The large increase in tax sharing mandated by the 1988 constitution prompted some observers to fear for Brazil's macroeconomic stability. There was concem that the increase in tax sharing would provoke federal deficits, unless the federal government could cut its ordinary (nontransfer) expenditures by an equivalent amount or raise federal taxes proportionately.

At the outset, this situation seemed likely to happen. President Collor's initial attempts to forestall this scenario failed. Under the rubric of Operagao Desmonte, Collor proposed a program of expenditure decentralization intended to match the new division of revenues. This was rejected by congress. In fact, it had very little support anywhere in the public sector. "Reducing the size of the federal government ran aground on the corporative resistance of the federal employees, the sectoral agencies, the executive branch, and principally the federal congress. All, in the end, had no intention of giving up the power to fill positions, contract staff, manipulate budget allocations, distribute subsidies, build works, and to lure the support of government, mayors, congressmen, and local leaders" (Afonso 1994).

Nevertheless, fiscal adjustment ultimately occurred at the federal level. Part of the adjustmen **t** ook place on the expenditure side in the early 1990s. Having failed to decentralize federal functions formally, the federal governument succeeded in off-loading the responsibility for certain expenditures onto subnational governments on an ad hoc basis. The federal suburban railways in S3O Paulo and Rio de Janeiro were transferred to their respective state governments, for example. Certain federal highways were also transferred to the states. In Rio de Janeiro, federal hospitals were transferred to the state and municipality. The federal government also managed to off-load some health care costs onto subnational governments by reducing the amount of federal compensation payments. Federal discretionary transfers to subnational govermments also fell.

**Table 6. Trends in Subnational Revenues and** Expenditures in Brazil, 1991-97

||(I|n percent of|GDP)|||||
|---|---|---|---|---|---|---|---|
|_Type of revenue_|_1991_|_1992_|_1993_|_1994_|_1995_|_1996_|_1997_|
|Federal Government||||||||
|Current Revenues|15.9|14.8|16.5|18.6|19.2|17.8|18.6|
|CurrentExpenditures|15.5|14.1|14.3|15.9|18.6|17.6|18.0|
|Capital Expenditures|2.7|1.0|1.4|1.0|0.8|0.8|0.9|
|Primary Surplus (deficit)|0.9|1.3|1.4|3.1|0.6|0.4|(0.3)|
|<br>Operational Surplus (deficit)|0.3|(0.8)|0.0|1.6|(1.6)|(1.7)|(1.8)|
|State and Municipal<br>Govemments||||||||
|Current Revenues|14.2|12.9|12.8|13.6|13.6|13.0|14.3|
|Taxes|8.5|7.9|7.6|8.5|7.2|7.3|7.0|
|Nontax revenue|2.4|1.6|1.7|_1.5_|2.8|2.0|3.3|
|National transfers|3.3|3.4|3.5|3.6|3.6|3.7|4.0|
|Current Expenditures|12.7|12.2|12.4|11.5|11.4|12.1||
|Capital Expenditures|2.3|2.1|2.1|1.9|1.9|1.6||
|Primary Surplus (deficit)|_1.5_|0.4|0.6|_0.5_|(0.2)|(0.6)|(0.7)|
|Operational Surplus (deficit)|1.3|(0.8)|0.3|(1.0)|(2.3)|(1.9)|(2.3)|

_Source: IMF,_ Brazil Recent Economic Developments Feb 1997 and April 1998; 1996-97 Bank staff estimates.

The politics of this process were complex and relied heavily on federal inducements. To persuade Sao Paulo and Rio to accept the suburban railway systems, for example, the federal government had to 21