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 on realized capital expenditures only for municipalities above a given population threshold (5000 residents). One possible interpretation of our results is that by exploiting the imperfect knowledge of voters, policymakers benefit from promising overly ambitious investment plans. The introduction of some form of capital-expenditure limit makes these promises less credible, and helps to bring spending plans in line with reality. Furthermore, we find that capital revenues are also overestimated, and that the forecast accuracy of these revenues improves due to the reform. This is in line with our political-economy interpretation: as there is less room to inflate expenditures, politicians also have fewer incentives to indulge in window-dressing on the revenue side.