Luiz de Mello

Income Inequality and Redistributive Government Spending

This article examines empirically the question of whether more unequal societies spend more on income redistribution than their more egalitarian counterparts. Theoretical arguments on this issue are inconclusive. The political economy literature suggests that redistributive spending should be higher in more unequal societies due to median voter preferences. Alternatively, it can be argued that unequal societies may spend less, not more, on redistribution because of capital market imperfections. Based on different data sources, the cross-country evidence reported in the article supports the “imperfect markets” hypothesis, showing that more unequal societies do spend less on redistribution. The empirical analysis also takes into account the fact that the share of redistributive transfers in GDP is nonnegative.

Can Fiscal Decentralization Strengthen Social Capital

Countries that are rich in social capital, defined as the social and political institutions that stimulate interpersonal trust, civic cooperation, and social cohesiveness, tend to have more efficient governments, have better governance systems, and grow faster. This article provides preliminary cross-country evidence for a sample of developing and developed countries that fiscal decentralization—the assignment of expenditure functions and revenue sources to lower levels of government—can boost social capital.Countries that are rich in social capital, defined as the social and political institutions that stimulate interpersonal trust, civic cooperation, and social cohesiveness, tend to have more efficient governments, have better governance systems, and grow faster. This article provides preliminary cross-country evidence for a sample of developing and developed countries that fiscal decentralization—the assignment of expenditure functions and revenue sources to lower levels of government—can boost social capital.

How Does Decentralized Minimum Wage Setting Affect Employment and Informality? The Case of Indonesia

The Indonesian labor market is characterized by widespread and growing informality (defined as non-salaried work). To what extent can the growth in informality be attributed to a sharp increase in the real value of the minimum wage since 2001, when minimum-wage setting was decentralized to the provincial governments? To answer this and related questions we use survey data on the labor market, on household income and expenditure, and on the industrial sector to construct a district-level dataset spanning the period 1996 to 2004. The effects of changes in the minimum wage on unemployment, formal-sector employment, and the incidence of informality in urban areas are estimated by fixed effects with a seemingly unrelated regression estimator. We find that an increase in the ratio of the minimum to the mean wage is associated with a net increase in employment: a rise in informal-sector employment more than compensates for job losses in the formal sector.

Estimating a fiscal reaction function: the case of debt sustainability in Brazil

This article reviews recent trends in fiscal performance in Brazil, estimates fiscal reaction functions for the consolidated public sector and different levels of government, and tests for the sustainability of the public debt dynamics. The empirical analysis, based on monthly data for the period 1995–2004, suggests that all levels of government react strongly to changes in indebtedness by adjusting their primary budget surplus targets. In addition, the central government appears to follow a spend-and-tax policy: changes in revenue are affected strongly by expenditure. About two-thirds of changes in primary spending are offset by higher revenue over the longer term. Institutions are also found to matter for fiscal sustainability. The responsiveness of the sub-national fiscal stance to indebtedness, as well as that of central government revenue to changes in primary spending, appears to have become stronger after 1998, when ceilings on indebtedness were introduced.

Public finance, government spending and economic growth: the case of local governments in Brazil

The impact of local government spending on output growth is estimated using a panel of Brazilian municipalities during 1985–1994. Attention is focused on three expenditure categories, housing/urbanization, health/sanitation, and transport services, which are expected to be growth-enhancing, and their sources of finance (local taxes, intergovernmental transfers, and borrowing). The determinants of these spending categories are also examined. The size of the municipality, measured by the resident population, is shown to affect government spending nonlinearly. This is a contribution to the recent empirical literature on the linkages between decentralized government spending, public finances, and economic growth at the local, rather than national, level.The impact of local government spending on output growth is estimated using a panel of Brazilian municipalities during 1985-1994. Attention is focused on three expenditure categories, housing/urbanization, health/sanitation, and transport services, which are expected to be growth-enhancing, and their sources of finance (local taxes, intergovernmental transfers, and borrowing). The determinants of these spending categories are also examined. The size of the municipality, measured by the resident population, is shown to affect government spending nonlinearly. This is a contribution to the recent empirical literature on the linkages between decentralized government spending, public finances, and economic growth at the local, rather than national, level.

