Fiscal crime doesn't pay.

Photographer: VANDERLEI ALMEIDA/AFP/Getty Images

The Real Lesson Behind Brazil's Mess

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.
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Brazilians taking to the street to protest corruption have been a driving force behind the (for now) temporary removal of Dilma Rousseff from the nation's highest office. Yet the fiscal responsibility law that underpins the case for impeachment brought against her is not directly linked to corruption.

That disjunction has fueled bitter protests by Rousseff's supporters, who argue that she is the victim of a "coup" perpetrated by her demonstrably corrupt political opponents. Yet such criticisms miss the two most salutary lessons of Brazil's crisis: first, that the country's democracy is strong enough for people to have their voices heard when they take to the streets; and second, that dishonest accounting to cover profligate spending of taxpayer money is indeed  a crime that can end a presidency. 

On May 12, legislators agreed to try the president on allegations she doctored fiscal accounts to mask the size of the budget deficit. That sounds far less vicious than the charges of corruption and money laundering that have brought down key members of her own party and that also hang over the head of some of her chief tormentors.  Moreover, Rousseff herself hasn't been personally implicated in corruption investigations. 

The fiscal crime that she is alleged to have committed, however, is in its own way no less serious. Indeed, it is at the root of Brazil's dire economic predicament. That incoming presidents now will be reminded they can be removed from office if they don't spend wisely is good news for Brazil. In fact, one of the worst outcomes to the current impasse would be if shrewd politicians see the revolt of some against the law that ousted Rousseff as an excuse to revoke it. 

Brazil's Fiscal Responsibility Law was enacted in 2000, in the second term of former president Fernando Henrique Cardoso. He had originally been elected in 1994 on the strength of his success as finance minister in controlling Brazil's runaway inflation and stabilizing its currency. Cardoso focused his first term on solidifying those advances, privatizing inefficient state-owned companies and making a few key reforms. By 1999, elected for his second term and having successfully removed the currency peg, the center-left politician set his sights on balancing the budget and locking in the progress he had achieved. 

The law required, among other things, the central government, states and municipalities to set budget goals with clear sources of revenue to meet them. It also capped personnel spending at 50 percent of current revenues in the federal sphere and 60 percent for mayors and governors.

At the core of the law is the concept of current revenue. That means verified receipts over the past year. Government can only spend a maximum of 120 percent of that. If that ceiling is breached, spending must return below it within a year.

Under the law, any expenses that weren't set out in the budget, especially if they recur, are considered unauthorized, illegal and damaging to public coffers.  

In 2015, Rousseff's administration asked state-owned banks to pay monthly outlays of social programs without giving them the money upfront. The delayed transfer had already allowed her administration to spend more heavily than it had envisioned in its budget between 2012 and 2014, when she was reelected. According to a government audit, the amount overspent topped 40 billion reais ($11.5 billion) in those two years.

That money wasn't included in the official accounts until it was paid to the banks, allowing limits in the fiscal responsibility law to be met. In other words, the administration was cooking the books as spending got out of hand. Last year, the bill for the strategy breached 50 billion reais.

To put this in context, the cost to the state-owned oil firm Petrobras from the  graft scheme that has led to the jailing of several senior members of Rousseff's Worker's Party were an estimated  29 billion reais last year.   

To finance so much spending, the government took on ever more debt. According to website Auditoria Cidada, in 2014, 45 percent of government spending in 2014 went to service debt. That's more than 11 times what it invested in healthcare and 12 times the education budget.

The only way to reverse that is to stop spending. Which goes back to why the fiscal responsibility law was created: to save future governments from having to pay for populist spending by the previous administration, and to ensure a sustainable fiscal balance. 

That's the challenge facing the incoming government of Rousseff's former Vice President Michel Temer, and whoever is elected to follow him. They will have to balance the budget as the country tries to exit one of its worst recessions in the past 100 years.

Perhaps one way to start is to carefully audit all government expenses. Every time public money goes into the pocket of a politician instead of into schools and hospitals, it comes out of the budget and hence puts spending a little bit closer to breaching the fiscal responsibility law. 

Relentless audits would show that Temer understood the real lessons behind Brazil's mess: the Brazilian people will no longer tolerate graft, and irresponsible spending of taxpayer money is a crime that can oust a president.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner at clangner@bloomberg.net

To contact the editor responsible for this story:
James Gibney at jgibney5@bloomberg.net