Despite the popular image of Brazil's public sector as a profligate spender and intense consumer of resources, public expenditures as a share of national product remained relatively stable until the mid-1980s. The containment of public spending under the government of President João Batista de Oliveira Figueiredo (1979-85) at the federal level included limitations on hiring and expenditures on goods and services as well as cuts in public investment. Spending by state and local governments was limited by reductions in the revenues transferred to them by the federal government.
Total spending for public-sector wages and salaries, which had actually declined as a share of national product between the early 1970s and 1984, only began to increase when the government of President José Sarney (1985-90) took over, reaching almost 10 percent of GDP in 1989. Public-sector spending on goods and services as a share of GDP also increased under President Sarney. A fall in net subsidies to the private sector and a stable level of social security spending were not sufficient to offset a sharp rise in government spending on wages and salaries. The expansion of public spending after 1985 occurred at all levels of government. At the federal level, it was partly caused by the efforts of President Sarney to secure a full five-year mandate, reinforced by the misperception that Brazil's budget deficit would be negligible if the effects of inflation on it were discounted. At the state and local levels, greater revenues were available as a result of changes in federal transfers after 1985, a trend reinforced by the 1988 constitution. Much of this spending went for current expenses, primarily personnel, rather than investment in infrastructure. Even with this expansion in state and local spending, however, the federal government remained responsible for about two-thirds of total expenditures. State spending was primarily for education and health, and local government expenditures were devoted principally to housing and urban development. At all levels of government, however, much of this spending, whatever the announced function, was for personnel and administrative costs.
The worsening of Brazil's public-sector finances in the 1980s was in part the consequence of the political and administrative decentralization that took place following the return to civilian rule in 1985. In 1988 the new constitution made this decentralization explicit, transferring to state and local governments a substantial part of the revenues that were formerly received by the federal government. There was not, however, a parallel decentralization of expenditure responsibilities. The federal government retained most of its functional responsibilities, while losing a significant part of its revenues.
Trends in tax revenues after 1983 further aggravated Brazil's public-sector finances. Tax receipts as a share of GDP fell sharply after 1983, having averaged about 25 percent in the preceding decade. With the exception of the atypical year of 1986 (the Cruzado Plan), they did not regain such levels until the first years of the Collor de Mello government, when increases in income taxes and social security contributions, as well as taxes on manufactured goods and financial operations, slowed the decline in revenues.
Although the federal government in the early 1990s made determined efforts to maintain its income by enforcing tax collection, these efforts met with limited success. Public cynicism about the government's use of tax revenues, fed in part by the corruption scandal that forced Collor de Mello from office in September 1992, led to increased tax avoidance and in many cases to outright tax evasion. Although little firm evidence is available to quantify tax evasion, considerable anecdotal and fragmentary evidence suggests that it rose significantly in the 1980s and early 1990s. With the increased financial opening of the economy, many Brazilians sought to shelter income derived from financial assets by placing them outside Brazil, even when before-tax returns in Brazil were substantially higher. Capital flight from Brazil, which had not been as serious a problem as it had been for a number of other Latin American nations in the 1970s and early 1980s, accelerated significantly in the late 1980s. Other ways in which Brazilians evaded taxes included substantial understatement of income from professional and service activities and the widespread practice of making transactions without documentation for tax purposes.
The adoption of the new constitution in 1988 had a significant impact on public-sector finances. Many Brazilians viewed it as the vehicle through which to redress what they regarded as excessive concentration of powers at the federal level. Consequently, strong support existed for decentralizing government and shifting power from the presidency to the Congress. Many Brazilians also saw the new constitution as a way not only to guarantee civil rights but also to secure specific economic rights in the areas of health, education, employment guarantees, and social security.
The result was a document that is far more specific and lengthier than those of most other nations. Some advances were made in the arrangement of public finances, among them restrictions on off-budget spending by the executive and better defined procedures for the preparation and passage of an annual budget. In a larger sense, however, the 1988 constitution made the potential for fiscal deterioration more likely, especially at the federal level. It not only reduced the revenues that went to the federal government by transferring them to states and municipalities but also linked many revenue sources to specific objectives, further restricting the federal government's ability to allocate expenditures. In addition, the new charter actually expanded some federal responsibilities in a number of areas, among them law enforcement, education, and cultural affairs. Another provision granted tenure to public employees after two years. The constitution strengthened employment and pension guarantees and the explicitly maintained pension and retirement rights based on length of service--thirty-five years for men and thirty years for women--without regard to age at retirement. Together, these provisions made fiscal equilibrium, especially at the federal level, even more difficult to attain than it had been before 1988.
A number of Brazilian economists and policy makers soon recognized the budgetary implications of the new constitution. The stabilization program of the new Collor de Mello government in 1990 temporarily halted the decline in federal government revenue through its price and wage freezes, but this was done at a very high cost. The dramatic freezing of most Brazilians' financial wealth under the first Collor de Mello plan raised basic legal and constitutional questions about the fiscal rights and responsibilities of the government. A number of Brazilian legal scholars questioned the right of the government to impose what they argued was a tax, not allowed for in the constitution, through the freezing of assets whose full real value would not be repaid to their holders.
