Fiscal consolidation by intergovernmental transfers cuts? The unpleasant effect on expenditure arrears
On a large dataset of Italian municipalities for the period 2003–2014, we investigate unexplored effects of fiscal consolidation in decentralized public finance. Based on a simple, realistic theoretical model, we show that municipalities increase arrears on committed public investment expenditure as a response to intergovernmental transfer cuts. Then, we test our predictions controlling for potential sources of endogeneity, and find that a reduction in central government transfers causes a significant increase in arrears, besides other usual adjustments to local fiscal policy (e.g., tax revenues). Our results highlight a perverse effect of fiscal consolidation packages implemented by centrally imposed fiscal restraints.
JEL classification: H30; H72; H77; C33; C36.