Local Fiscal Discipline

Abstract

Fiscal indiscipline at the local level disrupts delivery of basic services to residents and erodes trust in local governance. This chapter is concerned with policy responses especially legislated fiscal rules to ensure fiscal discipline at the local and state/provincial orders of government. A review of the experiences suggests that, when properly designed and implemented, fiscal rules have a positive impact on local but not provincial/state fiscal discipline. Broader fiscal responsibility legislation, with sanctions and enforcement regimes, binding on all orders of government points to even stronger positive influence of such legislation in ensuring prudent fiscal management in countries adopting such a legislation.

This chapter is a revised version of Ernesto Crivelli and Anwar Shah (2009). Promoting Subnational Fiscal Discipline: A Review of Budget Institutions and Their Impact on Fiscal Performance. Unpublished Working Paper, World Bank Institute, Washington, DC.

Annex A1: Brazilian Fiscal Responsibility Legislation 2000

The Brazilian Federal Government adopted a Fiscal Responsibility Law (Lei de Responsibilidade Fiscal—LRF) in May 2000 and its companion law (Lei 10028/2000) binding for federal, state and municipal/local governments (see Table 5.8 for a summary view). The LRF prohibits intergovernmental and government-controlled bank debt financing, imposes limits on total debt and personnel expenditures, establishes rules for the last year in office, requires compensatory measures for tax expenditures and new entitlements, establishes verifiable fiscal limits, mandates transparency of national and subnational fiscal data and fiscal administration reports and dissemination to public on a timely basis, correction mechanisms and intra-year adjustment rules to meet fiscal limits and institutes enforcement mechanisms and penalties for non-compliance. The escape clauses are few and specific and related to economic slowdown.

Table 5.8 Brazil fiscal responsibility law 2000 at a glance

The LRF is likely the most significant reform after 1988 constitution in terms of its impact on the dynamics of federalism in Brazil; as subsequent compromises between states and the federal government have continuously increased the negotiation leverage of the latter increasing also its effectiveness in macroeconomic management. The LRF requires that no program can be funded unless part of a multi-year (4-year) plan and the annual budget must evaluate fiscal risks from contingent liabilities. The LRF establishes ex ante institutions such as a threshold state debt, deficit, and personnel spending ceilings. According to the LRF federal government, states and municipalities must maintain debt stock levels below ceilings (3.5, 2.0 and 1.2 times own net current revenues for federal government, states and municipalities respectively) determined by the Federal Senate regulations. If a subnational government exceeds this debt ceiling, the exceeding amount must be reduced within one-year period, during which the state or municipality is prohibited of incurring any new debt and becomes ineligible for receiving discretionary transfers. The LRF also regulates that all new borrowing requires the technical approval of the Central Bank and the approval of the Senate. Borrowing operations are prohibited all together during a period of 180-days before the end of incumbents’ government mandate. In terms of personnel management, the LRF provisions define ceilings on payroll spending. This should not exceed 50% of federal government’s net revenues while this ceiling equals 60% at the subnational level. The LRF also institutionalized a variety of ex post provisions aimed at the enforcement of its regulations. For governments, violations to personnel or debt ceiling can lead to fines up to 30% of annual salary of the responsible officer; impeachment and removal from office of mayors or governors and ineligibility to run for office for five years; and even prison terms (1–4 years) in case of violation of mandates regarding election years. For capital markets, the LRF declares that financing operations in violation of debt ceilings would not be legally valid and amounts borrowed should be repaid fully without interest and the Bank officials involved could be criminally prosecuted. This provision is aimed at discouraging such lending behavior by the financial institutions. Sanctions can be imposed by the Executive (institutional sanctions), legislature (Audit Council) or by the independent Public Prosecutor. Citizens are also empowered to file suit against governments for a breach of any provisions of this act.

The Brazilian Federation had a remarkable success in ensuring fiscal policy coordination and fiscal discipline at all levels in recent years. By June 2005, the LRF (2000) had significant positive impacts on fiscal performance in Brazil. All states and the federal government have complied with the ceiling on personnel expenditures (50% of current revenues). On debt, only 5 states out of 27 states (inclusive of Federal District) are still above the ceiling of 200% of revenues, owing to 2002 currency devaluation. Ninety-two percent of municipalities have reduced debts below 1.2 times revenue levels and only a handful of large municipalities have unsustainable debt levels. Primary surplus was achieved by all states by 2004 (Levy 2005; Boadway and Shah 2009). A recent study by Liu and Webb (2011) reaffirms positive impact of the FRL on fiscal management in Brazil. Liu and Webb note that the rate of growth of sovereign gross debt as a share of GDP slowed from 15.13% in the pre-LRF period to 2.39% in the post-LRF whereas the rate of growth of the subnational debt fell from 4.99% in the pre-FRL to 1.31 in the post-FRL period. Figure 5.1 shows the positive impact of the LRF on the trend in net government debt as a share of GDP for both federal and subnational governments.

Fig. 5.1

Brazil net government debt as share of GDP. (Source: Liu and Webb (2011). Notes: SNG Subnational Governments, CG Central Government)