18 Brazil

Teresa Ter-Minassian
Published Date:
September 1997
  • ShareShare
Show Summary Details
Teresa Ter-Minassian

The history of intergovernmental fiscal relations in Brazil has been characterized by alternating phases of decentralization and recentralization. The period of the dictatorship, from the mid-1960s to the mid-1980s, was marked by strong centralist tendencies, with a clearly dominant role of the federal government and its enterprises in the management of public resources, as well as in the economy as a whole. The democratization process, culminating in the enactment of the 1988 Constitution, was accompanied by a resurgence of decentralization trends. These tendencies have been especially marked on the revenue side, resulting in a relatively high degree of control over revenue sources by the state and local governments, compared with other large federations around the world.

In 1995, own tax revenues of the subnational governments accounted for nearly 38 percent of total tax revenues (including social security contributions) and were equivalent to 10.5 percent of GDP. The share of tax revenues at the disposal of subnational governments (defined to include own plus shared revenues) represented nearly 50 percent of total tax revenues (Tables 1 and 2). In the same year, state and local governments accounted for about 60 percent of public consumption and for 63 percent of public investments. By contrast, the federal government (mainly through the social security system) maintained a preponderant (over 80 percent) share in social transfers (Table 3).

Table 1.Brazil: Operations of the General Government1(In percent of GDP)
Nonfinancial revenue26.724.425.928.828.7
Tax revenue24.022.223.626.428.0
Direct taxes3.
Value -added taxes9.
Social security taxes4.
Trade taxes0.
Other tax revenue5.
Nontax revenues2.
Nonfinancial expenditure24.422.724.025.328.3
Current expenditure24.922.923.223.826.7
Gross wages11.610.311.011.012.0
Pension benefits4.
Subsidies and grants0.
Other current expenditure8.
Capital expenditure5.
Float and statistical adjustment−5.5−3.2−2.8−1.4−0.8
Primary balance (deficit −)
Real net interest payments0.
Operational balance (deficit −)1.5−−4.0
Public sector borrowing requirement15.231.344.935.85.8
Sources: Ministry of Finance of Brazil; Central Bank of Brazil; and IMF staff estimates.

Figures may not add to totals due to rounding.

Sources: Ministry of Finance of Brazil; Central Bank of Brazil; and IMF staff estimates.

Figures may not add to totals due to rounding.

Table 2.Brazil: Summary Operations of State and Municipal Governments(In percent of GDP)
Tax revenue8.
Nontax revenue2.
Tax transfers3.
Other central government transfers0.
Current expenditure12.712.212.411.512.7
Gross wages6.
Materials and supplies2.
Transfers and subsidies3.
To enterprises0.
Pensions and welfare0.
Subsidies and other current expenditures2.
Capital expenditure2.
Primary balance (deficit −)−0.2
Net interest payments10.
Operational balance (deficit −)1.3−0.80.2−1.0−2.3
Sources: Ministry of Finance; Central Bank of Brazil; and IMF staff estimates.

Comprises interest payments on external debt, plus the real component of interest payments on domestic debt.

Sources: Ministry of Finance; Central Bank of Brazil; and IMF staff estimates.

Comprises interest payments on external debt, plus the real component of interest payments on domestic debt.

Table 3.Brazil: Federal Government Operations1(In percent of GDP)
Taxes on trade0.
Earmarked social taxes3.
Social security contributions4.
Other taxes0.
Nontax revenues0.
Current expenditure15.514.114.315.917.6
Gross wages4.
Social security benefits4.
To states and municipalities3.
Subsidies and grants0.
Other current expenditure2.
Capital expenditure2.
Other capital expenditure1.
Capital transfers to public enterprises0.
VAT adjustment−0.8−0.6−0.3−0.4−0.2
Float and adjustment−2.4−0.9−0.4−0.9−0.7
Primary balance (deficit −)
Net interest payments30.
Operational balance (deficit −)0.3−−1.6
Sources: Ministry of Finance; Central Bank of Brazil; and IMF staff estimates.

Includes the central administration, social security system, and Central Bank of Brazil.

Excludes proceeds from privatization.

Comprises interest payments on external debt, plus the real component of interest payments on domestic debt.

Sources: Ministry of Finance; Central Bank of Brazil; and IMF staff estimates.

Includes the central administration, social security system, and Central Bank of Brazil.

