Understand the tax framework in voting in the House – 05/23/2023 – Market

In March, the Luiz Inácio Lula da Silva (PT) government presented a proposal for a fiscal framework to replace the spending ceiling. The goal is to balance public accounts and prevent public debt from growing in a way that is harmful to the country.

The text was amended by the project’s rapporteur in the Chamber of Deputies, Cláudio Cajado (PP-BA), in response to criticism. After negotiations, the deputy reached an agreement with political leaders and presented the final version of his opinion on Tuesday night (23).

The framework is being voted on this Tuesday (23) in the plenary of the Chamber of Deputies.

Here’s the full text of the House vote:

What is a tax framework and what is it for?

The framework is the set of control rules for public accounts. The government’s proposal seeks to replace the current spending ceiling, created during the government of Michel Temer (MDB).

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

The framework 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.

Why is the government replacing the roof?

The government considers that the spending ceiling has limited the State’s ability to promote public policies. Despite this, it recognizes that it is not possible to do without a control rule for expenses.

Instead of the spending cap, spending could grow by the equivalent of 70% of the rise in revenues (for example, if revenue rises by 2%, spending can rise by up to 1.4%). There will, however, be minimum and maximum limits for this variation in spending. The minimum percentage prevents a sudden or temporary drop in tax collection from forcing the government to reduce expenses. The maximum limit, on the other hand, removes the risk of the Executive expanding expenditures in an exaggerated way when there is a peak in revenues.

But, if the country goes into crisis, won’t the rule prevent measures to revive the economy?

For this reason, the government has included some barriers to prevent expenditure from keeping pace with revenue when revenue rises significantly, or even if it is necessary to cut spending because revenue has dropped significantly.

This is because, due to the way it was designed, the proposal has a pro-cyclical character, that is, it allows for an increase in expenses when there is an increase in revenue and growth, at the same time that it imposes moderation in downturns. Avoiding this was one of the principles defended by economists from the PT itself.

Does the new rule affect spending on health and education?

The percentage will not be applied linearly to all expenses. With the end of the spending ceiling, the constitutional minimums for health and education will be resumed as they were until 2016: 15% of RCL (current net income) for health and 18% of net tax income for education.

In practice, the advance of these expenses will follow the collection more closely, while other expenses will need to have a more moderate growth to respect the limit as a whole.

The Fundeb (Fund for the Maintenance and Development of Basic Education) and the financial aid for states and municipalities to pay for the nursing floor had initially been placed on the list of exceptions to the framework, but the rapporteur changed this in his opinion, including them among those limited by the rules.

Is there no risk of further reducing investments?

The proposal provides for an investment floor close to R$ 75 billion, to be corrected for inflation. These expenditures should follow a minimum limit, obtained from the level of investments scheduled for 2023 —between R$70 billion and R$75 billion, already considering the Minha Casa, Minha Vida housing program.

It is this value that will serve as a minimum reference and will be corrected for inflation. In presenting the new rule, the government indicated that investments could go from 2.2% of GDP in 2022 to 4.2% of GDP in 2030, thanks to the spending floor rule for this area.

Is it possible to increase the collection?

Haddad stated that he will present a package of measures to increase federal revenues between R$ 100 billion and R$ 150 billion per year.

This, according to the minister, will make it possible to achieve the public accounts results announced by the economic team.

He stated that the idea is to review tax benefits and start charging taxes from sectors and companies that, due to lack of rules, do not pay today, such as electronic betting.

Why do investors care so much about the fiscal agenda?

If a government does not present a fiscal plan to contain public debt, the tendency is for creditors to charge more to borrow money.

With more expensive interest, financing becomes less attractive, credit for the private sector becomes more expensive, which can become an obstacle to economic growth.

With no prospect of growth, investors are less motivated to invest in companies and projects in the country.

What does the fiscal agenda have to do with a country’s outlook?

If a country is seen as fiscally irresponsible, interest rates tend to rise. 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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What are the main rules of the fiscal framework?

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% in real terms (that is, after discounting inflation), federal expenditures can only grow by 0.7% (also in real terms).

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 to June of the previous year (excluding extraordinary revenues, specifically grants, dividends, royalties and constitutional transfers to states and municipalities).

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

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

In these cases, the contingency will need to be proportionate to expenses to prevent it from falling entirely on investments.

RULE 3. If savings are not enough, spending will be tighter

The government establishes a commitment to seek to zero out the current fiscal deficit (accounts are in the red when expenditures exceed revenues) and to generate surpluses (surplus revenues, since 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 0.75% (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 being able to grow by 70% of the increase in revenues, they can only grow by 50%.

In 2024, the government will be able to increase the spending limit if the collection is higher than expected, up to the same limit of 2.5%.

RULE 4. Investments will have a floor and can grow if the economy is greater than expected

The proposal creates an investment floor of approximately R$79 billion in today’s values, corrected for each year’s inflation. If the saving of public resources is above the proposed band, the government can use this surplus of resources to direct resources to investments in works (considering a maximum bonus of R$ 25 billion).

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.

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PROCESSING

What happens after the House vote?

If approved, the text goes to the Senate. If there are no changes, the text goes to presidential sanction.

However, if the senators make changes to the text, the project returns to the Chamber, which will have the final word — the deputies can accept the senators’ changes or restore the text originally approved by the Chamber. In this case, after the new vote, the text is sent to the President of the Republic for sanction.

What does it take for the proposal to pass Congress?

Complementary bills require an absolute majority of favorable votes, that is, more than half of the members of each House. That means at least 257 votes in the House and 41 votes in the Senate.

Once approved by Congress, what happens to the proposal?

The Chief Executive has 15 working days to sanction the project in its entirety or with partial vetoes in some devices, or even veto it entirely. All vetoes undergo further validation by Congress, which can overturn them with an absolute majority of deputies (257) and senators (41).