Arminio Fraga: Automatic GDP stabilizers would be a welcome innovation for Brazil

In December of last year, I presented here some principles for building a more robust tax regime. I dealt with issues related to the management of public debt and the budget, with a view to making short and long-term interest rates much lower than the current ones feasible, as well as providing credibility space to implement counter-cyclical policies and to deal with emergencies such as the pandemic, for example.

Simplifying a bit, the main recommendation of the article was to keep public debt (as a proportion of GDP) at a comfortable level in normal times, in order to have room to increase spending (and therefore indebtedness) when necessary. Naturally, in order to prevent the debt from only rising, it is necessary to reduce debt in moments of greater tranquility. This point is essential but tends to be ignored.

The proposal is premised on an adequate initial fiscal situation, which is intended to be preserved. It so happens that, at the moment, the public debt is heading towards 85% of GDP and the primary balance towards a deficit of 1% of GDP. Such a combination seems to me to be quite precarious for Brazil, given that the National Treasury pays 6% real interest for all terms, the highest in the world. Based on a very optimistic scenario of growth at 3% and market interest rates, a primary surplus of 2.5% of GDP would be needed to stabilize the debt at current levels. But clearly it is necessary to reduce indebtedness. This would require a larger primary surplus.

It is important to note that only a fiscal adjustment of a macroeconomic nature is not enough for the full development of the nation. It is also essential to rethink the priorities of Brazilian State spending in the three branches of government and at the three levels of the federation. Large spaces for a course correction exist in the payroll, in social security and in tax expenditures and subsidies. But I feel that the penny has not yet sunk in on the importance of doing so.

There is also a need for a shift in the government’s qualitative priorities, which affect areas such as care for the environment, the fight against inequalities, respect for science and the quality of our democracy. The result would be less uncertainty, more well-being, more efficiency, a better business environment and therefore more growth. It would be a virtuous circle that, if put to good use, would even reinforce the fiscal health of the State.

Deep down, we lack the confidence that we have a political system capable of learning from our mistakes and correcting our course in a civilized and systematic way. This, in my opinion, is the biggest problem of all.

Returning to the topic of the day, a warning is in order. The implementation of a counter-cyclical fiscal policy requires certain care. The budget in Brazil contains numerous linkages, which introduce an undesirable degree of pro-cyclicality in public policy and need to be substantially reduced. Additionally, it is essential that permanent expenses are not created without also permanent sources of income.

An important step in the desired direction would be the adoption of a tax budget, which, once approved, is executed. It would give predictability and more efficiency to public management. Another advantage would be its countercyclical feature. Let’s see why. In years of above-average growth, tax revenue will be higher than projected, with a contractionary impact on the primary balance. In the event of a recession, the opposite will occur, characterizing the counter-cyclical policy that is generally thought of. It seems reasonable that social policy also contains countercyclical elements, such as, in theory, unemployment benefits and the like (in practice, this does not occur in Brazil). Such mechanisms are known in the literature as automatic GDP stabilizers and would be an extremely welcome innovation in our bands.

Deployment challenges are relevant. In practice, social policy contains procyclical elements that need to be corrected. Untyings would require the use of multi-year allocations. Commodity-related revenues would have to be handled especially carefully (a carioca speaks here). Ingrained political habits, such as re-estimating revenues and contingencies, would have to be curbed. Everything has a solution, but nothing is easy. There’s no way to avoid a learning process, but the wheels on the bike have to be removed.

A fiscal rule along the lines of the one presented here bears some parallel with the inflation targeting system. The Central Bank is given a clear target and the freedom to use monetary policy to achieve it, also leaving some space for it to seek to minimize fluctuations in the level of activity. In the case of fiscal policy, the definition of debt and primary surplus targets is somewhat subjective and subject to the convenience of the occasion. It is better then to set a relatively low debt target, which is valid for long periods. Something like 50% of GDP, accompanied by a primary surplus sufficient to stabilize this ratio, would do the trick. Getting to that level would take time, but some concrete steps and credible signage would pay off right away.

In more advanced countries, the long period of nominal interest rates around zero meant that monetary policy was undermined as a countercyclical instrument (since there was no more room to cut interest rates). It was then necessary to give more weight to fiscal policy in combating the risk of deflation, the major crises of 2008 and 2011 and the pandemic.

Fiscal policy is a less agile and far more complex instrument than monetary policy for dealing with fluctuations in aggregate demand. In the case of Brazil, there is plenty of room for monetary policy to act. On the fiscal side, the full implementation of automatic fiscal policy stabilizers would be more than enough and would represent a major step forward.