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

Veronica Grembi, Tommaso Nannicini and Ugo antonio Troiano

No 6952, IZA Discussion Papers from Institute of Labor Economics (IZA)

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-in-discontinuities" 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: local government finance; difference-in-discontinuities; fiscal rules (search for similar items in EconPapers)
JEL-codes: C21 C23 H62 H72 H77 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2012-10
New Economics Papers: this item is included in nep-pbe and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (61)

Forthcoming - published as 'Do Fiscal Rules Matter?' in: American Economic Journal: Applied Economics, 2016, 8 (3), 1-30

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Related works:
Working Paper: Policy Responses to Fiscal Restraints: A Difference-in-Discontinuities Design (2012)
Working Paper: Policy Responses to Fiscal Restraints: A Difference-in-Discontinuities Design (2011)
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