which nevertheless tends to be of a limited scope at the sub-national level, but also, and more importantly, to avoid disruption in the financing of public investment in bad times.<sup>19</sup> In this regard, evidence provided by Sorensen _et al._ (2001) suggests that the states that have relatively tight balanced-budget rules seem to have less pronounced swings in both revenue and expenditure over the business cycle than the states with less stringent fiscal rules.

# **_4.2 Overview of Brazilian municipal finances: a focus on infrastructure investment_**<sup>**_20_**</sup>

19. There are several constraints to the ability of Brazilian local governments to boost spending on infrastructure investment. They range from institutional provisions on the assignment of expenditure functions across and within the different levels of government to a lack of budget flexibility, against a backdrop of increasing downward rigidities in current spending and on-going fiscal adjustment.

20. On institutional constraints, the Brazilian Constitution empowers the local governments to delegate to the private sector, often through concessions, the provision of local services such as urban transportation, and water and sanitation. These services, together with housing and urbanization, are provided primarily by the municipalities (Table 2). Other services requiring considerable infrastructure investment, such as inter-municipal transport and gas distribution, are under the purview of the states, whereas energy, telecommunications and inter-state transportation, among others, are assigned to the federal government.<sup>21</sup>

- 19 . This is consistent with the evidence reported by Bohn and Inman (1996), which, although sensitive to the cyclical indicator used to gauge fiscal responsiveness, indicates that stringent fiscal rules encourage precautionary savings in good times, which can be used subsequently to finance counter-cyclical measures in bad times. By contrast, also using U.S. state data, Alesina and Bayoumi (1996) argue that fiscal rules have indeed reduced flexibility in state-level fiscal policymaking without, however, having a bearing on the cyclicality of state fiscal policy.

- 20 . The source of data on municipal finances is the National Treasury. The data refer to the balance sheets of the municipalities, excluding their decentralised agencies ( _autarquias_ and _fundações_ ) and off-budget funds (including pension funds). The number of municipalities in the sample, which spans the period 1998-2003 varies between 3 807 in 1998 and 4 881 in 2001. Due to methodological constraints, intertemporal comparability is ensured within the periods 1998-2001 and 2002-03. The National Statistics Bureau (IBGE) also publishes municipal data based on the national accounts but the coverage is less comprehensive and data are typically available with a two-year lag.

- 21 . This assignment of expenditure functions across the different layers of government is consistent with the principle of subsidiarity, whereby services should be delivered by the lowest level of government capable of internalizing the externalities associated with public provision. In principle, the assignment of expenditure functions to sub-national governments is constrained by the ability of smaller jurisdictions to make the most of economies of scale in service delivery. The other important constraints are spillover effects, by which the inhabitants of adjacent jurisdictions can benefit from spending in another, which may result in the underprovision of services or stretch local budgets beyond their means.

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