The opinions expressed in this report are those of the authors and do not necessarily represent the opinions of the World Bank.
Abstract
Fiscal Management in Federal Democracies:Argentina and BrazilIn the 1980s, Argentina and Brazil faced similar problems, with subnational deficits adding to excess public deficits and high inflation. In the 1990s both countries continued with fiscal decentralization and with the struggle to bring about macroeconomic stability. At least up to 1998, Argentina had greater success, partly because the country imposed a harder budget constraint on the public sector at the national level and partly because it had stronger party control of the subnational governments and of the national legislators. For restraining local and state borrowing, getting the right incentives for subnational governments and particularly for their creditors proved more effective, in Argentina, than central government rules, in Brazil. Decentralizing public finances has many advantages but also raises potential problems, especially in the area of fiscal management. One problem arises mainly during and soon after the transition to fiscal decentralization, when the central government, unless it reduces spending or increases its own tax resources, tends to have higher deficits as it shifts fiscal resources to subnational governments, via transfers, revenue sharing, or delegation of tax bases. Reducing spending is hard not only because cuts are always hard but also because subnational governments might not take on the tasks anticipated, leaving the central government with a legal or political obligation to continue spending for certain services. The second problem arises after decentralization, when the local or state government faces popular pressures to spend more and tax less, creating the tendency to run deficits. This universal tendency can be especially problematic if subnational governments and their creditors expect or rely on central government bailouts. Econometric evidence from 32 large industrial and developing countries indicates that higher subnational spending and deficits lead to greater deficits at the national level (Fornasari, Webb, and Zou 1998; see also Treisman 1998).This report investigates how these problems arose in Argentina and Brazil as they sought to decentralize in the 1980s and how each country dealt with them. We seek to understand the institutional arrangements-fiscal and political-that contributed to success or failure.Argentina and Brazil have two of the most decentralized public sectors in Latin America and, along with Colombia and India, are the most decentralized democracies in the developing world. Subnational governments (SNGs) account for about half of public spending and are vigorous democracies in most jurisdictions, especially the largest. In both countries in the 1980s, the return to democracy revived and strengthened long-standing federal practices while weakening macroeconomic performance, resulting in unsustainable fiscal deficits, high inflation, sometimes hyperinfla...
