Tax framework: understand it in five steps – 03/31/2023 – Market

The government of President Luiz Inácio Lula da Silva presented this Thursday (30) its proposal to balance public accounts and prevent public debt from growing in a way that is harmful to the country.

The proposal, also called the fiscal framework (framework means skeleton, that is, the rules that will support the balance of accounts), should now be presented to Congress.

What is a tax framework and what is it for

The fiscal framework sets rules, parameters and mechanisms to balance public accounts, so that the government does not spend more than its revenues, increasing the public debt in an uncontrolled way. This gives creditors predictability and security, allowing the interest charged to fall.

It is necessary because investors and creditors take into account the trajectory of a country’s public debt when making decisions. If the size of this debt grows in relation to GDP and there are no signs that the increase can be controlled, creditors may see a greater risk of default and start charging more to lend money.

With higher interest rates, financing becomes less attractive, credit for the private sector becomes more expensive, investors are less motivated to invest in companies and projects in the country. The currency also tends to devalue, which increases the risk of extra inflation. This scenario harms economic growth and, consequently, the supply of jobs.

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Understand in 5 points.

RULE 1. Expenses will have limited growth

The framework establishes that expenditures need to grow at a slower pace than revenues. The proposed percentage is 70%. For example, if revenues grow by 1%, federal spending can only grow by 0.7%.

To calculate how much it will be able to spend in the following year, the government will use net primary revenues in the 12 months up to June of the current year. (primary revenue is non-financial revenue, such as, for example, tax collection, royalties and transfers received from other public entities; net primary revenue is total primary revenue minus mandatory transfers to other entities).

RULE 2. Expenditure growth will have a ceiling and a floor

The real growth (discounting inflation) of expenses, according to the government’s proposal, cannot be less than 0.6% nor less than 2.5%.

For example, if revenues rise 4%, when applying rule 1, the allowable increase for expenses would be 2.8% (70% of 4%), but rule 2 bars this increase by the ceiling of 2.5%. This imposes a limit on expenses in good times and increases the possibility of reducing the public debt, since there are more resources left.

On the other hand, also in an example, if revenues do not rise at all in the 12 months of reference, rule 1 ceases to apply and an increase in expenses of 0.6% will be allowed. This allows expenses not to be strangled in years of crisis

RULE 3. Expenditure on education, health and amendments are an exception

rule 1 does not apply to health and education expenses, since these expenses have minimum amounts already established by the Constitution. In these areas, expenses may grow at the same pace as revenues. The same goes for parliamentary amendments.

RULE 4. If savings are not enough, spending will be tighter

In its proposal for a fiscal framework, the government establishes a commitment to reduce the current fiscal deficit (the fiscal deficit runs when expenditures exceed revenues), zeroing this deficit in 2024 and obtaining a growing surplus (surplus revenues, as they exceed expenditures). in the following years.

This commitment proposes an upward and downward margin (band) in the annual result of public accounts. For example, for 2025, the government is committed to obtaining a surplus of 0.5% of GDP, ranging from 0.25% to 0.27% (the bands are 0.25 percentage points for less and for more).

If the savings obtained are below the lower band, rule 1 will be stricter: instead of expenses growing 70% of the increase in revenues, can only increase 50%.

RULE 5. If the economy is greater than promised, investments will have a floor

If the saving of public resources is above the proposed band (understand what this band is in rule 4), the government can use this surplus of resources to invest in works.

This would happen, for example, if the government obtained a surplus of 3% of GDP in 2024, while its commitment for next year is to zero the deficit. Since 3% is above the upper band of 2.5%, he is licensed to invest the surplus.

In this case, there is now an investment floor of approximately R$75 billion in today’s values, corrected for each year’s inflation.