For a new fiscal federalism

Image: João Nitsche


It is essential to rehabilitate fiscal policy as a macroeconomic management instrument

Fiscal policy will be one of the most important topics in the great national debate that will take place in this election year. The election, which will redesign the correlation of forces in society, will give rise to a discussion on the country's main budgetary problems and challenges and will, above all, make it possible to bring back to scrutiny the ultraliberal reforms being implemented in the field of public finances since the 2016 coup This debate on fiscal policy will certainly not be carried out on the same basis as the 2018 election, when the national agenda was still contaminated and organized by the fallacious, moralistic and persecutory theme of fighting corruption.

The persistence of the socioeconomic crisis and the outbreak of the pandemic – implying an accelerated reactivation of the vicious circuit of unemployment, poverty and hunger – required the expansion of public spending and the reinvigoration of state action. Thus, the ultraliberal economic policy in force in Brazil from the second half of the last decade was put in check, making room for a broader questioning of its foundations and results, so that this year's election will be surrounded by a transformed and quite different context. the one who paved the rise of the extreme right to government.

Constitutional Amendment No. 95/2016 (EC 95/2016), which established limits to the evolution of the Union's primary expenditures, has catalyzed discussions on fiscal issues. The consensus that is being established in the popular-democratic segment points to the need to repeal this legal order, due to the understanding regarding the negative effects that it radiates for the consolidated set of the public sector. It is increasingly evident that such a device created increasing and amplified budget restrictions, both for the central government and for subnational entities, neutralizing fiscal policy and thus compromising the prospects of overcoming the crisis and recovering from a new lasting cycle of growth.

However, the rehabilitation of fiscal policy as a macroeconomic management instrument, crucial for any possibility of equating the country's current social and economic impasses, does not only involve the revocation of EC 95/2016. It also requires the review of several reforms implemented in subnational public finances, which seek to extend to states and municipalities the same restrictive parameters for controlling primary expenditures set for the Union through EC 95/2016. In fact, since the 2016 coup, successive regulatory changes have been made with a view to expanding the discipline of subnational entities, in particular state governments, whose loss of autonomy and decision-making power in the budgetary and financial sphere is being deepened.

As will be argued in this text, the reversal of the process of gradual economic and institutional emptying of state governments will require not only the repeal of the ultraliberal reforms made in the regulatory framework of subnational public finances, but will also demand the adoption of a program of financial restructuring of these federal entities, especially state governments. Such a program must be different from the previous ones and abandon the usual guidelines of strict and undifferentiated control of primary expenditures and indebtedness, in favor of initiatives aimed at recovering the capacity of states to make expenditures in a sustainable manner, thus rehabilitating the competences of these instances government, which will make it possible to reconfigure Brazilian fiscal federalism on a renewed basis.


state weakening

State governments experience a continuous historical process of institutional weakening, with increasingly weak and restricted powers of decision and action. The clearest evidence of this chronic and persistent weakening of power is expressed, for example, in the loss of space in the tax burden and in primary public spending.

According to the IBGE historical series, the participation of the states in the tax burden dropped from 34% to 25% between 1967 (year of enactment of the Constitution centralizing the military regime) and 1999. In primary expenditures, the participation of the states fell from 35 % to 30%. In the same period, the relative position of the Union in the tax burden went from 63% to 70%, while that of the municipalities rose from 3% to 5%. In primary expenditures, while the participation of the Union was stable at 55%, that of the municipalities varied positively from 11% to 16%.

Based on updated information from the National Treasury Secretariat, it is observed that the economic and institutional weakening of the states continues in this 32st century. In the consolidated total of public sector primary expenditures, the participation of states fell from 23% to 26%, which meant an accumulated decrease of 2000% between 2020 and 15. In the same period, the relative positions of municipalities and the Union rose by 18 % to 54% and from 59% to 20%, for an increase of 10% and XNUMX%, respectively.

