4. Taxation by size of municipality and region

Following the evaluation of the municipal tax burden, this section aims to breakdown municipalities into groups by population and region of the country. An analysis focused on this is important to see how the tax burden of local governments behaves as the socioeconomic

<sup>3</sup> Translation made by the authors.

profile of the localities is changed, allowing questions such as: "do bigger cities have a higher tax burden?" or "what is the profile of a municipality that receives relatively more transfers?" to be asked.

Due to the information that is presented in this section being in greater detail, it has not been possible to present data as recent (2016) as that of the two previous sections. Since the last GDP for municipalities released by the IBGE refers to 2014, this section is related to 2014. Therefore, the main base of information (Finbra) was also from that year. This on the other hand was reedited to remove major errors such as zero or negative values, but providing a final sample of 4866 municipalities—87.4% of the total number of municipalities in Brazil (5570) in 2014. To calculate the burden, the municipalities were divided into six bands of populations<sup>4</sup> and five regions.<sup>5</sup>

Given these brief methodological considerations, Figure 4 presents the municipal tax burden (% of GDP) in terms of direct taxation and available revenue in each of the six population bands and the general average.

Figure 4 presents two clear movements when the data are observed from the smaller to the higher population range: first, the local governments' own direct collection grows in relation to the size of the municipality in terms of population and second, the available

Figure 4. Direct collection and available municipal revenue by band of population, 2014.

However, classifying taxes by how they are levied is not enough to make such an assertion. This is because, even among direct taxes, there is evidence of low levels of progressiveness or even regressiveness. For example, Carvalho Jr. [31] is categorical in stating that IPTU—despite being a direct asset tax—is regressive, within the realm of real contributors (taxpayers). Another case is that of the social security contribution (tax base "salary and labour") which, "[…] by virtue of the upper limit of contribution, acts regressively" [32], p. 13.<sup>3</sup> In the same sense, Mélo and Campos [33] point to a historical process of deterioration in progressiveness of

Figure 3. Tax burden of the consolidated public sector and local governments by type of taxation, 2016.

In this way, considering indirect taxation's greater weight in the tax authorities of local governments, along with the fact that IPTU (the second largest municipal tax) also presents regressive characteristics, it is reasonable to assume that the municipal taxation contributes to accentuating social inequality in Brazil, following a characteristic which is inherent in the

Following the evaluation of the municipal tax burden, this section aims to breakdown municipalities into groups by population and region of the country. An analysis focused on this is important to see how the tax burden of local governments behaves as the socioeconomic

taxation on income and patrimony.

252 Taxes and Taxation Trends

Brazilian tax system as a whole [9].

Translation made by the authors.

3

4. Taxation by size of municipality and region

<sup>4</sup> The population bands are as follows: up to 10,000 inhabitants; from 10,000 to 20,000 inhabitants; from 20,000 to 50,000 inhabitants; from 50,000 to 100,000 inhabitants; from 100,000 to 500,000 inhabitants and 500,000 inhabitants and above. 5 The regions are according to the national geographic division: North, Northeast, Southeast, South and Central West.

revenue (including transfers) presents an opposite trend, having an inverse relationship with the size of the municipality in terms of population.

A few observations can be made from these results. Firstly, regarding the relatively higher tax burden in the larger cities, the evidence is consistent with the literature that points to a tendency of service agglomeration in major urban centres [34, 35], especially the more sophisticated services which are connected to industrial activity [36]. Therefore, considering it is the municipality's responsibility to levy tax on the services sector, it is expected that the municipal tax burden would tend to be larger in larger cities. Furthermore, the concentration of these services and population in a limited area of the region raises the value of the urban properties, providing greater potential for revenue gained from tax levied on real estate assets [37] such as IPTU.

