The effects of relaxing fiscal rules on Political Budget Cycle: A difference-in-discontinuities analysis on Italian municipalities

Abstract

We investigate whether the presence of fiscal rules might limit the insurgence of a Political Budget Cycle (PBC) in investment spending at municipal level. Data based on the balance sheets of Italian municipalities are explored for the period 1999–2012. We investigate the effect of the Domestic Stability Pact (DSP) and rely on the fact that, since 2001, this tax rule has not been binding for municipalities with under 5,000 inhabitants. Our main contribution consists of exploiting this quasi-experimental setting by means of a difference-in-discontinuities estimation strategy in order to obtain unbiased estimates. In comparison with existing results, our study makes three observations. Firstly, the easing of fiscal rules generates an increase in capital expenditure only in the year immediately before elections. Secondly, this increase only arises for those investments which produce immediately-visible effects. Finally, the size of the electoral cycle shows a 136 percent increase in these investments which is more than five times larger than that reported in the literature.