Avoiding the Value Added Tax: Theory and Cross-Country Evidence

This article develops a differential game of tax avoidance by modeling the interactions between a taxpayer and the tax authority. The solution to the game is a noncooperative Nash that depends on the resources used by the tax authority to enforce legislation and the cost borne by the taxpayer in tax compliance. Empirical evidence is provided for the value added tax (VAT) using a cross-section of Organisation for Economic Co-operation and Development (OECD) and non-OECD countries. VAT efficiency, defined as the ratio of collections as a share of consumption to the statutory rate, rises the lower the VAT rate, the lower the share of administrative costs in tax revenue (proxying for the efficiency of tax administration), the more pro-competition the regulatory framework in product markets (measuring non-tax incentives for noncompliance) and the better the countrys governance indicators (regulatory quality, rule of law, and government effectiveness).This paper develops a differential game of tax avoidance by modelling the interactions between a taxpayer and the tax authority. This framework is particularly useful for explicitly modelling situations of conflict. The solution to the game is a non-co-operative Nash that depends on the resources that need to be used by the tax authority to enforce legislation and the cost to be borne by the taxpayer in tax compliance, provided that the curvature of the utility functions is bounded. Empirical evidence is provided for the value added tax (VAT) using a cross-section of OECD and non-OECD countries. OECD indicators of tax administration efficiency are included in the regressions. The empirical findings show that VAT efficiency, defined as the ratio of collections as a share of consumption to the statutory rate, rises the lower the VAT rate, the lower the share of administrative costs in tax revenue (proxying for the efficiency of tax administration), the more pro-competition the regulatory framework in product markets (measuring non-tax incentives for non-compliance) and the better the country’s governance indicators (regulatory quality, rule of law and government effectiveness). This paper is forthcoming in the Public Finance Review. Evasion de la TVA : Theorie et Comparaisons Internationales Ce document developpe un jeu differentiel des evasions fiscales en modelisant les interactions entre les contribuables et les administrations fiscales. Ce cadre est particulierement adapte a la modelisation des situations de conflit. La solution du jeu est un equilibre de Nash non-cooperatif qui depend des ressources dont ont besoin les administrations fiscales pour appliquer la legislation et les couts imputes aux contribuables dans le respect des obligations fiscales, a condition que la derivee premiere de la fonction d’utilite soit bornee. L’analyse empirique utilise la TVA d’un echantillon de pays de l’OCDE et non-OCDE. Les indicateurs OCDE d’efficacite des administrations fiscales sont integres aux regressions. Les resultats montrent que l’efficacite de la TVA (definie comme le ratio entre les revenus de la TVA divise par la consommation et le taux de la TVA), augmente inversement au taux de la TVA et a la part des couts administratifs dans les revenus des impots (un indicateur d’efficacite des administrations fiscales). Par contre, l’efficacite de la TVA augment proportionnellement au biais pro-competition des reglementations des marches des produits et aux indicateurs de bonne gouvernance (qualite des reglementations, regle de droit et efficacite du gouvernement). A paraitre prochainement dans Public Finance Review.

The Rates and Revenue of Bank Transaction Taxes

This paper provides cross-country empirical evidence on the productivity of bank transaction taxes (BTTs). Our data set comprises six Latin American countries that have levied BTTs since the late 1980s: Argentina, Brazil, Colombia, Ecuador, Peru and Venezuela. We find that, for a given tax rate, revenue declines over time. Therefore, in order to meet a fixed revenue target in real terms, the tax rate needs to be raised repeatedly. However, we also find that successive increases in the tax rate erode the tax base by more than they raise revenue yield and that the higher the increase in the tax rate, the more and faster the tax base is eroded. We conclude that BTTs do not provide a reliable source of revenue, especially over the medium term. Ce document fournit une etude empirique de comparaison internationale sur la productivite des impots sur les transactions bancaires (ITB). Notre base de donnees correspond a 6 pays d’Amerique latine qui ont un impot sur les transactions bancaires: Argentine, Bresil, Colombie, Equateur, Perou et Venezuela. Nous trouvons que le revenu diminue au fil du temps pour un taux d’imposition donne. Pour cette raison, le taux d’imposition doit etre augmente regulierement en vue d’atteindre une cible de revenu en terme reel. Cependant, nous voyons que les augmentations successives des taux d’imposition reduisent l’assiette d’imposition plus que le rendement obtenu, et plus grande est la hausse du taux d’imposition, plus rapide est l’erosion de l’assiette d’imposition. Nous concluons que l’imposition des transactions bancaires ne fournit pas une source de revenu fiable, particulierement sur le moyen terme.