Excludes proceeds from privatization.

Comprises interest payments on external debt, plus the real component of interest payments on domestic debt.

The Brazilian federation encompasses three levels of government: the Union, 26 states plus the Federal District,1 and about 5,000 municipalities of widely ranging sizes. It is noteworthy that, in the 1988 Constitution, the municipalities have been formally granted a status of members of the federation. Although the operational implications of such a status are not spelled out, it appears to confer greater autonomy to the municipalities in Brazil than is the case in most other countries.

In recent years, there has been a rapid increase in the number of municipalities, quite divorced from economic and financial viability considerations. The increase reflected the lack of clearly specified criteria for the creation of new municipalities, and the fact that the revenue-sharing mechanism involves financial incentives to this creation.2

Despite longstanding efforts at income redistribution, Brazil remains a country characterized by major disparities, both among regions and in the size of incomes. In 1992, the eight states in the South and Southeastern regions, where 57 percent of the country’s population lives, accounted for virtually three quarters of the national GDP. Per capita incomes ranged from the equivalent of less than US$600 a year in the poorest state (Piaui) to more than US$4,200 in the richest (São Paulo) (Affonso, 1995). Social indicators show an equally wide range across the country (Table 4).

Table 4.Brazil: Regional Disparities in Social Indicators(In percent unless otherwise indicated)
Social IndicatorNorthNorth-eastCenter-WestSouth-eastSouthNational average
Infant mortality rate (per thousand; 1989)559841403859
Years of life expectancy (1985)64.555.767.765.365.762.6
Child malnutrition rate (1989)42.346.125.721.717.831.0
Rate of elementary school attendance (1987)88.7177.984.687.182.783.2
Rate of first grade repetition31.314.428.3319.8
Illiteracy rate19.8143.322.516.416.224.6
Percentage of dwellings with running water80.0148.462.084.468.470.9
Source: Afonso (1996).

Urban areas only.

State of São Paulo only.

State of Santa Catarina only

Source: Afonso (1996).

Urban areas only.

State of São Paulo only.

State of Santa Catarina only

Expenditure Assignment

The 1988 Constitution assigns relatively few functions exclusively to each level of government. Specifically, it reserves to the federal level its traditional functions, notably defense, foreign affairs, control of the money supply and of the financial system, and the exploitation of certain monopolies, currently in the process of being dismantled. It reserves to the state and municipal levels the provision of police and other security services, as well as a few other services, in their respective geographical areas. For the vast majority of public expenditures, however, the Constitution envisages concurrent responsibilities, to be further specified by a federal law—which so far has not been proposed (Table 5). This lack of clarity in the assignment of spending responsibilities contributed to duplication and waste of resources in the provision of goods and services. Thus, for example, the federal government continues to be actively involved in the provision of basic education, which in principle should be carried out by the local level, albeit with financial support by higher levels of government to the extent needed to ensure adequate minimum standards nationwide.

Table 5.Brazil: Expenditure Assignments
Expenditure FunctionResponsibility for Policy and ControlResponsibility for Provision
Foreign affairsFF
Foreign tradeFF
Monetary and financial policiesFF
Social securityFF,S
Sectoral policiesF,SF,S
Railroads and airportsFF,S
Natural resourcesFF,S
Environmental protectionF,SF, S
HealthF.SF, S, L
Social assistanceF.SF, S, L
Water and sewerageFS, L
Fire protectionF,SS
Parks and recreationLL
Source: Afonso and Ramundo (1996).Note: F = federal, S = state, and L = local.
Source: Afonso and Ramundo (1996).Note: F = federal, S = state, and L = local.

Despite the lack of legal definition of spending responsibilities, in practice, there has been a clear trend toward a decentralization of public expenditures. This trend has been, however, more a response to the fiscal stress on the federal budget—resulting from the decentralization of revenues and the adverse macroeconomic conditions of the early 1990s—than the result of a planned and orderly devolution of spending responsibilities. As a result of this decentralization, the share of the federal government (including the social security system) in total noninterest expenditures of the general government has declined significantly since 1988. The limited information available on the functional classification of expenditures by different levels of government in Brazil indicates that the federal government spends the bulk (nearly 80 percent) of its resources on social security and social assistance, general administration, and interest on the public debt. State spending is concentrated on general administration, education, social assistance, and health. Municipal spending focuses on general administration, housing and urban services, primary education, health, and local public transport (Figure 1).

