Fiscal rules to tame the political budget cycle: Evidence from Italian municipalities

The paper provides evidence that fiscal rules can limit the political budget cycle. It uses data on Italian municipalities during the 2000s and shows that 1) municipalities are subject to political budget cycles in capital spending; 2) the Italian sub-national fiscal rule (Domestic Stability Pact, DSP) introduced in 1999 has been enforced by the central government; 3) municipalities subject to the fiscal rule show more limited political budget cycles than municipalities not subject to the rule. In order to identify the effect, we rely on the fact that the domestic fiscal rule does not apply to municipalities below 5000 inhabitants. We find that the political budget cycle increases real capital spending by about 10-20 percent on average in the years prior to municipal elections and that municipalities subject to the DSP show a pre-electoral increase in capital spending which is only a quarter of the one of municipalities not subject to the rule.