While fiscal autonomy of local government has traditionally been a feature of Western Europe and North America, it is now also increasingly common in developing economies, as non-central areas ask for more independence (Dillinger 1994, Arzaghi and Henderson 2005, Fisman and Gatti 2002, Tselios et al. 2011, Ganhi et al. 2012). There is therefore a growing need to understand the extent to which fiscal decentralisation affects the provision of public services. From a theoretical point of view, two competing hypotheses stand out. On the one hand, fiscal decentralisation is expected to increase the accountability of local politicians. On the other hand, it could make it easier for interest groups to lobby local politicians, leading to increased corruption and inequalities.
Analysing these effects empirically has been proved difficult. A key challenge is that the transfer of fiscal authority to local governments is often a gradual process, making it hard to isolate the effects of fiscal decentralisation from other simultaneous events. In addition, fiscal reforms tend to be large-scale policies that affect local governments simultaneously, leaving little within-country differences in exposure that can be exploited analytically.
Moreover, while economic research has focused exclusively on the link between decentralisation and government spending, fiscal decentralisation can have consequences beyond its initial effects on publicly provided services. A change in the level of public services, such as welfare support, can affect labour supply and demand with far-reaching repercussions for local economies. As a result, a comprehensive analysis of fiscal decentralisation requires a combination of multiple data sources, ranging from balance sheets of local governments to labour market outcomes.
In a new paper (Bianchi et al. 2021), we study the effects of fiscal decentralisation on the provision of local public services and the functioning of labour markets. We exploit a 1993 reform that increased the fiscal decentralisation of Italian municipalities by replacing central government grants with revenues from a newly established local property tax (LPT). This policy increased the reliance of municipalities on local revenue sources without automatically increasing the overall size of municipal budgets or modifying the pre-existing municipal spending responsibilities (Figure 1).
Figure 1 Revenues per capita from local taxes and government transfers
Notes: This graph shows the change in the composition of revenues of Italian municipalities, by plotting the the average revenues from local taxes and from transfers issued by higher levels of government (provinces, regions, central government), as 2017 per resident.
Within a year of the policy implementation, local revenue streams (from local taxes and service fees) increased by more than 50% relative to 1992 and replaced central government transfers as the major source of municipal revenues. Moreover, the reform increased the accountability to residents of local politicians for mismanagement of public funds by improving the transparency of funding. Under the pre-LPT system, residents paid a personal income tax (PIT) to the central government, which then redistributed part of those revenues to municipalities to fund their expenses. This process made it difficult for residents to compute how much they had paid for their local services. Under the post-LPT system, individuals paid the LPT separately from their PIT and directly to their municipality, creating a direct link between taxes paid and local services (Surico and Trezzi 2015).
To identify the causal effect of fiscal decentralisation on the publicly provided services, we exploit the fact that the LPT depends on the age of municipality buildings. More specifically, older buildings have a lower LPT liability, due to the formula for computing the LPT bill. As a result, all else equal, municipalities with older properties raised lower revenues from the LPT and had to rely more heavily on central government transfers even after 1993. To exploit this observation, we use data on Allied bombings during WWII as a plausibly exogenous shock to the average age of buildings in 1993, by identifying municipalities that were not explicitly targeted by Allied air attacks but were hit by mistake due to their proximity to actual targets (Figure 2). Relative to otherwise similar non-bombed locations, these municipalities had newer buildings in 1993, increasing their revenues from the LPT and thus their share of revenues tied to local sources. In other words, the municipalities that were ‘treated’ with exogenous Allied bombings, and therefore younger buildings, experienced a larger degree of fiscal decentralisation after the reform.
Figure 2 Distribution of WWII bombings across Italian municipalities
Notes: Panel A shows the distribution of Allied bombings during WWII that were executed after the Armistice of Cassibile between Italy and the Allied forces (September 3, 1944). Panel B shows the municipalities in the main estimating sample. Bombed cities are matched to other non-bombed Italian municipalities using propensity-score matching. Then, the analysis compares cities around the bombed municipalities (in yellow) to cities around the matched non-bombed municipalities (in light blue).
Source: USAF Theater History of Operations Reports (THOR) Database, available at www.afri.au.af.mil/thor.
