Annex I. System of Intergovernmental Transfers
The main intergovernmental transfers are as follows:
States and Federal District Participation Fund (FPE)
Municipalities Participation Fund (FPM)
Maintenance and Development of Basic Education and Education Professionals Enhancement Fund (FUNDEB)
Royalties (financial compensation for natural resources exploration: oil, water, mineral resources)
Transfers under the National Health System (SUS)
Manufactured Products Tax Relative to Exports (Lei Kandir)
The FPE depends on a historic value and certain coefficients based on population and per capita income. The value was based on fixed coefficients from 1989 until 2015. The new FPE (Law nº 143/2013) established the two criteria for its evolution, in place since 2016: the amount received by each state in the same period in 2015 corrected by inflation and 75 percent of Gross Domestic Product change. Specifically, the FPE is distributed annually as follows: if the reference value (based on the 2015 level) is less than the amount of the resources (21.5 percent of IR and IPI), the reference value will be transferred to the states based on the coefficients defined in the Supplementary Law nº 62/1989; the rest will depend on the coefficients annually defined by the Brazilian Federal Court of Accounts (TCU). These coefficients are based on population and per capita income.
The transfers to municipalities depend on population and per capita income. In the case of state capitals, the distribution criteria depend on population and the inverse of per capita income (considering the state GDP). For the rest, population is the main criterion, but the coefficients for the municipalities of each state are fixed since 1989. For the group with more than 156,216 inhabitants, the distribution criteria are population and the inverse of per capita income (considering the state GDP).
States and municipalities also receive funds from Fundeb that are earmarked for education. The resources come from 20 percent of the following sources:
tax on inheritance and donation of any property or right (ITCMD)
tax circulation of goods and provision of interstate and intermunicipal transportation, services and services of communication (ICMS)
tax on property of motor vehicles (IPVA)
tax on rural real estate property (ITR)
tax on manufactured products (IPI)
transfers foreseen in the Supplementary Law nº 87/1996 (Lei Kandir).
The federal government supplements the resources of the funds with 10 percent of the total amount of revenues defined above. Every state and the federal district has its own fund (27 accounting funds). The criteria for distribution among municipalities are the numbers of students enrolled in infant education and in elementary and high school education; at least 60 percent of the FUNDEB expenses must be applied to improve teachers’ salaries. The criteria are calculated every year, and so they reflect the changes in the variables.
There are also transfers related to the health care system that depend on several factors, including regional characteristics, such as demographics and the quantitative and qualitative characteristics of the health care network.
Finally, there are also transfers from states to municipalities: 25 percent of the main state tax (value added tax, ICMS) and 50 percent of the tax on property of motor vehicles (IPVA).
Annex II. Spain’s Strategy to Control Spending Arrears
Considering the weight of small and medium enterprises in Spain, curbing late payment in public administrations has been one of the goals of Spanish economic policies in recent years and has played a fundamental role in the economic recovery.
The Spanish strategy for clearing expenditure arrears started with the reforms implemented in 2012, in the worst times of the economic crisis, within a context of severe liquidity restraint in financial markets and with public administrations whose late payments further aggravated the economic slowdown. According to the Bank of Spain, the aggregate commercial public debt grew from 57.1 billion euros (5.3 percent of GDP) to 87.3 billion euros (8.1 percent of GDP) between 2007 and 2011. Although this rise in the stock of public debt took place at all levels of administration, it was more concentrated in SNGs, autonomous communities, and local entities, whose debt accounted for 75 percent of the total in 2011.
The Spanish strategy is based on two types of measures32: some are of a temporary nature to clear the stock of arrears at the time, and others are of a structural nature to avoid the problem in the future:
The extraordinary funding mechanisms, such as the Payments to Suppliers Fund and the Autonomous Communities Liquidity Fund, aimed at reducing the temporary component of the arrears and clearing the stock of commercial debt. The Payment to Suppliers Fund mobilized around €)30 billion from the central government to suppliers of SNGs; the total in loans from the extraordinary funds is well above €)250 billion as of today. Those governments were required to sign 10-year loans with the central government. Those loans included conditionality and monitoring of the fiscal performance through the adjustment plans, which had to be in place until the loans were fully repaid.
The transparency of the indicator average payment periods (APP) of the administrations has played a fundamental role in creating incentives for them to curb their late payments. Even though the Spanish law contains a legal definition in line with the EU Directive on late payments and therefore establishes a 30-day legal limit on payments to suppliers in the public sector, the Spanish law built a system of obligations for the administrations similar to fiscal rules, around the APP indicator. Irrespective of its size, every government must construct its APP with a common methodology established by the law. The APP is an average that considers both the stock of accounts payable and the time used in the payments made in the past month. The Basic Stability Organic Law establishes a system of sanctions similar to those applying to fiscal rules of SNGs. In cases where the APP exceeds a certain limit, preventive, corrective and coercive measures apply progressively. In cases where a government is unable to reduce the APP, the central government can ultimately block payments from the regular system of transfers to SNGs, to pay that government´s suppliers directly and deduct the amount from the transfers.
