On March 30, the Lula administration officially presented its proposed new fiscal policy framework for Brazil.
Minister of Finance Fernando Haddad and Minister of Planning and Budget Simone Tebet presented the framework to the press after several rounds of negotiation within the administration and with the congressional leadership, in particular the Speaker of the House and the President of the Senate.
- The new framework tries to strike a balance between fiscal responsibility and social responsibility, combining fiscal adjustment measures with the preservation of budget for key social policies, in particular the conditional cash transfer to the poor, minimum wage, healthcare and income tax exemption for workers and the middle class.
- The new framework’s ‘fiscal anchor’ is based on an annual primary budget surplus target (excluding debt interest payment), from -0.5% of GDP in 2023 to 1.0% of GDP in 2026, growing in 0.5 pp increments per year.
- The annual primary budget surplus target will be pursued within a tolerance range between +0.25% and -0.25% of GDP of that year’s target (e.g., if the target for the year is 0.5%, the range will be from 0.25% to 0.75%). This tolerance range mechanism mirrors the existing inflation target mechanism used by the Central Bank.
- In addition to the target, growth in spending will be pegged to revenue increase at 70% (e.g., if revenue increases BRL 10 billion, spending can increase only up to BRL 7 billion). If the annual primary budget surplus target is not achieved, the spending growth peg is reduced to 50% to slow down further spending.
- There is a counter-cyclical mechanism built into the framework: a revenue increase tolerance range between 2.5% (a spending ceiling) and 0.6% (a spending floor). For example, if in an economic boom revenue increases 5%, per the general rule, spending could grow 3.5% (or 70% of 5%). However, the 2.5% ceiling to spending growth will apply as a way to curb excessive spending. On the other hand, if in an economic crisis revenue drops -5%, spending can still grow 0.6% as a way for the government to pursue a counter-cyclical policy. Constitutionally-mandated spending on education and healthcare are excluded from this mechanism.
- The new fiscal policy framework will be introduced in the National Congress in the form of a Supplementary Bill. Supplementary bills are bills that further detail constitutional provisions and require an absolute majority vote (50% of total possible votes + 1) in the House and in the Senate.
- The Lula administration has an estimated 282 votes out of 513 in the House and 46 votes out of 81 in the Senate, thus, in theory, securing the new fiscal framework approval.
- Once the new fiscal framework is approved, the current spending cap framework will cease to exist.
- The new framework seems to be reasonable. It has clear targets and transparent rules, as well as flexible mechanisms to survive changes in the business cycle.
- For the framework to work properly, revenue must increase. There is a justified fear in the private sector that the administration might increase taxes to achieve this result, although the Minister of Finance has been publicly stating that there is no plan to pursue this path and that revenue increase will come both from economic growth and a focus on tax compliance enforcement.
- The Lula administration has an expectation that the mere presentation of the framework creates an opportunity for the Central Bank to begin to reduce the benchmark interest rate (SELIC). If the rate is not reduced, total public debt will continue to grow up to 2026. However, with a substantial reduction of the rate, total public debt will probably peak in 2024 and then will gradually go down.
- The fact that the framework combines fiscal adjustment with preservation of budget for social policies increases its chance of approval by Congress.
- The framework’s approval is part of a larger economic strategy that includes (i) a number of revenue increase measures adopted in January (some of which are pending congressional approval), (ii) reestablishment of key social policies focused on the poor, workers and the middle class, and (ii) a future tax reform focused on taxation over consumption to simplify the tax system for businesses.
- To further improve the fiscal policy framework, the Lula administration would need either to propose and approve a substantial administrative reform to reduce the cost of government human resources or to change and reduce constitutionally-mandated spending, including on education and healthcare. Both are very unpopular measures that the administration seems unwilling to propose and that would likely face strong opposition in Congress. Furthermore, it is not clear if the Lula administration currently has enough votes to amend the Constitution.
- Markets reacted favorably immediately after the announcement, although some economists are critical of the fact that the framework does not include a clear goal to reduce total public debt as a proportion of GDP.