Impact of natural disasters on local public finance: Evidence from droughts and floods in Brazil

Abstract

Natural disasters can cause substantial damage to human lives, the environment, and the economy, leading to financial strain on subnational governments. This study examines the impact of extreme weather events on the local public finances in Brazil, focusing on government funding strategies for relief measures and policies to reduce future risks associated with such hazards. We leverage Standard Precipitation and Evapotranspiration Index (SPEI) data to identify extreme floods and droughts in 5,474 municipalities from 1997 to 2019. Then, we estimate the effects of these disasters on local public finance by employing an approach that combines a difference-in-differences estimator with a matching method and allows treatments with switching on and off behavior. Our findings reveal that droughts do not significantly impact intergovernmental transfers, leading to financial strain for the affected municipalities. Conversely, floods increase the grants received by local governments, improving their fiscal balances. However, this better fiscal situation does not affect the spending in flood mitigation areas (urbanism and the environment), suggesting a moral hazard problem related to the overreliance on resources from higher-level governments.