The document summarizes Brazil's experience with fiscal rules and centralization over the past century, and discusses lessons that may be applicable to the European Monetary Union. Key points: - Brazil has experimented with various degrees of fiscal centralization vs federalism over the decades, seeking the right balance of governability and representation. - Recent fiscal rules like the 2000 Fiscal Responsibility Law helped rein in subnational debt and inflation, improving credibility. However, unexpected oil wealth and the global crisis relaxed constraints. - The current administration expanded social spending and allowed new subnational debt, weakening fiscal discipline. Impeachment raised expectations of a return to responsible fiscal policies and stability.

1. Fiscally Sound Social Inclusion:
What, if any, may EMU learn from the Brazilian experience of fiscal and
political Centralization?
Carlos Pereira
Visiting Scholar, Hertie School of Governance
Professor, Getulio Vargas Foundation – FGV
Mini-Conference and Lecture on “Fiscal Federalism within the EMU”
European University Institute, San Domenico di Fiesoli, Florence
December 12, 2016

2. Fiscal Rules at Glance (IMF)
Out of 207 countries, only 14 (6%) adopted Real Expenditure Rules: Australia,
Belgium, Croatia, Denmark, Finland, France, Netherland, Hungry, Island, Israel,
Kosovo, Mexico, Peru, and Poland
79
67
40
14
7
0
10
20
30
40
50
60
70
80
90
Balanced budget Debt limits Other expenditure rules Real expenditure rules Revenue rules

3. Real Expenditure Rules
• Brazil is about to adopt a very tough real expenditure rule.
– Constitution amendment (biding)
– 20 years debt ceiling based on the inflation of the previous year
• The 14 countries that have also adopted real expenditure
rules applied different methodologies and control
mechanisms:
– Take into account economic cycles
– It is combined with other rules such as debt rules
– The nature of expenditure (current expenses versus investment)
varies
– Adapting exit valves
– Smaller periods than 20 years
– Not in the Constitution, which makes it more susceptible for
adjustments and adaptations

4. Why adopting such a tough
expenditure constrain?
• Severe diseases require bitter remedies!
• Serious lack of credibility
– Executive derives utility from fiscal stability and
inflation control because of credibility gains in
international markets.
• History books
– Do the right thing while you are unpopular (about 8%)
– Short time-horizon (No-reelection incentives)
• Impeachment of the president for fiscal crimes
– It provided incentives for the new political elite to
overshooting fiscal reforms to justify their actions

6. How can a country (or a region that decides to work
together) reaches an inter-temporal equilibrium?
Governability
Decisiveness
Representation
Accountability
Equilibrium is the
ability political and
economic players
achieve cooperation
inter-temporally.
In the case of Brazil, it
took more than one
hundred years…

7. Old Republic (1889-1930)
Federal
Government
Governors
and regional
parties
• Strengthening of Federalism
• Domination and
opportunistic behavior of
elites and regional
oligarchies
• Política dos Governadores
• Fragmentation via state
political parties
• Problems of governability
and lack of inclusion of elites
not contemplated

8. Era Vargas: centralization
(1930-1937 and 1937-1946)
National
Executive
End of
Federalism
• End of oligarchy federalism by
Vargas
• The autonomy of the states was
weakened and the end of the
monopoly of the state parties
• Electoral Justice in 1932 and
Proportional Representation in
1935
• Estado Novo: more
centralization
• State flags were burned
• Congress lost powers and
prerogatives

9. Decentralized Democracy: (1946-1964)
Weakened
Executive
Fragmentation
of Congress
• Constitutionally weak president
• No Decree Power
• No Urgency Power
• No Budgetary Powers
• Proportional Representation:
Multiparty and fragmentation
• Reestablishment of federalism
• Minority Governments
• Many governability problems

10. Military Regime (1964-1985)
Strong
National
Executive
Weak
Congress
and
Governors
• Re-centralization of the decision-
making process
– Decree Power
– Urgency
– Budget power and discretion
• Marginal role of parties and
Congress
• Two-party system
• Governors regain some powers
at the end of military regime
with elections

11. New Constitution in 1988:
New Equilibrium!
Strong Executive
(No Gridlock)
Strong
Checks &
Balance
• Maintenance of strong executive
• Maintenance of Proportional
Representation: Multiparty and
Fragmentation
• Political Re-centralization and weakening of
governors
• Coalition governments and and
institutionalization of gains-from-trade
mechanisms
– Cabinet, public jobs
– Budget
• Institutionalization of a web of accountability
• Independent Judiciary
• Independent Public Prosecutors
• Independent Federal Police
• Independent Audit Institutions: TCU/CGU
• Independent Regulatory Agencies
• Investigatory and Independent Media

