Lula’s Fiscal Cage

Among the factors securing Luiz Inácio Lula da Silva’s victorious return to power in the 2022 Brazilian presidential elections, the most important was the promise to increase government spending. The federal budget freeze imposed by Michel Temer in 2016, following the impeachment of Dilma Rousseff, had been in place for six years. Since lifting the caps would require action from the National Congress, in which Lula’s Workers’ Party did not have a parliamentary majority, the new Ministry of Finance under Fernando Haddad was tasked with designing a new rule for negotiations, which he proposed in April 2023.1Of the total 513 deputies, for example, the government’s “official” base—which includes PT, PCdoB, PSOL, Rede, PSB, PSD, MDB, Avante, and Solidariedade—has 231 members. However, this is an unstable base. In general, unrestricted alignment with the Planalto Palace accounts for far fewer votes than the “official” number. Parties such as the MDB and PSD, despite forming part of the base, commonly vote against the executive branch. Furthermore, parties that control ministries, i.e., have positions appointed by the executive branch, such as União Brasil, PP, and Republicanos, despite declaring themselves “independent,” repeatedly adopt openly oppositional behavior. Marked by intense political pressure in favor of austerity, the so-called Sustainable Fiscal Regime (Regime Fiscal Sustentável, or RFS) was finally approved by the legislature in August 2023.

Two years after the adoption of the RFS, disputes over the public budget already show that the progressive fiscal agenda that brought Lula back to power has shot itself in the foot. Despite attempts by the Ministry of Finance to use the rule’s design to increase tax collection, particularly from the super-rich and by closing tax loopholes, such efforts have been eclipsed by cuts to social benefits and public investments. The nature of the spending cuts have frightening consequences not only for the distribution of income, but for the macroeconomy. By slowing economic growth, they further reduce revenues and thus expenditures available under the rule. A short history of the RFS reveals a clearly self-undermining compromise, since the cuts affect precisely the spending that would have the greatest impact on GDP over time.

Fiscal turnaround

Historically speaking, the hegemony of “fiscal discipline” in economic thinking is a relatively recent phenomenon. During the postwar period—spanning the economic recovery in Europe, the expansion of the US welfare state, and attempts to overcome underdevelopment in Latin America, the Middle East, and East Asia—public spending was for decades considered an important instrument of macroeconomic coordination and aggregate-demand management. Starting in the 1970s—in Brazil’s case, especially since the 1980s—the intellectual winds began to change. 

High inflation and economic stagnation shifted dominant economic thinking toward “fiscal discipline.” Stabilizing public debt and reducing political influence over budgetary decisions came to be seen as essential goals of economic policy. Behind this shift was the idea that a competitive market economy’s internal mechanisms would be sufficient to ensure long-term stability and growth. The state’s fiscal role, therefore, was thought best limited to addressing specific “market failures.” Fiscal rules—institutional instruments to limit “discretion” in the management of the public budget—therefore came to dominate economic policy around the world.

The goal of insulating the public budget from political interference, however, is a contradiction in terms. An elected government’s fiscal policy is, by nature, an arena for political dispute. The adoption of a particular fiscal rule thus reflects the balance of political forces at a given moment in history. In this sense, fiscal rules do more than their stated objective of ensuring sound public finances: they shape and delimit the political terrain on which the budget dispute will take place. 

As public spending accounts for a significant portion of aggregate demand, it is the ultimate determinant of national income—in other words, it is the budget that defines who will appropriate what share of that income. It is necessarily a locus of distributive conflict. Lula’s first two terms (2003–2010) were marked by an unprecedented combination of economic growth, social inclusion, and improved fiscal indicators because growth alleviated this conflict. Between 2003 and 2011, the country’s GDP grew by an average of 4 percent per year. Public policies such as Bolsa Família significantly reduced poverty and inequality, while the Brazil Treasury recorded consecutive primary surpluses (budget surpluses after debt payments) and saw its debt-to-GDP ratio fall. Growth paid for both social inclusion and “fiscal responsibility.”

At the beginning of the last decade, however, this model began to show signs of exhaustion. Distributional conflict within the budget intensified as economic growth slowed during the 2010s. During Dilma Rousseff’s presidency (2011–2016), the external environment became less favorable, the productive structure proved incapable of keeping pace with new demand, and political mechanisms for macroeconomic coordination eroded.2Carvalho, L. (2018). Valsa brasileira: do boom ao caos econômico. Editora Todavia. Not only did the historical window for expanding redistributive policies close, but the country also began to run federal budget deficits. 

