Tax rule or spending rule? – 10/04/2023 – Why? Economês in good Portuguese

Recently, the federal government released its proposed reform of the fiscal framework. It does not seem good to us, as it is insufficient to stabilize the government’s debt over the relevant time horizon; Debt is already high and will continue to grow as a proportion of GDP for years to come under reasonable assumptions for other economic parameters, such as real interest rates and growth.

In short, the rule subordinates the achievement of primary surpluses in public accounts to the objective of greater expenditures in real terms, when, at the current moment in the Brazilian economy, the recommendation is exactly the opposite: realistic targets for the primary surplus as the main objective.

Let’s start with optimistic arithmetic. Let’s say that, looking at the next few years, the so-called medium term, we have a real interest rate of around 5% and an average GDP growth of around 2%. With the debt soon going to 80% of GDP, this combination implies that the primary surplus needed to stabilize it (see the account’s objective: that the debt stops growing, that’s all) will be approximately 0.8 x (0. 05 – 0.02) = +2.5% of GDP. The projected value for 2023 is approximately negative 2%.

I call the arithmetic “optimistic” because most economists project that GDP growth over the next four years will be less than the 2% of the above exercise. A real interest rate of 5% does not sound impossible, but it is certainly not the most likely scenario given the persistence of inflation and the Executive’s attacks on the Central Bank. With the new fiscal framework, is it possible to visualize primary surpluses around 2% of GDP? Only with brutal increases in tax collection. But the minister and the government say that new taxes or rates will not be created. So the account does not close, and the primary surplus will not be achieved in the coming years. If the economy stagnates then…

And it is not true that the rule that links spending growth to 70% of revenue growth means, at the very least, that spending will never grow above revenue. For example, if Brazil grows an average of 0.5% per year over the next few years and revenues are the same (elasticity is around 1), expenditures and revenues will grow at the same rate. And since the first is currently much higher than the second, the deficit will persist, putting pressure on indebtedness and risk premiums.

It is true that the rule imposes a ceiling of 2.5% (above inflation) for spending growth, but why does public spending, which is already high, need to grow even more above inflation? If revenue falls or stagnates, public spending will also continue to grow above inflation, in this case 0.6% in the year. The curious thing about the debate is: the government defends public spending at all costs, but nobody talks about private spending. With more taxes, private spending by families and companies is reduced, a fact that every first-year economics student knows. Obviously, this argument does not mean that public spending should not occur or that the State needs to be minimal, among other such nonsense. But it does mean that private spending by companies and households is compressed when spending rises.

Finally, a tax reform is fundamentally necessary and the special secretary for the subject, Bernard Appy, has a good diagnosis of what needs to be done. But tax reform should not be synonymous with increased revenue. Brazil actually fails to tax the poor excessively and the rich only moderately. But it does not fail to raise revenue, being one of the world leaders in revenue outside the group of rich countries.

What is obvious is that Minister Fernando Haddad and his team should be able to do more with the resources. But that implies facing interest groups, optimizing, cutting inefficiencies, reducing programs that have low return to society, adjusting pensions, etc. It is difficult and, to be honest, it must be recognized that increasing the efficiency of the State was never part of the current government’s campaign platform.

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