Figure 1.Brazil: Structure of Government Spending

(In percent)

It is interesting to note that 71 percent of total expenditures of the state and local governments are carried out by the eight relatively rich states of the South and Southeast (Afonso, 1994). This suggests that, despite the substantial redistributive role of the federal transfers, the wide disparities in own revenue-raising capacities of the states continue to substantially affect the regional distribution of state and local spending.

Revenue Assignment

The current assignment of revenue sources in Brazil departs in several respects from the traditional prescriptions of the fiscal federalism literature, especially regarding indirect taxes. The federal government is currently assigned the following main taxes: the personal and corporate income taxes (which are, however, shared with the states and municipalities—see section on Intergovernmental Transfers); a selective value-added-type of tax (the IPI), which is in essence a series of excises with different rates and a credit mechanism, and which is also subject to revenue sharing; a tax on rural property (shared 50 percent with the municipalities); various types of social security contributions levied on payroll or turnover of enterprises; taxes on foreign trade; and certain taxes on financial operations (Table 6). The last three categories are not shared with the lower-level governments. The states are assigned a broad-based value-added-type tax (the ICMS), a tax on motor vehicles, and estate and gift taxes. The municipalities are assigned a tax on services (the ISS), a tax on transfers of immovable properties, and a tax on urban real estate property.

Table 6.Brazil: Tax Assignments
Responsibility for
Tax CategoryDefinition of baseSetting of rateAdministration
Foreign tradeFFF
Corporate incomeFFF
Capital gainsFFF
Personal incomeFFF
Transfers of propertyS, LF, S, LS, L
Rural propertyFFF
Civil servants’ payrollF, S, LF, S, LF, S, L
Sales taxes
Fees, royaltiesF, S, LF, S, LF, S, L
Source: Afonso and Ramundo (1996).Note: F = federal, S = state, and L = local
Source: Afonso and Ramundo (1996).Note: F = federal, S = state, and L = local

The ICMS has traditionally suffered from a number of shortcomings (Affonso and Silva, 1996), some of which were eliminated in 1966 through a major reform. Specifically:

  • The ICMS is levied at different rates on different categories of goods: reduced rates on “essential necessities,” 17 percent on most goods,3 and 25 percent on luxury goods. These rates are levied on a tax-inclusive base, resulting in higher rates on a net-of-tax basis. All interstate transactions are taxed on an origin basis. The rate on these transactions is set by the federal senate at 12 percent, except for exports from the states in the South and Southeast to states in the other regions, which are taxed at 7 percent. The difference in rates on interstate and intrastate transactions complicates administration and provides an incentive to misclassify transactions, to reduce the tax liability.
  • Until the 1996 reform, exports of nonmanufactured goods were not zero rated, and credit was not allowed for the purchase of capital goods.
  • The base of the ICMS has been eroded by the granting of widespread, but not necessarily uniform across the country, exemptions and other preferential treatments for selected sectors.4
  • The superimposition of the ICMS with the selective federal (IPI) and municipal (ISS) taxes has given rise to cascading and distortions in the tax burden across sectors and localities. This cascading is reinforced by the fact that some sizable contributions earmarked for the social security system (COFINS and PIS/PASEP) are levied on turnover.

Following the 1996 reform, which zero rated all exports and introduced a credit for capital goods, the federal government has proposed a more comprehensive reform, which would replace the present ICMS and IPI with both a federal and a state-level VAT, levied on the same tax base and at homogeneous rates for interstate as well as intrastate transactions. It has also been proposed that this tax should be levied on a destination basis. Although the proposed mechanism5 is in principle compatible with different arrangements for the sharing of revenues among the states, any move from the current origin principle is bound to have a significant impact on the distribution across the states of their major revenue source, entailing losses for states that are net exporters to the rest of the country and gains for those that are net importers. It is, therefore, unclear whether and how the political consensus needed to implement such a reform—which would require a constitutional amendment—can be mustered.

The distribution of revenue across levels of government and by type of tax has undergone significant changes in recent years, with the share of the federal government (before revenue sharing) in total tax revenues declining by about 5.5 percentage points between 1988 and 1995 (to around 62 percent of total). Currently, various forms of social security contributions account for about 55 percent of own revenues of the federal government, the ICMS for nearly 93 percent of those of the states, and the ISS for nearly half of those of municipalities.

