Understanding Brazil’s new plan to overhaul the state

. Nov 06, 2019
Economy Minister Paulo Guedes Economy Minister Paulo Guedes. Photo: Marcello Casal Jr/ABr

“We want a state that provides us with healthcare, education, sanitation. Instead of having a state of authorities, we want a state of civil servants, that serve the citizens. The public machine cannot keep feeding itself.” This was the rationale presented by Brazil’s Economy Minister, Paulo Guedes, when unveiling his ambitious initiative to redesign the Brazilian state, in a bid to balance public accounts and reclaim investment-grade status.

The plan delivered to Congress by President Jair Bolsonaro included three proposals to amend the Constitution, while other developments—such as administrative and tax reform—are set to follow. The goal is to make the federal budget more flexible and increase checks and balances to ensure financial responsibility for states and municipalities. Ultimately, either by reducing the number of municipalities or repaying debt, it aims to reduce the size of the Brazilian state, which currently has liabilities corresponding to 79.8 percent of GDP.

</p> <p>The plan is set to release an extra BRL 400 billion for states and municipalities over the next 15 years, coming from pre-salt oil royalties and transfers. This figure was initially slated at BRL 500 billion, but a reduction in the savings expected from the pension reform—from BRL 1.2 trillion to roughly BRL 800 billion—saw these levels scaled down by 20 percent. </p> <p>During the launch event, Mr. Guedes showed optimism about approving this set of measures after the struggle to pass the pension reform. He said that the proposals were built in cooperation with all levels of government and branches of power, and the decision to divide them into different bills was intended to make their approval more straightforward.&nbsp;</p> <p>“We built this pension reform together, but there was much more friction. Now we have more cooperation and there’s an exceptional political climate to do so. Congress is free to analyze it and I’m not afraid of it getting disfigured,” he said in a press conference, adding that each bill will follow a different timetable.&nbsp;</p> <h2>Paulo Guedes&#8217; new &#8220;federative pact&#8221; </h2> <p>The first amendment redesigns the financial relationship between states, municipalities and the federal government, commonly called the &#8220;federative pact.&#8221; It creates the Brazilian Fiscal Council, which will include the President of Brazil, the speakers of the Senate and House of Representatives, the Chief Justice of the Supreme Court, the head of the Federal Accounts Court, state governors, and mayors, who will meet every three months. This committee will monitor public spending, diagnose problems and issue recommendations to help in the fiscal management of the federal government and states and municipalities, acting alongside governors and mayors in the case of financial emergencies.&nbsp;</p> <p>The bill also foresees giving more power to the Federal Accounts Court (TCU), establishing that its norms and standards be followed by all state accounts courts. The goal is to avoid states in terrible financial situations having their accounts approved, as has happened in the past.&nbsp;</p> <p>The pluriannual budget plan (PPA) will be made extinct, replaced by a long-term budget in order to steady flows of investments. Programs and construction works will be allocated in the budget for future years, ensuring that resources won’t be interrupted. On the other hand, laws and court injunctions creating new expenses will only be valid if there is room on the budget.&nbsp;</p> <p>This bill will allow for the aforementioned transfer of royalties to states and municipalities, but will demand checks and balances in return. The so-called &#8220;Mansueto Plan&#8221;—named after Treasury Secretary Mansueto de Almeida—which provides financial aid for states and municipalities that commit to improving their credit score, will have an important role in this process, according to the government. This bill is already being analyzed by the House of Representatives.&nbsp;</p> <p>With regard to checks and balances, from 2026 onward—when Brazil will reevaluate its cap on public spending—the federal government will not be able to bail out states in financial crisis. In addition, it will be able to act as a guarantor for loans obtained by states and municipalities abroad as of this date.&nbsp;</p> <p>Tax breaks will be reviewed every four years and, at the federal level, they will be restricted to 2 percent of GDP as of 2026.&nbsp;</p> <h2>More freedom for budget management</h2> <p>According to the Treasury Secretary, Congress has only room to decide on 7 percent of the budget, which severely hampers the government’s ability to prioritize investments. Aiming to guarantee more freedom, the bill affirms that revenues will no longer be automatically coupled with certain agencies or funds, except in the cases of fees, donations, state and municipal participation funds, and when established by the Constitution.&nbsp;</p> <p>Another proposal states that municipalities with less than 5,000 inhabitants and tax collection inferior to 10 percent of their revenue will be incorporated by neighboring towns. There will be tougher rules when it comes to creating new towns, according to the bill. The idea is to reduce spending on municipal administrations but it could have political shockwaves, as diminishing local levels reduces support bases for many lawmakers and governors. According to IBGE data published in July, Brazil had 1,254 cities with less than 5,000 inhabitants, though the numbers may be imprecise, as the population was not counted in 2015.