Municipality Budget Rules and Debt: Is the Italian Regulation Effective?

In this paper we investigate the Italian regulation on local government budget related to the European fiscal rules (the so-called Domestic Stability Pact), the Constitutional golden rule, and the pre-existing ceilings on new borrowing, with the intent to study the overall effect on local debt and investment expenditure. Our focus is on the municipality level of government. We use a dataset encompassing the main budget items of virtually all municipalities for the period 1999-2009 to perform panel estimation of the efficacy of local fiscal rules in terms of debt reduction and to detect possible unintended effects on investment spending. Empirical evidence supports the conclusion that the Italian system suffers from a lack of coordination between budget constraints and borrowing limits. Our main conclusion is that the decentralization process in Italy has not found an adequate solution yet: on the one hand, local administrations are not equipped to deal with the increased financial responsibility and the progressive sophistication of financial markets; on the other hand, central government has been inconsistent in devolving fiscal powers to municipalities while at the same time adopting multi-layered regulations to restrain local fiscal autonomy in order to pursue the overall public finance control.