Secondly, a big distortion can be seen when analysing the resources actually available to local governments after transfers from other spheres of government. As there is a clear difference in cities' abilities to levy taxes, intergovernmental transfers—notably those with unconditional redistributive characteristics such as the FPM—come into play to reduce horizontal inequalities between localities. However, as shown by the data, in fact, this does not happen. This had already been demonstrated by other authors such as Prado [38] in stating "[…] the Brazilian federation has a tax system which lacks an efficient and dynamic method for reducing disparities" [38], p. 41.6

In fact, intergovernmental transfers—especially the FPM and the State Participation Fund (FPE) —tend to accentuate the horizontal inequalities by prioritising the allocation of resources to locations with less population. Figure 5 shows the relationship between transfers distributed to municipalities per capita and the size of the municipalities' population, in which a negative relationship between the volume of resources received and the size of the population can be seen.

Once the Union and state transfers represent a relatively larger portion of the municipalities' disposable income than the local taxes levied, it is established that an unbalanced distribution of resources via intergovernmental transfers distributed horizontally (between municipalities), as shown in Figure 5, goes hand in hand with a lack of equality in available revenue. Figure 6 shows that even adding their own revenue to transfers, available revenue per capita tends to be higher in the municipalities with smaller populations.

populated locations have fewer resources to co-finance a growing number of policies formulated by the federal government and assigned to local governments. A significant part of municipal spending on social policies is protected by the Constitution, which makes the allocation of fixed percentages in state and municipal budgets for the health and education sectors mandatory [39]. In 2016, the governmental level which showed the bulk of spending on health and education, approximately 50% of the spending that year, was the municipal gov-

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Another way to observe the inequality between the different locations, from both of the aforementioned points of view of the municipal tax burden, is separating by region, as shown

Here, there is a pattern quite similar to that obtained in Figure 4, in which regions with lower socioeconomic development (with less populous cities) collect less tax themselves (direct collection) and have more available revenue. This is exactly the case of the North and Northeast.

ernments, according to STN [40].

Figure 5. Intergovernmental transfers per capita population, 2014.

in Figure 7.

In an ideal scenario, the trend line in Figure 6 should be completely horizontal: that is, the available revenue per capita should be exactly the same for all municipalities. This ideal scenario would use as a criteria only the population (number of residents) as a proxy for the level of demand for public goods in municipalities.

However, the scenario is a little more complex: the most populated cities require a greater volume of resources to meet the population's needs, due to the population density, the higher rates of urban problems (violence, traffic, etc.) and the greater complexity of services demanded (better informed voters with higher levels of education). At the same time, the less

<sup>6</sup> Translation made by the authors.

Figure 5. Intergovernmental transfers per capita population, 2014.

revenue (including transfers) presents an opposite trend, having an inverse relationship with

A few observations can be made from these results. Firstly, regarding the relatively higher tax burden in the larger cities, the evidence is consistent with the literature that points to a tendency of service agglomeration in major urban centres [34, 35], especially the more sophisticated services which are connected to industrial activity [36]. Therefore, considering it is the municipality's responsibility to levy tax on the services sector, it is expected that the municipal tax burden would tend to be larger in larger cities. Furthermore, the concentration of these services and population in a limited area of the region raises the value of the urban properties, providing greater potential for revenue gained from tax levied on real estate assets [37] such as

Secondly, a big distortion can be seen when analysing the resources actually available to local governments after transfers from other spheres of government. As there is a clear difference in cities' abilities to levy taxes, intergovernmental transfers—notably those with unconditional redistributive characteristics such as the FPM—come into play to reduce horizontal inequalities between localities. However, as shown by the data, in fact, this does not happen. This had already been demonstrated by other authors such as Prado [38] in stating "[…] the Brazilian federation has a tax system which lacks an efficient and dynamic method for reducing dispar-

In fact, intergovernmental transfers—especially the FPM and the State Participation Fund (FPE) —tend to accentuate the horizontal inequalities by prioritising the allocation of resources to locations with less population. Figure 5 shows the relationship between transfers distributed to municipalities per capita and the size of the municipalities' population, in which a negative relationship between the volume of resources received and the size of the population can be seen. Once the Union and state transfers represent a relatively larger portion of the municipalities' disposable income than the local taxes levied, it is established that an unbalanced distribution of resources via intergovernmental transfers distributed horizontally (between municipalities), as shown in Figure 5, goes hand in hand with a lack of equality in available revenue. Figure 6 shows that even adding their own revenue to transfers, available revenue per capita tends to

In an ideal scenario, the trend line in Figure 6 should be completely horizontal: that is, the available revenue per capita should be exactly the same for all municipalities. This ideal scenario would use as a criteria only the population (number of residents) as a proxy for the

However, the scenario is a little more complex: the most populated cities require a greater volume of resources to meet the population's needs, due to the population density, the higher rates of urban problems (violence, traffic, etc.) and the greater complexity of services demanded (better informed voters with higher levels of education). At the same time, the less

the size of the municipality in terms of population.

be higher in the municipalities with smaller populations.

level of demand for public goods in municipalities.

