Abstract
AbstractThe introduction of a new real estate taxes in Italy in 2011 provides a natural experiment, which is useful to test for political budget cycles. The new real estate tax allowed discretion to local governments. This generates a random variation in the distance of municipalities from the following elections when they choose the level of the tax rate. We do find substantial evidence of political budget cycles, with municipalities choosing lower tax rates when close to elections. We observe this budget cycle for smaller municipalities where the tax was more likely to be the single most important issue for the local government. Cities close to elections with large deficits did not set lower rates and so did municipalities with a lower average value of properties. Finally, the political budget cycle is stronger in the South.
Highlights
Do governments strategically manipulate fiscal policy tools in order to win elections, for instance reducing taxes and/or increasing spending close to elections? The empirical evidence is far from a clear cut
We find that political budget cycles on the main residence tax rate in 2012 are present only for small municipalities, while there is no such evidence in big cities
The introduction in 2011 of a new real estate tax in Italy provides an excellent natural experiment to test for strategic manipulations of fiscal instruments in anticipation of elections
Summary
Do governments strategically manipulate fiscal policy tools in order to win elections, for instance reducing taxes and/or increasing spending close to elections? The empirical evidence is far from a clear cut. In this paper we present evidence on Italian cities, where a recent policy development allows for a well designed test. Our results show clear evidence of “political budget cycles”, namely municipalities chose lower tax rates when close to elections. The political budget cycle is smaller in cities which had larger deficits We believe this is because when deficit is high it becomes a central issue in elections and governments tend to adjust it. Brender and Drazen (2005) find political budget cycles only in new democracies.[2] Several papers look at national level cycles for specific countries.[3]. Akhmedov and Zhuravskaya (2004) consider Russian provinces and show evidence of an increase of transfers to voters before elections They exploit the orthogonality of election timing to implemented policies.
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