Fiscal Responsibility and the Supply of Public Goods

In this paper we show a model where fiscal responsibility laws, by reducing the ability of politicians to use public resources for personal gains, can lead to an increase in the supply of public goods. We test this conjecture using data from Brazilian municipalities. As a nationwide institutional innovation, Brazil's fiscal responsibility law (FRL) was exogenous to all municipalities; therefore, there was no self-selection bias in its implementation. We found a higher supply of public goods in education after the FRL (teachers, classrooms, and enrollments). The education is the most important social expenditure at the municipal level in Brazil. Our result is robust for small municipalities, municipalities with greater or lower dependency of intergovernmental transfers, and municipalities where the second-round is permitted.