Public Accounts Report | II Quarter of 2015

How the fiscal deficit evolved in the second quarter of 2015 and what options were available to reduce it: borrowing, cutting spending, increasing revenue, or restructuring. November 2015 report.

With the exception of some seasonal movements, such as in the case of income tax revenue or the decrease in transfers to the Treasury by the Sustainability Guarantee Fund (FGS), due to the low performance shown by the low-risk shares in which the fund itself invests, the consolidated information for the second quarter of the year does not show major changes with respect to the trend that it had been exhibiting in previous quarters.

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On the other hand, there is the battlefront to which most analysts direct their questions, and which the presidential candidates have preferred to remain silent about. It has to do with monetary and exchange rate policy issues. That is to say, the much-discussed topics of capital controls , exchange rate lag , and the terms of a possible negotiation with the holdouts.

Assuming that all candidates' teams behave rationally (i.e., that they have all planned a strategy in case of being elected), the reason for this silence may not only be related to electoral issues, but also to keeping all available options open; a point that has been simplified in the media into the shock or gradualism debate.

Fiscal deficit and dominance

An even more sensitive issue than the three previous topics, and one that relates to the content of our report, concerns the diagnosis and subsequent solution (or lack thereof) to the fiscal deficit. In this regard, our reports on current monetary policy have consistently shown that the general scenario is one of fiscal dominance.

In other words, a scenario where the Treasury plays an increasingly decisive role as a source of monetary expansion. To illustrate this, transfers from the Central Bank of Argentina (BCRA) to the Treasury last year totaled $79.480 billion. This is more than double the amount recorded in 2013, which was $34.769 billion. By definition, these transfers represent monetary expansion.

However, this is not the point. It is merely the context that, in a very general way, characterizes the link between monetary policy and fiscal policy in the current situation.

The crucial point is how to maintain the general standard of living for the population and increase it over time. From this perspective, the limited public debate on the level of the deficit also seems to be reducing itself to a stark dichotomy between adjusting spending or not.

Three ways to reduce the deficit

It is true that one of the alternatives to reduce the deficit is to directly cut public spending; there is not much that is complicated about that definition.

But for the same reason, it is also perfectly correct to say that another alternative is to increase income. And a third alternative is to reorganize spending so that it generates positive effects on overall economic activity.

Thus, contingent upon the existence of and access to external financing, both spending cuts and increased revenue financed by debt are short-term alternatives for reducing the public deficit. However, as with everything in economics, every measure has its costs.

Broadly speaking, the first would be supported in the future tense, returning the capital borrowed and paying the corresponding interest, as well as with the fulfillment of conditional clauses, if any.

The second would be absorbed immediately, and everything depends—first and foremost—on where and to what extent spending is adjusted. Subsequently, it depends on the leeway economic actors have to pass on their costs to other actors in the economy.

Going into debt, the option with the lowest political cost

Without any political constraints from society, it is undeniable that opting for some form of debt would be the least politically costly option for any of the candidates who were elected. The reason is simple: if a problem arises, it can be postponed with the intention (or hope) of addressing it as it arises.

Furthermore, from any candidate's perspective, it seems to offer an additional advantage. Once the population begins to feel the immediate effects of the increased flow of resources, criticism of these measures loses steam. At least until the next payment.

More taxes or more growth

We are then left to analyze the other two options. At the current level of tax pressure, it is unlikely that state resources can be increased by further raising taxes.

The conflict sparked by the tax base of the income tax, a topic that has appeared in the discourse of all presidential candidates, seems to be a good example that this path is no longer feasible.

This leads us to the option of simply increasing resources. That is, to the desirable scenario of the State as a promoter of economic growth , and even more desirable, of development.

The problem is that these measures only bear fruit in the long term. How long? At least beyond the resolution of the triad of capital controls, exchange rate lag, and holdouts (again, assuming they are considered a problem). But even if they generated more jobs and economic growth, that wouldn't be enough.

For the solution to be complete, part of this growth must be able to generate tradable goods. That is, goods that generate foreign currency, with which we can import the capital and consumer goods (but especially the former) that our economy needs.

Reorganize spending

The third measure is the reorganization of spending. The national government, like virtually any organization of considerable size—whether public or private—probably has significant operational shortcomings. What is meant by this?

While the State continues to fulfill its social objectives, there may be areas where better results could be achieved with the same resources, or where the same results could be achieved by redirecting resources to areas of greater need. In this regard, some issues have gained greater visibility in recent years, such as the structure of subsidies . Others remain merely suspected.

