The inflationary fiscal adjustment


Source: Valor Econômico - 15/06/2011

By privileging the increase in tax collection instead of cutting expenses, the fiscal policy adopted by the government will not contribute to the anti-inflationary effort in 2011. In fact, the increase in the tax burden by 1,1 percentage point of the Gross Domestic Product ( GDP), forecast by the government itself, will fuel inflation. The emphasis on increasing revenues shows, in practice, authorities more interested in reducing public debt as a proportion of GDP than in helping to contain price escalation.

In 2010, the primary surplus of public accounts (excluding interest expenses and revenues from capitalization of Petrobras) was, within the federal government, 1,3% of GDP, the second lowest since 1999, when the country adopted the current economic policy tripod - surplus, floating exchange rate and inflation targets. In 2011, the goal is to increase the surplus to 2% of GDP.

Total Union revenues are expected to grow, according to official estimates, from 23% of GDP in 2010 to 24,1% of GDP this year. Transfers to states and municipalities are expected to jump, in turn, from 3,8% to 4,1% of GDP. Total expenditure is forecast to grow 0,1 percentage point of GDP in the period. Fiscal consolidation will therefore be carried out by increasing revenues and not cutting costs.

High tax burden should put pressure on the IPCA

This choice, maintains the chief economist of Credit Suisse bank, Nilson Teixeira, does not help the Central Bank (BC) to contain inflation. The increase in the tax burden reduces the level of activity and also the disposable income of families. In an environment of low competitiveness, the increase in taxes tends to be passed on, to a large extent, to consumers, putting pressure on inflation. The BC's response to this scenario is more interest.

If the adjustment option were to cut expenses, there would also be a negative impact on the level of activity, since lower government consumption would decrease aggregate demand. Through the demand channel, therefore, the effect on inflation would be negative. In view of this, the BC would operate with less need to increase the interest rate.

As the government opted for strong revenue growth, through the readjustment of tax rates such as IOF and IPI, and the near stability of expenses, the effect of the increase in tax collection on inflation will be greater than that of restraining public spending. “This is not only due to the relative magnitude of the variation in revenues being much higher than the variation in expenses. This result is also suggested by a broad empirical literature that points out that the multipliers associated with changes in taxation, in general, are much higher than those associated with changes in government expenditure to explain the dynamics of inflation, output and interest rates. ”, Explains the Credit Suisse economist.

Teixeira and his team carried out econometric exercises, based on the economic variables and the fiscal adjustment, and found that the fiscal policy will contribute 0,9 percentage points to the IPCA in 2011. It is, therefore, a different effect from that predicted by the Central Bank in its documents - the BC did not make public estimates of the impact of fiscal adjustment on inflation, but announced that, in its anti-inflationary strategy, it has met the target of a surplus of 2,9% of GDP (2% from the federal government) plus 0,9% of states and municipalities).

“In this context, the GDP growth rate accumulated in 2011 will be 0,4 percentage point lower than in the absence of the projected fiscal adjustment. At the same time, we expect a Selic, on average, 150 basis points higher, ”says Nilson Teixeira. For him, the government should promote this year the biggest increase in tax burden in recent years, making the contribution of fiscal policy to control inflation to be the most unfavorable since 2005.

If everything goes as planned, the fiscal effort will cause a reduction of 0,7 percentage point of GDP in the net public debt. The impact of fiscal policy on economic indicators (inflation, GDP and interest rates) should decrease this result, however, to 0,4 pp.

“In a context of low risk of fiscal insolvency and a strong need to control inflation, we believe that the benefit of this reduction in public debt does not outweigh the cost of an increase in inflation by 0,9 pp in the year. This result reinforces the assessment that the appropriate way to reduce the magnitude of the monetary tightening necessary to make inflation converge to the center of the target in 2012 would be through a fiscal policy with contraction of expenses as a proportion of GDP and not with an increase in tax burden ”, suggests Teixeira.

The problem is that containing expenses next year will not be easy. At the outset, the minimum wage will have an increase of about 14%, raising mandatory expenses such as social security and assistance benefits and unemployment insurance, items that account for about 45% of the total current expenditure. In addition, the political capital to continue to dampen the demands of civil servants for readjustments will be less and less.