Chiades P., Greco L., Mengotto V., Moretti L., Valbonesi P. (2015).
In this paper we investigate how tightening fiscal constraints (e.g., through intergovernmental transfer cuts) can lead local governments to postpone investments’ payments. We first provide a simple model showing how local governments can use arrears to relax their short-run financial constraints. We then empirically assess our theoretical prediction, using information from accounting and financial reports of all Italian municipalities for the period 2003-2010. Exploiting the long-lasting effect of 1979 structural reform of Italian local public finance, we employ an instrumental variable approach to face endogeneity concerns. We find robust evidence that tighter fiscal and financial conditions of the local governments determine larger arrears for public investment expenditures.