The Fiscal Responsibility Law Should be Changed

Forum for Budget Tracking (FBO), Brazil

May 4, 2009 will mark the ninth anniversary of the Fiscal Responsibility Law (FRL). Its introduction changed the economic, political, and legal scenarios. This document discusses the reasons for the FRL promulgation, and its impacts on public finances, in light of federalism and budgetary priorities. It also addresses the proposal to change the legislation based on the consequences of its application.

The document is divided into five sections, in addition to this introduction. The first section deals with the context in which the law was created; the second discusses its intersection with the Brazilian federation; the third addresses its impact on public spending; the fourth presents the Brazil Budget Forum (FBO) proposal to change the FRL; and finally, the fifth has brief final remarks.

II – EMERGENCE OF THE FISCAL REPONSIBILITY LAW

In the last thirty years, we witnessed an oscillation between Keynesian[1] (based on several conceptions of the Welfare State) and liberal (or neoliberal ) proposals. The Welfare State crisis in the 1970s had macroeconomic elements, such as the growth of public and private debts, the US unilateral break with the gold standard, and the oil crisis. In addition, the state was incapable of funding the expanding social security spending, and the declining job market could not totally absorb new generations of workers. Consequently, in this period the Welfare State was supposed to be in a terminal stage. Supporters of liberalism immediately saw the opportunity to launch a counterattack by intellectually condemning public planning, state intervention, and financial deficits. In the 1980s, the political and economic elites, led by Thatcher and Reagan, took the next step by blaming the state for the crisis; hence, it was viewed as an obstacle to economic development. As a consequence, privatizing broad sectors of the state action was the path to be taken. Neoliberals also targeted all public spending that did not directly favor capital accumulation, i.e., social security and social spending. In an ideal liberal system, state action should be restricted to defining and overseeing economic policy rules. It was the so-called minimal state.

The hegemony of neoliberal thinking changed the course of economic policies and budgetary priorities. The process of privatization began and the fight against inflation became the fundamental goal. Controlling expenditures became the justification for fiscal responsibility. Social inequalities and poor income distribution were not accepted as arguments in favor of expanding social spending. On the contrary, this type of spending was pushed into the background because the central goal was to maximize savings in order to be viewed as a responsible government. In the mid-1990s, Brazil’s public deficit increased (see chart 1).

CHART 1

Prepared by FBO. Cadernos para Discussão (Discussion Notebooks) – Primary Surplus. 2005.

Thus, the neoliberal ideal of fiscal austerity was intensified, based on policies to control indebtedness (restricting any expenditure that would increase the debt) and efforts to generate primary surplus[2], as a way to demonstrate capacity to repay financial debts. However, Brazil lacked a legal instrument to support this economic policy without the potential jolts allowed by a federative Constitution. Growth of municipal and state debts, combined with pressures from international institutions[3] resulted in the Fiscal Responsibility Law (FRL), published on May 4, 2000.[4] This law was created in the context of the fiscal adjustment implemented in the President Fernando Henrique Cardoso (FHC) administration and monitored by the International Monetary Fund (IMF). The agreement between the IMF and Brazil, signed after the 1998 elections, included loans in the amount of US$ 41 billion, imposing a number of conditions on macroeconomic policies, especially the generation of primary surpluses – i.e. primary savings in the budget to honor debt interest repayment. The Letter of Intent[5] signed with the IMF included a primary surplus target of 2.6% of the GDP for 1999, increasing to 3% in 2001. These targets were constantly upped until it reached 4.5% of the GDP in 2004. It is worth noting that the targets for primary surplus established by the Fund were surpassed in all periods. However, all those savings were not sufficient to pay off debt interests, and the public debt increased, as shown in Table 1.

Table 1

Primary surplus and interests of the federal government, states, Federal District, and municipalities

1999-2004 period, % of GDP

Source: FBO (2005, p. 10), quoted in Central Bank and IMF Letters of Intent.

