Lula’s fiscal framework too complex, watchdog says

President Lula and Finance Minister Fernando Haddad. Photo: Joédson Alves/ABr

The Luiz Inácio Lula da Silva administration bagged a major victory this week when its proposal for a new fiscal framework passed in the House. The bill now goes to the Senate, where it is not expected to face strong opposition.

The fiscal framework will replace the spending cap adopted in 2016, which limits public spending to no more than the official inflation rate of the previous year. It aims to provide fiscal controls while giving the administration some flexibility to finance social programs and investments. In short, it states:

Spending growth would vary from year to year between a minimum of 0.6 percent above inflation and a maximum of 2.5 percent (even in the unlikely event of a revenue boom).
It would be limited to 70 percent of revenue growth if primary surplus targets are met. For example: if revenues grow by 2 percent, expenditures can grow by up to 1.4 percent plus inflation. If the government fails to meet its primary goals, spending can only grow at half the rate of revenue growth.
The government will be forced to cut spending if it fails to meet its targets, with bans on new hiring, raises for public employers, new mandatory spending, or increases in aid policies or tax benefits. But the president will not be held criminally liable.

Last week, the International Monetary Fund said it “strongly supports” the government’s commitment to improving Brazil’s fiscal position and achieve a primary budget surplus of 1 percent of GDP by 2026. But the Independent Fiscal Institution (IFI), a think tank operating under the Senate’s umbrella, is less impressed.

In its latest fiscal monitoring report, it notes that international literature has shown that making fiscal rules simple is a key principle of successful reforms worldwide, but added that the fiscal framework “has proven to be very complex.”

“The complexity of the fiscal rule and the reliance on revenue sources that have not yet been presented increase the risk of non-compliance in the medium term,” the IFI wrote. “This scenario of uncertainty regarding primary revenues illustrates the magnitude of the effort required to achieve the primary outcome target.”

The IFI projects a deficit of 1 percent of GDP for 2024. With the proposed fiscal framework, the government is committing to a maximum deficit of 0.25 percent. This would force the government to either cut spending sharply or find new sources of revenue, which should be challenging in a scenario where growth should be near-zero from Q2 2023 onwards, according to IFI projections.