The Effects of Local Government Indebtedness: Evidence from Toxic Loans

53 Pages Posted: 12 Mar 2021 Last revised: 7 Feb 2023

See all articles by Julien Sauvagnat

Julien Sauvagnat

Bocconi University; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Boris Vallee

Harvard Business School - Finance Unit

Date Written: February 9, 2021

Abstract

We examine the response from municipalities and their voters to a large and exogenous increase in municipal indebtedness. We show that municipalities with "toxic loans" on their balance sheet exhibit a large increase in their debt and interest expenses following the Great Financial Crisis. This large increase in indebtedness causes a twice-as-large reduction in municipal investments, whereas local taxes remain unaffected. The reduction in investments is particularly pronounced for municipalities that are politically contested. These empirical findings are consistent with a model of municipal investment in which electoral competition act as a disciplinary device for local politicians.

Keywords: Public debt, public investments, political contestation, toxic loans

JEL Classification: P16, H74, G11, G32

Suggested Citation

Sauvagnat, Julien and Vallee, Boris, The Effects of Local Government Indebtedness: Evidence from Toxic Loans (February 9, 2021). Available at SSRN: https://ssrn.com/abstract=3782619 or http://dx.doi.org/10.2139/ssrn.3782619

Julien Sauvagnat

Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Boris Vallee (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States

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