Revenue sharing and local public spending: The Italian experience

Our statistical results confirm the hypothesis of a general upward shift in the spending function between 1971 and 1975. Both the constant and most coefficients of our estimated spending functions increased since 1971 indicating an increase in both the average and marginal propensity to spend. We have further determined that the political color of the local administrative unit has become a significant determinant of local spending with leftist administrations tending to spend more and that the leftist administrations' response to the revenue sharing reform has been more pronounced. Finally, it appears as though there has been little difference in response to the revenue sharing expansion between the large and smaller local governing units. Our conclusions must, however, be qualified to the extent to which our spending functions do not measure all exogenous influences on public spending between 1971 and 1975. Although we have controlled for various influences on the demand for public services including political influences through the dummy variables representing the political color of the giunte, it remains possible that other exogenous influences on public spending, such as the lobbying efforts of the labor unions, have exogenously affected spending. Finally, since we use expenditure data, we cannot determine whether any observed increases in per capita spending have been translated into increased service levels. In fact, increments in per capita expenditures may be associated with any combination of increases in quantity, quality, or reduction in the level of efficiency in the productive process. We have, however, conducted some further analysis to determine whether or not the observed increase in expenditures actually constituted a response to demands for new social programs or merely an increase in the relative share of labor costs in existing programs. Decomposition of aggregate expenditures into its component parts for both our samples indicated a clear trend towards a change in the mix of programs supplied by the local governments since 1971. For both samples we observed an increase in the share of the budget going to various instructional programs including child care and public kindergartens. For the provincial capitals instructional programs' relative importance rose from 16.2 to 19.9 percent of total expenditures while for the small suburban communes of Torino, the corresponding rise was from 17.8 percent to 22.6 percent. Further, we observed a sharp drop in both samples of the share of expenditures going to general administration. Much of the increased demands for public services has been concentrated in the area of instruction so the observed change in the composition of expenditures seems to suggest that local governments have responded to the increased demands. Further, we observed an increase in the share expenditures going to public security for the provincial capitals. Analysis of wage data for our samples indicates that increased unit labor costs were not a cause of the increase in real per capita expenditures. In fact, for the period under consideration average cost per public employee actually declined somewhat after adjusting for the effects on inflation. It seems likely, therefore, that the measured increase in per capita expenditures since 1971 does represent an increase in public services and a response by local governments to increased demands for particular services. The rigidity of revenue shares built into the Italian system of local finance and their failure to keep up with inflation after the reform coupled with the lack of constraints on spending decisions has clearly contributed to the incredible growth of local public deficits since 1971. Real local per capita public expenditures in Italy since 1971 have grown over and above what one would normally expect after adjusting for the effects of various demographic, socioeconomic and political influences. We have interpreted the effects of the reform as those of providing incentives to meet increased demands for local public services without comparison of marginal costs and benefits of such increased service levels. The increase in budget deficits has contributed to increases in the rate of inflation which has served as the mechanism in Italy to reallocate resources to the local public sector. Although the Italian experience with general revenue sharing is surely colored by the institutional peculiarities of the Italian system, especially the inflexibility of the revenue shares and the absence of effective constraints on local public spending, one may use the Italian results to offer some insights into the possible effects of increased revenue sharing in other nations. It is clear that any revenue sharing plan must be accompanied by some sort of mechanism to allow at least minimal comparison of benefits and costs of local public services at the local level to avoid the kind of explosion of local public budgets observed in Italy since the reform. The Italian system has financed increased public services in part through inflation creating a situation where local governments not increasing expenditures ran the risk of paying for more than their share of public services in other localities. Although the risk of local budget deficits is minimal in, for example, the United States due to various statutory constraints, the process by which resources would be reallocated to the local public sector in the absence of spending constraints could be similar but consist of increased (and perhaps explosive) allocations to the general revenue sharing fund without adequate consideration of the marginal benefits of increased local expenditure. As a concluding comment, it may be noted that there is a general consensus in Italy today that the reform of local finance was misguided. Local finance in Italy has recently been ‘re-reformed’ with restraints on local borrowing and limits on deficit spending by local governments. Copyright Martinus Nijhoff Publishers bv 1980