Losing to Gain: Revenue Shortfalls and Fiscal Capacity in Brazil

This paper investigates how shocks to non-tax revenues impact tax collection in Brazilian municipalities, exploiting an exogenous shift in intergovernmental transfers driven by population updates. Our analysis reveals asymmetric effects of shocks: revenue gains lead to increased spending without tax reductions, while losses in transfers prompt investments in fiscal capacity and boost tax revenues. Enhancing fiscal capacity entails adjusting tax bureaucrat payments, improving property registries, and cracking down on delinquency, with heterogeneous responses based on political competition and the educational levels of local leaders and the bureaucracy. These findings emphasize the importance of rules that reduce the reliance on non-tax revenues and promote effective tax collection.