With regard to the tax burden, information from the Federal Revenue Service shows the occurrence of a moderate decentralization in recent years, which favored, above all, municipalities. The Union's share dropped from 69% to 66%, dropping 4,5% between 2000 and 2020. About 2/3 of this relative loss by the Union (2 percentage points) was captured by the municipalities, which increased their share in the tax burden from 5% to 7%, making a gain of 40% in the first two decades of this century. The states, in turn, had a marginal increase (1 percentage point), going from 26% to 27%, which meant an increase of 3,8% in the reference period.

These numbers are enough to show the continued weakening of state governments, generating a distorted pattern of fiscal federalism in Brazil, whose trajectory, since at least the late 1960s, has been characterized by the compression of the intermediary entity (the states) between the others. two levels of government (national and local). Such a peculiar evolution resulted in the formation of an increasingly unbalanced federative structure, with the progressive hypertrophy of the upper and lower spheres, creating structural problems of coordination, since municipalities tend to cross the states to articulate directly and without mediation with the central government. , which implies fragmentation, inequality, dispersion, heterogeneity and asynchrony of public policies in territorial and jurisdictional terms.


New fiscal institutionality

This process of weakening state governments within the scope of Brazilian federalism reached a new political-institutional standard and became much more structural and systemic from the mid-1990s onwards, when a new regulatory apparatus for subnational public finances began to be organized, in the midst of the inflationary stabilization of the Brazilian economy promoted through the Real Plan and the neoliberal reforms implemented at that time to pave the way for the country's reintegration into the global financial system.

With budget structures compromised by high and costly liabilities, originating from the national industrialization effort of the 1970s and the recessive and hyperinflationary crisis of the 1980s, the states began to face serious fiscal impasses in the new macroeconomic context of low inflation and high interest rates derived from the Real Plan. With disorganized finances and the imminent paralysis of the public machine, the states had to submit to the federal government's guidelines in the search for equating the financial and patrimonial imbalances they were experiencing. Through Law nº 9.496/1997, the Support Program for the Restructuring and Fiscal Adjustment of the States (PAF) was created, through which the Union ensured the long-term refinancing of the state debt, but conditioning the support to the adoption, by the entities , of a rigid adjustment of the public accounts.

In general, the PAF's main strategy was to force the states to limit their expenditures to the conditions given strictly by the availability of resources of a tax nature. To this end, the federal program established severe indebtedness controls, restricted state governments' access to credit operations and determined the fulfillment of mandatory targets related, mainly, to personnel expenses, the primary result and the public debt.

Later, the PAF was extended to municipalities (MP nº 2.185-35/2001) and, more importantly, its parameters were incorporated in Complementary Law nº 101/2000, the Fiscal Responsibility Law (LRF), thus consolidating a new fiscal institutionality for the country, fundamentally based on disciplinary norms that imposed on subnational entities, especially the states, a framework of strong budgetary constraints (hard budget constraint).

The PAF managed to change the fiscal dynamics of state governments. It is enough to verify that, after the refinancing agreements were signed (1997/1999) and the LRF was enacted (2000), the states were able to revert the chronic deficit position of their budgets, registering practically continuous primary surpluses. Between 1995 and 1999, state governments recorded, in consolidated terms, consecutive primary deficits, amounting to an annual average of 1,02% of GDP. A different situation was observed between 2000 and 2013, with successive primary surpluses, reaching an annual average of 0,46% of GDP. The period between 2014 and 2020 was more unstable, but even so it was possible to reach an average primary surplus of 0,08% of GDP per year. Finally, it is worth noting that, in the 21 fiscal years between 2000 and 2020, only three of them recorded primary deficits – 2014, 2016 and 2017.

This improvement in the fiscal result, however, did not express or make possible the financial recovery and the federative strengthening of the states. On the contrary, in the new institutional framework set up in the country based on the conditional debt refinancing agreement, state governments lost even more decision-making power and scope for action, to the extent that they were obliged to manage their budgets based on previously established compulsory targets and based on a compressed financing structure, since it is based, above all, on the availability of tax resources (own and transfers), considering that access to credit came to be heavily controlled and restricted.

Persistent financing difficulties and the greater economic and institutional fragility of state governments can be summarized from the behavior of the Real Investment Self-Financing Margin (MGA-RI), an indicator that allows verifying the capacity that governments have to make investments, after paying debt services (interest, charges and amortization).

