Intergovernmental transfers and fiscal performance: evidence from Brazil

This study examines the impact of intergovernmental transfers, particularly the Municipal Participation Fund (FPM), on municipal fiscal performance in Brazil, with a focus on per capita current expenditure and own-source revenue. Using a panel dataset covering all municipalities in São Paulo state from 2013 to 2021, we estimate instrumental variable regressions to address potential endogeneity between transfers and fiscal outcomes. The number of FPM quotas assigned to each municipality, determined by population thresholds established in federal legislation, is used as an exogenous instrument for per capita transfers. The results reveal a positive and statistically significant association between FPM transfers and per capita current expenditure, confirming the ‘flypaper effect’. However, FPM transfers are negatively associated with own-source revenue, suggesting that greater reliance on intergovernmental transfers may undermine local tax effort. The findings underscore the need to reassess FPM allocation rules to reduce fiscal dependence and enhance local government autonomy.