LOCAL SPENDING INCREASES WITHOUT THE PROPERTY TAX

Italians have always considered the property tax (PT) particularly iniquitous. In 2008, the central government cancelled PT for homeowners. However, replacing local taxes with a transfer makes harder for residents to compute the cost of local public goods. The analysis of Italian municipalities’ balance sheets allows to isolate the change of spending associated to the reform: between 2007 and 2009 the average budget rose by 0.9%. The effect is even higher in major cities.

Italians do not like taxes and PT is not the exception. Since its introduction, the majority of Italians have always considered PT particularly iniquitous. It is not surprising, then, that its cancellation has often been at the center of the political debate. In 2008, the current government annulled a partial reform of the previous ruling coalition and decided the total abolition of PT for homeowners. On October 13, 2011 PT regained the attention of the press. During a talk at the Senate, the chief economist of the Bank of Italy declared that the government should start to think about the reintroduction of PT on owner-occupied houses.

THE CANCELLATION OF PROPERTY TAX AND THE EFFECT ON LOCAL PUBLIC SPENDING

The 2008 reform cancelled PT for homeowners and established a transfer to cities. The goal of the government was clear: give a significant fiscal benefit to owners, leaving untouched municipalities’ resources. The analysis of the effects of the program turned out to be wrong. There are many reasons why replacing local taxes with an intergovernmental grant can lead to a budget increase and, thus, to a deterioration of cities’ financial balance. Political economics suggests that the sources of revenues affect the fiscal responsibility of local administrators. Under fiscal federalism, municipalities depend primarily on local taxes and a budget rise must be financed with an increase of local tax rates: this can entail a high political cost for administrators, because it can jeopardize their re-election. This does not happen in a centralized state, where cities depend heavily on intergovernmental transfers: local administrators would ask the central government, and not directly the voters, to bear the costs of a bigger budget. At the same time, replacing local taxes with grants makes harder for residents to compute the correct cost of local public goods. This gives the opportunity to politicians to increase spending and waste. (1)

THE EFFECTS IN THE SHORT AND MIDDLE RUN

After more than three years, it is possible to study the effects of the reform on local spending.(2) In 2007, PT on owner-occupied houses generated 16% of tax revenues in the average city. In the same year, local taxes were the main source of funding (26% of total revenues). In 2009, grants were equal to 28.8% of total revenues, while the share of local taxes dropped to 24%.

alt Evolution Local Finance 

The analysis of the balance sheets allows to isolate the change of spending associated to the PT cut. (3) Between 2007 and 2009 (the first post-reform year) the program caused an average budget rise of 0.9%. The effect in the major cities was significantly higher. Evidence suggests that the increase in Milan was equal to 2.67%: this would imply a €31Mil. increment. An even higher percentage increase took place in Turin (+3.64%; €27Mil.), Rome (+3.23%; €87Mil.), and Florence (+3.09%; €8.7Mil.).

alt Main Results 

The analysis of the different types of spending shows that the positive impact extended to almost all local functions: for example, the welfare budget rose on average by 1.71%, while educational expenditures increased by 1%. These estimates do not simply report the total budget change (which could be affected by the macro business cycles), but isolate the impact of the reform. The results show that at least part of the fiscal benefit for homeowners was offset by the rise of the local public spending. Even though it is still early to evaluate the middle-run effects, 2010 provisional data offer interesting insights. After two years, municipalities more affected by the reform were more likely to finance their operational spending with extraordinary measures, like the alienation of assets. This shows that the effects of the tax cut might have extended to cities’ financing decisions.

alt Different SPending 

The fiscal benefit received by homeowners in 2008 eliminated one of the main sources of local tax revenues. The drastic reduction of municipalities’ fiscal autonomy had and will have significant costs for all, homeowners included. This consideration could foster the discussion about the full reintroduction of PT, as suggested by the Bank of Italy.

Footnotes

(1) This theory is known as fiscal illusion.
(2) Data come from the balance sheets of municipalities, published on the website of the Ministry of Internal Affairs.
(3) The details of the empirical analysis are contained in the paper “The Effects of a Tax-Relief Reform on Local Public Spending”, available upon request.
Table 1: Computations based on coefficients estimated on 2007-2009 for total non-personnel spending. All monetary values are expressed in real terms, taking 2007 as reference.
Table 2: Bold percentages signi cant at 1%, education signi cant at 5%. Environ groups budget for urban management activities, waste collection, and public water system. Welfare collects spending for kindergartens and elderly care.