Big state or strong state?

By ETCO
15/06/2009

Source: Valor Econômico, 15/06/2009

The Brazilian public sector currently spends the equivalent of almost 40% of all goods and services that are produced in the country. Tax collection is around 37% of GDP. Comparisons of these statistics with other countries have become common practice. “Pro-market” observers, defenders of the small state, argue that the Brazilian tax burden it is very high compared to 17% of GDP in the case of Chile, 18% in India or even 28% in the case of the United States. The “anti-market” commentators, who defend the big state, point out that the tax burden of Denmark and Sweden is 50% of GDP. These statistics and comparisons, however, hide a more complex reality.

It is necessary to remember, first of all, that - especially in the case of developing countries - this indicator hides the real tax burden for those who, as good citizens, effectively pay their taxes. In Brazil, this problem was accentuated with the inclusion of the informal sector in the calculation of GDP. As the informal sector does not pay taxes by definition, and part of the formal sector withholds tax, the tax burden felt by the Brazilian business community that actually pays taxes is even greater. If we consider that in Brazil around 25% of the taxes due are not paid (Brazilian Institute of Tax Research, 2009), the tax burden for those who pay their taxes religiously is already in fact equal to 50% of production.

In addition to having a heavy and complex tax system, it is known that the use of tax revenue reduces the concentration of income very little - unlike what occurs in developed social welfare countries (OECD Latin American Economic Outlook 2009). In this context, it can be said that the Brazilian State is large. However, the solution is not necessarily to reduce it: what the country needs is a tax reform that simplifies the tax system combined with a redirection of public spending.

The obstacles to necessary reforms are obviously immense, and come in part from the Federal Constitution itself. With the well-intentioned intention of reducing regional inequalities, article 159 of our Magna letter establishes that 48% of the income tax and industrialized products (IR and IPI) revenues are transferred to states, municipalities and regional development banks. In practice, the central government currently has to transfer the equivalent of 18% of its total revenue to these other spheres of government. As a result, you need to increase your collection by R $ 1,21 to finance each additional real you spend.

Upon receiving a practically fixed portion of federal revenues, states and municipalities effectively became partners in the big state - regardless of the quality of the services provided by it. The large budget has many members. If until recently the main villain of federal public spending was the real interest rate out of step, lately factors such as the public service payroll have taken on greater weight. Those who hoped that the interest rate cut would make room for tax cuts saw their expectations dashed once again. Expense reductions at one end are quickly offset by new expenses at the other. The truth is that when government officials speak of fiscal stimulus, they typically refer to patches and specific measures such as tax exemptions or compensation and not to reducing tax rates.

The political economy of article 159 of the Constitution may explain part of this apparent spending bias by the Brazilian State. It is enough to note that, for half of the states of the federation, only the direct participation in the revenues of the Union represents more than 30% of its total revenues. In the case of Amapá and Roraima, 65%. In addition, the rule of article 159 of the Constitution also creates incentives for the federal government to make less use of IR and IPI as the main source of revenue and gradually use more taxes that are more distorting and harmful to economic activity.

The result of this mandatory participation of states and municipalities in the Union's revenues is that the comprehensive tax reform that we urgently need is very difficult to pass in the legislative chambers. Deputies and senators need to be persuaded to vote against the financial interests of the governments of their states and municipalities, and possibly against their own political aspirations, for the greater good of the country. Many deputies and senators are from the same party as the governor (partly due to concurrent elections), and are looking forward to occupying that position in the future. This is just one of the factors that lead Brazil to have a large state. The 250 articles of our Constitution provided sufficient space for other sources of a spending bias. But the rule in Article 159 is probably the main root of the “culture of the big state”.

The constitutional tax-sharing mechanism, when it was created, aimed to reduce regional disparities. In order to make progress in reducing inequality as a whole, it is imperative that the federal government make good use of the space created by reducing interest rates, investing in programs that benefit the poorest strata of the population as a whole. In contrast, deputies and senators need to look less at the individual interests of their states and more for the good of the nation. The responsibility for promoting this change in political culture lies with both the government and political parties with national ambitions. The maturing of the debate will eventually require discussing less the size of the state and more the quality of health and education provided by it. A strong state is not a large state, but a state that does its duty well to its citizens!

Emanuel Kohlscheen, doctor of economics from the University of Stockholm (Sweden), is a professor of economics at the University of Warwick (United Kingdom) and coordinator of the Economics, Politics and International Relations course.

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