By the early 1990s, a consensus had emerged that successful economic and price stabilization would require profound changes in Brazil's fiscal system and, if necessary, amendments to the 1988 constitution. Although such views were rejected vigorously if suggested by others, such as the IMF or foreign lenders, many Brazilians recognized that the 1988 constitution had created a number of fiscal problems. In October 1991, the Collor de Mello government submitted to Congress a series of proposals aimed at reducing the fiscal pressures at the federal level. Among the proposed changes were modifications of the constitutional obstacles to administrative reform, limitations on the constitutional guarantees for social security, and authority to create new sources of federal tax revenue. With the erosion of support for the Collor de Mello government during 1992, the proposals had little chance of passage, and the fundamental fiscal disequilibrium continued under the administration of Itamar Franco (1992-95), Collor de Mello's successor.
The root of Brazilian inflation has been the monetization of the public sector's fiscal deficit, because deficits that are not financed by borrowing either from abroad or domestically must be covered by the creation of money. By the early 1990s, the old debate between the monetarists (see Glossary), who emphasized the central role of money supply growth in the inflationary process, and the structuralists (see Glossary), who attributed price increases to supply problems in developing economies like Brazil's, was viewed as an obsolete and largely sterile discussion. Instead, debate focused on the causal relationship between inflation and the money supply, and on how much freedom the government actually had in determining money-supply growth.
However important monetization of the public sector's fiscal deficit may have been in the past in either initiating or accelerating inflation, the reinforcement of the inflationary process by past inflation and by expectations of future inflation was an important part of the Brazilian experience in the 1980s and 1990s. In Brazil the feedback effect of past inflation has been institutionalized in an extensive indexation or "monetary correction" (correção monetária ) system, which was developed and extended to most markets between 1964 and 1970. The result was an economy in which apparently modest initial shocks could be transformed into high and continuing inflation. Recognition of this feedback effect in the early 1980s played a role in the design of the 1986 Cruzado Plan, as well as in subsequent stabilization attempts, notably the Real Plan in 1994. The inflation indexation system, which in the 1970s had been virtually unquestioned, was increasingly blamed for contributing to the continuation and acceleration of inflation in the 1980s and early 1990s.
Although inflation accelerated significantly in the 1980s, it had long been a feature of Brazil's economy. The first major inflationary surge began in the late 1950s and continued until 1964, in part the result of the monetary accommodation of fiscal pressures resulting from a sharp rise in government expenditures. A second surge began in the 1970s, partly as a result of the external shocks caused by the rise in energy prices. The indexation system served as a vehicle for amplifying energy price increases into higher widespread price increases than might have occurred. Inflation worsened dramatically in the 1980s, however, as Brazil lost its access to foreign capital markets and domestic borrowing to finance the growing public-sector deficit became increasingly expensive (see table 15, Appendix). Inevitably, money creation became one of the primary ways to finance the deficit.
It is difficult for non-Brazilians to grasp the significance of double-digit inflation for forty years, with triple- and even quadruple-digit inflation in the 1980s. By the late 1980s, annual rates of inflation were almost meaningless, and Brazilians themselves routinely characterized inflation by its monthly rate, which in the early 1990s was over 35 percent. Between the end of World War II and Brazil's Real Plan in 1994, the price level had increased more than 100 billion times.
Not only did inflation accelerate over the 1980s, but the rate became more variable and less predictable. The frequency of price adjustments increased, and wage and salary adjustments that had once occurred annually were adjusted semiannually, then quarterly, and in some markets monthly, as inflation accelerated. In other markets, especially the capital markets, inflation had similar effects in shortening contract periods. Few borrowers or lenders would dare to make long-term commitments, and by the late 1980s most Brazilian firms, as well as most wealthier individuals, held any excess assets in short-term, highly liquid deposits that were literally known as the "overnight."
The rise in indexation in Brazil after 1964 had permitted the government to tap the supply of domestic saving by selling indexed government bonds to savers, who were thus protected against the effects of inflation on the value of such assets. Although indexed bonds were regarded as a great success in the 1960s and 1970s, the need to pay not only the interest but also the inflation adjustment became an increasing burden for the government in the 1980s.
Despite the burden that indexed bonds placed on government finances as inflation accelerated, inflation itself appears to have been an important source of revenue for the government. The "inflation tax," which is the real income that the government receives through the issuance of new money, tends to increase with inflation, because nonindexed money or partially indexed financial assets issued by the government lose their real value. This loss in spending power incurred by the holders of money is in effect a tax, because the government spending financed by money creation is paid for by the loss in value of the money held by the public. Attempts have been made to measure the income that the Brazilian government earned through the inflation tax, and some estimates suggest that income from this source in the 1980s was over 3 or 4 percent of GDP.
Data as of April 1997