![]() 1 In particular, the evidence summarized by Alesina et al. 2012 Alesina and Ardagna 2013, Alesina et al. Recent works in both macroeconomics and political economics show that the output effect of fiscal consolidation depends on its composition, as the choice of increasing revenues vs cutting expenditure is not neutral from both an economic and a political perspective (see Berndt et al. From a political economy perspective, this revenue based fiscal consolidation is driven by local governments with low electoral competition and low party fragmentation. We find a pass-through mechanism by which local governments react to the contraction of intergovernmental grants by mainly increasing taxes rather than reducing spending. This allows us to implement a difference-in-discontinuities design in order to estimate the causal impact of transfer cuts on the composition of fiscal adjustment, also because tight fiscal rules impose a balanced budget on Italian municipalities. We evaluate this transmission mechanism in Italy, where municipalities below the threshold of 5,000 inhabitants were exempted from (large) transfer cuts in 2012. Indeed, transfer cuts at the central level might translate into higher local taxes, changing the effective composition of the fiscal adjustment. Existing studies, however, underscore the role of local governments in a federal setting. ![]() A growing literature emphasizes that the output effect of fiscal consolidation hinges on its composition, as the choice of increasing revenues vs cutting expenditure is not neutral.
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