Opinion – Why? Economese in good Portuguese: What does a government program need to contain?

In 2022 we will have presidential elections. For now, there are only indications of potential candidates, and we are far from having government programs on the table. However, some challenges for the Brazilian economy come from a long time ago, and will need to be faced in the candidates’ proposals.

Many ideas, however, will not be viable. We will have tough choices in terms of public policies. Today, we begin a series of articles that will address the economic elements present in government plans, with the aim of making them more accessible to citizens. In this text, we will address fiscal policy.

First of all, what is fiscal policy?

Fiscal policy is the management of government finances, and involves spending, taxes, public deficit and public debt (we’ll see what this means below). The government has a series of expenses (health, education, pensions, income transfer programs, subsidies, civil servants’ salaries, interest to creditors, etc.) and needs to raise funds to cover them. Much of these resources come from the taxes we pay.

The government often spends more than it collects. To finance this difference – called the public deficit – the government needs to borrow, which increases the public debt. This debt comes at a cost, as the government needs to pay creditors with interest. And the higher the interest rate and the size of the debt itself, the larger this account will be.

How to analyze fiscal policy in a government plan?

Initially, it is important to be wary of promises that involve exaggerated increases in public spending or substantial tax cuts. It is no secret that Brazilian public accounts are in a delicate situation. Today, the government spends more than it collects, even without including interest payments on the debt. This has been boosting public debt, which is already large compared to other emerging countries.[1]

Considering this, every government program should reflect on the fiscal problem and, at least, consider alternatives so as not to make it worse. It would be a good start.

Given the social demands of our country, such as fighting inequality and poverty or improving the quality of public services, there are valid arguments for the expansion of spending. It cannot be forgotten, however, that spending increases will require more taxes, which can further burden production and consumption, bringing negative impacts on economic growth and job creation.

Tax cuts, on the other hand, can lead to a reduction in the quality of public services. After all, these activities depend on tax money to support themselves.

Thus, proposed changes in taxes and expenditures have potential benefits (which politicians often emphasize), but they also have costs that need to be factored into voters who evaluate different platforms.

Why should we care about this?

There is a common argument that we do not need to worry about fiscal issues in the proposals, because they “pay for themselves”. In other words: increases in public spending or tax cuts, for example, would stimulate the economy in such a way that there would be a growth in revenue that would more than offset the initial stimulus.

Although this argument has logical consistency, it almost always makes no sense quantitatively, as we would need a very strong reaction from the economy to make public accounts better in a situation of increased spending or lower taxes. In addition, there are other costs associated with greater clutter on the fiscal side. Debt grows faster and it becomes more costly to maintain. This raises expectations that these commitments will not be honored in the future, causing creditors to demand higher interest rates to continue financing the government.

The possibility that the government will despair and finance itself with printing money also increases. As a result, inflation expectations grow, which makes the Central Bank’s task of maintaining price stability more difficult. In other words: higher interest rates, more inflation, less growth.

A look at public debt

This brings us to a fundamental question: the long-term sustainability of the public debt. For a few years, mainly in the late 1990s and during the 2000s, we managed to record primary surpluses – that is, the difference between government revenues and expenditures, not counting interest payments on the debt. This guaranteed stability to the government debt.

For some time now, revenue has stopped growing, but spending has not, and we are now in the red in this category, with successive years of primary deficits. In other words, the federal government spends more than it collects, even without counting the interest on the debt. In light of this situation, we had a crisis in the mid-2010s, with the Brazilian debt being viewed with suspicion by creditors. Interest rates soared, inflation soared, and the economy slumped.

The constitutional amendment to the spending ceiling has given relief to this situation. By containing expenditure growth for at least 10 years, it signaled the return of primary surpluses in the future. Thus, the Brazilian debt started to have a less risky profile, which allowed for successive cuts in interest rates.

However, the ceiling also has its problems, as it imposes rigidities on public accounts. It makes it difficult, for example, for the government to act in an anti-cyclical way, that is, for it to expand its spending in times when the economy is weak, compensating for it with lower spending during periods when the cows are fat. During the pandemic it was possible to “turn off” these rules temporarily, due to the state of public calamity. But the ceiling makes this countercyclical government action difficult in difficult times, but less extreme than a pandemic.

Pay attention to the spending ceiling!

Most likely, candidates will talk about spending caps in the next election. This is an important point for us to discuss as a society. Will it be kept as is? Will there be adjustments? Or will we simply remove it?

We will certainly have proposals to repeal the law entirely. But it is important to emphasize that simply ending the ceiling, without putting anything in its place, is not a good strategy: it is important to propose a fiscal rule to replace it, with a view to maintaining the perception that our debt is sustainable.

Pay attention to our channels to have access to upcoming texts on economic aspects of government plans.