IPTU.

254 Taxes and Taxation Trends

6

Translation made by the authors.

ities" [38], p. 41.6

populated locations have fewer resources to co-finance a growing number of policies formulated by the federal government and assigned to local governments. A significant part of municipal spending on social policies is protected by the Constitution, which makes the allocation of fixed percentages in state and municipal budgets for the health and education sectors mandatory [39]. In 2016, the governmental level which showed the bulk of spending on health and education, approximately 50% of the spending that year, was the municipal governments, according to STN [40].

Another way to observe the inequality between the different locations, from both of the aforementioned points of view of the municipal tax burden, is separating by region, as shown in Figure 7.

Here, there is a pattern quite similar to that obtained in Figure 4, in which regions with lower socioeconomic development (with less populous cities) collect less tax themselves (direct collection) and have more available revenue. This is exactly the case of the North and Northeast.

(reverse) given by intergovernmental transfers. Empirical evidence shows that, if a city receives resources from a third-party above what is required and without having to incur the administrative and political cost itself, there is a tendency for the beneficiary government to decrease in fiscal responsibility in the following ways: over-proportionately increased spending by the local government, which is known as the flypaper effect [41]; a drop in the quality of local public spending, such as a decrease in investments and an increase in running expendi-

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Section 2 of this chapter shows, through official statistics and other authors, that municipalities have had an expressively increased participation in the fiscal federalism in Brazil, especially after the 1988 Constitution, which raised local governments to the level of a federated entity

Despite the intense development of municipalities with regard to the decentralisation of resources, the current position of local governments in the national tax burden can expand even more. At least, this is the evidence that emerges from a quick comparison of Brazilian data with the position of countries in the Organisation for Economic Cooperation and Devel-

It can be noted that Brazil's position in the ranking of local governments' participation in the national tax burden is intermediate. With a participation of approximately 6.9% in 2014, the

ture [42] and, finally, the disincentive to raise their own revenue [43].

Figure 7. Direct collection and available municipal revenue by region, 2014.

and made them responsible for implementing much of the social policies.

5. International comparison

opment (OECD), as can be seen in Figure 8.

On the other hand, the Southeastern, which is known to be more advanced economically and in terms of population, has a higher municipal tax burden from the perspective of direct collection and a lower available revenue from the standpoint of local governments.

This pattern of a smaller tax burden in poorer and less populated regions is directly related to a more restricted taxable base, in addition to the costs and administrative difficulties of the collection procedure in small municipalities [5]. Nevertheless, it is possible to affirm that with the arrival of the Public Digital Bookkeeping System (SPED)<sup>7</sup> and dissemination of the use of Electronic Invoices, these barriers should be reduced.

Besides the economic and administrative aspects, it is possible to point out yet another contributing factor to the lower municipal tax burden in less affluent locations: the incentive

<sup>7</sup> Established by Decree No. 6022, of 22 January 2007, the SPED is to modernise the current performance of ancillary obligations, provided by taxpayers to the tax administrations and oversight agencies, using the digital certificate for signing electronic documents, ensuring the legal validity of those only in digital form.

Figure 7. Direct collection and available municipal revenue by region, 2014.

(reverse) given by intergovernmental transfers. Empirical evidence shows that, if a city receives resources from a third-party above what is required and without having to incur the administrative and political cost itself, there is a tendency for the beneficiary government to decrease in fiscal responsibility in the following ways: over-proportionately increased spending by the local government, which is known as the flypaper effect [41]; a drop in the quality of local public spending, such as a decrease in investments and an increase in running expenditure [42] and, finally, the disincentive to raise their own revenue [43].