We find that municipalities responded to the LPT in two main ways. First, local administrators reduced the size of the government in terms of both spending and revenues. They also rebalanced their spending in favour of revenue-generating and customer-facing services, reducing the budget for their internal administrative processes. These changes were not mandated by the reform and should be considered the municipality responses. Despite the lower budget, there is no evidence of a reduction in the quality of public services. Overall, these findings suggest that decentralisation induced local politicians to cut waste and increase efficiency.
Second, access to many local services increased. We focus on the municipal provision of nursery schools, given its importance in determining female labour supply. Municipalities that raised more revenues through the LPT increased the share of their budget to nursery schools by 18% and increased the number of public nursery schools by 20%. In the same cities, the number of pupils in nursery schools increased by an additional 24% after the reform (Nicodemo 2009, Cornelissen et al. 2018, Hermes et al. 2021). We also show that municipalities that raised more revenues through the LPT experienced a larger increase in female participation in the labour market. In these locations, women’s labour force participation increased by up to 20%, leading to a reduction in the pre-existing gender gap in employment (Figure 3).
Figure 3 Yearly effects of fiscal decentralisation on women in the labour market
Notes: This graph show the post-LPT change in women in the labor market in cities adjacent to municipalities bombed by Allied tactical air attacks during WWII.
Source: 8mila Census, ISTAT, available online at http://ottomilacensus.istat.it/.
To explore this channel more in depth, we rely on employer-employee matched data from the Italian Social Security. We explore the conjecture that most local public services benefit women in all age groups equally, while subsidised nursery schools should be more helpful to younger working women. Consistent with this hypothesis, we find that labour supply increased the most among women under the age of 35. Moreover, our analysis suggests that fiscal decentralisation lowered the reservation wage of younger women. This result is consistent with the idea that expanded availability of nursery schools decreased the opportunity cost of working for mothers of young children. In addition, the availability of yearly observations between 1974 and 2011 allows us to study the dynamics of labour supply. The entry and re-entry of women into labour markets started increasing in 1995. This two-year lag relative to the introduction of the LPT is to be expected if the increase in labour supply was indeed a response to improvements in local services. In fact, an expansion of public nursery schools would have required a few years to prepare new infrastructure.
Finally, we analyse the motivations that may have induced administrators to expand the provision of local services after the LPT. We find two main pieces of evidence. First, higher political competition, measured by higher turnover of mayors, is associated with more local services and a greater increase in female employment after the LPT. Second, higher exposure to fiscal decentralisation is associated with higher levels of political participation. Other factors, such as heightened competition between municipalities or heterogeneous preferences for publicly provided services, do not appear to be significant.
Our results are most instructive for settings in which municipalities receive revenue-generating authority to fund the delivery of local public services. The Italian experience suggests that increasing the accountability of local administrators through a higher reliance on transparent local taxes can improve the delivery of local services and therefore the labour market outcomes of the residents. Out of all local services, the central role played by nursery schools is particularly relevant for countries in which access to affordable childcare is limited.
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Bianchi, N and M Giorcelli (2021), “Reconstruction Aid, Public Infrastructure, and Economic Development”, NBER Working Paper 29537.
Bianchi, N, M Giorcelli and E M Martino (2021), “The Effects of Fiscal Decentralization on Publicly Provided Services and Labor Markets”, NBER Working Paper 29538.
Cornelissen, T, C Dustmann, A Raute and U Schӧnberg (2018), “Universal childcare, family background, and school readiness”, VoxEU.org, 7 June.
Dillinger, W (1994), “Decentralization and Its Implications for Urban Service Delivery”, The World Bank, Urban Management Programme, Discussion Paper 16.
Fisman, R and R Gatti (2002), “Decentralization and Corruption: Evidence across Countries”, Journal of Public Economics 83(3): 325–345.
Ghani, E, L Iyer and S Mishra (2012), “Is decentralization helping the poor regions”, VoxEU.org, 10 April.
Hermes, H, P Lergetporer, F Peter and S Wiederhold (2021), “The socioeconomic gap in childcare enrolment”, VoxEU.org, 7 December.
Nicodemo, C (2009), “Childcare and mothers’ labour supply in southern European countries”, VoxEU.org, 25 July.
Surico, P and R Trezzi (2015), “Consumer spending and property taxes”, VoxEU.org, 22 August.
Tselios, V, A Rodríguez-Pose, A Pike, J Tomaney and G Torrisi (2011), “Income inequality, decentralisation, and regional development in Western Europe”, VoxEU.org, 15 October.