Tax Reform: general funds fiscal risk for the Union – 12/08/2023 – Market

The amounts foreseen in the Tax Reform to supply compensation funds to states and taxpayers for the end of ICMS tax benefits should generate additional fiscal risks for the Union, especially in the medium term, warns the IFI (Independent Fiscal Institution) of the Senate.

In a technical note signed by analyst Eduardo Nogueira, the organization states that the economic and revenue gains resulting from the change in the tax system will, initially, be insufficient to cover the financing costs of these funds alone.

“We identified this mismatch problem,” says Nogueira. According to him, the reform already establishes the values ​​and start date of disbursements (2025), but the economic benefits should only begin to be felt in the next decade, from 2033, when there is a full transition to the new model of taxation on consumption.

“In the short and medium term, there will have to be an increase in the government’s fiscal effort [para bancar os fundos]”, says the analyst.

The PEC (proposed amendment to the Constitution) provides for the creation of four funds, two of them with values ​​already defined. The tax benefit compensation fund will receive R$160 billion between 2025 and 2032 and was designed to reimburse companies covered by ICMS incentives during the period of migration from current taxes to the new system.

The FNDR (National Fund for Regional Development), whose objective is to finance new incentives in the states, will have a first contribution of R$8 billion in 2029. The amount will grow to R$40 billion in 2033 and reach R$60 billion per year from 2043.

The amounts will still be adjusted for inflation, ensuring the maintenance of the real level of incentives even in a more adverse scenario of revenue or GDP (Gross Domestic Product). To give you an idea, the IFI calculates that the Union’s disbursement in current prices will be between R$106.7 billion and R$136 billion in 2043.

“The big question was to evaluate the government’s premise that the Tax Reform would pay the costs of these funds”, says Nogueira. In the long term, according to the analyst, it is possible that the reform will provide additional economic growth sufficient to cover the additional fiscal effort.

“But in the short term we identified this mismatch problem. The total contribution [dos dois fundos] starts in 2025 and goes from R$8 billion to R$40 billion in four years, it is quite significant. There will have to be an increase in the government’s fiscal effort”, he warns.

In the version approved by the Chamber of Deputies, the value of the FNDR only increased to R$40 billion, but was raised to R$60 billion by the senators, in agreement with the Ministry of Finance.

At the time, minister Fernando Haddad minimized the impact of the extra increase of R$20 billion, which will only be effectively felt in two decades — that is, in a future government.

“It’s a small amount per year. In today’s R$2 trillion Budget, having a R$2 billion annual increase seemed to me to be a fair request from the governors. We decided to accept it. The R$40 billion remained and, after the transition made each year, an additional contribution”, said Haddad at the time of the announcement, at the end of October.

“If you compare it with other funds, you will see that it is absolutely bearable and makes sense,” he added.

The IFI’s conclusions, however, show that the costs should put pressure on the government’s accounts in the medium term, a horizon that encompasses the period between 2024 and 2033.

In the base scenario, drawn up under assumptions that are more likely to come to fruition, additional economic growth to support the two funds would range between 0.4% and 1.8% per year over the period. In a pessimistic scenario, the range would remain at these values, but with a greater number of years in which demand would be for an expansion of 1.8%.

The central point of the discussion is that, in the first years of the reform, gains should be below this — something that is already expected by government technicians and economists. The positive impacts on productivity and growth should only become more significant from the 2030s onwards, when the new system is fully implemented.

“In the medium term, it is likely that the Union will have to pay for transfers to the funds, given a scenario in which productivity gains have not started or are very small”, says the IFI note.

Nogueira also recalls that the reform provides for two other funds, one for the sustainability and economic diversification of Amazonas and the other to support the states of Acre, Rondônia, Roraima and Amapá. For these, the value of the contribution has not yet been defined and will represent an additional source of fiscal pressure in the future.

In June, economist Manoel Pires, coordinator of the Economic Policy Center and the Fiscal Policy Observatory at FGV Ibre (Brazilian Institute of Economics of the Getulio Vargas Foundation), had also pointed out how the size of the funds can consume a significant portion of the revenue gains arising from the economic impulse of the reform.

Although the simulations were carried out before the votes on the proposal in the Chamber and Senate, they illustrate the mismatch of impacts. According to Pires, even if there is additional growth of 5% until 2034, the gains would be insufficient to finance the FNDR with contributions of R$50 billion per year — a value lower than what was established in the text.