Fiscal Rules and the Reliability of Public Investment Plans : Evidence from Local Governments

We document that Italian public administrations systematically overestimate capital expenditures, and that the introduction of a cap on this spending item improves the accuracy of their plans. Our analysis relies on a unique dataset including budgetary figures (both planned and realized) for all Italian municipalities, and exploits a national reform which introduced a limit to realized capital expenditures only for municipalities above a given population threshold (5,000 residents). One possible interpretation of our results is that policy-makers, exploiting the imperfect knowledge of voters, benefit from promising over-ambitious investment plans. The introduction of expenditure limits makes these promises less credible, and helps to bring expenditure plans in line with reality. Furthermore, we find that capital revenues are also over-estimated, and that the forecast accuracy of capital revenues improves due to the reform. This is in line with our political-economy interpretation: as there is less room to inflate expenditures, politicians have also less incentive to indulge in window-dressing on the revenue side