What is the Value of (My and My Family's) Good Health?

This paper uses several waves of the General Social Survey (GSS) including data for up to about 32,000 individuals to estimate the effect of a variety of health conditions on happiness. We show that healthy people are in general happier than individuals with poor health, controlling for a number of personal and household characteristics. On the basis of the regression results, we computed the monetary value of good health, suggesting that relatively large sums of money would be required to compensate individuals for the loss in happiness associated with poor health. Finally, we show that people become unhappy when the health status of their loved ones deteriorates. In particular, the compensating value associated with a spouses poor health can be very large, thus pointing to some altruism in the relationship between health status and happiness.

Fiscal Responsibility Legislation and Fiscal Adjustment: The Case of Brazilian Local Governments

This paper discusses trends in fiscal adjustment in Brazil since the 1990s, with particular emphasis on the strengthening of institutions for fiscal policymaking, and its effect on local government finances and their ability to invest in infrastructure building and upgrading. Although fiscal adjustment, which is ongoing, has taken a toll on the governments ability to finance much-needed infrastructure investment, it is not the only culprit. A lack of budget flexibility, against a backdrop of increasing downward rigidities in current spending, also constrains the governments ability to invest. The paper argues that regulatory uncertainty in many sectors, particularly water and sanitation, in which the municipalities play a leading role, has discouraged private sector investment and that the financing of infrastructure building and upgrading goes beyond the municipal level of government. Higher-level jurisdictions are responsible for financing investment in energy and transport infrastructure, for example.

Managing Chile's Macroeconomy during and after the Copper Price Boom

Compliance with the structural budget surplus rule, which has been in place since 2001, has allowed the government to maintain a counter-cyclical fiscal stance in an environment of rising copper prices, while delivering a gradual reduction in public indebtedness. Monetary policy is conducted within a framework that combines inflation targeting with exchange-rate flexibility. A Fiscal Responsibility Law was promulgated in September 2006, strengthening the macroeconomic framework further by embedding the fiscal rule in law and setting out regulations for the use of fiscal savings. Complementary pension reform is being discussed in Congress with the objective of strengthening the pension system’s solidarity pillar and encouraging retirement saving. The tax system is also being improved with a view to removing obstacles to financial deepening and to business-sector development. Government spending on social programmes is budgeted to rise considerably, in line with the authorities’ emphasis on social development. The main challenge in the macroeconomic area is to maintain the policy setting that has served Chile so well over the recent copper-price upswing, while tempering demands for hiking public social spending and maintaining a lean public sector in a low-tax, low-debt environment. This paper relates to the 2007 Economic Survey of Chile (www.oecd.org/eco/surveys/chile). La gestion macroeconomique du Chili durant et apres la forte hausse des prix du cuivre Respectant la regle d’excedent budgetaire structurel, appliquee depuis 2001, le gouvernement a pu maintenir une orientation budgetaire anticyclique dans un contexte de hausse des prix du cuivre tout en reduisant progressivement la dette publique. La politique monetaire s’appuie sur un cadre associant le ciblage de l’inflation a un taux de change flexible. Une loi de responsabilite budgetaire, adoptee en septembre 2006, a encore renforce le dispositif macroeconomique en conferant un caractere legislatif a la regle budgetaire et en reglementant l’utilisation des economies budgetaires. Une reforme complementaire des retraites est actuellement examinee par le Congres, son but etant de consolider le regime fonde sur la solidarite et d’encourager l’epargne retraite. Les autorites s’efforcent egalement d’ameliorer le systeme fiscal afin d’eliminer les obstacles au developpement du secteur financier et du secteur des entreprises. Les depenses publiques devraient beaucoup augmenter pour les programmes sociaux, l’accent etant mis sur le developpement social. Le principal enjeu macroeconomique est de preserver le cadre d’action qui a ete si benefique pour le Chili durant la forte hausse recente des prix du cuivre, tout en temperant les revendications d’augmentation des depenses publiques sociales et en conservant un secteur public dimensionne au plus juste dans un environnement de faible fiscalite et de faible endettement. Ce document se rapporte a l’Etude economique du Chili 2007 (www.oecd.org/eco/etudes/chili).