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States face lower tax revenue, higher expenses

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

03/04/2024

Renata dos Santos — Foto: Ricardo Ledo/Valor

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/
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States have few options to compensate for revenue loss

Sharp reduction in taxes will put governors under pressure

06/28/2022

The reduction of sales tax ICMS on fuel, electricity, communications and public transportation, in effect since Friday, and the analysis by the Federal Supreme Court (STF) on how to calculate taxes levied on fuels will cause a loss of R$105 billion to R$136 billion for states and municipalities, nearly 10% of all revenues from the state tax. The abrupt reduction in revenues will put governors under pressure, especially from 2023 on. Experts and politicians see a limited menu of options for them to balance it out.

The idea of compensating for the loss of revenues by increasing ICMS rates on other goods and services, or the rates of state taxes like IPVA (on vehicles) and ITCDM (on inheritance), is seen as insufficient and politically difficult. An alternative, from the revenue point of view, is to lift tax benefits granted to certain companies and industries.

Another solution is to force the ICMS tax reform, to adjust the new tax in a way to recover these losses. Some people believe, on the other hand, that the result will be pressure for more transfers from the federal government and public services deterioration. The tax collection today is on the rise because of inflation, but this same inflation will begin to pressure spending soon for salary and contract adjustments.

The decision adopted by Congress and signed into law by President Jair Bolsonaro (Liberal Party, PL) to curb inflation has trampled states and municipalities. The governors were divided between those who criticized the bill, saying it would not solve the high power and fuel prices, and those allied to the president, who praised the measure. There was concern on all sides that resistance to the tax cut would be used to attack them in October, given the proximity to the election campaigns.

Among lawmakers leading the bill, the discourse behind the scenes is that there will not be a substantial drop in revenue this year, because of inflation and the measure that will force the federal government to compensate for a loss of more than 5% in revenue compared to 2021, a rule that will be in force only by December. Starting in January, they say, the new governors and the president-elect will be able to evaluate the scenario and adopt the necessary measures.

States see gigantic losses ahead. The National Confederation of Municipalities (CNM) estimates that the cut in ICMS will take R$85 billion in revenue per year from states and municipalities. They also say that the decision of Supreme Court’s Justice André Mendonça, who ruled that the calculation of taxes levied on fuels must be based on the average of the last five years, will increase losses by more R$20 billion. The National Committee of Finance Secretaries of the States (Comsefaz) presented larger numbers Tuesday to the STF – they foresee revenue losses of R$136 billion.

A source in the treasury department of one of the largest states in the country told Valor last week that there are still no discussions among governors about what to do. They were waiting for the unfolding of all the actions to be taken by the government and the decision on possible lawsuits. He corroborated, however, the view that the deficit is high and will require measures, either spending cuts or tax increases, probably announced only in November, after the election. The impact on the coffers will also differ for each state, because it depends on the rate currently applied to items with a reduced rate under the new law, so the solutions in each location may also be different.

Ítalo Franca — Foto: Divulgação

Ítalo Franca — Foto: Divulgação

Santander’s economist Ítalo Franca points out that regional governments (state governments and municipalities) reported last year the largest surplus since official records began, with a positive balance of R$97.7 billion between revenues and expenses, but that the new law will hinder this result.

He had projected a surplus of R$70 billion this year. With the ICMS reduction, he reduced the figure to R$25 billion. For 2023, when the impact of the new law will reach the entire year’s collection, there would be a deficit, also considering the increase in expenses such as salaries and constitutional floors for spending in health and education. “This would bring problems for the state accounts. It will be a very hard adjustment.”

Rodrigo Spada, head of the State Tax Auditors Associations (Febrafite), points out that some states do see a temporary relief for cyclical reasons, while others in fiscal recovery regime as Rio de Janeiro, Goiás and Minas Gerais. “And any loss is permanent,” he recalled.

In Mr. Spada’s opinion, the governors will have difficulty in compensating for the loss in ICMS with increases in IPVA and ITCMD because they are direct taxes, with the bill going to the richest taxpayers, with the greatest mobilization capacity.

“The most likely is the increase of the ICMS itself on other fronts. The taxpayer does not know how much he pays because it is embedded in the price of the goods. Businesspeople are the ones who collect the tax, but the buyer bears the burden,” he said. This solution, he highlighted, would harm mainly the poorest people.