To this extent, Garagorry (2007, pp. 203-204) noted:

As government creditors witnessed the privatization process – the state selling off its assets and, at the same time, the stock of government securities increasing – they started to express fear of some type of government default. To a certain degree, the FRL was an answer to creditors’ lack of confidence in the government ability to honor its commitments, and the repeated promises of fiscal austerity made by the first FHC administration, which were never fulfilled. Basically, this legislation is a set of mechanisms geared to generate primary surpluses. Thus, in essence it meets the interests of a specific social group, the holders of government securities (italics added).

Undoubtedly, the FRL central objective is to build up primary surplus. Financial debt is de-linked from the remaining budget. To make it possible to achieve these positive results, the FRL imposes many constraints on public spending.

Regarding fiscal discipline, the government should have a surplus to pay its debts at the end of each budgetary period, either by cutting expenditures or increasing revenues. However, with the FRL, only expenditures are taken into account. Ideologically, state presence was viewed as necessary only when the private sector could not fulfill a given function. The state should merely regulate market activities, ensuring healthy competition.

International influences in drawing up the FRL

At the international level, the FRL should also be viewed as part of a worldwide process of fiscal adjustments, which was intensified in Latin America in the 1980s. The Mexican moratorium (1982) and the Brazilian moratorium (1987) occurred in this framework and were used as arguments to spread neoliberal conceptions. International financial institutions, such as the IMF and the World Bank, were instrumental in disseminating and imposing the new doctrine through signed agreements.

It is worth noting that the IMF Code of Good Practices on Fiscal Transparency proposed that national authorities, financial markets, and international institutions should oversee economic policies.

The FRL was inspired by several pieces of international legislation: a US law (1990), a New Zealand legislation (1994), the Maastricht Treaty (1992), in addition to the above mentioned IMF Code (NÓBREGA and FIGUEIREDO. 2001; FERRAZ, 2001. In LOPES, 2008).

From the US experience, the Brazilian model adopted the rules included in the Budget Enforcement Act. It should be emphasized that the US legislation is only applicable to the federal government, while the Brazilian version is valid for all government levels. Among the “imported” mechanisms are the sequestration (FRL, art. 9) and the “pay as you go” mechanism (FRL, art. 17, paragraph 2). From the New Zealand experience, the FRL adopted mechanisms for public accounts transparency. The Fiscal Responsibility Act was the basis for chapter IX of the FRL, which specifically addresses “transparency, control, and supervision” of fiscal management. However, this incentive to transparency has the objective of increasing the control over fiscal policy by supervisory institutions and financial markets, rather than promoting society’s participation in following and discussing issues related to public budget. From the Maastricht Treaty, the FRL adapted general norms regarding public debt, personnel expenditures, standardized rendering of accounts, and long-term expenditures.

III – ATTACK AGAINST THE FEDERATION

As discussed earlier, while the US version of the FRL affects only the federal budget, the Brazilian law encompasses all government levels. Hence, its impact on society is deeper. Historically, Brazil’s federalism was based on a centralized and unitary state. Although Brazilian constitutions have tried to reduce power centralization, the trend is still to deal in an uniform way with all levels of government, often ignoring the high degree of inequality among regions, states, and municipalities.

The 1988 Constitution eliminated federal intervention in states, when they passed laws contrary to federative principles. However, post-1988 intergovernmental federative relations are far from a cooperative model, both in fact and in law. There are few mechanisms to promote coordination and inhibit competition between the different government levels, creating many asymmetries in the tax system and public policy management (SOUZA, 2006 and MELO, 2008).

One of the false arguments used to produce the FRL was to stop the tendency by states and municipalities to transfer to the federal government the cost of their activities (COSTA, 2007). However, as Souza (2006) stressed, except for exclusive competences, constitutionally defined, the responsibilities of each governmental sphere for concurring competences, which include most public services (specially social services), are not determined. Moreover, no constitutional provision regulates intergovernmental relations. This absence creates conflicts regarding what government level is responsible for a given policy or public service. Likewise, without a clear division of competences with the respective source of funding, it becomes difficult to consolidate a balanced federalism. As a result, the FRL cannot be justified as a source of equilibrium for the federation[6]. On the contrary, it aggravates existing problems in the federative pact. In its art. 35, the FRL prohibits any change in the negotiation terms of state and municipal debts contracted with the federal government prior to the publication of the law. This provides financial gains for the federal government, financed through the Selic[7] interest rate, while the debt of other government spheres is linked to the IGP-DI[8] (6-9% additional interests per year). The IGP-DI index increased more than the Selic interest rate, and this formula ensured that state and municipal debts have continued to grow, despite all repayments. Chart 3 shows the evolution of the two:

CHART 3

Source: FGVDADOS (http://www.fgvdados.fgv.br) in February 2009.