Intergovernmental Transfers

As in other countries, intergovernmental transfers in Brazil fulfill several functions: fill a “vertical” imbalance between expenditure and own revenue assignments that, albeit smaller than in the majority of federal, as well as unitary, countries, remains significant, especially as regards the municipalities; help moderate horizontal imbalances; and promote specific objectives through special purpose grants.

The changing balance between these, not necessarily always compatible, goals has shaped the evolution of the system of intergovernmental transfers over time, in particular the relative weights of revenue sharing versus grants and the composition of the latter. The democratization process and the attendant decentralization trend have been reflected in a marked increase in the share of nonconditional transfers (revenue sharing and block grants) at the expense of special purpose grants. The 1988 Constitution set specific criteria for revenue sharing, both among different levels of government and among different governments of the same level (see below). As a result of these trends, the federal government has seen the share of tax revenues at its disposal6 decline from about 66 percent at the beginning of the 1980s to about 54 percent by the mid-1990s. The corresponding shares of state and local governments have risen from 24.5 percent to nearly 29 percent (for the states) and from 9.5 percent to over 17 percent (for the municipalities) over the same period.

Revenue Sharing

The main vehicles for revenue sharing are two funds: the Fundo de Participação dos Estados (FPE) and the Fundo de Participação dos Municipios (FPM). The FPE is constituted with 21.5 percent of the net7 revenues of the three main federal taxes, namely the personal (IRPF) and corporate (IRPJ) income taxes and the selective VAT (IPI). The distribution of the fund among the states is fixed by a law of 1989 that determines a coefficient for each state. These coefficients are mainly based on redistributive criteria, which attribute higher weights to the three poorer regions (North, Northeast, and Center-West). The coefficients vary between 9.4 percent for the state of Bahia (the largest and most populous state in the Northeast) to 1 percent for São Paulo (the state with the highest per capita income). Altogether, the above-mentioned poorer regions account for 85 percent of the FPE.

The FPM is constituted with 22.5 percent of the net revenues of the income taxes and the IPI. Its distribution formula is more complex than that of the FPE. Specifically, 10 percent of the fund is distributed to the capitals of each state, 86.4 percent to other municipalities with populations of less than 156,216, and the rest to the remaining municipalities. Within these shares, the coefficient of each municipality is determined by two criteria: the state to which the municipality belongs and the size of its population (as determined by periodic census). The regional allocation of the FPM is less redistributive than that of the FPE, given the importance of population size in the formula. Accordingly, the combined share of municipalities in the three poorer regions is around 51 percent in the FPM, compared with 85 percent in the FPE.

In addition, the 1988 Constitution mandated the following:

  • Ten percent of the IPI be transferred to a fund (FPEX) intended to compensate the states for the loss of revenue entailed by the zero rating of exports of manufactured products under the ICMS. The distribution of this fund among the states reflects their relative shares in manufactured exports.
  • Three percent of the IPI be earmarked for the financing of investment credits to the private sector in the three poorer regions of the country.
  • The revenue from a tax on financial operations on gold be fully devolved to the states and municipalities in which these operations take place.
  • Fifty percent of the revenue from the federal tax on rural property (ITR) be devolved to the municipalities.

As regards revenue sharing between the states and the municipalities, the 1988 Constitution raised the percentage of the ICMS to be transferred by the states to the municipalities from 20 percent to 25 percent, and stipulated that 75 percent of these transfers should be distributed among the municipalities of each state on a derivation basis, that is, on the basis of the contribution of each municipality to the value added of the state. The balance is distributed according to criteria decided by the individual states.8

The mechanism of revenue sharing was temporarily amended in 1994, in preparation for the introduction of the stabilization plan (Piano Real), to reduce the earmarking of federal revenues, and the percentage of these revenues to be transferred to state and local governments. Specifically, a constitutional amendment created a special fund (Fundo Social de Emergencia, FSE) fed by various types for revenues9 that would not be subject to sharing or earmarking. The FSE expired at the end of 1995, but was extended—with the new name of Fiscal Stabilization Fund (Fundo Estabilização Fiscal, FEF)—through the end of June 1997 by a second constitutional amendment. It is estimated that this mechanism increased significantly the portion of federal revenues not subject to earmarking or sharing.