Between 1995-1999, the consolidated MGA-IR was persistently negative, reaching an annual average of -1,25% of GDP. In real values ​​at 2020 prices, deflated by the IGP-DI, the average annual MGA-RI of the states was negative by about R$ 75 billion between 1995-1999. With the implementation of the PAF, this financial deficiency was reversed, but at very compressed levels and, moreover, on precarious and unsustainable bases. Between 2000-2011, the MGA-IR became positive, reaching, however, an annual average value of only 0,6% of GDP, with its highest level, recorded in 2005, being 1,02% of GDP. At deflated prices, the MGA-IR was, on average, equivalent to around BRL 38 billion per year. This phase, however, was brief, with the MGA-IR returning to being continuously negative from 2012 onwards: the average annual margin was -0,87% of GDP between 2012-2020. In those same years, the real value of the MGA-RI was negative by R$ 78 billion per year, thus reaching a level practically equal to that of the period prior to the PAF (1995-1999).

These data are unequivocal in demonstrating that the PAF was unable to recover the financing conditions for state public spending. Furthermore, the unsustainable trajectory of the MGA-RI reveals that the PAF introduced and reinforced a strongly pro-cyclical bias in state finances. In general, the MGA-IR was positive in a context of more favorable macroeconomic conditions, being reversed at a time of greater instability and deceleration of the Brazilian economy after the great international financial crisis of 2008, a situation that was aggravated later with the 2016 coup and the outbreak of the pandemic.

This pro-cyclical bias in state finances is problematic for at least two reasons. In the first place, in crisis situations, the dynamic potential of state public spending, which could be mobilized in a coordinated way to face macroeconomic difficulties, is neutralized, overloading the central government's fiscal policy. Secondly, the pro-cyclical bias ends up making the state finances start to generate depressive tendencies, which establishes an additional factor of aggravation of the crisis.


course correction

Faced with the chronic financing problems of the states, the federal government decided to change the debt parameters renegotiated with subnational entities, including municipalities and involving contracts signed under the terms of Law 9.496/1997 and MPs 2.185-35/2001 and 2.192- 70/2001. Through LC 148/2014, the interest rate on these liabilities was reduced to 4% per annum (against the prevailing rates of 6 and 7,5% per annum); the IGP-DI was replaced by the IPCA as the index of the contracts and, finally, the charges were limited to the cost equivalent to the SELIC rate. Furthermore, and this measure was of paramount importance for states and municipalities, the limit on charges at the cost of the SELIC was applied retroactively to the date of signature of the contracts, providing an effective downgrade of the stock of debt refinanced by the Union. Subsequently, the subnational debt renegotiated under Law 8.727/1993 was also covered by these contractual changes.

The amendments forwarded by LC 148/2014 had an important and extensive positive impact on subnational entities, which went far beyond the simple reduction of the debt stock. On the one hand, the decrease in liabilities lowered the financial cost borne by municipal and state treasuries, which eased budget constraints and opened fiscal space for absorbing additional public spending. On the other hand, the improvement in the level of indebtedness enabled subnational entities to contract new credit operations, implying yet another force to reduce budget restrictions, which created conditions for an even greater expansion of expenses.

Some synthetic information allows observing the developments of LC 148/2014 for the indebtedness of states and municipalities, in its main aspects. The subnational net debt dropped from 12,9% to 10,1% of GDP between 2015 and 2021, meaning a significant drop of around 21%. The reduction in the renegotiated debt was more pronounced, with the gross stock falling more than 26%, from 9,3% to 6,8% of GDP between 2015 and 2021. In comparison with 2000, reflecting, in part, the effects retrospective of LC 148/2014, the retraction of the total stock was greater than 34%, while that of the renegotiated debt was even more expressive, reaching a decrease of over 55% in proportion to GDP. But it is worth noting that the degree of subnational indebtedness, when observed in relation to the PB, had been showing improvement even before the enactment of LC 148/2014, due to several factors, among which it is worth mentioning the long cycle of exchange rate appreciation experienced across the country between 2004 and 2014. In those years, the exchange rate appreciated by more than 23%, reducing the variation of the IGP-DI, which was the main index of renegotiated debts of subnational entities. An element of concern, however, is the upward trajectory of the external debt of states and municipalities: this liability denominated in foreign currency more than doubled in size between 2000 and 2021, amounting to 115% growth in relation to GDP.


