Tax Changes, Budgetary Effect, and Economic Growth

Abstract

Fiscal policy decisions – in particular, those related to tax policy – have real impact on private sector activity. A central result from studies on taxation is that taxes affect behaviour and result in distortions on the choices of companies, workers and investors; thus, a country's tax system - and, therefore, variations in that system - reflects on the nation's economic growth. In Brazil, changes in tax legislation bringing about revenue losses at federal level must obey the fiscal neutrality rule, assuring compensation equivalent to the estimated decrease in revenue. Consequently, it becomes mandatory measure the corresponding revenue loss, so that the task of scorekeeping gains special contours in the fiscal control framework which aims to promote the balance of public accounts. This paper demonstrates that the static technique of estimating budgetary effects, coupled to the legal design that requires prompt compensation of the effects on revenue, discourages the production of tax rules seeking to promote efficiency and economic growth. The result was reached using a general equilibrium model stylized and calibrated for the Brazilian economy, by simulating permanent shocks on the average tax rates on consumption, labour, and capital income. Comparing the different methodologies, we concluded that the static scoring overestimate revenue losses in face of tax cuts, in parallel to results produced from dynamic estimations. The latter, in turn, allow to capture and differentiate – according to the tax base – the positive effects stemming from cuts in the tax burden on capital stock, labour supply, consumption and aggregate investment, ultimately identifying higher long-term economic growth. Dynamic scoring offers clarity about the extra-fiscal consequences on the economy that may yield from changes in the tax system, and provides a more accurate measurement of the normative change's budgetary effect, qualifying the debate and the political decisions in the country.
 Keywords: Taxation. Growth. Budgetary effect. Dynamic scoring.