The historical backdrop to Haddad’s RFS is the recent intensification of this conflict within the public budget—a process that has been ongoing since at least the adoption of Temer’s spending cap in 2016.

The budget dispute in Brazil

It was in this environment that fiscal austerity discourse, in hibernation during the high-growth Lula years, took over public debate. In 2016, it provided the political basis for Rousseff’s impeachment. The next year, Michel Temer’s administration (2016–2018) instituted its spending cap, a fiscal rule that froze public spending in real terms for twenty years. The proposal showed its limitations from the outset by quickly compressing discretionary spending and, in practice, stifling the state’s ability to function positively. During the administration of Jair Bolsonaro (2019–2022), the National Congress authorized exceptions to the ceiling, and the following year, the rule had to be completely circumvented in order to deal with the Covid-19 pandemic. 

In this context, the design of a new fiscal arrangement emerged as a top priority  for Lula’s return to the presidency in 2023. The RFS combines a revenue rule, an expenditure rule, and a surplus target to impose a bias on public accounts. Under these rules, expenditure will always grow below revenue, except in the event of an economic crisis or near-zero growth.3 The “primary result target,” refers to revenues after debt service. The RFS determines a range of +0.25 and -0.25 percentage points relative to a (positive?) value proposed annually by the government and approved by Congress. In real terms, primary expenditures may grow up to a limit of 70 percent of the previous year’s revenue growth rate. However, if the previous year’s primary result was below the lower band of the primary result target, the limit on the expenditure growth rate is reduced to 50 percent of the previous years’ revenue growth rate. In addition, the rule introduces a countercyclical mechanism of upper and lower limits on expenditure growth, preventing sharp declines or increases if revenues vary significantly. The real growth rate of spending cannot be less than 0.6 percent or greater than 2.5 percent. Thus, spending will always grow below revenues, unless, in a situation of economic crisis, revenue growth is less than 0.6 percent. This surplus bias implies a progressive reduction in the size of the state as a proportion of GDP. By imposing tight limits on the government’s budgetmaking, the RFS represents a continuation of the post-Dilma pattern. 

The fiscal-policy scoreboard under the RFS has so far made it clear who wins and who loses: government attempts to increase revenue collected from political and economic power groups have consistently failed, resulting in the most vulnerable segments of the population paying for the soundness of Brazil’s finances. At the same time as total spending is limited, constitutionally guaranteed spending—such as public health and education—further limits budget space for any other progressive projects, particularly those related to combating the climate crisis that require increasing resources for mitigation and adaptation projects.

The Brazilian Constitution stipulates that at least 15 percent of net current revenue must be allocated to public health spending and 18 percent of tax revenue must be spent on education. Existing welfare statutes also link various benefits and social transfers to the minimum wage (currently indexed above inflation). The aging of the population means that expenses related to the social security system tend to increase. Since spending growth must be lower than revenue growth, and since 32 percent of revenues must be spent on health and education, social benefits and public services are already competing for space in the federal budget. Vying for budgetary inclusion in this mix are also parliamentary amendments—expenditures controlled by the legislature (rather than the executive branch) that are partly mandatory and linked to revenues.4Parliamentary amendments are proposals made by deputies and senators to modify the Annual Budget Law. Over the last decade, the volume of these amendments has grown significantly. Traditionally, it was up to the government to choose whether and when these resources requested by parliament would be released. Recently, however, some of the amendments have become mandatory: they include a minimum budget amount and must be executed by the government.

The Ministry of Finance has been trying to link RFS-mandated fiscal adjustment not only to spending cuts but also to increased revenue collection. Since the growth rate of spending is linked to the growth rate of revenues, an increase in revenues would reduce the pressure to cut spending and ensure the RFS’s planned budget surplus. Some revenue-raising measures have been successful, such as the taxation of offshore funds, approved in 2024, which generated revenues equivalent to 1 percent of the 2025 budget—R$ 22.8 billion (or US$ 4 billion).5Exchange rate: US$ 1 = R$ 5.65. Others have not, such as the failed attempt to reduce tax expenditures, which in 2024 amounted to 2.1 percent of the federal budget, or R$ 45.1 billion (US$ 8 billion).6Tax expenditures are forms of revenue foregone by the government, generally through subsidies and tax exemptions. In Brazil, there are development programs that grant tax exemptions to less developed regions, income tax refund programs for expenses incurred with private health care and education, payroll tax exemptions for certain sectors and companies, among others. The government also intends to propose an income-tax reform that would establish a minimum effective tax rate for millionaires of 12 percent to 15 percent—this measure could generate budget increases between 2.9 percent and 4 percent, or between R$ 62.8 billion (US$ 11.1 billion) and R$ 87 billion (US$ 15.4 billion).