ultraliberal reforms

This movement that emerged in 2014 in the sense of seeking to mitigate, to some extent, the budgetary restrictions of subnational governments and, in particular, of the states, providing fiscal space for a certain increase in public spending, came to be interrupted with the 2016 coup. another agenda of reforms of an ultraliberal nature was imposed on the country and, in the field of public finances, the orientation that came to prevail was to reverse the pattern of greater fiscal activism that had characterized the performance of the federal government, specifically between 2007-2014 ( Lula-2 and Dilma-1)

The enactment of EC 95/2016, creating the so-called New Fiscal Regime within the scope of the Union, can be considered the corollary of this inflection in economic policy. By establishing limits to the evolution of the Union's primary expenditures, EC 95/2016 reinvigorated, on a broader basis, the principle of strong budget constraint (hard budget constraint) which had based the organized fiscal institutionality in the country in the post-Real Plan period, based on the adjustment program of state public finances, as discussed earlier.

Two important aspects regarding EC 95/2016 should be highlighted. The first is that this norm incorporated into the Brazilian Constitution complied with the recommendations of the institutions of global governance, which began to advocate for underdeveloped countries measures aimed at intensifying the national framework of strong budget restrictions, with the aim of inhibiting the discretionary action of those responsible for policy. Supervisor ("strengthening hard budget constraints” became the watchword of the World Bank, for example).

The second aspect, which consists of a new fiscal guideline in Brazil, is that the federal government was inserted into a regulatory framework of strong budget constraints, with implications, therefore, of great extension for the country, considering that, in federalism In Brazil, the central government is the main federative actor and the one that operates the large systems of financing and regulation of national public policies, such as health, education and social assistance, for example.


ultraliberal regulation

After the implementation of the New Fiscal Regime within the scope of the Union, several regulations were approved, with the purpose of extending, to the subnational sphere, devices to control primary expenditures similar to what was established at the federal level through EC 95/2016. It is worth mentioning that the regulatory reforms involving subnational finances, affecting mainly state governments, aim to expand the institutional scope of the New Federal Fiscal Regime, giving it a national and homogeneous scale for disciplining the budgetary management of the consolidated public sector.

Among these new regulations, the following should be highlighted:

(1) LC 156/2016 – amended state debt refinancing agreements, extending the payment period for these liabilities for an additional period of up to 20 years, and granted decreasing extraordinary discounts on the payment of debt installments due between July 2016 and June de 2018. It also established a fiscal balance stimulus program, which has been called the “New PAF”. The new contractual terms were conditional on the governors' commitment to limit the expansion of primary current expenditures to the IPCA variation in the two years following the signing of the amendments.

(2) LC 159/2019 – instituted the so-called State and Federal District Tax Recovery Regime. Determines tough fiscal and equity adjustment measures, among which the following should be mentioned: (i) limiting the annual growth of current expenses to the IPCA variation; (ii) privatization and concession of public services and assets, as well as the liquidation and extinction of companies; (iii) prohibition of the following acts, among others, during the term of the tax recovery regime: concession of advantage, increase, readjustment or adequacy of remuneration of civil servants; creation of a position, job or function that implies an increase in expenses; holding public tenders and hiring or hiring personnel; contracting credit operations and receiving or granting guarantees; (iv) matching the legal and social security regimes with those of the federal government; (v) institution of the Supplementary Pension System; (vi) reduction of at least 20% in fiscal or financial-tax incentives and benefits.

(3) LC 178/2021 – instituted the Fiscal Balance Promotion Plan (PEF), aimed at States, the Federal District, capitals and municipalities with more than one million inhabitants, specifically entities with fiscal and financial problems. Offers the granting of Union guarantees to annual credit operations equivalent to up to 3% of Net Current Revenue, but subject to the adoption of fiscal and equity adjustment measures provided for in the Tax Recovery Regime.

