Do fiscal rules reduce the political 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 early 2000 and shows that: 1) municipalities are subject to political budget cycles in capital and total spending; 2) the Italian sub-national fiscal rule 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 5,000 inhabitants. We find that the political budget cycle increases real capital spending by about 15 percent on average, and total spending by 5 percent, in the years prior to municipal elections and that the sub-national fiscal rule reduces these figures by about one third. A regression discontinuity analysis around the 5,000 threshold reinforces these results, as the reduction in capital spending in pre-electoral years for municipalities subject to the fiscal rule is about two-thirds as compared to the municipalities not subject to the rule.