One of the key elements of the system is the transparency of the APP. It is monitored by the central government and published on the Minister of Finance’s website every month. These publications have an important impact on local media and force discipline on the managers. An example of a local news release is available at the following website:
Annex III. Spanish Regions’ Progressive Return to Financial Markets: Back to Normal
In 2012, the Spanish Central Government created a system of loans to solve the severe liquidity restraints of the subnational governments (regions and municipalities). Subnational governments had seen their revenues fall dramatically after the 2009 crisis and access to financial markets closed, leading them to accumulate important stocks of debt in arrears. The system of loans was designed to clear this stock of arrears, fund the deficit target of the subsequent years (to avoid new accumulation of arrears in a time when there was no access to financial markets), and fund the debt service of SNGs. It transferred the lower cost of borrowing of the Central Government to SNGs, which signed 10-year contracts with a grace period of two years of no interest and which were subject to strong conditionality. The system has mobilized a total amount of €)277 billion.
Financial conditions have changed since the inception of the system. SNGs are in a much better situation; most municipalities are in a surplus position. Financial markets are willing to lend again to subnational governments, which would benefit from low interest rates and which are in a better position to honor their debt service.
For these reasons, the Central Government approved an agreement that established the rules governing a progressive return of the regions to financial markets, on July 5, 2018. This agreement is independent of the current regime of authorizations by the Central Government, applicable in certain cases; these cases include issuance of bonds, use of foreign currency instruments, and noncompliance with the fiscal rules as an automatic corrective measure and when debt service is high relative to current revenue. The agreement only establishes the rules applicable to the combination of borrowing from the markets and borrowing from the Central Government.
The strategy should be transparent and known by the markets.33 The return to markets is likely to be gradual, considering the short average maturity of the debt of the regions and the accumulation of amortizations in the coming years. The regions starting this transition should be those in a better position to access a wide range of institutional investors and those with the most favorable financial conditions. For these reasons, several criteria were required to start the process. These conditions were linked to compliance with fiscal targets in previous years, presenting a low average payment to suppliers, and having a minimal credit rating of investment grade. If the region met these requirements, it had to present a three-year Multiannual Debt Plan, to be assessed by the Ministry of Finance and the Treasury to determine its feasibility.
In the future, all of the regions are expected to gradually return to the financial markets. The transition should be monitored so that it is a one-way transition, reducing the possibility of remaining in the extraordinary funds in the medium to long terms. In this context, it is under consideration to establish a temporary transition fund with a fixed end date of, for example, three to five years; after this period, the region should obtain funds only from markets. The future of the current extraordinary mechanisms would be as a last resort instrument in cases of severe unexpected financial distress; it would bbe linked to strong conditionality and punitive interests and only used as a last-resort option.
The 1988 Constitution assigns exclusive powers to the federal government (including national defense, social security, issuance of currency, control of public debt, and regulation of interstate and foreign trade), and concurrent responsibilities shared with states (including taxes, education, and social assistance). States are granted the powers not prohibited in the Constitution, and municipalities are elevated to federal entities.
See IMF. 2019. “Technical Assistance Report: Strengthening the Framework for Subnational Borrowing.” IMF Country Report No. 19/302, Washington, DC, September.
See the Brazilian National Treasury “Boletim de Finanças dos Entes Subnacionais” (2019).
Firjan’s report “Índice Firjan de Gestão Fiscal” (2019).
The National Treasury calculates the indicator with a consistent methodology across all states and in line with the FRL. See National Treasury. 2019. “Boletim de Finanças dos Entes Subnacionais.”
See IMF. 2019. “Technical Assistance Report: Strengthening the Framework for Subnational Borrowing.” IMF Country Report No. 19/302, Washington, DC, September.
The FMIS vary across states and municipalities and do not usually follow the federal system.
Some also question whether the National Treasury has the authority to impose the standards, given the autonomy of the different levels of government.
There are 33 Courts of Accounts, including those of the state, four for the municipalities, one for the city of São Paulo, and one for the city of Rio de Janeiro.
A study on the activities of the state Court of Accounts identified many decisions that contributed to weaken the FRL. See Nunes, S. P. P., G. F. Marcelino, and C. A. T. Silva. 2019. Os Tribunais de Contas na interpretação da Lei de Responsabilidade Fiscal. Revista De Contabilidade E Organizações, 13, e145151. https://doi.org/10.11606/issn.1982–6486.rco.2019.145151.
As noted by the International Organization of Supreme Audit Institutions (INTOSAI), it is critical to ensure the independence and professionalism of the audit institution.
In recent years, at least four highly indebted states (Goiás, Minas Gerais, Rio de Janeiro, and Rio Grande do Sul) and one less indebted state (Amapá) have obtained injunctions from the Supreme Court to suspend debt service payments and/or to prevent the execution of collaterals on debt guarantees. Echeverria (2019) provides a comprehensive analysis of the legal impediments for the federal government to execute collaterals on such guarantees. See Echeverria, Andrea. 2019. “O Árbitro da Federação Pode Influenciar o Jogo do Resgate? O Impacto da Jurisprudência Federalista do STF na Crise Fiscal dos Estados Brasileiros,” Ph.D. Dissertation, Centro Universitário de Brasília.