As indicated above, the weight of grants in total intergovernmental transfers has tended to decline over the last several years, reflecting the reaction of the federal government—in a context of growing fiscal stress—to the increase in the share of its revenues transferred to the lower levels of government, especially the municipalities. There remain, nevertheless, a wide variety of grants, some of a block, some of a special purpose nature, some more or less regular, others ad hoc (the so-called convenios). Grants are a main vehicle for federal funding of programs in the education, health, and social areas. Together with own spending by the federal government on education programs, they contribute to meeting the constitutional mandate that 18 percent of federal revenue be spent on education.10 The revenue of a special contribution levied on enterprise turnover (COFINS) is earmarked for the financing of health and other social programs, including—through the convenios—some programs carried out by state and local governments.

Some Weaknesses of the Current System of Intergovernmental Transfers

The brief overview above of the current system of intergovernmental transfers in Brazil points to a number of weaknesses in the system:

  • Some federal sources of revenue are subject to sharing with subnational governments, while others are not. This has led to undue reliance of the federal government on these latter sources, which tend to have substantial efficiency costs (for example, contributions on salaries or on enterprise turnover, or taxes on financial transactions);
  • The coefficients of vertical distribution are fixed in the Constitution, which has the advantage, from the standpoint of the recipient governments, of facilitating their budgetary and financial planning. However, this also imparts considerable rigidity to the federal budget, thereby constraining the scope for using the shared taxes as instruments of fiscal adjustment or stabilization.
  • The coefficients of horizontal distribution are the result of political bargaining, and bear no clear and systematic relation with either relative tax capacities and tax efforts, or relative expenditure needs of the individual states and municipalities.11
  • Although a quantitative assessment of the redistributive impact of block and special purpose grants across and within states is extremely complex (due to spillover effects, lack of adequate data, and so on), available studies suggest that the incidence of many of these programs has been both highly variable over time and not clearly related to the level of development of the states (see Barrera and Roarelli, 1996).

Subnational Borrowing and Debt

Past experience with borrowing by state and local governments in Brazil illustrates well the risk of a lack of limits and controls on such borrowing in an environment not conducive to the effective working of market discipline.


State borrowing, primarily to finance public infrastructure, began in earnest in the second half of the 1960s, and was initially financed mainly by federal financial institutions that channeled to state utilities and other state enterprises funds collected through a variety of forced savings schemes, based on payroll taxes. As these funds dwindled during the 1970s, reflecting the adverse impact of the first oil shock on the economy, resort by the states, as well as the federal government, to external borrowing increased sharply. This source of finance came, however, also to a virtual end in the early 1980s. These events, in combination with a deepening recession in the economy, led to widespread default by the states on the service of both their external and internal debt. After nearly a decade of negotiations and ad hoc interventions by the federal government, Law 7976 of 1989 and Law 8727 of 1993 formalized the rescheduling by the federal government of state debts to external creditors and to federal financial intermediaries, respectively. The debts were rescheduled over a 20-year period, with varying grace periods on payment of principal and somewhat more favorable interest rate terms, including an annual cap (initially 9 percent, later 11 percent) on the ratio of debt service to state revenues and automatic capitalization of debt-service obligations exceeding this cap.12

This rescheduling eased the cash flow problem of the states, by shifting onto the federal Treasury the cost of temporarily financing the difference between actual debt service and the cap. The evolution of interest rates and the revenue performance over the period of rescheduling will determine the size of the outstanding obligations for the states at the end of that period (the year 2013).

These debt rescheduling operations were not accompanied by firm steps to improve the budgetary performance of the states, in particular to rein back their noninterest spending, which continued to rise through the mid-1990s. The deterioration in the primary balance of the states was especially marked in 1995, when the fiscal dividends for disinflation were mostly dissipated through large salary increases to state and local employees.

The deterioration in the primary balance was accompanied by a rapid increase in real interest rates on nonrescheduled debt (mainly debt to state banks and bonds).13 With the service of this debt having come to a virtual halt, the capitalization of interest payments led to an escalation of debt. The domestic bonded debt of the states rose from the equivalent of 2.3 percent of GDP in 1991 to 5.4 percent of GDP by mid-1996. The withdrawal of private investors from the market for state bonds and the drying up of interbank lending to some state banks forced various forms of intervention by the federal authorities (including the Central Bank), which effectively shifted most of the default risk on these types of state debt onto the federal government.

