Fiscal crisis in municipalities, again

Municipalities are, again, clamoring for financial istance from the Federal Government. An unusual “mayors’ strike” was organized to intensify political pressure.

The simple, and wrong, explanation for these recurring fiscal crises is that the Union concentrates tax revenue and leaves municipalities in the lurch. In one of my first columns in this space, I showed that the argument is not sustainable: the Brazilian federation is one of the federations that most decentralizes revenue in the world. In the 1990s, when federal transfers to municipalities were smaller than today, Anwar Shah already wrote that “Brazilian municipalities are the envy of local governments in developing and developed countries”. It’s not for lack of income.

The real cause has several factors. The first is that interest groups manage to approve measures in Congress that harm municipal accounts. Salary floors for various categories and real increases in the minimum wage weigh on municipalities’ payrolls, and mayors can do little. In the last column, I analyzed the case of the teaching salary floor, which increased by 53% in the last two years.

On the revenue side, decisions by Congress or unilateral measures by the Executive also affect municipal accounts, such as the cut in IPI rates (which makes up the FPM Municipal Participation Fund) and the imposition of a ceiling on ICMS rates (a tax shared with municipalities), both in 2022. Other revenue losses are caused by sectoral tax benefits, which reduce tax collection shared with municipalities.

The FPM, made up of federal income tax and IPI revenues, is the main source of financing for municipalities, especially sparsely populated ones. The “easy money that comes from Brasília”, and does not weigh heavily on local voters’ pockets, encourages city halls to spend a lot and poorly, in addition to relaxing in the collection of local taxes, such as IPTU and ISS.

It turns out that FPM revenue is procyclical: when the Federal Government’s revenue grows a lot, as occurred in 2021 and 2022, the FPM gains weight and the municipality increases its expenses. When revenue falls, as is happening in 2023, the FPM also falls, and the mayor is unable to pay the expenses increased in previous years.

Part of the increase in expenses in the high FPM phases is the responsibility of the municipalities themselves, which relax in budget execution when cash is looser. But there is another part that is the responsibility of the Constitution: the minimum mandatory spending on health and education rises when the municipality’s revenue rises. Hence, the mayor is obliged to spend more, and this additional expenditure is not reversible when, later on, revenue falls.

Reacting to this reality, municipalities begin to act as another pressure group, demanding financial help from Congress and the Federal Executive. They have been successful.

Since 1997, four constitutional amendments have already increased the FPM from 22.5% of Income Tax and IPI revenues to 25.5%. One more amendment is in the oven, to move to 27%. This eases the municipalities’ bills, but aggravates the destabilizing role of the FPM, described above.

Annual mayoral marches to Brasilia always elicit debt forgiveness and extra cash. Total transfers from the Union to municipalities grew 78% in real terms between 2008 and 2022, according to data from the National Treasury. Congress has just approved a reduction in the contribution of municipalities to the INSS.

Fiscal relief comes at the cost of perpetuating distorted and ineffective public policies, incentives for mismanagement and recurring fiscal crises in municipalities, in addition to an increase in the deficit and federal debt.

It would be a gain for society if municipalities changed their strategy and, instead of asking for help, worked to change the indexation of minimum health and education spending, review and limit wage floors, moderate the increase in the minimum wage, revoke benefits taxes and reform of the FPM. However, this is a difficult battle with high political costs for mayors.

An ociate researcher at Insper, he is the organizer of the book ‘Not to forget: public policies that impoverish Brazil’.

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