Foto: Ricardo Stuckert from fotospublicas.com
As the election has come to a fold, Brazil needs to address an immediate issue: - Should it keep Bolsonaro-era gas tax incentives, or should it start from a Lula blank slate tax policy?
Brazil has managed to aggressively reduce its inflation rates over the past year by having its Central Bank impose some of the highest interest rates in the world (13.75%). As expected, this has had a negative impact on economic growth. The idea is to reduce interest rates as soon as possible to reduce poverty in a controlled, targeted inflation scenario.
Inflation has been shown to be up to 40% correlated and impacted by gas prices in Brazil. Bolsonaro cut down gas taxes to reduce inflation without having to raise basic interest rates (Selic) even further. Our analysis shows that Lula could start reducing Selic from 13.75% soon by keeping the tax cut.
If you agree that Lula should keep Bolsonaro’s tax break to bring interest rates down or if you don’t agree feel free to comment below.
As one can see in the chart below, Weaver analyzed both scenarios: - with and without ICMS tax breaks (ICMS is the VAT-style tax accrued on gas consumption). The orange line shows interest rates with the tax break, and the blue line shows the opposite scenario. Both inflation and interest rates declined faster with the tax break than without it. Actually, average interest rates are expected to fall by more than 400 bp in a few months if inflation targets are reached thanks to the tax break benefits.
Inflation is expected to go down from above 6% to close to 4% on December 23. If the tax break is kept, this scenario would happen as early as February 23. Selic rates will only get to 10% by December, and the tax break would likely allow it to happen by January.
This would mean an extra year of economic growth enjoying the benefits of the commodity spike caused by the Ukrainian war. Lula would help lift millions of people out of poverty in an attempt to return to his early years on his first and second terms.
We estimate a U$ 8 billion tax revenue loss arising from this tax break. However, we also believe that the expected savings in terms of lower interest rate payments in government bonds linked to the Central Bank Selic rates should be massive. The total reduction in yearly payments should amount to U$ 29 billion.
In conclusion, by extending the tax break, Lula could generate very large economic value for government coffers. This tax break, however, was created by Bolsonaro, and, as the old saying goes: - “The king is dead! God save the new king”. The new Lula presidency would be wise to maintain some of the old habits, including some of the tax policies (and the ICMS tax break).
This is a clear mathematical case where the new government will create value for the people if they are able to work side by side with the previous administration. They will destroy value if they allow hubris to prevail and political radicalism to succeed. Therefore, we suggest Lula extend the tax break and leave politics behind.