In the long term, however, simply increasing revenue is not enough. The RFS’s surplus bias means that revenue growth alone does not ensure compliance with the fiscal rule, as the Minister of Finance himself acknowledges, since the rules require ongoing spending reviews. To generate more fiscal space under the RFS, the revenue growth rate must be increased. And even if it does increase, the growth rate of spending will always be lower than the growth rate of revenue.7 “The real growth rate of spending cannot be less than 0.6% or greater than 2.5%. Thus, spending will always grow below revenues, unless, in a situation of economic crisis, revenue growth is less than 0.6%.”

The resulting need to cut spending was felt in the first year of the RFS. At the end of 2024, the government announced a broad package that promised to save R$ 327 billion (or US$ 57.9 billion) between 2025 and 2030, equivalent to 2.8 percent of GDP in 2024. The plan included reducing maximum civil service salaries,8Super salaries, for example, reflect a few careers in the civil service, particularly in the judiciary, which receives large benefits outside the payroll. The government’s proposal provided that funds exceeding the legal salary limit would be regulated by a Complementary Law, an instrument that requires an absolute majority to be approved and is less prone to change. The approved version states that individual cases should be dealt with by Ordinary Law, which can be approved by a simple majority and is therefore more susceptible to flexibility.An absolute majority in congress requires a specific percentage of total possible votes from the entire membership of the body, while a simple majority may consist of just those members present to vote for a measure.  limiting the growth of parliamentary amendments,9Since 2013, Congress has changed successive rules to increase its influence over the public budget, making the implementation of individual amendments—changes to the budget proposed by parliamentarians—mandatory and with a minimum allocation of 2 percent of net current revenue. Parliamentary-amendment spending jumped from 0.001 percent of the budget in 2015 to 1.8 percent in 2024. As expected, this element of the package was not approved. cutting tax expenditures (which had already been rejected by the legislature),10The approved text prohibits the granting, expansion, or extension of tax incentives or benefits only in the event of a primary government deficit. and changing the rule for annual minimum wage increases. Changes to FUNDEB, constitutional minimum spending on health and education, and social benefits—such as Bolsa Família, the country’s main cash transfer program—were also discussed.11An education fund, FUNDEB  consists of transfers from the federal government to states and municipalities to assist in financing public education.

Congress’s assessment of the package highlighted the distributional dispute within the budget. The proposed cuts that survived the December vote will impact some of the most important social spending programs for promoting social justice and reducing inequality in Brazil. Among them are, for example, changes to Bolsa Família—a transfer to formal workers who earn up to two times the minimum wage—and to PROAGRO—a subsidy program for small and medium-sized producers in the agricultural sector. Those that failed would have limited maximum judicial salaries, tax expenditures, and parliamentary-amendment spending. 

The most important change, however, is in the rule for adjusting the minimum wage. Previously, the amount was adjusted for inflation in the previous year plus the average GDP growth for the two previous years. The government proposed applying to the minimum wage the same rules set by the RFS for total spending, which represents an increase in real terms between 0.6 percent and 2.5 percent—lower than the previous rule. The Congress adopted this change without resistance, which, since they are indexed to the minimum wage, significantly affects the value of most social and welfare benefits.12The consequence of such a change is twofold. First, the countercyclical nature of the Sustainable Fiscal Regime is also reflected in the dynamics of the minimum wage. On the one hand, the average growth rate of the real minimum wage would be lower during periods of significant expansion; on the other hand, it would be higher during times of crisis. However, if Brazil’s potential growth exceeds 2.5 percent, as it did in the early 2000s, the rule could act as an obstacle to taking advantage of the positive effects of reducing inequality associated with the appreciation of the minimum wage.