(4) EC 109/2021 - Creates an optional fiscal adjustment mechanism for states, the Federal District and municipalities, to be triggered when the ratio between current expenditure and current revenue exceeds the 95% mark, providing for the prohibition of the following acts, among others , during the period of persistence of excess spending: (a) concession of advantage, increase, readjustment or adequacy of remuneration; (b) creation of a position, job or function that implies an increase in expenses; (c) public tender, admission or hiring of personnel; (d) creation of mandatory expenditure; (e) concession or expansion of tax incentives or benefits.

This new regulatory apparatus for subnational finances, which is still being constituted, deepens the control over the public finances of the federative entities, mainly the state governments. The reforms implemented so far emphasize mechanisms to contain current primary expenditures, but without relaxing the limits imposed on indebtedness and the contracting of credit operations. In this sense, it is evident that this emerging regulatory apparatus reiterates and accentuates the previous framework of strong budget constraints, further weakening state governments from an economic and institutional point of view and, consequently, intensifying the distortions of Brazilian fiscal federalism.


Federal Program

The reconfiguration of fiscal federalism, one of the most urgent and important national challenges to be tackled with a view to consolidating a more lasting cycle of development for the country, necessarily involves the economic and institutional rehabilitation of state governments. It is through the recovery and reinvigoration of the governing capacities of the states that the distortions of Brazilian fiscal federalism can begin to be corrected, creating more promising conditions to induce a federative structured coherence capable of synergistically and hierarchically articulating the three governmental entities, in accordance with their respective jurisdictional powers.

A starting point for this redesign of Brazilian fiscal federalism is the establishment of new financing bases for state public spending, which requires completely changing the purely “fiscalist” and “financialized” logic that has guided the regulation of subnational public finances in the country. since at least the mid-1990s. It is therefore a question of implementing a “Federal Program for the Recovery and Sustaining of Subnational Public Expenditure”, which will have state governments as its emphasis, but which will also favor municipalities, especially those with capitals and those of medium and large size.

The core of this federative program consists, basically, in the use of the Union's financial assets with states and municipalities for the constitution of a fund that would provide resources for these subnational entities to invest in investments and various public purchases (OCC - Other Costing and Capital) and/or for the formation of reserves of their own pension schemes.

The most recent data available show that these financial assets amounted to BRL 2021 billion in February 664. Of this total, approximately 89% corresponded to renegotiated debts of states and municipalities, with 83% referring to state liabilities linked to Law 9.496/1997. The financial fund to be constituted with these assets would have the function of receiving the corresponding debt services paid by the subnational entities, later returning to each one of them the same resources that were spent individually.

In practice, therefore, the federal program presupposes the cancellation of state and municipal debts by the Union. Based on accounting information for 2020, it is possible to estimate, in an exploratory manner, the impacts that such a waivers of subnational debts could entail. From the patrimonial point of view, the impacts could be more relevant, considering that the assets with states and municipalities corresponded, in 2020, to more than 47% of the financing and loans granted by the Union, considering the short and long term ones. However, taking into account the adjustments for losses and the provisions made for the assumption of guarantees by the Union, the adjusted value of these assets would decrease from R$ 650 billion to R$ 223 billion.

Thus, in asset terms, the impact can be estimated at 3% of GDP. However, as assets with states and municipalities would be used to set up a Union investment fund, the equity impact would be null. There would then remain the budgetary effects, generated by the non-appropriation of revenues arising from these assets by the Union, which would then be returned to states and municipalities in the form of non-refundable transfers to sustain primary expenditures.

In 2021, the Union's capital revenues derived from the amortization of loans totaled R$ 87 billion, with a large part of this amount being calculated with states and municipalities - just note that expenditures on total debt services (domestic and external) of subnational entities was R$ 81 billion in the same year. Based on these values, it can be stated that the budgetary impact of the waivers of subnational debt by the Union would be less than 1% of GDP. Or, still, it would represent less than 15% of the liquidated expenses of the Union's debt services in 2021, excluding the costs related to the refinancing of the federal public debt and the values ​​of the services registered in remains to be paid.


meeting of accounts

The estimates presented above are quite exploratory, but sufficient to indicate that the fiscal impact of this federal program would be in magnitude, at least, compatible with the expected gains in terms of strengthening subnational finances, in particular of state governments.

