Economists say fiscal discipline can coexist with social protection

Bringing Brazil’s public finances under control will require slowing the growth of mandatory spending, but economists interviewed by Valor say that does not mean dismantling the social safety net guaranteed by the Constitution. Rather, fiscal consolidation is essential to preserving social programs over the long term and ensuring the government has resources to respond to emergencies.

This is the first article in “False Dilemma”, a series exploring how Brazil can reconcile fiscal responsibility with efforts to reduce inequality. The reports will examine the challenges of keeping social protection programs sustainable, tackling privileges and improving public-sector efficiency. Other articles will explore the economic costs of inequality, including its impact on productivity, as well as indicators of violence in Brazil, among other issues.

Unchecked public spending can fuel inflation, which hits low-income households hardest, said Rafaela Vitória, chief economist at Inter. “Inflation is not out of control today, but we are paying the price of high interest rates to keep it low. Households are burdened with debt because of this. Fiscal discipline matters because it helps improve the well-being of low-income people. It is an indirect form of social welfare.”

Bráulio Borges, a director at LCA and researcher at the Brazilian Economics Institute of the Getulio Vargas Foundation (FGV Ibre), warned that prolonged fiscal instability could ultimately force the government to print money to service its debt.

“That results in too much money circulating in the economy, the currency depreciates and inflation rises. And the inflation tax is regressive.”

The proposals for curbing spending growth bear little resemblance to the sweeping cuts to primary expenditure imposed by Argentine President Javier Milei in 2024. Instead, economists point to changes in Brazil’s minimum wage policy as one of the most important steps toward fiscal consolidation. Their proposals would preserve purchasing power while allowing annual increases of between 0.5% and 1.5% above inflation.

Some argue that the best approach would be to sever the link between the minimum wage and pension and social assistance benefits. Other recommendations include ending the automatic link between health and education spending and government revenue, imposing an effective ceiling on total expenditure, eliminating fraud and reducing overlap among social programs.

Although the economists differ on how these changes should be implemented, they agree that fiscal responsibility and social protection are not mutually exclusive.

Borges pointed to President Luiz Inácio Lula da Silva’s first administration as evidence. “When he took office in 2003, he raised the primary surplus target from 3.75% to 4.25% and created [cash-transfer program] Bolsa Família. That shows there is no incompatibility between fiscal and social policies.”

Marcos Lisboa, former president of Insper and economic policy secretary during Lula’s first term, said constitutional and legal restrictions make substantial cuts to major spending categories difficult. Wages and pensions cannot be reduced, while pension, health and education spending are subject to their own adjustment formulas and revenue-linked requirements.

Slowing expenditure growth is therefore the more viable option, although Lisboa also favors removing those automatic links.

Carlos Kawall, founding partner of Oriz, noted that no presidential candidate had advocated a draconian fiscal policy involving an immediate reduction in benefits equivalent to 2% or 3% of GDP.

“What is being proposed is a policy to contain the growth of social spending, keeping that expenditure from rising as a share of GDP, and changing indexation rules so that, within five years, we can put public debt on a path toward stabilization. That signal would bring interest rates down and prevent the crisis we could face if we stick to the cosmetic measures suggested so far.”

Debt pressures

Economists warn that Brazil’s current debt burden and the pace at which it is growing are unsustainable.

Central Bank data show that gross general government debt reached 82.93% of GDP in September, up 5.09 percentage points from a year earlier. In December 2022, the ratio stood at 71.68%.

The 12-month nominal deficit reached 9.5% of GDP in September, compared with 4.6% in December 2022, reflecting the burden of high interest rates. At its most recent meeting, the Central Bank’s Monetary Policy Committee (Copom) held the benchmark Selic rate at 13.75%, interrupting its previous easing cycle.

Samuel Pessôa, an economist at BTG Pactual and researcher at FGV Ibre, said an economy operating with a real benchmark interest rate of 8% a year cannot be considered healthy.

“The Brazilian economy is sick. Unless we bring interest rates down, we will enter a crisis. No economy can withstand interest rates this high for very long. And if we force the Central Bank to cut rates, inflation will return. We have done that before.”

Economists say stabilizing public finances will require slower spending growth, including on pensions and social assistance, given their weight in the federal budget.

A report by the Independent Fiscal Institution (IFI) shows that pension benefits totaled R$1.03 trillion in 2025, while spending on the Continuous Cash Benefit (BPC), a social assistance program, reached R$127.2 billion.

Together, the two programs accounted for 9.1% of GDP and 48.2% of central government primary expenditure. The proposed 2027 budget projects combined spending of 9.2% of GDP.

“The debate is not about whether social protection should be maintained. It is about how quickly that protection should improve. I support a 0.5% annual real increase in the minimum wage. That was the average growth rate of labor productivity over the past 40 years,” Pessôa said.

Productivity, he explained, determines the pace at which resources expand in the economy. “Some advocate a 2% real increase, but that is incompatible with what the economy can deliver.”

Since 1995, the minimum wage has risen 195% in real terms, while labor productivity has increased just 22%, he said.

Minimum wage reform

Under current rules, real increases in the minimum wage automatically raise the floor for pensions and social assistance benefits such as the BPC. As a result, pay increases for active workers also drive up a substantial portion of federal spending.

