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International Tax and Public Finance

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01.04.2014

How sticky are local expenditures in Italy? Assessing the relevance of the flypaper effect through municipal data

verfasst von: Elena Gennari, Giovanna Messina

Erschienen in: International Tax and Public Finance | Ausgabe 2/2014

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Abstract

An extensive literature analysed the impact of upper tier transfers on spending behaviour of lower level governments finding evidence of a flypaper effect, an overreaction to varying grants from upper tiers. Our work seeks to supplement a dearth of evidence for the Italian case by focusing on the responsiveness of municipal expenditures to State grants. We use a panel of almost 8,000 municipalities from 1999 to 2006. Budget data are matched with several other information sources, enabling us to investigate also the role played by some important political factors like the electoral cycle or the political strength of local cabinets. Application of panel data techniques with the use of instrumental variables and a dynamic setting highlights the presence of a sizeable flypaper effect and a significant role for political variables while the asymmetric response is not confirmed in all specifications.

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The fiscal replacement type of asymmetry as been dubbed as “money sticks where it hits, but it comes unstuck without leaving a gaping hole” (Gamkhar and Oates 1996, p. 502).

Endogeneity problems, for instance, may create an upward bias by a factor of almost ten.

The share of sub-national expenditures accounted for by each level of government is roughly two thirds for regions, and less than 30 % for municipalities.

This was a consequence of the fiscal reform of the early seventies, which centralized most of taxing and collecting powers to the State while suppressing some municipal taxes (such as the family tax, the consumption tax and the tax upon the value increases of building areas).

The work by Darby et al. (2004) shows that attempts for consolidation have brought substantial changes in lower tiers financing system in many OECD countries. For a more detailed description of fiscal decentralisation in Italy, see Franco et al. (2004).

See Decree law n. 504/1992.

The application of the allocation criteria of Decree law n. 544/1997, based on new parameters concerning the extent of service provision, the presence of military bases and indicators of socio-economic decay and of fiscal effort, was postponed indefinitely.

The change in the rule was set by financial law for the year 2001. The percentage was initially set equal to 4.5 % and then to 6.5 %. For each municipality, the amount of lump sum transfer was accordingly reduced.

Several other grants were also provided on the basis of specific laws.

For further details on the financing of Italian municipalities, see the document archive on local public financing of the Italian Home Office: www.finanzalocale.interno.it.

In particular, municipalities were not allowed to increase rates for the local surcharge on personal income tax (which accounts for a share of roughly 6 % of municipal total tax revenues). It should be noticed that, for this kind of tax, revenue effects of varying rates are observed with a 1-year lag.

We are fully aware that we are considering only a small fraction of all research work in the field; for a comprehensive survey, we refer the reader to Gamkhar and Shaw (2007).

Data exclude Valle d’Aosta and Trentino Alto Adige since these regions have a different regime with respect to State transfers.

In Sect. 4.5, we check the robustness of results to the trimming.

We did not take into consideration sub-items of municipal expenditures as the corresponding data are not completely reliable. As a matter of fact, the classification of local expenditures into sub-categories is not homogeneous among municipalities.

Expenditures include interest expenditures whose incidence is, however, quite low.

Current transfers include proper State current transfers and the proportion of national personal income tax assigned to municipalities by financial law 448/2001.

Another variable to be considered would be debt but unfortunately data at municipal level are not currently available. Debt does not play, however, a major role in financing since borrowing is allowed only to finance investment expenditures (golden rule) and is subject to quantitative ceilings in terms of the ratio of interest expenditures to current revenues (for provinces and municipalities) or to the ratio of amortization instalments to tax revenues (for regions).

Elections for all levels of government take place every 5 years unless the majority dissolves before or the council is no longer in charge for other reasons. In the period, we consider (1998–2006), two national and two regional elections took place; every year some municipal elections took place since the timing is different for the various local authorities.

We followed the definition proposed by Tovmo and Falch (2002): \(\mathrm{COMP}_{i}= \sum^{P}_{p=1}{Q^{2}_{ip}}\) where, for each local council i, Qp is the fraction of representatives belonging to party p. The index ranges from 1/n, when the seats in the council are equally divided among the n parties (maximum political fragmentation), to a value of 1, which is attained when only one party is locally represented (minimum political fragmentation).

In following, the same approach as Guryan (2001) we stop at the first stage since our aim is to estimate the impact of grants on expenditure and the set of included controls is deemed sufficient to account for all factors involved in the grant rule.

The preliminary estimation of a model with time dummies for all years led us to restrict the choice to a simple shift in mean for only 3 years.

See Dalle Nogare and Galizzi (2011), for an analysis of cultural expenditures of Italian municipalities.

The results for the other specifications are not presented here for space limits. The fixed effect IV model was estimated without the asymmetric effect because of instability of parameter estimates. We believe this is not a major inconvenience since the asymmetric effect is not significant in all instrumental variable specifications (RE_IV, RE_iii, DPD, and FE_iii).

See Wooldridge (2010), p. 375. A similar approach is followed also in Dharmapala and Khanna (2012).

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Titel: How sticky are local expenditures in Italy? Assessing the relevance of the flypaper effect through municipal data
verfasst von: Elena Gennari
Giovanna Messina
Publikationsdatum: 01.04.2014
Verlag: Springer US
Erschienen in: International Tax and Public Finance / Ausgabe 2/2014
Print ISSN: 0927-5940
Elektronische ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-013-9269-9

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