12. Brazil in Transition:
Beliefs, Leadership and Institutional Change, 1964-2014
19 6 0 19 6 4 19 74 19 8 5 19 9 4 2 0 0 3
An t i-Aut ho r it ar ian ism
Aver sio n t o In f l at io n
Mil it ar y
Co up
St ar t
O pen in g
Redemo -
c r at i-
zat io n
Real
Pl an
FHC Lul aTan c r ed o /
Sar n ey
Co l l o r
It amar
GeiselCast el o
Br an c o
Co st a
E Sil va
Med ic i Fig uei-
r ed o
Jan g o
6 0 .7 %
2 4 .6 % 9 8 .3 %
1 0 5 0 .6 %
1 0 .1 %
Po pul ism Aut ho r it ar ian Rul e
Demo c r ac y
Wit ho ut Chec ks
& Bal an c es
Rul e-o f -Law
New
Co n st i-
t ut io n
5 .7 2 %
8 .8 9 %
4 .0 3 %
2 .8 1 %
3 .1 2 % 4 .8 1 %
Fisc al
r espo n -
abil it y
Bel ief s
Inf l at io n
 GD P
Po l it ic al
O ut c o me
-
-
-
+
+
-
-
-
-
-
-
+
+
+
+
Appr oval
Event s
Timel ine
Pr esident
Fr an -
c hise
Devel o pmen t ism

13. Fiscal Responsibility Law – FRL
• In the year of 2000, Brazil implemented a hard-budget constraint
legislation – the FRL.
• Along with its companion law, the Fiscal Crimes Law, the FRL is the
culmination of a relatively successful set of measures to constrain
fiscal behavior and control the state governments indebtedness.
• The FRL also bars the federal government from financing sub-
national governments. This is meant to eliminate the
possibility of bailouts as well as any changes in the financial
clauses of the existing debt-restructuring agreement.
• The FRL illustrates the kinds of policy outcomes that reflect the
national executive’s ability to implement its policy preferences in
the political game.
• There is no question about the positive effect of the FRL with
regard to the states’ fiscal situation, which improved considerably
since the enactment of the FRL in 2000.

14. Brazilian States’ Fiscal Accounts (1993-2010)
-12.00
-10.00
-8.00
-6.00
-4.00
-2.00
0.00
2.00
4.00
6.00
8.00
10.00
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

15. Fiscal Responsibility Law (2000)
F
• President
• Mandatory Top-down (the federal government has the exclusive
prerogative of setting debt parameters and expenditures ceilings)
R
• Governors
• Control the state governments’ indebtedness (Audit Courts)
L
• Mayors
• Sets parameters for all levels of government (Audit Courts)
• provides ex ante and ex post controls on both borrowers and lenders

16. Renegotiation of States’ Debts and
Privatization of State Banks
• The view that governors in Brazil wield vast powers is
inaccurate
• The President was able to impose his fiscal preferences
– The President enjoys agenda powers and other legislative
prerogatives to implement its agenda.
– He controlled resources – such as loans from federal banks and
treasury’s advances - that were used in exchange for fiscal
reforms, including privatization of state banks and utilities.
– He was also helped by the reelection, which strengthened not
only the President vis-à-vis governors but also helped extend the
time horizons of governors; (19 governors ran for reelection),
thus introducing some element of self-enforcement in the fiscal
game.
– Financial vulnerability state governors faced
– High electoral competition

17. Tax Revenue %GDP
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Consolidated Public Sector Central Government States Municipalities

18. Tax Burden in Latin America
0
5
10
15
20
25
30
35
40
1990
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Ecuador
El Salvador
Guatemala
Honduras
Mexico
Nicaragua
Panama
Paraguay
Peru
D. Republican
Uruguay
Venezuela
Average
Source: CEPAL

19. Net Debt %GDP
-10.0
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Net Debt of Public Sector Federal Government Central Bank States Municipalities States Companies

20. Primary Surplus, % of GDP
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Consolidated Public Sector Federal Government + Centra Bankl Regional Governments States Municiplities

21. Why has this equilibrium been out of track?
1. The discovery of pre-salt oil reserves in 2006
2. The boom for Brazilian commodities
3. The global financial crisis of 2008
Those shocks, which were unexpected exogenous
events with high consequences, have
momentarily relaxed the constraints imposed by
the fiscal imperative.