Subnational governments administer pension plans for their own public employees. The aggregate deficit of these systems has widened over time, reaching 1.4 percent of GDP in 2017. Looking forward, partly driven by population aging and absent a pension reform, the deficit of the subnational pension systems is projected to increase to 2.9 percent of GDP by 2030.
See Annex 1 for a summary of the intergovernmental transfer system.
See Flynn, Suzanne, and Mario Pessoa. 2014. “Prevention and Management of Government Expenditure Arrears.” Technical Guidance Note, IMF, Washington, DC.
For example, the state Court of Accounts of Parana sanctioned the secretary of finance for unduly canceling RAPs in 2015 related to recurrent expenditures; canceling RAPs in 2015 and subsequently registering them in 2016 as expenditures of past exercises (DEA) in 2016; and recognizing as DEA in 2016 expenditures effectively done in 2016 but not registered.
Campos da Silva, Claudiane, Carlos Eduardo Chagas Batista, and Valeska Farias da Silva. 2017. “Despesas de exercícios anteriores (DEA) como instrumento de gestão de resultados fiscais nos estados brasileiros.” In Revista do BNDES 48:105–58. https://web.bndes.gov.br/bib/jspui/bitstream/1408/13854/1/RB%2048%20Despesas%20de%20exerc%C3%ADcios%20anteriores%20%28DEA%29%20como%20instrumento%20de%20gest%C3%A3o%20de%20resultados%20fiscais%20nos%20estados%20brasileiros_P_BD.pdf.
Spain is an example of a country with a strategy to deal with arrears by SNGs at a time of economic crisis. See Annex 2 for details.
In 2014, the federal government conceded to SNGs a retroactive debt relief estimated in near R$ 100 billion (1½ percent of GDP). In 2016, the federal government reduced the debt service payments of SNGs for 24 months while extending the repayment schedule by 20 years. This measure is estimated to have reduced SNGs’ debt service by R$ 50 billion. In exchange, the federal government required states to adopt a spending cap for two years, with mixed evidence of compliance.
The process could be gradual to ensure that SNGs return to markets with a sound strategy. See Annex 3 for the example of Spain.
For more details on these proposals, see IMF. 2019. “Strengthening the Framework for Subnational Borrowing,” Technical Assistance Report, Washington, DC.
In recent years, several states have stopped paying their debt to the federal government or have stopped paying debt service on debt guaranteed by the Union.
Subnational spending caps can also facilitate taxpayer oversight and enhance credibility. Sutherland, Douglas, Robert Price, and Isabelle Joumard. 2006. “Fiscal Rules for Sub-Central Governments: Design and Impact,” Working Paper 1, OECD Network on Fiscal Relations across Levels of Government, OECD, Paris.
The four highly indebted states are Minas Gerais, Rio de Janeiro, Rio Grande do Sul, and São Paulo. In addition, three smaller states have somewhat high debt-to-revenues ratio: Alagoas, Goiás, and Santa Catarina. Together, these seven states account for more than 80 percent of the total subnational debt outstanding.
The debt ratio could be set to the average level of revenues (for example, over the past five years) or to a level of revenues consistent with a long-term average revenue growth (for example, over 10 years). Doing this would avoid large fluctuations in the debt ratio due to temporary volatility in revenue.
Balanced budget rules in different forms are common in OECD countries. In practice, rainy day funds are used together with nominal budget balance rules, mainly by SNGs in federal countries. This is the case for 48 US states and state and local governments in Canada, Mexico, and Sweden.
Given the complexity of Brazil’s federative system and the uneven technical capacity across states and municipalities, the latter entities could be expected to adhere to the state-specific primary spending cap rule.
That is, there should be caution with respect to linking expenditure growth to the behavior of oil prices in recent years. The analysis should focus on longer trends and take into account the fact that oil resources are nonrenewable.
The baseline scenario reflects actual data. The spending cap scenario assumes primary expenditures growth at a constant annual growth rate of 5 percent from 2010 onward (similar to Pernambuco’s own average over 2001– 09). In the calibration of the primary target rule, we replace the actual primary-to-revenues ratio from 2010 onward with a constant ratio of 3 percent (similar to Pernambuco’s average over the previous six years).
For example, a local government may receive support from the state or the Union to deal with a natural disaster and, as such, may be able to manage the shock without the use of the escape clause.
For more information on the Spanish strategy, see Gonzalez, Fernando. 2018: The Management of Government Expenditure Arrears in Spain (Instituto de Estudios Fiscales): https://www.ief.es/docs/destacados/publicaciones/documentos_trabajo/2018_06.pdf.
The press release on the July 5, 2018, agreement is available at the following website: https://www.hacienda.gob.es/Documentacion/Publico/GabineteMinistro/Notas%20Prensa/2018/S.E.%20HACIENDA/1-07-18%20CCAA%20Mercados%20Financieros.pdf