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# Box_2: BRAZIL: A RECENT CASE OF FISCAL DECENTRALIZATION

Background. The new Constitution promulgated on September 20, 1988, bears significant fiscaL consequences for Brazil. The whote tax system is being restructured and the revenue position of both the State and Municipat governments is expected to improve substentialLy due to increasing transfers and the devolution of considerable fiscal authority from the federal to the sutnational levels. This is especially interesting because Brazil, by Latin American standards, did not present an extreme case of centralization.

Main Features. The federal level is now restricted to seven taxes: Income (R), Industrial Production CIPI), Rural Property (ITR), Imports **(II),** Exports (IE), Financial Operations (IOF), and Large Patrimonies tIGF). The yield of the first two sources Is earmarked for revenue sharing with the subnational governments. The State level gains from the inclusion of fuel, energy, transport and communications In the base of Value Added Tax tIChTC) and acquires the faculty of piggy-backing the federal Income Tax (IR) with a 5 percent surcharge. The MunIcioal level increases its share of the ICMTC from 20 to 25 percent and has the authority to charge real estate transactions (ITIVBI), to introduce a fuel tax (IVVC) and to levy betterment charges in conmection with capital inprovements.

The new fiscal system is expected to produce an overall increase in tax revenues on the order of 3.2 percent (about half point of GDP) by FY 1993, but the federal goverrment's disposable Income (after revenue sharing and social security cortributions) wtil contract by 15.6 percent, the equivalent of 1.05 percent of GDP. In turn, the States revenues will increase by 12.9 percent (.73 percent of GDP) and those of the Municipalit es by 29.5 percent (.81 percent of GDP). The displacement of 1 1/2 points of GDP in the general goverrnent budget represents a rather drastic reversal of the historical trend from 1957 onwards which saw the federal government increase its participation in general tax revenues from 50 to 62 percent while the States and Municipal shares had declined from 44 to 34 percent and frwa 7 to 4 percent respectively. The new proportions will be 36.5, 40.7 and 22.8 percent for the Federal, the State and the Municipal levels. Soatial Iffmact. Simulations of the 1993 distribution of transfer resources, coupled with the expected increases in tocal revenues indicate measurable gains for the Northern and Northeastern States which will receive consistentLy higher increases than the 12.6 percent average State of Brazil, although also the State of Rio (23.7 percent) and the Federal District (+17.8 percent) will fair exceptionally well. The average Municipality of Brazil will record a +32.2 percent increase in revenues, based on additional federal and state transfers (+33.1) and on new independen **t** ax sources C+23.9). Per capita tax income In sample Municipalities would rise between 25 and 50 percent (especially in small and medlum size cities). There is, however, a danger that much of the new resources be used to foster growth of current expenditures.

Imoact on National Accounts. The heavy requirements of revenue sharing and the loss of some tax bases will limit the budgetary flexibility of the central government. Additional budgetary pressures will arise from the new Constitution: On the exoenditure side, incremental public outlays will be required by the following:

- (a) universal social security coverage;

- (b) more fringe benefits granted to workers and civil servants as well as to non active personmel;

- (c) higher tax shares earmarked for education, health and family/children assistance;

- td) aduinistrative costs related to new, state-level functions, and to the establishment of four new States;

- (e) expenditure growth associated with the 1988 and 1990 elections.

On the revenue side, shortfalls may be produced by:

- (a) tax exemptions, rebates and deferred payment allowances;

- (b) reduced control by the central fiscal authorities;

- (c) credit subsidies to the productive sectors Ca 3 percent share of the main federal taxes (ZR and IPI);

- td) failure to incorporate many services In the State collected ICNTS; and

- (e) doubtful effectiveness of the federal tax on large patrimonies t:GF).

- Possible Fiscal Adiustments. The loss of resources of the Federal goverrment could be offset by the following: (a) expanding the IR and IPI coverage so as to compensate for the loss of other subnational contributions;

- (b) redL2ing current exemptions from these taxes (especially on agricultural Income and capital gains);

- Cc) conditioning transfers to States and Municipalities to the payment of the corresponding credit obligations;

- (d) eliminating Onegotiated" or "discretionary" transfers;

- Ce) tying social security contributions to the gross profiz of enterprises;

- (f) staging the social benefits expansion over several years.

Coctcusions. Many questions remain, which need to be settled through the elaboration of a new regulatory framework. While no fixed calendar has been established for this second stage (except for the revenue sharing system), the foltowing still await definition:

- (a) norms for the Imposition of the income tax (IR)

- (b) rationing criteria for the territorial distribution of the participation funds;

- tc) establishment of a new Tax Code;

- (d) rutes and procedures for the decentralization of public service functions;

- (e) redefinition of the budgetary categolies in public aecounvs;

- (f) establishment of a Public Finance Code, especially for the control of debt of States and Municipalities.

- I/ Abstract of IPEA paper No. 121 by F. Rezende and J.R.R. Afonso, November 1987. IPEA produced the initial design upon which the wide ranging constitutional debate was subsequently based.