Prepared by FBO.

In addition, the FRL establishes several indiscriminate limits and restrictions, disregarding the differences among over 5,000 municipalities and dozens of states. In view of such diversity, it should be assumed that public spending structure will vary in the different units. In sum, the effort to accumulate primary surplus was expanded to include states and municipalities without rediscussing the federative pact.

IV – PUBLIC SPENDING IS THE VILLAIN

Since the early 1990s, public spending control has been the central issue in the economic policies put forward by international financial institutions. It is worth noting that those who are against expanding public services are the same ones who view public debt payment as a virtue – no matter how this debt was formed or for what purpose. The discourse arguing the need to cut costs in order to preserve investments has emerged recently. However, cutbacks in federal investments in March 2009 and the ruthless cuts in the transfers made through the Municipal Participation Fund (FPM) in the beginning of this year have already belied that argument. Garcia (2008) discusses more specifically the reasons why current expenditures are seen as the villain. In his words:

(...) pressures to reduce current expenditures rapidly. In this case, this haste boils down to penalizing those who cannot defend themselves because they do not have a voice, organization, or access to the media. Hence, the majority of the Brazilian population is penalized. Another byproduct of this process is to put the government on the defensive, always presenting justifications and incapable of initiatives contrary to the interests of the privileged sectors.

Without denying the need for public works and investments, many of them of complex nature and very high cost, one of the origins of the attacks against current expenditures is that many public officers, as well as contractors and equipment suppliers, overvalue large constructions, costly and sophisticated public works and projects, which are highly profitable. The former for lack of knowledge and/or cunning, and the latter for their own interests.

The FRL deals specifically with personnel expenditures and payroll charges in art. 19 and 20. The established ceilings are the following:

1.                       Federal government (50% of Net Current Revenues[9]): 2.5% for the Legislative Branch, including the Court of Audit; 6% for the Judiciary Branch; 0.6% for the Federal Public Prosecutor’s Office; 3% for expenditures of the Federal District and former territories; and 37.9% for the Executive Branch.

2.                       States (60% of Net Current Revenues): 3% for the Legislature, including the State Court of Audit; 6% for the Judiciary; 2% for the State Public Prosecutor’s Office; and 49% for the Executive.

3.                       Municipalities (60% of Net Current Revenues): 6% for the Legislative, including the Municipal Court of Audit (if any); and 54% for the Executive.

If these ceilings are not adhered to, the law establishes a time period for compliance and measures to adjust personnel expenditures to legal limits.

The reasons for those ceilings and the detailed calculations to reach those percentages are not explained in the FRL[10].

There is a consensus that public servants are an important element in determining the capacity to deliver public services. Obviously, this depends on the type of service because they are different in relation to intensity of labor requirements. However, two of the most sensitive areas in the public spending structure – health and education – are labor-intensive. The importance of these two areas was recognized when the Constitution established a minimum spending requirement for them – just the opposite of the concept that permeates the FRL. Thus, it is reasonable to assume that there are cases of conflict when complying with these two directives: the constitutional (minimum level of health and education expenditures) and legal (ceilings for personnel expenditures).

In fact, a 2006 study by the National Federation of Municipalities (CNM) assessed and compared fiscal and administrative performances of municipalities, and afterwards compared the data with social results. The lack of correlation was evident. The widespread idea that compliance with the FRL would result in well-being for society proved to be false. The law has another purpose.

Another 2008 research carried out by the Federal Rio Grande dos Sul University Postgraduate Program in Economics with Rio Grande do Sul municipalities reached similar conclusions. The author, Chieza (2008), was conclusive:

Likewise, expenditures in social areas (health, education, sanitation, among others, according to our methodology) also decreased in reals per capita, after the FRL. Generally, these expenditures cannot be separated from the government function because they meet the needs of people with less purchasing power.

