Do Fiscal Rules Matter? A Difference-in-Discontinuities Design

We evaluate the e ect of relaxing scal rules on budget outcomes in a quasi-experimental setup. In 1999, the Italian central government introduced scal rules|also known as the Domestic Stability Pact|aimed at imposing scal discipline on municipal govern- ments, and in 2001 the rules were relaxed for municipalities below 5,000 inhabitants. This institutional change allows us to implement a \di erence-in-discontinuities" design by combining the before/after with the discontinuous policy variation. Our estimates show that relaxing scal rules triggers a substantial de cit bias, captured by a shift from zero de cit to a de cit that amounts to 2 percent of the total budget. The ad- justment mostly involves revenues as unconstrained municipalities cut their real estate and income taxation. The impact is larger if the mayor can run for reelection, the number of political parties seated in the city council is higher, voters are older, and the e ciency of public good provision is lower, consistently with models on the political economy of de cit. A falsi cation test in 1999 shows that our ndings are not driven by cities just below and above 5,000 being di erentially a ected by scal rules.