It should also be noted that the program cannot be interpreted as a fiscal-financial operation that will unduly “reward” wasteful governments and encourage budgetary irresponsibility, which could systematically compromise the foundations of the fiscal arrangement established in the country.

In fact, the operation must be considered as a meeting of accounts between the Union and the subnational entities. This is because norms set by the federal government have resulted in the loss of state resources, without due compensation. The exemption from ICMS on exports of primary and semi-finished goods is a historical example that generated a large Union liability with the states, which remains open, despite the compensatory transfers created through LC 176/2020.

A study by the Court of Auditors of the state of Pará (TCE-PA), based on information systematized by the National Council for Finance Policy (CONFAZ), concluded that state governments accumulated a net loss of ICMS collection of R$ 647 billion between 1996 and 2018 , due to the exemptions established by the Kandir Law, against a net consolidated debt (NCD) which, according to data from the National Treasury Secretariat (STN), totaled R$ 798 billion in 2018. Updating the amount of losses until 2020, year of enactment of LC 176/2020, based on the same index used by the TCE-PA, the net loss of the states reached BRL 858 billion, while the DCL, according to the STN, reached BRL 847 billion, thus making it these entities are net creditors of the Union, with a positive balance to be received of R$ 11 billion.

It should also be remembered that the solution given to these estimated losses is flagrantly unsatisfactory. LC 176/2020 created an unconditional transfer flow in favor of states (75%) and municipalities (25%) of BRL 58 billion, to be settled by 2037. This amount corresponds to only about 9% of estimated net losses for 2018 – considering the value updated until 2020, this percentage drops to 6%.

In addition to these losses arising from the appropriation of ICMS revenues, the large disbursement made by state governments to pay interest, charges and amortization of their debts, which has proved to be incapable of effectively and structurally reducing liabilities, despite the substantial amounts allocated to this financial expense. Between 2000 and 2021, the expenditure committed by the states in debt service added, in nominal terms, R$ 757,4 billion, while the total net debt rose, in the same period, from R$ 161,2 billion to R$ 809,9, 648,8 billion – increase of R$ XNUMX billion.


Other programmatic measures

The following additional measures would also form part of this federative program, aiming to establish sustainable financing bases for subnational public spending, on the one hand, and to induce fiscal discipline, on the other:

(1) Strengthening ICMS collection – ending the advantageous tax regime for exports of primary and semi-finished goods, through a constitutional amendment that returns the incidence of ICMS on the country's foreign sales of these products. At least two proposals in this sense are currently being discussed in Congress: PEC nº 42 (Senate) and PEC nº 201 (Chamber of Deputies), both from 2019.

(2) Subnational debt market – Constitution of a subnational public debt market, with regulation shared by the Central Bank and the National Treasury Secretariat (STN), with the objective of providing low-cost and long-term resources to finance the OCC of states and municipalities.

(3) External debt refinancing – implementation of an operation to refinance the external debt of states and municipalities, in order to promote the exchange of liabilities denominated in foreign currency for securities in national currency, eliminating the exchange rate risk on subnational public accounts.

(4) Fiscal balance induction program – adoption of a program monitored by the STN that induces the fiscal and financial balance of subnational governments, primarily aimed at intertemporally sustaining the primary spending capacity of these entities, with the fulfillment of compulsory targets consistent with economic growth projections and related to primary current savings, net of intergovernmental transfers and other current expenditures; investments; indebtedness; remaining payable; unbound cash availability, among other indicators.

A federative program to recover the ability to finance the expenses of subnational entities, as proposed above, would be quite promising in terms of creating conditions to induce the redesign of Brazilian fiscal federalism. But other structuring measures would still be necessary to reverse the historical process of weakening the role played by the states in the Brazilian federation. The first step towards this structural transformation, however, needs to be taken as soon as possible.

*Danilo Jorge Vieira He holds a PhD in Applied Economics from Unicamp.


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