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

57 Pages Posted: 27 Oct 2012

See all articles by Veronica Grembi

Veronica Grembi

University of Milan - Department of Economics, Management and Quantitative Methods (DEMM)

Tommaso Nannicini

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

Ugo Troiano

University of Michigan at Ann Arbor - Department of Economics; National Bureau of Economic Research (NBER)

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

JEL Classification: C21, C23, H62, H72, H77

Suggested Citation

Grembi, Veronica and Nannicini, Tommaso and Troiano, Ugo, Policy Responses to Fiscal Restraints: A Difference-in-Discontinuities Design. IZA Discussion Paper No. 6952, Available at SSRN: https://ssrn.com/abstract=2167614

Veronica Grembi (Contact Author)

University of Milan - Department of Economics, Management and Quantitative Methods (DEMM) ( email )

Via Conservatorio, 7
Milan, 20122
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 Troiano

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States

HOME PAGE: http://sites.google.com/a/umich.edu/troiano

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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