Policy Responses to Fiscal Restraints: A Difference-in-Discontinuities Design

56 Pages Posted: 21 Nov 2012

See all articles by Veronica Grembi

Veronica Grembi

University of Rome I - Sapienza University of Rome, Department of Earth Sciences and Forecasting Research Center, Prevention and Control of Geological Risks

Tommaso Nannicini

Bocconi University - Department of Economics; IZA Institute of Labor Economics

Ugo antonio Troiano

University of California Riverside

Multiple version iconThere are 3 versions of this paper

Date Written: November 21, 2012

Abstract

We evaluate the effect of relaxing fiscal rules on policy outcomes applying a quasi-experimental research design. In 1999, the Italian central government introduced fiscal rules aimed at imposing fiscal discipline on municipal governments, and in 2001 the rules were relaxed for municipalities below 5,000 inhabitants. This institutional change allows us to implement a “difference-indiscontinuities” design by combining the before/after with the discontinuous policy variation. Our estimates show that relaxing fiscal rules triggers a substantial deficit bias, captured by a shift from a balanced budget to a deficit that amounts to 2 percent of the total budget. The deficit comes primarily from reduced revenues as unconstrained municipalities have lower real estate and income tax rates. Finally, we investigate the heterogeneity in policy responses across municipalities to provide new evidence about the costs and benefits of restricting fiscal policy. The impact is larger if the mayor can run for reelection, the number of political parties seated in the city council is higher, voters are older, the performance of the mayor in providing public good is lower, and cities are characterized by historical deficit, consistently with models on the political economy of fiscal adjustment.

Keywords: fiscal rules, local government finance, difference-in-discontinuities

JEL Classification: C210, C230, H620, H720, H770

Suggested Citation

Grembi, Veronica and Nannicini, Tommaso and Troiano, Ugo antonio, Policy Responses to Fiscal Restraints: A Difference-in-Discontinuities Design (November 21, 2012). CESifo Working Paper Series No. 3999, Available at SSRN: https://ssrn.com/abstract=2178962 or http://dx.doi.org/10.2139/ssrn.2178962

Veronica Grembi

University of Rome I - Sapienza University of Rome, Department of Earth Sciences and Forecasting Research Center, Prevention and Control of Geological Risks ( email )

Rome
Italy

Tommaso Nannicini

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Ugo antonio Troiano (Contact Author)

University of California Riverside ( email )

900 University Avenue
Riverside, CA 92521
United States

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