Redistribution and risk-sharing effects of intergovernmental transfers: an empirical analysis based on Italian municipal data

ABSTRACT

This paper studies the redistributive and risk-sharing effects of intergovernmental grants at the municipal level, taking advantage of the 2015 reform of the Italian municipal equalization system. The reform introduces formula grants to equalize the fiscal gap only in municipalities in standard regions, but not in municipalities located in special autonomous regions. We can, therefore, use difference-in-differences estimators to identify the causal relationship between formula grants and local gross domestic product thanks to this asymmetric pattern. The final results show that formula grants lead to greater redistribution than pre-reform transfers. On the contrary, new transfers have low risk-sharing effects due to the lag in data available to evaluate fiscal capacity and expenditure needs.

KEYWORDS:

• intergovernmental grants
• redistribution
• risk-sharing
• fiscal capacity
• standard expenditure needs

JEL:

• H70
• H73
• H77
• H84

ACKNOWLEDGEMENTS

We thank the participants at the Italian Society of Public Economics – Siep Conference 2020 (17 September 2020) and the Italian Association of Regional Sciences Conference 2020 (2 September 2020) for their useful comments and suggestions. We are also thankful for the comments of three anonymous referees.

DISCLOSURE STATEMENT

No potential conflict of interest was reported by the authors.

Notes

1. The same approach has been applied in several contributions, such as by Buettner (2002) and Hepp and von Hagen (2013).

2. A few studies (Decressin, 2002; Gandullia & Leporatti, 2020; Obstfeld & Peri, 1998) have relied on times-series analysis. The amount of redistribution is recovered from the estimated steady-state relationship between the regional ‘activity’ variable plus intergovernmental flows and the regional activity variable alone. Risk-sharing is measured by the contemporary response or from the impulse responses of the two variables.

3. The autonomous regions are the Aosta Valley, Friuli Venezia Giulia, Trentino-South Tyrol, Sardinia, and Sicily.

4. For a general overview of the structure of the financing system of Italian municipalities in the aftermath of the COVID-19 crisis, see Greco and Porcelli (2021).

5. Law 228/2012 (art. 1, par. 380) introduced the MSF mechanism to accommodate the reform of the real estate property tax (IMU) and the abolition of existing vertical transfers, during the fiscal consolidation process that followed the EU sovereign debt crises. Instead, for a detailed analysis of the MSF mechanism, see Marchionni et al. (2017).

6. See Law 232/2016.

7. For a detailed analysis of the models adopted for the evaluation of standard expenditure needs, see Porcelli (2015) and the methodological note reported in the following decree: Decreto del Presidente del Consiglio dei Ministri del 29 Dicembre 2016 (G.U. Serie Generale n. 44 del 22-02-2017 – Suppl. Ordinario n. 12). For a detailed analysis of the models adopted for the evaluation of fiscal capacity, see Di Liddo et al. (2016) and the methodological note reported in the following decree: Decreto del Ministero dell’Economia e delle Finanze del 31 dicembre 2020 Adozione della stima della capacità fiscale per singolo comune delle regioni a statuto ordinario.

8. The distribution of the average municipal reported income makes the stark territorial divide of Italy evident: most of the municipalities located in the Centre–North are above the national average, most of the municipalities located in the South (including the main islands) are below the average. Standard expenditure needs are not correlated with municipal income because expenditure determinants associated with local income play a marginal role in evaluating standard expenditure needs. Instead we observe a strong positive correlation between fiscal capacity and income because reported income is the tax base of the local income tax and significantly correlates with the cadastral values representing the tax base of the property tax.

9. For simplicity we decided to limit the lags for income to 5 since we observed the maximum impact at t – 3, as expected given the delay in the updating procedure of standard expenditure needs and fiscal capacity.

10. We simulate the full implementation of the new equalization system by computing the distribution of grants, setting the parameter α of equation (A2) in Appendix A in the supplemental data online as equal to 1 (in 2020, instead, α = 0.275).