&nbsp;</p> <p>The bill proposes that the minimum amount of investment established by the Constitution for education and health should be merged; then, the government will have the power to decide whether to spend more on education or health, depending on need. Currently, 18 percent of tax collection should be spent on education, while investments in health are determined to be the same as the previous year with the addition of GDP variation over the previous two years, <a href="">according to Congress</a>.&nbsp;</p> <p>Following the same logic, the “education salary”—<em>salário-educação,</em> a contribution paid by companies to fund public elementary schools—will be fully directed to states and municipalities which may decide how to invest it. Currently, <a href="">10 percent</a> goes to the National Education Development Fund (FNDE) and states and municipalities receive only two-thirds of the remaining 90 percent.</p> <p>The government has also decided to slash transfers from the Workers&#8217; Support Fund (FAT) to the Brazilian Development Bank (BNDES) from 40 percent to 14 percent. Today, these resources make up almost 38 percent of the BNDES&#8217; available funding and are mainly invested in infrastructure projects.&nbsp;</p> <h2>The Fiscal Emergency PEC</h2> <p>This bill runs alongside the proposal to redesign Brazil&#8217;s federative pact. While the main bill introduces permanent instruments for states and municipalities to adjust their public accounts, the second provides special emergency conditions which are valid for two years. The mechanisms in this law will be triggered if credit operations overtake capital expenses in the course of a year, and 25 percent of savings obtained will be directed to infrastructure works.&nbsp;</p> <p>If a state or town finds itself in a fiscal emergency—when expenses are over 95 percent of state revenues—automatic control mechanisms for expenses will be triggered for one year, and may be renewed until the public accounts are balanced.&nbsp;&nbsp;</p> <p>Under fiscal emergency status, no government may offer promotions to civil servants—except judicial civil servants, members of the military, police officers, and diplomats—increase salaries, or hire new employees. It also allows these administrations to reduce civil servants&#8217; working hours and salaries by up to 25 percent. Tax benefits and new mandatory expenses will be suspended while states or governments are in financial emergencies.&nbsp;</p> <h2>Judicial repercussions</h2> <p>The plan aims to create “moralizing measures” in order to increase trust levels in Brazil, according to the economic team. One of them is to forbid all levels of government from using judicial deposits related to private legal cases, or money from pension funds to finance its own expenses.</p> <p>Another positive outcome expected by the Jair Bolsonaro administration is the end of the legal battle regarding the so-called &#8220;Kandir Law.&#8221; It was approved in 1996 in an effort to increase exports, offering tax exemptions on State Goods and Services Tax (ICMS) for the export of raw materials or semifinished products. The problem is that the states’ loss of revenue must be compensated by the federal government.</p> <p>A seemingly endless battle ensued between state and federal governments over how this compensation should be calculated. In 2016, the Supreme Court decided that Congress should pass a new law on the matter within a year, or the Federal Accounts Court will have the right to decide on compensation criteria. Neither has happened so far.</p> <p>By dishing out pre-salt royalties and approving a law before February—when the Supreme Court is expected to discuss the matter again—the government now expects to draw a line under the Kandir Law and establish more legal security for taxes in Brazil.&nbsp;</p> <h2>Cutting public debt  </h2> <p>Brazil currently has 281 public budget funds which are not enshrined by the Constitution. Many of those funds aim to foster specific sectors, such as the Telecom Service Universalization Fund. However, roughly BRL 220 billion is lying dormant in these funds. The government has proposed to extinguish the funds that are not revalidated by supplementary laws in up to two years after the bill’s approval and use this money to repay public debts and diminish the burden with interest—which amounted to BRL 379 billion as of 2018. Furthermore, Congress would be free to redirect resources from funds to the budget, if the bill is approved.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p> <h2>Additional measures</h2> <p>The set of measures focused on the three main bills, though the government is expected to present details about its much-awaited tax reform, as well as an administrative reform and law to fast-track privatizations.&nbsp;</p> <p>In a press conference at Tuesday&#8217;s launch, Mr. Guedes provided some spoilers regarding these measures. For the administrative reform, he stated that current servants won’t be affected by administrative changes. However, job stability, one of the most desired perks of public service in Brazil, will be harder to obtain.&nbsp;</p> <p>“The reforms do not impact on rights already guaranteed, but young people that are joining now won’t get a salary similar to Mansueto de Almeida (the National Treasury Secretary), who has been here for 20 years. The salaries will be more consistent with market prices. Also, they need more time to become civil servants and gain stability, which they will only get if they are not affiliated to political parties. Otherwise, they’re not civil servants, but militants,” said the minister.&nbsp;</p> <p>Regarding privatizations, the goal is to reduce the average time necessary to privatize a state-owned company, now estimated at 2.6 years.

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Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Before joining The Brazilian Report, she worked as an editor for Trading News, the information division from the TradersClub investor community.

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