The unexpected outcome of fiscal rules: the fiscal responsibility law and increases in social spending in municipal Brazil

Abstract

Much work has been done on the impact of fiscal rules on fiscal discipline, usually measured as either changes in budget deficits or debt burdens, but there is little comparative research on the impact of such rules on the distribution of spending and on spending outcomes. Moreover, the effects of such rules are not static, and may depend upon whether a given government is dealing with an economic boom or bust or which party or parties are in office. In this paper, we argue that fiscal rules reduce the asymmetry of information between voters and incumbents over the budget and, as a consequence, the latter reduces their rent increasing the supply of public goods. At the same time, which types of public good receive higher priority depends upon which party is in power. To examine this argument, we focus on the budgets of municipalities in Brazil. We examine the distribution, and changes in, spending across different portfolios in a period without such rules in place and after the country’s Fiscal Responsibility Law (FRL) entered force. The Law passed at the national level and is exogenous to all municipalities. Moreover, different cities experienced substantial economic booms and economic busts owing at least in party to largely exogenous factors, such as changes in commodity prices. We show that the imposition of the rule generally led to increases in social expenditures through 2010. We also find a “de facto” higher supply of public goods in most the important expenditure at the municipal level: education. In broader theoretical terms, these findings suggest that a fiscal rule like the FRL can affect more than fiscal discipline. It can also lead to greater shifts in budget allocations to a given party’s most preferred policy area, which in turn increases “allocative efficiency.