The government is banking on Moraes to guarantee revenue from IOF and maintain the fiscal target.

Under pressure from public finances, the government of Luiz Inácio Lula da Silva (Workers' Party) is confident of a favorable ruling by Justice Alexandre de Moraes of the Federal Supreme Court (STF) upholding the constitutionality of the decree that increased the Tax on Financial Transactions (IOF). Moraes' decision will be crucial for the Treasury to navigate the fiscal crossroads and secure the expected revenues—around R$12 billion—to meet the framework's target.

At the conciliation hearing this Tuesday (15), which ended without an agreement, representatives of the Legislative branch asked for more time for negotiations between the branches. But the Attorney General of the Union, Jorge Messias, chose to await the court decision on the merits of the action, showing that the government is betting its chips on maintaining the decree, as anticipated by the Minister of the Civil House, Rui Costa , the day before.

The hearing was scheduled after the Planalto Palace appealed to the Judiciary to try to reverse Congress's decision, which overturned the presidential decree through a Legislative Decree Project (PDL), a historic defeat for the Executive. Before the conciliation, Moraes suspended the effects of both decrees, effectively halting revenue collection for the federal government.

With no forecast for Moraes' decision, Finance Minister Fernando Haddad is expected to present alternatives that compensate for the revenue shortfall and ensure at least a minimum balance in the budget in the next Primary Revenue and Expenditure Assessment Report (RARDP), next week.

The RARDP is a bimonthly document required by the Fiscal Responsibility Law, which assesses whether government revenue and spending are aligned with the fiscal target for the year. When there is a risk of noncompliance, the report determines the freezing of expenditures.

By overturning the decree, representatives and senators removed part of the makeshift patch that keeps the fiscal framework afloat, and now it seems destined to founder.

Haddad must offset IOF with MP

According to public accounts analyst Murilo Viana, the government may opt for a new contingency in July, which would add to the R$30 billion already frozen in May. However, it could also link the year's results to the approval of Provisional Measure No. 1,303, hastily issued this month, which provides for new revenue sources. The government expects to raise approximately R$10.5 billion in 2025 and R$20.6 billion in 2026.

“The Treasury can count on the advance of projected revenues to make the size of the block or contingency more flexible,” says Viana.

The MP provides for the increase of the Social Contribution on Net Income (CSLL) from 9% to 15% on institutions such as fintechs and card operators, the taxation of online betting, the taxation of currently exempt applications (such as LCI, LCA, CRI and incentivized debentures) and the creation of a single rate of 17.5% on capital gains, including crypto assets.

Although significant, only the taxation on online gambling came into effect immediately after the publication of the Provisional Measure. The others are subject to the ninetieth tax year (fintechs and payment institutions) or will only come into effect next year, such as income tax on LCI/LCA, financial investments, JCP, and crypto assets.

For this year, according to Viana, the government still has options, including the possibility of oil-related revenue. The Planalto Palace's plan is to advance the sale of its share of oil production in pre-salt areas that do not yet have exploration contracts. "But, for next year, the options are limited because the government will not want to give up discretionary revenue in an election year."

IOF reflects fiscal and political imbroglio

Even with tax compensation alternatives, the outcome of the IOF impasse is significant because it exacerbates the relationship between the Planalto and the Legislative branches, in a political chess game that also involves the dispute over mandatory amendments, currently being fought in the Judiciary.

The government's appeal to the Supreme Federal Court to reverse a political decision already made by the legislature generated a strong reaction from lawmakers. A favorable ruling by Moraes could further fuel the debate.

The Lula administration hopes that Moraes will only invalidate the taxation of the drawee risk, a type of transaction in which the supplier receives cash from a financial institution and the debt is repaid by the buyer over a longer period. The remainder of the decree, with the increase in IOF rates, should be maintained.

"This isn't just a fiscal game, it's a political one," Viana assesses. "The government needs Congress to approve the compensatory measures." Among them, the most significant stands out: the income tax exemption for salaries up to R$5,000 per month, Lula's main campaign plank for 2026.

The Planalto Palace, however, believes the government is stronger for negotiations with the legislature. The bet is that the government has gained muscle from its friction with US President Donald Trump.

The clash over the 50% tariffs on Brazilian products, considered excessive and politically biased by agribusiness sectors, reportedly generated a "sense of unity" in the country and benefited Lula. The government also believes it was successful in officially communicating the IOF on social media, reinforcing the rhetoric of "tax justice."

Even with income reform, fiscal collapse is on the horizon

For Felipe Salto, of Warren Rena Investimentos, "income reform" is the only one likely to proceed at this time of "high institutional tension and political risk." "It carries significant electoral appeal and strategically serves as a 'vaccine' in the ongoing conflict created around the "Poor vs. Rich" narrative," says the economist.

Murilo Viana believes that, even with success in all future initiatives to increase revenue, Minister Fernando Haddad will not be able to comply with the fiscal framework without cutting spending.

While increasing revenues may help achieve the primary balance target, it fails to address a central requirement of the new fiscal regime: the spending cap. According to the rules established by the economic team, public spending can only grow up to 2.5% per year above inflation.

So far, the government has managed to stay within the budget limit by utilizing a few loopholes, such as excluding court-ordered payments and other expenses from the general rule, and by reducing discretionary spending—those that aren't mandatory, such as investments and public sector operating expenses. But this strategy can't be permanent.

With mandatory spending taking up ever larger slices of the budget and with court-ordered debts returning to the spending cap set for 2027, there will be little or no room for cuts,” he says.

Salto also warns of the risk of the collapse of the public sector. "The paralysis of the government's fiscal agenda is on the horizon," he says.