Lula goes against the grain of what led to the success of his two governments

By defending breaking the spending ceiling as a “social responsibility” and trying to keep expenses from the resurrected Bolsa Família outside the current fiscal anchor, president-elect Luiz Inácio Lula da Silva (PT) embarks on the opposite path that led to the success of his two governments , between 2003 and 2010.

Estimates point to a value of R$ 175 billion a year, equivalent to about 2% of GDP, which the new government wants to keep outside the ceiling throughout its mandate.

The value will put pressure on the public debt to increase and make it very difficult for Lula to finish his government (with that amount of additional expenses) achieving a primary surplus of 2% of GDP, considered necessary to stabilize the public debt in relation to GDP.

The primary surplus is the savings that the government should make, between revenue and expenses, to pay interest on the public debt. If it does not, the debt increases, and the market will demand ever higher interest rates from the government to finance it.

This jeopardizes productive investment and makes borrowing more expensive for consumers, bringing down the economy. It also ends up leading to more inflation, as the government will have to issue money to finance spending and interest payments, leading to a scenario of stagflation (recession with inflation).

Data from the last 20 years make it clear that fiscal responsibility and primary surpluses were fundamental for Lula to do more for the social — as he says is his priority now.

By running surpluses every year, between 2003 and 2010, to reduce the public debt, Lula achieved an average annual GDP growth rate of 4% (almost double the FHC era), lowered unemployment, extreme poverty, inflation, dollar and increased investments in the country.

This occurred because economic agents (companies, the financial market, entrepreneurs) trusted the country’s solvency with the reduction of public debt provided by surpluses.

As a result, the government was able to pay lower interest rates to finance itself, removing the need for an eventual increase in the tax burden to pay the debt. A virtuous cycle of sustainable growth then took place.

A point that Lula most emphasizes in his speeches, the period of surpluses contributed to his government halving the total number of miserable people in Brazil, from 29% in 2003 to 14% in 2010.

The extreme poverty rate even continued to fall when he left the Presidency. But only until her successor, Dilma Rousseff, interrupted spending control and stopped making surpluses, starting in 2014. From then on, all indicators worsened, and Brazil experienced stagflation at the end of the Dilma government.

The graphs below show details of this trajectory.

The long period of low growth that followed the end of the surpluses in 2014 directly affected the poorest and informal workers, now targets of social programs such as Auxílio Brasil and the controversy surrounding fiscal versus social responsibility.

It is quite likely that, if Brazil had kept its accounts in order, the drop in income and the increase in informality would not even have existed in recent years. Because it was when businessmen and the market started to bet, from 2014, that there would be an overflow in the public debt that they drastically reduced investments in Brazil.

The result of this retraction in the face of the lack of fiscal control ended up affecting mainly those that Lula now says he wants to help. The poorer you are, the greater the degree of informality at work today — and the greater the drop in income over the last decade.

The period of disarrangement of public accounts and low growth was so acute that even the increase in schooling of the poorest was insufficient for them to manage to increase their income.

In the poorest half of the country, while years of study increased by 27% between 2012 and 2021, income fell by 26.2%. It’s as if all their educational effort had had no effect —at least in terms of income—because of the low growth engendered by the end of fiscal responsibility.

The big question now is how to resume fiscal responsibility (and primary surpluses) in a scenario of a tight budget and immense social demands.

Persio Arida, from Lula’s transition team, defended this week the need to “review the government’s spending”. “We see layers and layers of spending that have lost their meaning,” he said.

On this point, Brazil fails to collect more than R$ 300 billion every year with tax benefits granted to companies and sectors —almost double what the so-called Transition PEC could cost to adjust the 2023 Budget and meet the promises of Lula’s campaign.

The so-called tax, financial and credit benefits to sectors and companies doubled during the Lula and Dilma governments and today amount to almost 4.5% of GDP. Most of them refer to Simples, which has led many individual entrepreneurs to pay proportionally less taxes.

But even if Simples is maintained, specialists see a lot of room for cuts in these benefits. And the World Bank’s analysis of incentive policies in Brazil, Australia, Canada, South Korea, and Mexico concluded that only the Brazilian case resulted in a combination of increased tax expenditures and a drop in tax collections—suggesting that they did not accelerate growth.

Brazil also spends around 25% of GDP (R$2.2 trillion) in the social area, including health, education and social security. While in force, Bolsa Família consumed just over 0.5% of GDP (about 43.5 billion at 2021 prices), being successful due to its targeting.

Experts defend, for example, a program that would reach 1% of GDP (almost R$ 90 billion), but very well focused and that takes into account the vulnerabilities of each family and number of children, among other factors.

Lula’s proposal provides, on the contrary, a linear value of R$ 600 to all those assisted, regardless of the size of the family and its needs. That just makes the program more expensive and unfocused on those truly in extreme poverty—approximately 14% of Brazilians.

Faced with the precariousness of public accounts and past experience, Lula and his team could address what went well, and where it is possible to save and improve the efficiency of public spending.

As the trajectory of Lula and Dilma in the Presidency has shown, there are two paths to follow. Lula seems to be taking the wrong route.