In summary, while budgetary privileges were maintained, social benefits were cut. In 2025 alone, the cuts will amount to R$ 34 billion (or US$ 6 billion), equivalent to 1.6 percent of the planned budget. 

The political economy of fiscal policy

Limiting evaluation of the RFS to criteria such as balanced public accounts or “fiscal responsibility” shows the rule works well and delivers what it promised. Under the RFS, the government proposes a target value for the “primary result” (budget surplus) that must be approved by Congress, around which actual budget performance can vary by a range of +0.25 and -0.25 percentage points of GDP.13 For further details, see footnote 3. In 2024, the target was zero deficit, and the government delivered a deficit of 0.09 percent of GDP, a result considered positive within the implemented range. The approved cuts, as intended, reduce the size of the state relative to GDP. This limits the executive branch’s ability to shape policies and stimulate development.

But there is another issue that is relevant to the very sustainability of the “fiscal sustainability regime”: cuts in different areas of spending have different consequences for the rule’s implementation. 

This is because different forms of public expenditure have different “multiplier” effects. A multiplier  refers to the ability of a kind of spending to generate an impact on national income greater than itself. The size of the multiplier of government spending is determined by how much it increases subsequent private spending, generating a cycle of continuous spending and income. Social benefits, for example, have a high multiplier effect because they are targeted at people with a high marginal propensity to consume, boosting circulation and income for the people who sell to this market.14Cardoso, D. et al., “The Multiplier Effects of Government Expenditures on Social Protection: A Multi-country Study,” (<)em(>)Development and Change(<)/em(>) (<)em(>)56(<)/em(>) (2025): 172–224. Public investments have a high multiplier effect because they generate jobs and induce private investments.15Iasco-Pereira, H. and Duregger, R., “Public investment, infrastructure and private investment in Brazil: is there a crowding-in effect?”, (<)em(>)EconomiA(<)/em(>) (<)em(>)25(<)/em(>), No. 2 (2024). Spending on parliamentary amendments, excessive salaries, and tax exemptions, on the other hand, have a reduced multiplier effect because they reflect increasing incomes for people with a low propensity to consume. These are unproductive forms of public spending from a growth perspective. Estimates indicate that every R$ 1 spent on social benefits in Brazil increases GDP by R$ 2.15 after 25 months. The effect of public investment is even greater, raising national income by R$ 2.60. The nature of the spending cuts means that the final version of the 2024 package not only has the worst distributional consequences but also the most unfavorable macroeconomic effects.

In addition to the negative effects on the economy, the reduction in income resulting from budget cuts creates even more unfavorable consequences for the goals of the fiscal rule. The state’s revenue-raising capacity depends largely on the level of economic activity. When GDP growth is lower, tax revenues also tend to decline. By cutting spending with a high multiplier effect, the RFS imposes a kind of trap: a reduction in GDP also reduces tax revenue and, consequently, the space for future spending. If the cuts were to fall on spending with a low multiplier effect, it would be possible to improve fiscal indicators under the rule without impacting economic growth so severely—and without increasing social inequalities.

If the impacts for 2025 are already worrying, the situation is even more serious in light of the budget estimates for 2026: to meet the fiscal surplus target of 0.25 percent of GDP, the government forecasts extra revenues of R$ 118 billion (US$ 20.9 billion) will be needed, about 3.7 percent of projected revenues. If this expectation is not met, federal spending may face even more cuts in the near future. The dynamics behind the approval of the 2024 budget package already indicate what the main targets will be—and who is likely to emerge unscathed. The macroeconomics of distributive conflict, moreover, demonstrates how the RFS can end up sabotaging itself. By reducing economic growth, it decreases revenues and therefore further reduces government expenditure in a vicious cycle. 

A truly sustainable fiscal arrangement must take into account the multiplier effects of different types of public spending and revenue collection on economic activity  such as income and employment. This is essential not only to ensure the sustainability of the public debt trajectory, but also to guarantee the adequate supply of essential public goods and services. Fiscal adjustment policies that ignore these factors risk compromising future economic growth and, with it, fiscal space itself. Thirty years later, Maria Conceição Tavares’ lesson on the Brazilian economy remains valid: “An economy that says it needs to stabilize first, then grow, and then distribute is a fallacy and has been a fallacy. It does not stabilize, it grows in fits and starts, and it does not distribute.”