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José Roberto Afonso and Luiz de Mello

The global crisis had a milder adverse effect on Brazilian subnational budgets than in most OECD countries, essentially on account of a less severe deceleration in economic activity – at least until a sharper deceleration since 2011. Counter-cyclical responses were predominantly of a quasi-fiscal nature in the form of capital injections by the National Treasury in government-owned financial institutions, but also included some targeted tax cuts at the central and state levels. Since then, and despite a pick-up in activity, budget outcomes have deteriorated at the central and subnational levels, with gradually falling primary budget balances and an increase in gross indebtedness for the general government. Also, a ratcheting-up of current expenditure is constraining the ability of the states and municipalities to invest, despite rising borrowing after the crisis. Moreover, a number of structural challenges will need to be addressed to put the subnational finances on a sounder footing and in support of stronger long-term growth. They include a reform of the state-level VAT, a rationalization of expenditure to deal with the emerging pressures associated with population ageing and to enhance cost-effectiveness of subnational programmes, efforts to reduce budgetary rigidities due to widespread revenue earmarking and mandated spending, and further institutional improvements to foster coordination among the different layers of government.

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José Roberto Afonso, Sulamis Dain, Vivian Almeida, Kleber Castro and Ana Cecília Faveret