PLP 93/2023 | Tax Framework | House of Representatives

On March 30th, the current government presented its proposal for a new fiscal framework, after months of discussions and years of tension related to the spending cap. Experience with the previous tax rule brought benefits, especially the reduction in interest rates imposed on government bonds due to its credibility regarding the need for public debt stability. Additionally, the rule also made the approval of the pension reform, enacted in 2019, more urgent, and led to greater control over the public sector payroll, considered high compared to countries at a similar level of development and constantly growing, in contrast to the private sector, where salaries have shown a much more moderate trend.

Bad aspects of the text:

• Reduced flexibility: One of the main disadvantages of the fiscal rule is that it limits the government's ability to respond to changes in economic conditions. This reduced flexibility can be problematic, especially during economic recessions, when increased government spending may be necessary to stimulate growth and support vulnerable populations. We saw this during the Covid-19 pandemic.

• Potential procyclical fiscal policy: Strict adherence to the fiscal rule can lead to a procyclical fiscal policy, in which government spending is cut during economic recessions, exacerbating the negative impact on growth and employment.

• Inadequate focus on long-term investments: The fiscal rule's focus on short-term spending limits can lead to underinvestment in long-term priorities such as infrastructure, education, and research and development.

• The trade-off between flexibility and predictability in fiscal policy is a central theme in the literature. While it is argued that fiscal rules should be designed with escape clauses or countercyclical elements to allow flexibility during times of economic stress, an overly flexible framework can undermine the rule's credibility, making it less effective in promoting fiscal discipline and stabilizing public debt in the medium term. Finding the right balance between flexibility and predictability is essential to ensure that fiscal rules are effective and adaptable to changing economic conditions.