Why do some governments resort to 'creative accounting' but not others? Fiscal governance in the Brazilian federation

Abstract

This paper investigates the determinants of compliance with fiscal rules. Using information from 27 Brazilian state governments, the paper shows that the level of political competition and the degree of political autonomy of the fiscal watchdogs explain the extent of creative accounting in the Brazilian federation. Despite hard budget constraints imposed by the much-acclaimed Fiscal Responsibility Law, state governors retain the strategic ability to undertake fiscal window dressing in response to fiscal stress. As fiscal watchdogs are not immune to the influence of the legislature and state governor, however, this paper demonstrates that their level of independence and autonomy is associated with the degree of creative accounting. In addition, we show that political competition encourages non-compliance through various causal mechanisms. Building effective and autonomous institutions is a precondition for deterring fiscal misconduct but this solution is ultimately a by-product of a political equilibrium resulting from self-enforced behavior of politicians.