Despite federal government compensation, states could face tough 2024 after losing revenues from taxes, federal grants

03/04/2024

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Renata dos Santos — Foto: Ricardo Ledo/Valor

While the federal government compensated states for losses from lower collection of the Tax on Circulation of Goods and Services (ICMS), the combined revenues of Brazil’s 26 states and the Federal District dropped by 1.8% in adjusted terms in 2023 compared to the previous year.

The drop was primarily caused by a 3.2% decline, adjusted for inflation, in ICMS revenue and a 1.4% decrease in transfers from the State Participation Fund (FPE). Conversely, current expenses rose by 3.3%, mainly due to an increase in personnel expenditures, which went up by 5.1%.

Experts and state representatives say the figures indicate that 2024 could be “very difficult” for some subnational governments. They pointed to expectations of an economic slowdown in a year where the demand for pay raises is expected to persist. Additionally, there are spending pressures stemming from political campaigns for municipal elections. Moreover, the absence of federal compensation for ICMS losses, which were accounted for in 2023, further exacerbates the situation. Nonetheless, some states are closely watching the increase in the federal government tax revenue in 2024, which may favor mandatory transfers.

“The data shows that we have a big revenue problem. The increase in the standard ICMS rate last year by some states wasn’t enough to bring collection to the desired level. At the same time, the strong increase in current expenses is concerning. From 2024 onwards, the gap between revenue and expenses is expected to increase,” said Gabriel Leal de Barros, an economist and partner at Ryo Asset. “In 2024, we will likely see the pressure for federal salaries and public hiring tests spill over to states and municipalities.”

The unfavorable situation in the stream of revenue and expenses was widespread among the states in 2023. In nine of the 27 subnational entities, current revenues fell while current expenses increased.

As for the other 18 entities, revenues rose in 14, but at a slower pace than expenses.

Spending on personnel, states’ main expenses, also increased in 2023 compared to the previous year. Last year, spending on personnel by the Executive branch measured in relation to the Net Current Revenue (RCL) increased in 21 of the 27 entities. In six states—Rio de Janeiro, Paraíba, Acre, Roraima, Minas Gerais, and Rio Grande do Norte—it came in above the 46.55% cap set by the Fiscal Responsibility Law (LRF). The latter three states also exceeded the 49% cap set by the same law.

In 2022, only three states were above the cap, while Rio Grande do Norte was the only one to exceed the limit.

The data reviewed by Valor is part of the tax reports sent by states to the National Treasury. Authorized spending and realized revenues were considered. The 2022 data was adjusted by the Extended Consumer Price Index (IPCA), Brazil’s official inflation index.

Representatives of current state administrations point out that the indicators could have been worse without the extraordinary revenues. Supplementary law 201/2023 established a compensation of R$27.1 billion by the federal government to the states for the loss of ICMS revenues in 2022.

That year, federal laws led to a reduction in state tax rates on fuel, electricity, and telecommunications.

Supplementary law 201/2023 created a compensation schedule until 2025, with part of it to be made through debt payment relief and another part through transfers of funds from the federal government to the states.

In addition to the amounts due in 2023, the federal government also transferred around R$10 billion at the end of last year as an advance payment of the amounts that would be paid in 2024.

The compensation contributed to a 7.3% increase in current transfers to states in 2023 compared to the previous year.

Carlos Eduardo Xavier, Rio Grande do Norte’s secretary of taxation, said that this compensation contributed to an 8.7% increase in the state’s current revenue.

He highlights that there were also extraordinary revenues from the state itself, such as the sale of the payroll, which generated an additional R$ 384 million for the state last year. Additionally, he recalls that from April to December, the standard ICMS rate in Rio Grande do Norte increased to 20%, compared to the previous 18%.

The law to increase taxes in the state was passed in 2022, but it included the higher rate until December 2023 only, and the state government could not extend the increase for this year. The ICMS revenue had a boost from the installment program for tax debts Refis, which brought additional revenue of R$250 million in 2023.

The installment program and the increase in rates, together with the improvement of collection control and inspection, according to the secretary, led to higher ICMS revenue. According to data from tax reports, the state’s ICMS revenue grew 10.1% in real terms in 2023.

“For 2024, the scenario will be more challenging because we will not have higher ICMS rates, Refis, payroll sale, or the compensation by the federal government. It will be really difficult. For now, FPE revenues came in better in January and February and we will work to increase the ICMS [revenue], but still far from what we had last year,” the secretary points out.