This, however, comes up against two obstacles. To prevent the gasoline tax reduction from being offset by higher taxes on diesel and ethanol, Congress forbid states from raising fuel and energy taxes that were already lower than the standard (17% or 18%). Furthermore, fuels, energy and communications are today the most profitable items of ICMS, representing 50% of the tax collection in some states. These are products that, even with higher prices, the population can’t stop consuming, unlike a new refrigerator or stove.

Deputy Aguinaldo Ribeiro (Progressive Party, PP, of Paraíba), the rapporteur of the tax reform in a mixed congressional committee, believes that, because of these obstacles, there will be greater pressure to vote on the issue in 2023. The tax overhaul was shelved due to political divergences.

“It makes it easier because neither the federal government will be able to compensate the states nor the governors will be able to survive with a cut like this,” he said. For him, the proposal to amend the Constitution (PEC) 45 would have solved the problem by applying a single tax rate for all goods and services, with extra taxation for items that cause “negative externalities.”

Gabriel Leal de Barros, a partner and chief economist at Ryo Asset, also sees a consensus forming on the need to change state taxation. “It will be inescapable. It is a blessing in disguise,” he said. The risk, he points out, is if this is not accompanied by measures on the expenditure side: the administrative reform, the revision of social programs and the definition of the country’s new fiscal anchor.

“Whoever wins [the presidential election], Lula or Bolsonaro, it is clear that the spending cap will be revised and the size of this flexibilization will be proportional to the quality of tax reform,” Mr. Leal said, citing former president Luiz Inácio Lula da Silva, the front-runner in the electoral race. “If the new spending space is too big, instead of doing tax reform that focuses on efficiency, the government will end up doing reform to increase revenue. And if that’s the concern, the chance of raising tax in the wrong place is much higher, which could reduce potential GDP growth even further.”

In the current legislature, the states pressed for the approval of the ICMS reform, with the creation of a Value Added Tax (VAT) that would unite five to nine taxes, but in the end, there were divergences with the federal government about the creation of a fund to compensate for losses, with the opposition of business sectors, such as services and agriculture. In addition, Chamber of Deputies Speaker Arthur Lira (Progressive Party, PP, of Alagoas) opposed the rapporteur.

Paulo Ziulkoski, head of the National Confederation of Municipalities (CNM), said that the tax reform has been discussed for 30 years without progress and that he does not believe it will be approved in the next legislature. The most urgent issue, he stressed, is a reform of the federative pact, to discuss the responsibilities of the federal government, states and municipalities. “We have no leeway to try and reverse this loss,” he said. The cities only have three taxes (property tax IPTU, service tax ISS and real tax transfer ITBI) that, even in the largest municipalities, such as São Paulo, only represent 7% of revenues.

The loss of up to R$13 billion this year and R$26 billion annually as of 2023 due to the ICMS cut will not be compensated with other revenues, but with the precariousness of public services to the population, said Mr. Ziulkoski. “Citizens will be affected. There will be no money for school maintenance, school transportation, distribution of medicine, adequate health care,” he said.

Juliana Damasceno, a senior economist at Tendências Consultoria, pointed out that the states live an atypical situation, with lower spending because of the freezing of wages during the two years of the pandemic, and increased revenue because of inflation, but this combination will take its toll and this may occur sooner if inflation slows down. “An inflation-adjusted tax helps in the short term, but in the medium and long term it hinders on the spending side. Either because the civil servants will press for salary raises, or because contracts will be adjusted,” she said.

As a tax reform is a “very long, exhausting and difficult path,” she believes that states are likely to increase taxes and review tax incentives granted to economic activities, mainly in the scope of the fiscal war. “These governments will be forced to rethink these benefits and study how they can withdraw them,” she said. A study by Febrafite, a federation that gathers state tax inspectors, showed that, in 2020, the tax waiver as a result of these incentives reached R$92 billion, a value close to the deficit now imposed by the federal government. In states like Paraná, Paraíba and Goiás, the amount exceeded 30% of the ICMS revenue.

*By Raphael Di Cunto — Brasília

Source: Valor International

https://valorinternational.globo.com/
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