Fiscal Rules to Tame the Political Budget Cycle: Evidence from Italian Municipalities

IMF Working Papers, January 20, 2017

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Fiscal Rules to Tame the Political Budget Cycle: Evidence from Italian Municipalities

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Bibliographic details

• Authors: Lorenzo Forni, Andrea Bonfatti
• Published: January 20, 2017
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781475569971.001

Summary

• Paper examines application of the Italian subnational fiscal rule over the period 2004-2006.
• Focuses on whether fiscal rules can limit the political budget cycle at the municipal level.
• Uses the fact that the domestic fiscal rule does not apply to municipalities below 5,000 inhabitants to identify effects.

Key findings

• Municipalities are subject to political budget cycles in capital spending.
• The Italian subnational fiscal rule introduced in 1999 has been enforced by the central government.
• Municipalities subject to the fiscal rule show more limited political budget cycles than municipalities not subject to the rule.
• The political budget cycle increases real capital spending by about 35 percent on average in the years prior to municipal elections.
• The sub-national fiscal rule reduces these figures by about two thirds.

Evidence and identification

• Period analyzed: 2004-2006.
• Identification leverages the DSP threshold: rule does not apply to municipalities below 5,000 inhabitants.
• Empirical approach references regression discontinuity analysis (keyword list includes "regression discontinuity" and "regression discontinuity analysis").

Policy implications

• Fiscal rules can be an effective tool to curb election-driven increases in capital spending at the subnational level when enforced by the central government.
• Enforcement of subnational fiscal constraints appears necessary to limit politically motivated fiscal expansions prior to elections.

Source: Lorenzo Forni and Andrea Bonfatti, "Fiscal Rules to Tame the Political Budget Cycle: Evidence from Italian Municipalities", January 20, 2017.

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