Mr. Xavier says that the government is also studying alternatives for extraordinary revenue.

The favorable scenario for revenues in 2023 did not prevent the state from increasing the spending on personnel in relation to the net current revenue. The indicator increased from 53.37% to 56.94% of the net current revenue from the end of 2022 to last year, 7.94 percentage points above the cap defined in law.

The biggest challenge in payroll spending comes from education, as the legislation in Rio Grande do Norte determines that pay rises should be linear for all professionals, including those at higher salary levels. “It’s the only state with such legislation,” he said.

The performance of 2023 and the scenario expected for 2024, according to Mr. Leal de Barros, will make the states reopen the debate on structural issues that have been left aside since 2020, when the COVID-19 pandemic broke out, until 2022, when revenues still benefited from inflation and high commodity prices.

On the revenue side, the worsening of the ICMS base is expected to return to the debate, while the increase in spending on personnel should reopen the agenda of structural reforms, such as administrative overhaul.

At the end of last year, the Rio Grande do Norte government formally joined the Fiscal Balance Program offered by the National Treasury, said Mr. Xavier. According to him, the state is committed to reduce the spending on personnel by 10% per year.

In Rio Grande do Sul, there was also the effect of ICMS compensation brought forward by the federal government. ICMS collection in 2023 fell 1.1% in real terms, still under the effect of changes in the tax in 2022. Even so, the state’s current revenues increased by 7% in real terms, and the net current revenue, by 6.9%, an increase equivalent to R$6 billion from 2022 to 2023.

The federal compensation paid in 2022 contributed to this scenario, with R$2.3 billion unadjusted, according to the Rio Grande do Sul government. Part of the amount was compensated through a setoff, while another part came in the form of a financial transfer.

Additionally, the state received extraordinary revenues in 2023, such as the R$1.4 billion dividend payout from Corsan, the state’s water utility. These revenues are unlikely to occur again in 2024.

The increase in the net current revenue allowed the government of Rio Grande do Sul to end 2023 with the spending on personnel indicator at 45.03%, down from 47.88% in the previous year, after almost reaching the cap in the first four months of 2023, with 48.81%. In a note, Rio Grande do Sul’s finance department said that it expects to maintain strict control over expenses to comply with the Fiscal Recovery Regime requirements to which the state joined in 2022.

At the end of last year, the Rio Grande do Sul government proposed an increase in the standard ICMS rate, but faced resistance by local legislators and ended up alternatively reviewing the tax benefits, a measure that will come into force by April.

According to Mr. Leal de Barros, one potential solution for states to address the loss of ICMS revenue is to scrutinize tax incentives. Additionally, updating tax collection and inspection procedures could be part of the solution, although the effectiveness of these measures may vary from state to state.

Renata dos Santos, secretary of Finance of Alagoas, says the current administration has been mapping the state’s economic activity and its impact on ICMS collection. She says the state has received a large flow of tourists and the activity has benefited from the pay rises and the expansion of the Bolsa Família income-transfer program in 2023. The state achieved a real increase of 11.7% in tax collection by implementing changes in the tax structure and raising the standard ICMS rate from 17% to 19% in April of last year. The state’s current revenues rose 4.8% while current expenses increased 8.1%.

According to Ms. Santos, the increase in current expenses is due to the opening of two new prisons. She explains that, to cover this new expense, the state maintained the level of other expenses and backed with its own revenues the amount that was not included in the FPE funds. For 2024, she says, the state will keep a strict expense control.

Alagoas closed 2023 with R$2.68 billion in investments, an increase of 2.8% compared to 2022 and of 148.7% in real terms, when compared to R$1.1 billion in 2019, which was also the first year of the previous administration. According to the secretary, the idea is to maintain the same high level of annual investments throughout the current administration. Last year’s investments, she says, were made possible by surpluses from previous periods and by loan transactions. She said the state contracted around R$1 billion in loans last year.

Mr. Leal de Barros highlights that the stimulus the government has offered through loan transactions should be closely monitored. In some subnational entities, that could aggravate the scenario ahead, because part of the spending on investments results in an increase in spending on personnel and costing as well.

*Por Marta Watanabe — São Paulo

Source: Valor International

https://valorinternational.globo.com/