Lula needs to explain plan and how he will increase tax – 03/30/2023 – Vinicius Torres Freire

The preview of the Lula-Haddad fiscal plan was a relative success with the public. It is more difficult to know about the success of the critic or to make an analysis.

They didn’t play the entire movie or parts are missing from the synopsis. Imagine a movie where the villain is an Arnold Schwarzenegger, who tries to end Margot Robbie’s life. No need to give spoilers, but it looks weird if Schwarzenegger doesn’t appear at least in the trailer. The lack of plan details is exasperating, to put it mildly.

It is still not possible to know whether the new expenditure limiter, the relaxed “fiscal framework”, makes sense in the short term (until the end of Lula 3). There may be bad issues later on. It’s going to require a lot of tax increases at least until 2025 or thereabouts — that’s Schwarzenegger.

That said, the first impact of the Lula-Haddad plan is positive. It allows at least to project what Lula 3 in theory intends to do with regard to expenditure and debt. Even with inaccuracies or excessive flexibility, it is better than having no predictability other than that the debt would easily exceed 90% of GDP.

As for the plan itself, there is a lack of data to know how it will make sense, even during Lula 3. That is, given the spending increase rules, the primary result targets (revenue minus expenditure) and some more or less realistic projections (optimistic ) for the economy, it will be necessary for the increase in revenue to be greater than the growth of GDP.

The proposed adjustment (transforming a deficit into a surplus) is very aggressive in the early years.

Minister Fernando Haddad (Finance) said this Thursday (30th) that he will find a way to find an extra R$ 100 billion or R$ 150 billion (something from 1% to 1.5% of GDP, in today). If you fix it, it seems possible to reach the primary surplus projected by the government, given some additional not-too-crazy projections. That is, economy growing at 2% and other revenues growing at the pace of GDP.

Given this primary surplus of 1% of GDP and other projections, public debt will fall little or not at all over the next decade (surplus: revenue greater than expenditure, excluding interest expenditure).

What is “realistic (optimistic) projection”? Economy growing at 2.5% per year. Average real interest rate on public debt (“implicit rate”) of 3.5% (now it is 4.9%).

Is it realistic to say that revenue will grow as much as GDP? On average over the last 20 years, it was more or less that. From one year to another, the variation is enormous.

Is it realistic to think that the real interest rate will be 3.5% (this is the cost of financing public debt)? Difficult, even more so if the debt/GDP ratio remains at around 76% of GDP for a decade.

What is the problem with the debt not falling? One problem, for example, is that, in case of a new increase in interest rates, the debt will increase even more. That is, unless there is a radical effort to cut expenses or increase revenue, which is precisely our problem right now.

The Lula-Haddad plan has a bias towards increased spending. Yes, the expense can only increase, per year, the equivalent of 70% of the annual revenue increase. Otherwise, the expense can increase by a maximum of 2.5% per year. That is, even if revenue increases by 3.6% or more, there is a “ceiling” for spending variation. But even if revenue does not grow at all, expenditure may increase by 0.6%.

These limits mitigate the “pro-cyclical” nature of spending, but still allow us to have a Dilma-Cabral effect: excessive spending increases in good times, several of them permanent spending, and some spending increase even in bad years (no increase in revenue). These exceptional revenue increases occur during large commodity price spikes and strong world growth, for example. When the tide goes out, we get naked. So it is possible that we have bad deficits in bad years.

The primary result is at the discretion of the government. There is no rule to fix it in the Lula-Haddad plan (or there was no such rule). A more conscientious government may do what is necessary (surplus) in order to avoid disturbing increases in the public debt. But it’s up to you. Hmm.

In any case, under the Lula-Haddad plan, the government can break the surplus target it has set and leave the problem for the following year. If so, the authorization for the expense increase drops from 70% to 50% of the revenue increase. But it’s still too loose a norm.

Another problem, more subtle, is that Lula’s “roof”, although flexible, has problems similar to those of Michel Temer’s old and deceased roof. Some expenses will grow as much or more than GDP (INSS, social security and assistance benefits). Others will grow at the pace of revenue: mandatory spending on health and education. Others should remain stable in relation to GDP (server spending).

Given the Lula-Haddad spending increase limit, although flexible, there will be some compression of non-mandatory expenses, unless there are profound reviews of public spending.

Imagine now that mandatory spending has grown and that the economy is going through a weak period, as well as government revenue; that the government did not meet the primary result target for the previous year; that the public debt is still large. What are you going to do? Deep cuts in spending, usually of poor quality, if done suddenly?

It’s one of the problems we have now.

Finally, the Lula-Haddad plan and “framework” depend, at least initially, on a tax increase, be it an increase in rates, the creation of taxes, the end of tax exemptions, etc. Will it go through Congress? Won’t that complicate tax reform?

The government still has a lot to explain.