observing the pace of revenue and the impacts of the economic slowdown”, believes Barros.

Spending cut debate is banned by the government

Even with the uncertainties about the behavior of the economy and even if the government manages to push the revision of the target forward, Gabriel de Barros assesses that sooner or later it will become clear that the fiscal framework is fragile and insufficient to guarantee fiscal adjustment. “It has an origin problem. It’s a wrong flight plan, because it doesn’t solve the structural problems of expenses,” he says.

According to their calculations, published in an article published on the blog of the Brazilian Institute of Economics of Fundação Getulio Vargas (FGV-Ibre), specific measures that would improve the public sector could generate fiscal savings of up to R$700 billion in ten years.

“Administrative reform, which is already mature in Congress, is one of them. Arthur Lira himself [PP-AL, presidente da Câmara] has already raised the need for the topic”, he states.

There are at least two spending review measures – a mechanism adopted by governments around the world as a way to eliminate or redesign inefficient public policies.

The first is the fusion of social policies, currently distributed across several benefit programs. The second is the reform or elimination of the salary bonus, implemented at a time when the minimum wage was out of date and which today makes no sense, according to Barros.

The economist also highlights that studies on international experience show that countries that tried to make adjustments only on the revenue side resulted in higher inflation and lower potential GDP.

“It doesn’t work anywhere in the world. But you can’t say that without being insulted or cancelled,” he says. According to him, the government banned the debate as a political-ideological option. “We’re like a frog in a pot. And the water is getting hotter,” he says.