In addition to their funded debt, a number of states accumulated various forms of so-called fluctuating debt, including short-term borrowing from commercial banks secured with future revenues (the so-called revenue anticipation loans, AROs), arrears to suppliers or employees, and guarantees (or comfort letters) for bank borrowing by contractors for state infrastructure projects. It is estimated that by the end of September 1996 the total indebtedness of the states and other public entities under their control had reached the equivalent of 17.5 percent of GDP.

Recent Developments

Growing concerns about the seriousness of the problem of state debt has led to a tightening of controls on new state borrowing in recent years. Specifically, central bank regulations now prohibit a state from borrowing from its own banks.14 This prohibition has been interpreted not to cover the increase of the debt resulting from the capitalization of unpaid interest. New issues of bonds (other than to refinance maturing ones) are prohibited by a constitutional amendment until the end of this decade. Senate Resolution 11 of 1994 sets guidelines restricting new borrowing on the basis of two criteria, relating to the size of borrowing and the coverage of the overall debt service.15 These guidelines appear, however, to be relatively generous, and not to be enforced consistently. In particular, they do not cover the growth of debt resulting from capitalized interest.

At the end of 1995, the federal government, through one of its large banks (the Caixa Economica Federal), set up lines of credit to provide short-term financial support to indebted states, in exchange for commitments by the latter to undertake fiscal adjustment programs (including a retrenchment of payrolls). Preliminary information suggests that, although some of the larger indebted states did indeed undertake initial adjustment steps, the overall financial position of the states continued to worsen in 1996, partly reflecting one-time expenditures in connection with the payroll retrenchment and a clearance of wage arrears.

A more comprehensive approach to the restructuring of state debt was undertaken in the last months of 1996, through the negotiation of federal-state agreements. These involved the following:

  • The replacement of state debts to banks and of bonded debt with debt to the Treasury, mostly of 30-year maturity and with a real interest rate of 6 percent16 a year, well below current average levels. In addition, the agreements contemplate a cap of 13 percent (15 percent for some states) in the annual debt-service ratio, with automatic rescheduling of service in excess of this cap.
  • The sale of state assets (mainly state-owned enterprises and banks) equivalent to at least 20 percent of the debt.
  • Commitments by the states to adjustment programs aimed at securing a reduction of the ratio of the state debts to their projected revenues to a maximum of 100 percent within a prespecified period (ranging from 6 to 19 years, depending on the state).

Once approved by the federal and state legislatures, the agreements will involve a pledging of own and shared revenues of the states as guarantees to the federal government for the scheduled service of the restructured debt. About 16 such agreements had been signed by early 1997.

These agreements represent an important step in the right direction in addressing the problem of state debt in Brazil. Especially positive features are the provision for privatization of state banks and enterprises, with the proceeds used to reduce the debt, and the stipulation of guarantees for the federal government, through the pledges of state revenues. Nevertheless, the agreements remain so far rather unspecific regarding the adjustment measures that the states will need to take to reduce their debt-revenue ratios within the prespecified (for the major part, relatively lengthy) periods. Moreover, the stipulation of a cap on debt-service payments creates an undesirable element of moral hazard.

As part of the effort to strengthen the state finances, the federal government has recently begun an active program of technical and financial assistance (with the support of international financial institutions) to modernize the tax administration and financial management systems of the states. This effort should help the states improve the management of their finances, as well as ensure the availability of more timely and reliable information on developments in the latter.

Concluding Remarks

This brief review has made it clear that Brazil’s system of intergovernmental fiscal relations has both positive and negative elements. On the positive side, the Brazilian states, and to a lesser extent the municipalities, have substantial own revenue-raising powers, a fact that should foster fiscal responsibility and political accountability for their budgetary policies. The current system of tax assignments is, however, inconsistent in some respects with the received wisdom in the literature and with prevailing international practice in this area.

In particular, the coexistence of a broad-based state VAT with a more narrowly based multirate federal VAT is awkward and has given rise to cascading and distortions in the tax burden across sectors and localities. Also, the state VAT is plagued by erosion of the base and by substantial difficulties in administration. A reform of the entire VAT system along the lines proposed by the federal government in late 1995 would address many of these weaknesses. Any move away from the current origin-based system would have, however, substantial implications for the distribution of revenue and is unlikely to be accepted by the losing states, unless accompanied by compensating measures. Such measures could involve, for instance, changes in the current system of horizontal distribution of shared revenues.