For example, in the second quarter of 2015, transfers to the private sector represented 18% of primary spending by the non-financial national public sector (NFPS). This makes them the third largest category of total spending.

The analysis presented in our report includes not only transfers to the private sector but also those to state-owned enterprises. As of the first half of the year, these transfers totaled $110.983 billion.

Of that amount, 70% was allocated to the energy sector. A portion of those resources—we don't have information to specify how much—subsidizes utility rates for high-income households. These households are not supposed to be receiving subsidies.

And of course, all the above alternatives can be combined. And not only that: most public discourse revolves around debating only the direct effect of a measure. It's as if a chess game ended in a single move.

Subsidies: direct and indirect effects

Let's return to the example of subsidies. Let's consider a hypothetical scenario: suppose there is a $100 reduction in subsidies, say for gas. Now, that $100 must be paid by the users; let's say Pedro, Pablo, and Juan. This would be the direct effect of the measure.

However, those $100 that the State saves can now be used to subsidize, for example, the least wealthy of the three; let's say Juan.

This would be the indirect effect if such compensation were to be granted. Unfortunately, arguments of this kind are not common.

The craft of a good reader

Generally, the articles published on our website are of a technical nature. The aim is to provide a status of a specific topic, based on a selection of variables that seem relevant to characterize a phenomenon and, above all, observing it from the perspective of the quantitative information published on the subject.

In this publication, we felt it necessary to delve a little deeper into conceptual explanations, in light of how the current economic debate has been developing.

However, all of the above is meaningless without information on the national government's fiscal performance. At best, it's like opaque vessels whose contents are unknown.

The primary deficit in the second quarter

Let's proceed as usual and examine the consolidated information in our report. As of the second quarter of 2015, the primary balance of the non-financial public sector shows a deficit of $14.161 billion, bringing the year-to-date negative balance to $46.154 billion. This represents approximately 20% more than the total deficit of the previous year. Furthermore, it maintains virtually the same share of GDP as in previous years.

Although the current scenario for Latin American countries is one of stagnation, the trend towards an acceleration of the deficit has been recorded since 2011 onwards, without a significant rebound in economic activity.

If we add to the above the situation of real exchange rate lag, everything seems to indicate that there is indeed a problem, regardless of who is elected as a candidate.

Income: profits and VAT

Regarding tax revenue, given the strong seasonality observed in the second quarter, it is difficult to predict what will happen in the following months. The performance seen in income tax collection is unlikely to be repeated until the revenue collected in May of the following year is received, when companies that close their books at year-end deduct their payments for this tax. For now, income tax revenue in the second quarter was $109.294 million, of which 41% corresponded to the month of May.

Meanwhile, VAT revenue shows, for the first time since 2009, a lower nominal amount than in the immediately preceding quarter. In the second quarter, it was $95.790 billion, while in the first quarter it was $97.861 billion.

Of course, although the latter does not imply a trend, when looking at the actual tax collection, this is the fifth consecutive TRIM in which the interannual rate does not exhibit positive growth ratios.

Expenditures: social security, subsidies, and provinces

Regarding the main expenditure items, it is worth clarifying that at the end of June and December of each year, the balance of the social security system registers an abrupt increase in expenses over income, and that the following month the opposite effect occurs, although to a lesser extent.

The novelty of the second quarter is that the level climbed beyond its historical trend. It registered a deficit of $26.614 billion, representing a year-on-year increase of 138,31%.

Another major expenditure category is subsidies and capital transfers, as discussed in previous paragraphs. In this regard, the slowdown is notable: barely 12% growth compared to the same quarter last year. Finally, the third largest category is automatic transfers to provinces.

Little can be added about these, since they are legally tied to the revenue collection performance of shared taxes.

To gain further insight into this state of affairs, we invite you to further analyze the data on the performance of the national government in the second quarter of the year by reading our quarterly economic report, which we have made available for download below.

Open access, for use and citation

The report is available freely and without charge, under a Creative Commons license (CC BY-NC-SA 4.0):

Informe Trimestral de Cuentas Públicas | II Trimestre de 2015. Informes del Observatorio UNR N.º 14 — Serie Informes de Coyuntura N.º 8, noviembre de 2015. ISSN 2683-9067 / 2683-9075. Autor: Germán A. Tessmer.