Who do you blame in local finance? An analysis of municipal financing in Italy

We study the effect of introducing a less transparent tax tool for the financing of local governments. A political agency model suggests that politicians with stronger re-electoral incentives would raise more tax revenues and use more the less transparent tax tool to enhance their probability of re-election. This prediction is tested by studying a reform that in 1999 allowed Italian municipalities to partially substitute a more accountable source of tax revenue (the property tax) with a less transparent one (a surcharge on the personal income tax of residents). Exploiting the existence of a term limit for mayors, we use a Difference in Difference approach, to estimate how mayors facing re-electoral concerns reacted to the introduction of the less transparent tax tool compared to mayors facing term limit. We find results in line with theory. We also show that the reduction in the property tax is larger in smaller municipalities and in municipalities with lower level of social capital. The normative implications are then discussed.