A more fundamental reform—but one that may be less acceptable to the states and municipalities—could involve replacing the existing system of sales and excise taxes with a more standard VAT with a single rate or two rates, levied at the federal level on a broad base including services, with the proceeds shared with states and municipalities on a derivation basis, and complemented by a narrow range of excises. To provide them with a degree of fiscal autonomy, the states could be assigned the personal income tax, or a part thereof (with a piggybacking mechanism), while maintaining the existing vehicle taxes. The municipalities should have full control of the bases for property taxation, and could also be allowed to levy a modest surcharge on the personal income tax, as well as business license fees.

Given the existing wide disparities in income levels, tax capacities, and expenditure needs across states and municipalities, intergovernmental transfers aimed at equalization will need to continue to play an important role in Brazil in the foreseeable future. The present system of revenue sharing is based on rigid coefficients, for both vertical and horizontal distribution, which are not based on transparent criteria linked to tax capacities, tax efforts, and expenditure needs. A reform of the intergovernmental transfer system should ideally aim at:

  • Eliminating the incentives that the system currently provides to the federal government to rely on nonshared but distortive taxes.
  • Introducing elements of flexibility in the coefficients of vertical distribution, to help smooth out the impact of cyclical fluctuations in revenues.17
  • Redesigning the criteria for horizontal distribution, to gear the amount of transfers to each subnational jurisdiction to allowing it to provide an average level of the services it is responsible for, with an average degree of tax effort.18

A reform of this type would be a medium- to long-term project. It would necessitate as preliminary steps a clearer definition of expenditure responsibilities assigned to each level of government and a major effort to gather, on a systematic basis, the information needed for a realistic assessment of tax capacities, efforts, and expenditure needs (see Appendix of Chapter 4 for details). In the shorter run, more approximate indicators of tax capacities and spending needs could be utilized, such as those used in other countries surveyed in this book,19 to introduce greater transparency and a more explicit equalization orientation into the system. Brazil could also consider the creation of an independent commission (such as those in Australia and India) to regularly monitor and advise on the implementation of a reformed, more transparent and flexible, system of intergovernmental transfers.

Brazil’s experience until recently with state debt illustrates well the dangers of a lack of control on subnational government borrowing, in a situation where the conditions for the effective working of market discipline are not present. The steps already taken by the authorities to restrict such borrowing and to link the restructuring of past debts with adjustment programs of the states are certainly in the right direction. Firm political will—at the federal as well as the state levels—will be needed to ensure that these programs are strictly adhered to over the short and the medium term. The successful implementation of certain needed structural reforms (in particular of the civil service and of the social security system, as well as the privatization of financial and nonfinancial public enterprises) would greatly help the targeted adjustment in the finances of all levels of government in Brazil.

The author wishes to thank Trevor Alleyne, Adrienne Cheasty, Isaias Coelho, João Oliveira do Carmo, Lorenzo Perez, Tej Prakash, and Gerd Schwartz for useful information and comments.


The states are grouped, mainly for analytical purposes, into five regions: North, Northeast, Center-West, South, and Southeast. These regional groups are also relevant for the distribution of certain transfers from the federal government.


The Constitution stipulates that any newly created municipality must receive transfers from the federal and state governments adequate to ensure its basic functions. These transfers are, however, financed through a redirection of funds previously allocated to other municipalities in the relevant state.


18 percent in three states.


Tax preferences under the ICMS have to be approved unanimously by a committee of the Secretaries of Finance of the states (CONFAZ), chaired by the Deputy Minister of Finance. The unanimity rule has helped moderate, but far from eliminated, the proliferation of preferences under the ICMS.


Specifically, the proposed system would work as follows. Under the hypothesis of a move to a full destination principle, intrastate transactions and imports from abroad would be taxed under the federal and the state-level VAT in the stare of the ttansactions. Exports abroad would be zero rated under both taxes. Exports to another state would be subject to a VAT levied federally at a rate equivalent to the sum of the rates of the federal and state VATs. Imports from another state would pay both the federal and the state VAT in the state of destination, but the importer would be entitled to a credit for the combined VAT paid by the exporter. Under this scheme, the full revenue of the state VAT would accrue to the destination state. The system could be adjusted to allow for different revenue sharing between the states of origin and destination by modifying the respective rates of tax, and adjusting correspondingly the federal component of the combined rate.

