Tax rules so that if the country’s leaders are constantly trying to circumvent them? – 07/04/2021 – Solange Srour

The vote on the 2021 Budget opened up the dispute over funds and the fragility of Brazil’s public accounts. By cutting mandatory expenditures to house parliamentary amendments, Congress has jeopardized all of the country’s fiscal rules. The government itself, by failing to update the parameters that serve as the basis for calculating expenditures, annihilated budget transparency, leaving a gap to be resolved later.

Why does a country have more than ten tax rules if its leaders are constantly trying to circumvent them? Why should we expect restrictions to be effective when they go against voter preferences?

Fiscal rules arose precisely in response to the deficiencies in the budget construction process, in which politicians tend to demand spending and exert pressure that unbalances public accounts.

It is the well-known bias of concentrated benefits and dispersed costs. Spending, in general, is concentrated on a restricted group of beneficiaries, representing a strong incentive for interest groups to campaign for its increase.

On the other hand, the reflexes of higher spending are, in general, more taxes, high inflation and loss of confidence – and affect the entire population. The situation becomes more serious when the costs are not immediately perceived. This is where the deficient trend finds an extremely favorable environment to develop.

In the practical world, fiscal rules seek to allow the debt trajectory to be seen as sustainable, despite the existence of the bias. They are designed to encourage the choice between the level of spending and taxes to be made with economic rationality, and not according to political sentiment.

Deficit or surplus budgets then depend on economic conditions. The implementation of an anti-cyclical fiscal policy allows the economy to adjust efficiently to exogenous shocks.

In “Fiscal Rules: Theoretical Issues and Historical Experiences”, Charles Wyplosz analyzes the experience of several tax rules. Based on ample empirical evidence, he argues that these are neither necessary nor sufficient to achieve fiscal discipline, but they do help. The most enduring rules are not so rigid as to be unenforceable. Those that are too loose become useless quickly. Finding the middle ground between the extremes and creating exceptions to the rules requires great care.

The IMF, in “Fiscal Rules, Escape Clauses, and Large Shocks”, examines how countries applied the escape clauses of their fiscal rules during the pandemic.

Brazil was included in the successful cases. The approval of a specific “War Budget” to face the pandemic allowed the suspension of all fiscal restrictions for a certain period. However, the experience with escape clauses is unequivocal: the process must be transparent so that the rule itself is not called into question.

It is precisely this path that Brazil is taking now. The Emergency PEC (proposed amendment to the Constitution) should be the counterpart for the expansion of emergency aid. However, its dehydration increased the perception of the debt sustainability risk.

The possibility of decreeing the “state of calamity” defined by the PEC constitutes a veritable “blank check”, as it allows the government to spend above the ceiling without compensation this year. This perspective tends to be more and more concrete, given the worsening of the sanitary and economic conditions in this first semester.

The approval of the Budget was another “blow” in the tax rules: by making the functioning of the public machinery unfeasible, it brings the perspective that the spending ceiling will be breached. This uncertainty will not decrease with a partial recomposition of the underestimated mandatory expenses or with the announcement of a substantial contingency of discretionary expenses. Faced with the risk of the public machine going down, we will find creative solutions to comply with the ceiling or we will play part of the bill for 2022.

The success of tax rules depends on the political environment in which they are applied. Its effectiveness results from the willingness of governments to operate in compliance with restrictions. This is not the picture of Brazil today. The Executive has no conviction that it is necessary to persevere in the fiscal adjustment, while the Legislative one generates impasses that threaten to dismantle the existing rules.

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