Brazil’s Fiscal Responsibility Law and the Quality of Audit Institutions

INTRODUCTION

Brazil has made great improvements in its fiscal governance over the last 15 years. While these improvements have led to fiscal adjustments and positive economic outcomes, they have encouraged incumbent politicians in Brazil to make use of "creative accounting" in order to facilitate the government meeting its budget deficit ceiling. That is, the use of fiscal window-dressing as a response to fiscal constraints might undermine the sustainability of fiscal balance.

In 2000, Brazil implemented a hard-budget constraint legislation – the Fiscal Responsibility Law (FRL) – which was applicable to all levels of government regardless of their prior economic conditions. The FRL illustrates the kinds of policy outcomes that reflect the power of Brazil’s executive to implement its policy preferences in the federal political game. In its relations with the state governments, a powerful president and a strong finance minister have managed to recentralize fiscal authority in the country, curbing state level fiscal autonomy. Brazil’s executive branch was able to implement its preferences because of its institutional prerogatives and because there were gains-from-trade in federal-state relations. State governors developed an interest in reforms in the wake of the approval of the re-election amendment and in view of the compensation mechanisms involved in the reform process.

There is no question about the positive effect of the FRL with regard to the fiscal situations of Brazil’s states, which have improved considerably since the enactment of the Fiscal Responsibility Law. Whereas all states faced a deficit prior to the law, the consolidated state accounts have systematically presented a surplus roughly equivalent to 4 percent of GDP after the law was enacted. A similar success story can be told regarding public debt. A succession of primary surpluses enabled the government to effectively reduce the GDP/debt ratio. Since 2002, when the GDP/debt ratio peaked at 55 percent, there has been a reduction in net debt as measured by percent of GDP, which is estimated to be below 36 percent in 2008.