The proposed system would eliminate the scope for evasion created, under the current system, by the differential in the rates levied on intrastate and interstate transactions. To remain administratively manageable, it would require uniformity of the state VAT rates across the country, as well as little or no differentiation of the rates by type of commodity. See Varsano (1996) and Silvani and dos Santos (1996) for further details.


For each level of government, this is defined as the ratio of own tax revenues (plus revenue shared with upper levels, minus revenue shared with lower levels) to total tax revenues. It is an indicator of relative fiscal autonomy of each level of government.


Net revenues exclude refunds and fiscal incentives.


These included, among others, income taxes withheld on the salaries of federal employees, a social contribution (PIS) paid by financial institutions, the revenue from an increase in the rate of another contribution paid by the same institutions, and 20 percent of federal revenues transferred to the FPE and the FPM.


In addition, the full revenue of a special 2.5 percent payroll tax (the so-called contribução do Salario-Educação) is earmarked for elementary school education.


For example, there appears to be no clear relation between the level of transfers per capita from the FPE to the different states and the level of per capita income, or indicators of tax efforts or of expenditure “disabilities” of the state.


See the World Bank (1995) and Oliveira do Carmo (1996) for a more detailed account of developments in state debt during the 1980s and early 1990s.


These debts are especially concentrated in four large states: São Paulo, Rio de Janeiro, Minas Gerais, and Rio Grande do Sul.


The prohibition does not extend to borrowing from other state banks. This represents a loophole, which, however, does not appear to have been significantly exploited to date.


Specifically, in any particular year, new borrowing should not exceed the total debt service for the year or 27 percent of revenue, whichever is greater, and total debt service (including on the new borrowing) should not exceed the state’s current surplus for the previous year or 15 percent of its revenue, whichever is less.


The rate is 7.5 percent a year for some states that have chosen to limit the sale of assets to 10 percent of their outstanding debt.


At a rate of 7.5 percent a year for some states that have chosen to limit the sale of assets to 10 percent of their outstanding debt.


A system of this type is implemented, among others, in Australia (see Chapters 4 and 8).


See, for example, the chapters on Canada, Germany, Japan, and Korea.


    Affonso, R.,1995, Os Estados e a Descentralização no Brasil (unpublished;December).

    Affonso, R., andP.L.Silva,eds., 1995, A Federação em Perspectiva: Ensaios Selecionados–FUNDAP (São Paulo).

    Affonso, R., andP.L.Silva,eds., 1996, Reforma Tributável e Federação–FUNDAP–UNESP (São Paulo).

    Afonso, J.R.,1994, Descentralização Fiscal na América Latina: Estudo de Caso do Brasil, Serie de Política Fiscal No. 61 (Santiago: United Nations Economic Commission for Latin America and the Caribbean).

    • Search Google Scholar
    • Export Citation

    Afonso, J.R., andJ.C.Ramundo,1996, Federalismo Fiscal no Brasil–Breves Notas–Ministério da Fazenda–Seminário sobre Gestão da Despesa Púbica (Brasília, March).

    • Search Google Scholar
    • Export Citation

    Barrera, A.W., andM.L.Roarelli,1996, “Relações Fiscais Intergovernamentais,” in A Federação em Perspectiva: Ensaios Selecionados–FUNDAP, ed. by R.Affonso andP.L.Silva (São Paulo).

    • Search Google Scholar
    • Export Citation

    Oliveira do Carmo, J.,1996, “Controle do Endeudamento dos Governos Estaduais e Municipais,”paper presented at the first Seminar on Public Finance (Brasília, September).

    • Search Google Scholar
    • Export Citation

    Silvani, C., andP. dosSantos,1996, “Administrative Aspects of Brazil’s Consumption Tax Reform,”VAT Monitor, Vol. 7, No. 3 (May/June).

    • Search Google Scholar
    • Export Citation

    Varsano, R.,1996, “A Proposta de Reforma Tributária em Discussão no Brasil,”paper presented to the Eighth Regional Seminar on Fiscal Policy of CEPAL (Santiago, January).

    • Search Google Scholar
    • Export Citation

    World Bank, 1995, Brazil State Debt: Crisis and Reform Report (Washington, June).

    Other Resources Citing This Publication