With inflation surge, Brazilian states should enter 2022 election year with full coffers

RIO DE JANEIRO, BRAZIL – With the boost from higher inflation, governors’ coffers are significantly fuller in the run-up to the 2022 election campaign. From January through May of this year, revenue levels already exceeded the same period in 2019, before the Covid 19 pandemic, by US$45.1 billion.

With statutory limits on mandatory spending increases in place through the end of 2021, the trend is for states to take advantage of bulging coffers next year as governors look to curry favor with constituents in an election year after tough times during the pandemic. One of the risk points, according to experts, is that governors could use that surplus to increase permanent spending in 2023.

By May, revenue from the value-added Tax on Goods and Services Turnover (ICMS), a tax collected by states and their main source of revenue, reached R$250 billion, with a real increase (after inflation, measured by IPCA, the official index) of 11%.

Compared to 2020, when the pandemic reduced revenues, this year revenues increased by R$50.6 billion, a 16% increase.

ICMS survey data from January to May were collected at Estadão newspaper’s request by the Brazilian Federation of State Taxpayers Associations (Febrafite), based on electronic invoices issued.

Driven by the international boom in commodity prices, Mato Grosso, a food producer, tops the list of states with the highest growth in ICMS revenues, 41.2% in the first five months. The state of São Paulo, the largest economy in the country, took in 8.7% (R$12 billion) more compared to 2019, reaching R$72 billion.

The recovery in state revenues is also accompanied by federal government revenues. The first five months of the year have already grown by R$96 billion compared to 2019 and R$156 billion compared to last year’s results.

“If you look at the political aspect, there is a tendency for governors to earn money to spend in the 2022 election year,” predicts Febrafite president Rodrigo Spada. According to him, 2022 is a year in which governors will want to have higher cash and deliver work in the first half.

Spada says states will try to save the money because Supplemental Law 173 (which established the rules for federal aid to states and municipalities) prohibits the increase in mandatory spending until the end of this year and freezes salaries for employees of the federal, state, and municipal governments.

SALARY ADJUSTMENTS

As a recent report in Estadão showed, many states and municipalities have already contracted adjustments for next year. In addition to the cities of São Paulo and Manaus, at least seven states have made adjustments or cleared the way for employee pay raises this year despite the legal restriction, according to a survey by the newspaper.

Spada warns, however, that there is no certainty that the states are leaving the crisis, since this recovery of revenue is partly due to the increase in inflation, especially the IGP-M, which is used to correct the prices of rents. He points out that despite the increase in revenue, the number of invoices issued in 2021 has not increased compared to last year.

“That means you didn’t have much more to do. It was the prices of those transactions that went up significantly.” He explains that when prices are higher, states collect more because the ICMS is levied on a percentage of the product’s resale value.

The president of Febrafite believes that it is revenue that comes from inflation, the worst “tax” for the low-income population. He recalls that with higher inflation, government spending also grows. The ICMS is one of the most important thermometers of economic activity, because when a company sells a product in one month, by the beginning of the next month it must make the value-added calculations and pay the tax due.

TEMPORARY PROFIT

An expert in government accounts and consultant to Febrafite, economist Vilma Pinto, says that this improvement in revenue is temporary and not structural, due to the cycle of commodities (basic products such as food, oil, and iron ore) and the corresponding inflationary effect. “It will be risky and reckless to increase mandatory spending,” she says, because of two new laws that require more adjustment in the governors’ accounts. Vilma will take a position on the Independent Fiscal Institution (IFI) board in the coming days.

Ana Paula Vescovi, a former Secretary of Finance, warned that the positive perception of the temporary cycle of high commodity prices could lead to the vision that there is more left for spending than the country actually has. “The risk is that the fuller coffers of the federal, state, and local governments will later be transformed into permanent spending,” said Vescovi, who is chief economist at Santander and also a specialist in government accounts.

INVESTMENT IN SÃO PAULO

São Paulo Finance Secretary Henrique Meirelles says the state will use the extra revenue to increase investments this year and 2022. The former finance minister in the Michel Temer government, Meirelles points out a framework of underinvestment in Brazil that needs to be turned around.

“This increase in tax revenues is essential, precisely so that we can make these investments,” says Meirelles, who predicts that São Paulo’s gross domestic product (GDP) will grow by 7.8% in 2021. In his opinion, the major works, such as the Panorama and Litorânea highways, can be carried out through concessions to private enterprise. Therefore, the focus of investment will be on health, security, and education.

He says there is no discussion about increasing civil servants’ salaries for 2022. “There is not even a discussion about it. There is no such demand. I don’t believe it,” he says. Meirelles says the election risk to state finances will depend on the attitude of individual governors. He stresses that the state’s revenue also reflects the new economy, such as e-commerce, which grew in the pandemic.

According to Alagoas Finance Secretary George Santoro, the increase in tax revenues reflects fuel, energy, construction, and food prices in the first half of the year. “I believe that state spending will come under pressure in the second half and next year,” he says.

The secretary acknowledges that it will be difficult, to say the least, not to pay inflation on civil servants in an election year, as was the case in 2021. Santoro, however, considers it a major fiscal risk to use that extra revenue with permanent spending, such as perks for state employees. In 2021, he plans to more than double investments, reaching R$2.3 billion, compared to R$1 billion in 2020. “Cash flow is extremely high,” he says.