In sum, fiscal improvement by compliance with the FRL is directly affected by a decrease in personnel expenditures, as well as diminishing investments and expenditures in health, sanitation, and education.

This obligation imposed on all federative levels has especially harmed municipalities, concentrating budgetary execution at the federal level, which contradicts the logic of the 1988 Constitution. Art. 9 of the FRL requires that at the end of every two-month period each branch of government will verify its compliance with primary or nominal targets. If noncompliance is detected, adjustment of expenditures is determined, with budgetary sequestration and limits to financial movements. However, these budgetary constraints do not include “expenditures which are constitutional and legal obligations, including those to pay for debt service” (FRL, art. 9, paragraph 2).

According to Miranda (2001), the FRL deals with public expenditure in an asymmetrical and hierarchical way. On the one hand, it restricts and imposes conditions on nonfinancial expenditures, particularly investments and social spending. On the other hand, it expands and guarantees financial expenditures. State governments saw their capacity to expand budget investments and local social spending limited as they lost access to financing from state public banks. Santos et al (2003) affirm that the coup de grâce to force states and municipalities to adhere to the federal fiscal adjustment was the FRL promulgation, imposing sanctions for managers who did not comply with the legal obligation of a balanced budget. Privatization of state banks, together with the FRL, integrated all other levels of government into “the fiscal adjustment the federal government was pursuing at any cost, and were also key factors in meeting the budgetary surpluses agreed with the IMF” (SANTOS et al, 2003, p. 41).

Analyses by Menezes and Júnior (2006) evaluated FRL impact on municipal expenditures, showing the increased expenditures with debt interests and charges. The FRL caused significant reduction in investments, reflecting the adjustment and the significant drop in the share of Net Current Revenues allocated to investments in most municipalities studied by the authors.

However, at the federal sphere, there are no constraints for deficits shown in the Central Bank balance sheets because it was privileged in the FRL (art. 7, paragraph 1), which ensures automatic transfers from the National Treasury to make up for any loss of the monetary authority. That is why the Central Bank is free to conduct monetary and exchange rate policies, as well as support and bailout the financial system.

In sum, the FRL is an instrument to control fiscal expenditure, diminishing government capacity to intervene and hampering expansion of social spending.

Thus, it is understandable that society itself is mobilizing to change the Fiscal Responsibility Law. This is discussed in the next section.

V – FISCAL AND SOCIAL RESPONSIBILITY LAW[11]

In 2002, the Brazil Budget Forum[12] (FBO) decided to apply its efforts in elaborating a national Social Responsibility Law. Since then, the social responsibility concept acquired new contours. The debate organized by the FBO at the World Social Forum (Belo Horizonte, November 2003) indicated the new basis for the concept.

Five principles guided the notion of social responsibility adopted by the FBO:

§ Social promotion and empowerment

§ Sustainable development

§ Fight against social and regional inequalities

§ Participation and social control

§ Transparency and information clarity

The law would be focused on social control. And social control is linked to the concepts of empowerment and social capital. This was a major change.

The FBO does not propose social control because it is a right, but because it wants to combat inequalities and effectively implement sustainable development, overcoming destructive policies and actions.

These principles were developed into concrete proposals that resulted in an outline for the Social Responsibility Law. Initially, the proposals for this legislation were focused on three areas:

a)       Establishing social minimums, annual and quadrennial social goals to be defined by each level of government, based on priorities for social improvements;

b)      Creating a Public Monitoring System for Social Policies and Goals, supported by public funds, and made up of representatives from existing rights and public policy councils;

c)       Including this law in the budget cycle, setting up as a norm the establishment of social goals in the Budget Law, Budgetary Guidelines Law, and Multi-Annual Plan at municipal, state, and federal levels.

This proposal also included the principle of accountability for public authorities. After defining social goals, the Public Monitoring System would allow studies to support annual social balances, assessing the evolution of each social goal established by the social responsibility law to be created at the three governmental levels.

