Report Nº: 102724/08/2023
With the worsening of inflation, a strong fiscal adjustment appears to be inevitable, although very much resisted. The alternative to balancing sustainably public finances, and simultaneously improving public management, is to impulse a comprehensive reorganization of the whole public sector.
The economic crisis is deepening. Very high inflation with a fall in production, together with the Central Bank selling dollars that are not its own, a negative balance of exports minus imports of USD 1,7 billion per month, massive issuance of pesos, record of Leliqs and an extreme level of foreign exchange restrictions. Beyond all the aspects that a stabilization plan must contemplate, it is known that the central issue is to eliminate the fiscal deficit. This recurrently leads to the inevitable discussion about a fiscal “adjustment”.
Doing nothing inexorably leads to inflation doing the “adjustment”. In other words, a sharp increase in prices reduces expenses and debts in real terms. There is also the possibility of taking explicit measures, for example, manipulating pension indexing, freezing salaries and investments, and increasing (or not reducing) taxes. Both strategies allow temporary lowering of the financial deficit, at the cost of increasing public management deficits and the anti-productive bias. The alternative path is to address a comprehensive reorganization of the whole public sector that allows fiscal balance with a favorable climate for expanding production and improving the social situation.
To illustrate the difference between adjustment and reorganization, it is useful to look at the composition of national public spending. In 2022 the Nation’s primary spending amounted to 20.3% of GDP and was distributed as follows:
These data show that, if the national State were to concentrate only on the functions that correspond to it, there is ample fiscal space (5.3% of GDP) to reduce national public spending. It should be considered that economic subsidies should tend to disappear together with the strengthening of social tariffs, which, like the rest of social policy (health, education, housing, urban planning) are provincial responsibilities -and their municipalities- given the federal regime adopted in the national Constitution.
This functional organization of the State must go hand in hand with the tax system. The financing of the provinces should be focused on VAT (which should absorb the provincials’ sale tax and municipals’ taxes) and a wealth tax (arising from the unification of Personal Property tax, real estate, and automobile taxes). While the Nation should be financed only with the personal income tax (social security contributions and personal income), corporate tax, customs, and employer’s contributions.
This scheme will allow the elimination of the co-participation law since the general rule will be that each jurisdiction is supported by its own taxes. In order to contemplate the situation of the poorest provinces of the north, it is necessary to allocate resources to a Convergence Fund that guarantees them the current level of financing but conditioned to a development plan. This plan should prioritize strategic investments instead of financing the expansion of unproductive public employment and clientelistic expenses, as currently is encouraged by co-participation.
If the next government prioritizes stabilizing the economy based on a fiscal “adjustment” plan, the probabilities of failure are high. The reason is that fiscal “adjustment”, by overlooking the fact that the State suffers from severe organizational deficiencies, maintains (in some cases increases) the barriers to development. Among the most important of these are the complex and irrational tax system, the perverse incentives generated by co-participation, and the inefficiencies generated by the overlapping between the three levels of government. The “adjustment” may reduce the deficit, but it does not remove the obstacles to development. A more sensible approach is to comprehensively review the organization of the whole public sector. The objective is to achieve fiscal balance (an essential step to eliminating inflation) with a more favorable environment for investment, the generation of good jobs, and the improvement in the management of social services.