22. Dilma Rousseff’s Administration
• New economic matrix
• Creative accounting
• The FRL prohibits the union to finance states and
municipalities.
– However, it does not veto the authorization for states
and municipalities do contract new debts up to 60% of
their revenue, which has allowed new indebtedness.
– From 2013 to 2014, the National Treasure has
endorsed about R$ 50 billion of new debts at the state
level.

23. New Economic Matrix
(Primary Government Expenditure, GDP)
4.9 5.3 5.4 5.5 5.7 5.9
6.2 6.4 6.7 6.9 6.8 6.4 6.7 6.6 6.4 6.6 6.7 6.9 7.4
8.3
4.5 4.7 4.5 4.6 4.9 4.9
4.6 4.5 4.3 4.4 4.3 4.2 4.6
4.3
4.1 3.9 3.9 3.9 4.0
4.2
0.9 0.8 1.1 0.9 0.9 0.9
1.3 1.4 1.8 1.9 2.1 1.8 2.0
2.1
2.1 2.1 2.4 2.7 3.9
3.3
3.6 4.0 3.6 3.7 4.1 4.1
3.0 3.3 3.5 3.6 3.7 3.7 4.0
5.2
4.1 4.3 4.3 4.7
4.3 4.1
14.0
14.8
14.6
14.8
15.6
15.9
15.1
15.6
16.4
16.8 16.9
16.2
17.3
18.1
16.7
16.9
17.3
18.3
19.6
20.1
13.0
14.0
15.0
16.0
17.0
18.0
19.0
20.0
21.0
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Social Security Benefits Personel Others Discretionary spenditure Spenditure
Source: IBRE/FGV

24. New Economic Matrix
(Income Transfers, % of GDP)
5.4
5.8 5.8 5.9
6.2
6.4
7.0
7.3
7.7
8.0 8.0
7.6
8.1
7.9
7.8
8.0
8.2
8.6
8.9
10.1
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Social Security Benefits Pension and Unemplyment insurance BPC Income Transfers
Source: IBRE/FGV

25. Very high primary deficit in four consecutive years
(Primary New of the consolidated public sector)
-0.9
0.0
2.9
3.2 3.2 3.2 3.2
3.7 3.8
3.2 3.2 3.3
1.9
2.5
2.9
2.1
1.4
-0.8 -1.1
-2.4
-2.5
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Central Government (Recurrent) Not Recurrent Regional Governments State Companies Cnsolidated Public Sector
Source: IBRE/FGV

26. Even with the real expenditure rule, the
primary net would be positive in 2020 only
15.0
16.0
17.0
18.0
19.0
20.0
21.0
EVOLUTION OF REVENUES AMD PRIMARY SPENDITURE OF THE CENTRAL GOVE RNMENT,
% OF GDP
Net Revenue Spenditure (PEC 241/2016)
Source: IBRE/FGV

27. Expectation post-impeachment
(Consumers and Business Confidence)
60
70
80
90
100
110
120
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
Jan-13
May-13
Sep-13
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-16
May-16
Sep-16
Consumers Confidence versus
Business Confidence
CCI BCI
Source: IBRE/FGV

28. Expectation post-impeachment
(GDP)
-5.4%
-3.6%
-2.9%
-2.2%
-1.2%
0.0%
0.9%
1.4%
2016.I 2016.II 2016.III 2016.IV 2017.I 2017.II 2017.III 2017.IV
Source: IBRE/FGV

29. Expectation post-impeachment
(Inflation)
10.7%
6.6%
5.1%
4.7%
10.7%
6.6%
5.5%
5.1%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
2015 2016 2017 2018
Actual Inflation (IPCA) Pessimistic Inflation (IPCA)
Scenario
Exchange rate
2017
Actual R$ 3,25 / US$
Optimist R$ 2,85 / US$
Source: IBRE/FGV

30. Expectation post-impeachment
(Interest Rate)
14.2% 13.8%
11.0%
10.5%
14.20%
13.8%
11.3% 11.3%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
2015 2016 2017 2018
Interest Rate (Selic)
Interest Rate (Actual) Pessimistic Interest Rate
Source: IBRE/FGV

31. Conclusion
• Conditions for fiscal reforms to succeed in the
Brazilian federalism
1. Centralization of the political game
• The Union has to have the agenda setting-power
• Control of discretionary gains-from-trade
mechanisms
2. Reform initiatives have to to be self-enforcing
• Politicians in the different levels of the government
have to identify