State Equalization Transfers to Municipalities in Brazil Fernando Blanco Cossio World Bank – Brazil Country Management Unit

Outline Brazilian Intergovernmental Transfers System State Equalization transfers to municipalities. State VAT Transfers to Municipalities FUNDEF Basic Education Fund Conclusions

Brazilian Intergovernmental Transfer System Mechanisms established in the constitution of 1946 and expanded in the 1967 and 1988 constitutions. Earmarking of tax revenues distributed by automatic formulas. Federal transfers to state and municipalities have regional equalization objectives: FPE and FPM and Regional Funds. State transfers to municipalities: earmarked tax revenues and distribution based on origin and demand driven.

State VAT Transfer to Municipalities State VAT is the most important tax in Brazil – (10% of GDP). 25% of state VAT collection should be distributed to municipalities 20% according to origin basis 5% according to re-distribution formulas that can vary among states: per capita income, HDI, proportion of poor, etc

State VAT transfer mechanism is equalizing? Given the low weight of the redistribution component this transfer is regressive. Reasons: Concentration of revenue collection on state capitals and industrial cities. Also, problems with the lack of updated socioeconomic information creates difficulties for redistribution objective.

FUNDEF – Basic Education Fund Objectives: Guarantee Financing for Basic Education. Demand driven mechanism that promote equalization of basic education expenditure per student within the state. Alleviate regional disparities in education expenditure per student

Fund is financed by 15% of: State Participation Fund Municipal Participation Fund State VAT Other state revenues Federal contribution if needed Resources are distributed according to: Number of students in basic education in each municipality. The state level per student is: FUNDEF resources / number of students in the state. Earmarking Revenue Mechanism for Funding of Basic Education Within-state redistribution of resources

Other aspects : Federal government defines a national minimum levels of expenditure per student. If state Fund does not achieve this minimum level, federal government complement the resources to achieve the national minimum level. Thus, regional differences are partially alleviated. State governments also have basic schools, thus they receive resources from the state Fund. There is different minimum values according to the grade of students. Conditionalities in the use of Fundef resources.

Results: Basic objective was achieved: equalization of basic education expenditure per student. Strong increase of enrollment rates. Increase of teacher salaries. Weak results in terms of improvement in quality of education? Competition among municipalities and between state and municipalities. In some states it generated decentralization of education. State governments are complaining for resources losses. Problems to finance secondary education. Large disparities among states subsist.

Conclusions and Policy Implications Regional redistribution mechanism to be efficient should be based on demand driven. Conditional transfers are more efficient than unconditional. Are the transfers going to the right places Is there a trade-off between reducing regional inequalities and improving aggregate welfare? Economies of scale – Population - Social indicators

Population, poverty and geography Poverty Rate (P oor/Population)

Population, poverty and geography Poverty Density (Poor/km2)

Poverty rate and density by municipality, NE - Brazil Poverty Density Poverty Rate

Expenditure/eligible population

Population with no access to improved water

Policy Implications (cont) Geography and returns to investments – economies of scale. Population, poverty and geography. Poverty rate vs poverty density Need for flexibility- different redistribution mechanisms. Low densityHigh density Low rate High rate