Cleveland Brats - The tax base discussed at the Department of the Economy will be a time bomb

Cleveland Brats – The tax base discussed at the Department of the Economy will be a time bomb

Last week, the news was published that there will be a discussion within the Ministry of Economy about the implementation of a new financial anchor. The idea is to model the fluctuation ranges around a predetermined target for the debt/GDP ratio.

Ultimately, this proposal will aim to contain the evolution of public debt and restore lost credibility after the spending cap has gone through several adjustments in recent years. The big question is whether a model like this will really work.

On the one hand, it is clear that setting a goal to control the amount of public debt is something that satisfies the market, as well as healthy for the economy itself. In particular, for creditors, it does not matter how you arrive at a controlled debt, as long as it is actually controlled. In this sense, the spending cap, then in effect, was a means to achieve this.

In theory, the proposed new rule would be more useful, as it gives greater flexibility to the Director-General in managing fiscal policy. After all, reducing debt by cutting spending is just one of three tools available to achieve this goal. The other two are the increase in current income and the increase in extraordinary income through the sale of assets.

Thus, the goal can be achieved by combining several tools and not just one, and freeing the government from the constraints represented by the spending ceiling. But the case is not as simple as it seems, as it involves a mathematical aspect of non-trivial control.

The new proposal to control the level of debt brings with it a pro-cyclical policy, which implies a tightening of the “tournament” when the country is most in need of investment. It must be remembered that the debt/GDP ratio has GDP in the denominator. Thus, when GDP falls, this ratio increases.

With lower GDP, less taxes are collected, which worsens the debt/GDP ratio. At this point, the government will have to reduce its expenditures to bring the debt/GDP ratio back to the set target. But this will only add to the economic slowdown that has started this process even more.

On the other hand, the old spending cap is counter-cyclical. By carrying a nominal target (previous year’s inflation-adjusted expenditures) in a recessive process, expenditures, as a proportion of GDP, will increase, precisely because of the decline in GDP.

In other words, the spending cap rule helps mitigate the effects of business cycles, because it allows spending more in relation to GDP when there is a recession and less when the economy is expanding.

Precisely in keeping pace with the cyclical fluctuations of the new proposal under discussion, the major weakness lies in the objective of the public debt to be adopted. Basically, we’re going to be setting up a time bomb that will surely bring new political pressure to “exception” to the new rule when the economy “goes to the swamp” in the future.

Perhaps that is why technicians from the Ministry of Economy thought about the “bands” of debt fluctuations. These ranges will absorb unexpected shocks that would derail the debt/GDP ratio, similar to how inflation targets work. In this way, the government will still have room to maneuver in the event of an “unexpected” recession.

But the difference is that an effective central bank (BC) starts to act with an interest rate hike immediately after understanding that the target (the target center, not the upper band) is at risk. To mimic the behavior of BC in the target system, the federal government should cut spending immediately, after it became apparent that the target position of the indebtedness would be compromised.

To be clearer, in an inflation targeting regime, range is not an excuse to let inflation run wild, as it tends to destroy the credibility of monetary authority (as it did during the Tombini administration in British Columbia).

In the same way, the debt target band should not be used as an excuse to spend more “if necessary,” otherwise we would be dumping that rule into the same mass grave we already had. But, unfortunately, that’s exactly what will happen here; Just look at our history of political decisions.

In essence, the cap-spending rule written into the constitution was our best opportunity to build fiscal credibility: a simple, easy-to-understand, countercyclical rule that would have spurred public budget reform. But, unfortunately, what happened recently was the opposite: the public budget led to the reform (in fact, ending) of the spending ceiling.

Indeed, any other type of rule that does not cut expenditures would be less willing to spur reforms that would make the Brazilian state sustainable over time. If the ceiling in place is unable to withstand political pressures, how about a more flexible rule, such as the one proposed?

At the end of the day, the lack of fiscal oversight will continue to put pressure on the debt/GDP ratio, and unfortunately, the result will be a continued loss of credibility with creditors, with the consequent increase in real interest rates and, worse, lower economic growth over time. time and reduced ability to create jobs. Is this what we want?

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