Opinion – Solange Srour: Tax illusion nearing the end?

The public sector is likely to post its second consecutive primary surplus in 2022, after seven years of running deficits; while public debt, which reached close to 90% of GDP in February 2020, is expected to close the year at around 80% of GDP. The current improvement in the fiscal position can be explained by the maintenance of the spending ceiling, the increase in inflation and the positive performance of GDP. But how long will these factors continue to help?

We know that the spending ceiling is “threatened” from all sides. Despite having fulfilled its role, preventing the increase in revenue from being neutralized by the corresponding increase in spending, few politicians or even economists defend its permanence. It is true that the flexibilities promoted by constitutional amendment 114/21 diminished its credibility as a fiscal anchor. However, those who are willing to do the math will find that the cap will remain achievable for the next 2 or 3 years, if pressures for new subsidies, wage increases and other initiatives targeting specific sectors do not prosper.

Unfortunately, campaign speeches indicate a waiver of the fiscal anchor before the end of fiscal consolidation, an easier path than reviewing the budget amendment process, optimizing the design of social benefits and advancing administrative reform. Under the argument of the need for more space for public investment, we run a high risk of having spending resume growth at rates above GDP as before 2016.

On the inflation side, it is expected that the Central Bank will continue to pursue the target system, that is, we will not be able to count on its help to increase collection (about 40% of collection is on nominal revenue from companies or indirect taxes on products and therefore rises with the rise in the price level) and for the fall in the debt/GDP ratio — whose denominator is affected by the rise in the GDP deflator.

Inflation as a hidden financing mechanism —via inflation tax— or as a means of improving GDP statistics does not prevent reality from imposing itself sooner or later. With high inflation, non-indexed expenses end up being readjusted (with time, demands for readjustments appear), and interest expenses increase significantly.

The effective cost of inflation-linked government bonds (NTN-B) in the last 12 months was 16.2%, close to the historic peak of 16.8% in 2016. Since January 2021, projections for interest expenses between 2022 and 2024 increased by around R$400 billion (almost ten times the annual cost of the former Bolsa Família). Interest on new public debt issues rose from 4.7% in January 2021 to 10.5% in March 2022 and should remain high, given the expectation that monetary policy will have to be restrictive for a long time.

Like inflation, the positive performance of GDP — driven by non-recurring factors, such as the opening of the service sector, anticipation of the salary bonus, FGTS withdrawals and the rise in commodities — should also be short-lived. Going forward, the impacts of interest rate hikes and tighter financial conditions will cause growth to decelerate. Not to mention the likely reduction in global growth.

We shouldn’t look at a pretty picture without thinking about the future. Lasting adjustments are only possible through reforms that reduce the growth of mandatory expenditures and increase spending discretion. In the context of high inflation, fiscal policy has the role of stabilizing expectations and helping to control inflation. This is not what we have seen, with countless improvisations to control inflation and boost growth (such as recent tax cuts) and a desert of proposals for some new fiscal rule.

The central issue for the coming years is not an eventual short-term fiscal adjustment. If the upward trend in mandatory expenditures is not reversed and productivity does not increase, we will continue to be a country with low per capita income, recurrent inflationary pressure, high interest rates and the need for a continuous increase in the tax burden to avoid the perception of immediate insolvency. Any and all fiscal illusions are good while they last.