When Your Neighbor Goes Bust: Fiscal Adjustment without Fiscal Contagion

Abstract

Municipal bankruptcy can affect nearby governments even when fiscal liabilities remain local.

This paper studies whether municipal bankruptcy generates fiscal contagion or precautionary

adjustment. I combine Italian municipal bankruptcy events, administrative fiscal data, budget

plans, and a municipal adjacency network for 2001–2015. Comparing exposed municipalities

with other municipalities in the same province-year, I find that direct exposure to a bankrupt

neighbour reduces current expenditure by about 2–3 percent. The response is concentrated in

flexible non-payroll spending; payroll expenditure changes little. Crucially, the adjustment is

visible already in subsequent municipal budget plans: directly exposed municipalities budget

3–4 percent less non-payroll current expenditure, consistent with deliberate fiscal retrenchment

rather than an ex post execution shortfall. The response is strongest among municipalities

with greater pre-existing fiscal vulnerability and more flexible budgets, but is not systematically

shaped by electoral timing or political alignment. By contrast, exposed municipalities do not

become more likely to enter bankruptcy or riequilibrio finanziario pluriennale, worsen on ob-

jective fiscal-distress indicators, or experience systematic deterioration in fiscal balances, debt

burdens, or off-balance-sheet liabilities. Municipal bankruptcy therefore appears to generate

local fiscal discipline rather than fiscal contagion

Keywords: fiscal spillovers, yardstick competition, local public finance, Italy, municipal bankruptcy

JEL Classification: H72, H74, D72