In parallel to defining those areas and principles, the FBO provided input to an important debate on the relation between social responsibility and fiscal responsibility. FBO members have always known that the FRL raised serious obstacles to social investments[13]. In addition, it was developed around the concept of providing guarantees of public debt reduction and repayment of government debts. However, the function of government is to promote social development. This cannot be accomplished through the market, which is competitive and tends to form oligopolies.

Hence, the FBO views public spending as social investment, provided safeguards against corruption and political irresponsibility of public authorities are in place. As a principle, public spending reduction is substituted by social and fiscal responsibility in public spending. This discussion finally shaped the new law proposed by the FBO, under the name of Fiscal and Social Responsibility Law (FSRL). The proposal is not limited to allocating more funds to the social area. New mechanisms were included to take into account the diversity and decentralization in this huge country, which lead to discussing a new federative pact. For example, the use of municipal resources to pay for activities which come under the competence of states and federal government would be subordinated to the fulfillment of prioritized social goals.

One of the expected results of dealing with financial expenditure and social spending on an equal footing is to free government officers from the numerous constraints imposed by the FRL, so they can attain chosen social priorities. However, this liberalization should not compromise fiscal balance. Fiscal responsibility should be at the service of social justice, with fiscal balance as an objective and government authorities having an ethical and moral conduct in managing public resources.

Another objective of the FBO proposal is to open all budgetary process to public control with the creation of the Public Monitoring System for Fiscal and Social Management. This system would make it clear how and where funds were allocated. This proposal provides for the creation of a Public Monitoring System for Fiscal and Social Policies and Goals, whose competence and authority would be to monitor evolution of social indicators as defined in the FSRL and in the Multi-Annual Plan in its jurisdiction; elaborate the Annual Social Balance to be presented to the Legislative, with a formal statement on the evolution of each social indicator and goal, as well as indicators prioritized by the municipality taken as a whole, defining whether or not its execution presented a positive, negative, or nonexistent evolution. This system would allow public administrators commit to achieving social goals, as well as defining the necessary resources. Social balances would increase transparency and understanding of public activities by citizens, as well as change current attitudes of government bureaucrats who just require strict compliance with legislation, with no concern for results. It is the culture of efficiency, efficacy, and effectiveness at the service of citizens.

Moreover, the legislative proposal institutes performance evaluation for the public administrator, making him/her responsible. Public and systematic evaluations would help to manage and control public services, and government would fulfill its duty to publicize its actions and take on responsibility for them.[14]

The legislative proposal was concluded in April 2007 and formally presented to the Chamber of Deputies Committee on Legislative Participation on May 3 (Complementary Legislative Proposal n. 264/2007) to coincide on the following day with the seventh anniversary of the FRL, which is always celebrated by liberals. FBO members hope the proposed FSRL under discussion in the Chamber of Deputies will stimulate debate on the democratic reform of the Brazilian state, which has an ancient and privatized structure.

VI – FINAL REMARKS

Undoubtedly, the ideological pillars supporting neoliberalism are being questioned by reality. Facts demoralized the defense of the minimal state. However, the Brazilian state, still under neoliberal influence and based on the FRL, transforms public finances from a means into an end in itself. Thus, it is urgent to change the FRL to preserve its best element: the notion embedded in society – although currently fictitious – that it promotes control of the budget, frugality in expenditures, and punishment for public authorities’ mismanagement. FRL success in promoting fiscal transparency should be acknowledged, although the same did not happen in relation to social control. One of the reasons is that some of its provisions (art. 48 and 59) were never fully enforced.

In sum, concretizing what is already in the popular imaginary is the pathway to advance sustainable development, without ignoring that the main reason for the FRL existence – ensure the financial debt repayment – should be superseded because its application merely serves the interests of rentiers.[15]

REFERENCES

ÁVILA, Rodrigo; LINS, Renata. Superávit Primário. Revision: CABRAL, Gilda; PISCITELLI, Roberto B. 3. ed. Brasília: Brazil Budget Forum, 2005 (Discussion Notebooks). Available at: http://www.forumfbo.org.br/cgi/cgilua.exe/sys/start.htm?sid=54

BEHNKEN, Luiz Mario; RICCI, Rudá. A responsabilidade fiscal e social, Revista de Administração Municipal (Municipal Administration Journal), 2007, year 52, n. 261. IBAM, Rio de Janeiro.

