Economists back budget cut, warn credit may suffer under new tax hike

The figures released in the government’s Bimonthly Revenue and Expenditure Report show that controlling mandatory spending remains a major challenge, even after the fiscal package signed into law by President Lula at the end of 2024, said Manoel Pires, associate researcher and coordinator at the Fiscal Policy Observatory of FGV’s Brazilian Institute of Economics (FGV Ibre).

“When presenting the report, the government pointed to an increase of more than R$30 billion in mandatory spending. That’s a lot. There’s more spending on pensions, the BPC [a social benefit for low-income elderly and disabled individuals], and subsidies. And we already have a fiscal framework that allows real spending growth of 2.5% per year,” said Mr. Pires. “Mandatory spending rising far above that obviously puts pressure on other government expenditures.”

According to Mr. Pires, the freeze improves the government’s chances of hitting its primary result target for the year: a zero balance, with a tolerance range of ±0.25% of GDP. “What the government did was a relevant early-year fiscal adjustment to raise the likelihood of meeting the target and, consequently, reduce the market pressure that usually builds when targets are missed,” he said.

Regarding the IOF increase, Mr. Pires acknowledged that while it helps raise revenue, it also creates negative side effects. “It brings in more revenue and raises the chances of meeting the target, but the downside is the cost to credit operations, which are likely to feel the impact.”

Economically, raising the IOF is not a sound measure—ideally, this type of tax wouldn’t exist, as is the case in many other countries. But fiscally, it supports the government’s efforts to meet its target, he added.

Carlos Kawall, founding partner of Oriz Partners, said the R$31.4 billion spending freeze was more substantial than expected. However, he argued it does not amount to a “genuine fiscal effort” because it came alongside lower revenue projections and higher estimates for mandatory expenditures, partly accommodated through credit openings allowed under the new fiscal framework.

“Let’s be honest, they never really promised anything. At one point, it seemed like they might surprise us by delivering something. But in reality, expectations were low—and they met those expectations,” Mr. Kawall said.

The government revised down its revenue projection for the 2025 budget, with net revenues falling R$41.7 billion. This drop mainly came from so-called “administered revenues.” During the report’s presentation, technical staff said that the revision included eliminating projected revenues from CARF (Administrative Council of Tax Appeals) settlements and scrapping expected gains from a proposed increase in the Social Contribution on Net Profit (CSLL) for banks, which had been planned to offset payroll tax relief.

The CSLL hike was proposed and included in the 2025 budget bill, but has not been approved. As for the administrative tax appeals court CARF revenues, they fell short of expectations last year, and there was skepticism they would meet projections this year.

On the spending side, Mr. Kawall noted an increase of R$23.2 billion in primary expenditures subject to the fiscal cap. Part of that was accommodated through a R$12.4 billion extraordinary credit, tied to the difference between projected and actual inflation for 2024, as allowed by the fiscal framework. This made room for more mandatory spending, but still required an additional R$10.6 billion to be blocked.

Mr. Kawall believes the IOF hike will help with revenue and the 2025 budget, as it is immediately collected and not shared with states or municipalities. However, it will likely “generate market noise and come at a cost.” One key concern is private pensions: a 5% tax on contributions above R$50,000 to VGBL plans could discourage savings. In some foreign exchange transactions, a 3.5% IOF rate “is also excessive and could be seen as currency control.”

Economist Rafaela Vitória of Inter Bank said that the spending freeze, along with unspent funds from prior budgets, should help meet the 2025 fiscal target. She noted that the R$31.4 billion freeze exceeded market expectations of around R$15 billion.

However, she also highlighted a significant upward revision in spending—an additional R$25.8 billion—mostly in pensions and BPC payments. “The latest report suggests total spending will grow by more than 4% above inflation in 2025, likely exceeding 19% of GDP.”

Ms. Vitória acknowledged greater transparency in accounting for mandatory spending, but said managing the growth of such expenditures remains a challenge. “On the revenue side, the updated projections were realistic, which is a positive, but the announcement of new taxes like the IOF hike shows the government is still leaning on revenue increases to cover rising expenses.”

Economist João Leme of Tendências Consultoria said next year will be the real test, as the electoral calendar will pressure spending. “The main concern is whether the new fiscal framework can hold in 2026, when election-year incentives could push spending higher amid slower economic growth, inflation still above target, high interest rates, and structural issues in spending trends that could even lead to a complete squeeze on discretionary spending.”

Mr. Leme said the government’s announcement was positive, as it showed a genuine concern with meeting the fiscal target, even if only at the lower end. He noted that revised assumptions for key variables—like average key interest rate Selic, inflation (IPCA), and Brent crude oil prices—brought the government’s numbers closer to market consensus, which enhances the budget debate.

Economist Italo Faviano of consultancy Buysidebrazil said the report signals a shift in how the government is handling revenue and spending, indicating a concern for a healthier fiscal path. “It was expected that instead of large freezes late in the year, we’d see smaller, more consistent freezes throughout. But what we got was R$30 billion right out of the gate, which was what was needed for the year as a whole.”

Sergio Vale, chief economist at MB Associados, said a more ambitious administration might only come in 2027 to seriously reform expenditures. He acknowledged that the government anticipated criticism about last year’s overestimated revenues. “The effort is significant, but it’s at the lower end of what’s needed.”

“We’re still talking about another year of a high deficit—over R$70 billion. Combined with high interest rates, this will push public debt close to 80% of GDP,” Mr. Vale said. He criticized the IOF hike as “a bad tax, typically used in emergencies.” “We’ve been in a fiscal emergency since 2022, and the core issue is the government’s failure to create a truly durable fiscal regime.”

Tiago Sbardelotto, economist at XP, said the report exceeded market expectations with a larger-than-expected freeze and signaled a shift in the government’s approach. “The report was based on more realistic assumptions,” he said. Realistic budgeting alone doesn’t ensure fiscal sustainability, but it’s a prerequisite, he added. The biggest surprise, according to Mr. Sbardelotto, was the R$20.7 billion in spending containment, while the R$10.6 billion in blocked funds was in line with expectations.

On the spending side, Mr. Sbardelotto noted a significant revision in pension spending. “They seem to have factored in a partial reduction in the backlog,” he said. A recent Valor report showed that the Social Security waiting list nearly doubled in one year. However, he said, BPC spending projections still seem “somewhat disconnected.”

Santander economist Ítalo Franca said the report offered positive signs for meeting the 2025 primary result target. Since the government raised the spending cap by R$12.4 billion, due to the difference between projected and actual inflation, Mr. Franca estimated the “net fiscal effort” at R$18.9 billion. That’s above market expectations and even above Santander’s upper-bound scenario of R$15 billion.

Given this, he said, achieving the 2025 target range looks feasible. On the spending side, pension benefits were in line with projections, even assuming a partial reduction in the claims backlog.

*By Anaïs Fernandes, Marsílea Gombata, Marta Watanabe, Michael Esquer  and Alex Braga Jorge  — São Paulo

Source: Valor International

https://valorinternational.globo.com