Fernando Veloso, research director at the Institute for Social Mobility and Development (IMDS), said this arrangement has no parallel in other countries, where pension adjustments generally aim only to preserve purchasing power.

Brazil’s current formula adjusts the minimum wage for inflation plus GDP growth, subject to a cap of 2% on real gains. Veloso argues that linking benefits to the minimum wage makes wage increases more expensive for the government and complicates spending control.

He proposes adjusting the minimum wage for inflation, as measured by the IPCA consumer price index, with real gains tied exclusively to labor productivity. Pensions, meanwhile, would receive inflation adjustments plus a real increase that would not necessarily match the minimum wage.

Gabriel Leal de Barros, chief economist at ARX, also supports real minimum wage increases of 0.5% a year, reflecting productivity growth. But he believes the best solution is to eliminate the link between the minimum wage and pension and social assistance spending, even if doing so requires the government to invest political capital in a constitutional amendment.

“We need to cut that umbilical cord. It is worth the effort because the impact on market expectations would be enormous. It would radically change the trajectory of public finances, affecting the yield curve and the Treasury’s borrowing costs.”

The goal, Barros emphasized, is to preserve the purchasing power of pension and social assistance benefits, “without any loss in real terms.”

Fabio Giambiagi, also a researcher at FGV Ibre, proposes creating a separate national wage floor for the labor market. Initially set at the same level as the minimum wage, it would subsequently increase at a faster pace, without automatically passing the full adjustment on to minimum pension benefits.

The arrangement would allow wages for active workers to continue rising in real terms while limiting the impact on pension spending.

“This is not a squeeze on retirees. A squeeze means a reduction,” Giambiagi said. “The minimum wage and the pension floor would continue to rise, but the increase would be larger in the labor market.”

Giambiagi also advocates freezing spending growth in real terms in 2027, the first year of Lula’s fourth term, followed by a rule limiting annual increases to inflation plus 1.5%.

He stressed that the proposal is fundamentally different from an abrupt spending-cutting program.

“Milei reduced Argentina’s primary spending by 27% in real terms in 2024. In Brazil, that would not only be unworkable but an aberration,” he said.

For Giambiagi, a commitment to zero real spending growth in the first year would provide an opportunity to put public finances in order and signal a change in fiscal direction, without triggering a contraction comparable to Argentina’s.

Budget rigidity

Beyond minimum wage reform, economists broadly agree that Brazil’s current fiscal framework has lost coherence because its overall spending ceiling coexists with expenditure commitments linked to revenue growth, particularly in health and education.

As a result, measures designed to boost tax revenue also increase some mandatory expenses, which account for more than 90% of spending in an already highly rigid budget.

The government has also introduced mechanisms allowing certain expenditures to be excluded from the fiscal rules, further weakening the framework’s ability to restrain total spending.

For health care, Giambiagi proposes aligning the minimum spending requirement with the overall expenditure ceiling. In other words, mandatory health spending would follow the same adjustment formula as the fiscal framework.

The government could still allocate additional resources to the sector, but those funds would have to compete with other budget priorities.

In education, Giambiagi recommends adjusting federal contributions to the Fund for the Maintenance and Development of Basic Education (Fundeb) by inflation alone.

His argument is that Brazil’s school-age population is shrinking because of demographic changes, making it possible to increase spending per student in real terms even if total funding remains constant after inflation.

Barros said reforms to health and education spending must involve not only the federal government but also states and municipalities.

Borges noted that congressional earmarks and spending through the Federal District Constitutional Fund (FCDF) are also linked to revenue and should be reviewed.

Together, changes to those spending links and the minimum wage policy would account for “70% of the spending-reduction package,” he said.

Borges considers limiting annual real minimum wage increases to between 1% and 1.5% “feasible.”

Social program efficiency

Alongside efforts to restrain expenditure growth, economists advocate improving the design and targeting of social programs.

Veloso argues that their success should be measured by how effectively they reduce poverty, rather than by the amount of money spent.

He described Bolsa Família as an internationally recognized anti-poverty program that delivers results at a relatively low cost. But he believes its targeting has deteriorated since the pandemic.

One of his main criticisms concerns the introduction of a minimum benefit per family, dating back to the R$600 payments under “Auxílio Brasil” during the pandemic.

Combined with an increase in single-person households receiving benefits, the policy has reduced the extent to which payments vary according to family income and household composition.

Barros also sees a need to redesign social programs to eliminate overlapping benefits and combat fraud.

He estimates that each of these measures could potentially save between R$25 billion and R$30 billion a year.

Revenue measures

Pessôa cited several possibilities, including taxing currently exempt securities, reducing tax expenditures such as personal income tax deductions for health and education, and taxing dividends distributed by companies operating under special tax regimes, including Simples and the presumed-profit system.

While economists agree that fiscal consolidation must focus primarily on slowing spending growth, they acknowledge that revenue measures could also help.

Although the additional revenue would offset the higher spending and prevent the fiscal deficit from worsening, it would do little to contain aggregate demand.

He cautioned, however, that raising taxes to finance a 2% real increase in the minimum wage would not be the best approach.

That is because minimum wage recipients tend to spend virtually all their additional income, sustaining pressure on the economy.

Inflation and interest rates would therefore remain elevated.

*By Marta Watanabe and  Vinícius Lucena — São Paulo

Source: Valor International

https://valorinternational.globo.com/