BLAUG, M. Economic theory in retrospect, Cambridge: Cambridge University Press, 1975. In: ALMEIDA MAGALHÃES, João Paulo de, Novo Desenvolvimento – Um Enfoque Teórico, Carta Mensal (Monthly Letter), magazine published by the Confederação Nacional do Comércio de Bens, Serviços e Turismo (National Federation of Commerce in Goods, Services and Tourism), June 2008, volume 54, n. 639 p. 45.

BRAZIL. Complementary Law n. 101, May 4, 2000 – Fiscal. Responsibility Law

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Subsecretariat of Technical Editions, 2004.

BRAZIL. Brasília, DF.

CHIEZA, Rosa Ângela. Impactos da Lei de Responsabilidade Fiscal sobre os gastos orçamentários e transparência fiscal. In: Jornadas Interncionales de Finanzas Públicas, 41, 2008, Córdoba, Argentina. Abstract: Impacts of the Fiscal Responsibility Law on social control (transparency and participation) and budgetary expenditures: municipalities of Rio Grande do Sul state – Brazil. Córdoba: Universidad Nacional de Córdoba. 2008. CD-ROM.

COSTA, Valeriano. Federalismo: as relações intergovernamentais. In: Sistema político brasileiro: uma introdução / Orgs: Lúcia Avelar & Antônio Octávio Cintra. 2. ed. Rio de Janeiro: Konrad-Adenauer-Stiftung; São Paulo: Ed. UNESP, 2007.

FBO. Superávit primárioBrasília: Brazil Budget Forum, 2004..

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GARAGORRY, Jorge. Economia e política no processo de financeirização do Brasil (1980-2006). PhD dissertation in social sciences. São Pontifical Catholic University. PauloSão Paulo, 2000.

GARCIA, Ronaldo Coutinho. Despesas correntes da União: visões, omissões e opções. IPEA. January 2008.

GONÇALVES, Reinaldo; POMAR, Valter. A Armadilha da Dívida. São Paulo: Ed. Perseu Abramo Foundation, 2002.

LOPES, Bruno. Impactos Econômicos da Lei de Responsabilidade Fiscal no Orçamento Público: Estudo de caso do Município do Rio de Janeiro (2000-2004). Monograph (graduation) - Economics, UFRJ/Institute of Economics, Rio de Janeiro. 2006.

MELLO, Eduardo Duprat Ferreira de. Escolhas Estratégicas e Guerra Fiscal: Competição ou Cooperação no Caso do Estado do Rio de Janeiro. Master’s thesis in Public Administration – BRAZILIAN SCHOOL OF PUBLIC ADMINISTRATION, FGV. Rio de Janeiro, 2008.

MENEZES, Rafael; JUNIOR, Rudinei. Regras fiscais no Brasil: a influência da LRF sobre as categorias de despesa dos municípios. Planejamento e Políticas Públicas (IPEA), v. 29, pp. 7-37, 2006.

MIRANDA, Sergio. A verdadeira face da Lei de Responsabilidade Fiscal. Revista princípiosn. 61, July 2001. ,

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SANTOS, Reginaldo et al. Economia política e finanças públicas no Brasil: a recuperação de um debate. Bahia análise e dados, Salvador, V. 12, n. 4, pp. 25-43, March 2003.

SICSÚ, João. Gastos públicos, déficit e desemprego (2007). Available at: http://www.ie.ufrj.br/aparte/pdfs/sicsu011007.pdf

SOUZA, Celina. Desenho constitucional, instituições federativas e relações intergovernamentais no Brasil pós-1988. In: Democracia, descentralização e desenvolvimento: Brasil e Espanha / Org. Sônia Fleury. Rio de Janeiro: Ed. FGV, 2006.

APPENDIX 1

FSRL legislative proposal presented by the FBO

Attached file