Chapter

11 Italy

Editor(s):
Teresa Ter-Minassian
Published Date:
September 1997
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Author(s)
Nicoletta Emiliani Sergio Lugaresi and Edgardo Ruggiero

This chapter reviews the Italian experience with decentralization since the 1970s. This experience highlights the following. First, for a decentralization policy to achieve its objectives, several factors—whose roles are often underplayed by the theory of intergovernmental fiscal relations—may be important. These factors include budgetary procedures and transparency, effective accountability of local governments, regional differences in fiscal capacity, and institutional performance. Second, the level and quality of local public expenditure are strongly influenced by other characteristics of intergovernmental fiscal relations—such as the budgetary practices of the central government, tax assignments, transparency of the grants distribution formulas, and appropriate rules promoting fiscal effort—that may in fact be perceived as loosely linked to the delivery of local public services.

In Italy, the fiscal relationship between the central and the subnational governments is characterized by a high degree of vertical fiscal imbalance, ambiguity over responsibility for financing expenditure, and a lack of transparency and stability of policies.1 The Italian experience of the 1970s and 1980s confirms that expenditure decentralization, when coupled with revenue centralization, may be associated with a loss of accountability at the subnational level. This, in turn, may cause excessive growth of total public expenditure.

The intergovernmental fiscal relations in Italy are based on constitutional laws for expenditure assignments and on ad hoc legislation for revenue and financing. Though piecemeal legislative changes are made in the tax and financing arrangements almost every year, some characteristics remain constant: (1) a marked revenue centralization, (2) a correspondingly high share of grants in revenues of subnational governments, and (3) a marked predominance of conditional grants. The ensuing strong vertical imbalance, together with unrealistic ex ante limits on the amount of transfers to subnational governments, has legitimated the creation of ex post subnational deficits. These unbalanced fiscal relations have often resulted in higher-than-budgeted, contingent liabilities for the central government through the centralization of subnational deficits, debt, and interest costs.

Safeguard mechanisms have been repeatedly introduced and have succeeded in controlling subnational cash expenditure. However, expenditure commitments have been controlled to only a limited extent, because of the lack of local accountability—partly a result of the poor definition of expenditure assignments and financial responsibilities, of effective budgetary procedures and controls, and of hard budget constraints. The particular financing arrangements established between the central and the subnational governments, as well as the budgetary procedures adopted at every level of government, have not provided the incentives to improve expenditure efficiency.

The latest legislative changes have only partially addressed these problems. In 1990, the framework law reforming local administrations established the following three general principles.2 First, central government grants are to be limited to financing “necessary” expenditures (to be later defined by implementing laws) and corresponding grants are to be allocated to local governments by the central government. The lower levels of government are responsible for raising the resources to pay for other services. Second, to foster fiscal responsibility, new taxes have been transferred to the local governments, and central government grants are reduced by corresponding amounts. Third, managers of subnational entities have been given responsibility for their units’ economic results. Similar principles have been adopted in new sectoral laws for the health and transportation sectors, which are a responsibility of the regions. However, these new laws remain ambiguous as to which level of government is ultimately responsible for financing expenditure. This ambiguity is reinforced by the lack of credible threats (that is, bankruptcy procedures) for regions, and the fact that budgetary practices and subnational governments’ accountancy rules have not kept pace with the new legislative framework. These problems have complicated the government’s current attempts to reintroduce subnational fiscal responsibility.

This chapter is organized as follows. The structure of government is examined first, followed by discussions on expenditure assignments, revenue assignments and tax administration, and budget formulation and expenditure management. In the final two sections, policy implications and conclusions are drawn, and the latest developments are described.

Structure of Government: Current Arrangements and Main Issues

There are four levels of government in Italy: central, regional, provincial, and municipal. Subnational governments comprise 20 regions, 99 provinces, approximately 8,100 municipalities, and 212 Local Health Units. While provinces and municipalities have long been subnational governments in Italy, regions are a relatively new entity, as the regions were only established under the 1948 Constitution.3 Five regions are called “special statute” regions (henceforth special regions), as their statutes were issued in the form of constitutional laws that give them considerable legislative autonomy on expenditures: their expenditure assignments are wider and their primary source of revenue is—unlike that of “ordinary statute” regions (henceforth ordinary regions)—shared national taxes (see below). These special regions either are large islands or are areas close to the border that have a sizable foreign population. Four of the five governments were established in 1949 (Friuli-Venezia Giulia in 1964) to reduce the threat of separatist movements and ethnic tensions. The 15 ordinary regions’ governments were not formally established until 1970; their process of expenditure devolution was completed only much later (1978), when responsibility for health care was assigned to the regions.

Strong political forces lay behind both the decentralization process and its delays. The largest party in parliament in the 1970s (the Christian Democratic Party) was afraid to lose its grip on regions with a high concentration of support for the opposition parties. Only with the leftist electoral successes of the mid-1970s did the ruling party give in to decentralization. While the Constitution mandated the devolution of expenditure assignments, it did not specify which level of government would be responsible for financing these expenditures or provide specific guidelines on revenue sources. Therefore, when new expenditure responsibilities were assigned to the regions, the central government was able to establish its control over the new political entities by removing most subnational taxes, centralizing tax administration, and assigning new taxes only to the center. Regions were transferred exactly the amount of grants needed to finance the previous year’s cost of the responsibilities newly assigned to them and, for the first years, grants were increased below the rate of inflation. Therefore, while regions achieved expenditure autonomy relatively early, revenue autonomy has never really been achieved, essentially because their financing has been the result of a political compromise.

Expenditure decentralization, coupled with an enhanced redistributive role of the central government, was also viewed as a way to reduce the regional disparity in access to, and quality of, services and in income levels.4 Italy continues to be characterized by wide regional differences in per capita income, with the northern regions richer than the southern regions. Although this gap has narrowed slightly in the past two decades, it is still considerable; furthermore, the quality of services is still characterized by large regional differences.5

Expenditure Assignments

Subnational government expenditure doubled from 1970 (7 percent of GDP) to 1985 (around 14 percent of GDP), reflecting the evolution of the expenditure programs decentralized during the second half of the 1970s (Table 1). It has remained broadly constant since. During 1980–93, the expenditures of the central administration itself increased considerably, from 18 percent to 29 percent of GDP, propelled by wages and interest outlays.6 Therefore, the share of subnational government expenditure in total public expenditure increased from 22 percent in 1970 to above 27 percent in 1985, then decreased to below 26 percent by 1992. This was also due to the fact that, after 1978, no more expenditures were decentralized. In 1979, the central government assumed responsibility for paying the municipal debt—including interest—accumulated prior to 1977, through an increase in grants allocated to municipalities. This rewarded the municipalities that had accumulated more debt. Following this debt-clearing operation, the central government started to impose formal controls on the current budgets of local governments and succeeded in controlling the level of their current cash expenditures.

Table 1.Italy: Operations of General, Central, and Subnational Governments(In percent of GDP)
General Government1Central Government2,3Subnational Governments2,3
RevenueExpenditureDeficitRevenueExpenditureDeficitRevenueExpenditureDeficit
(Revenue, Expenditure, and Deficit)3
196129.67.0
196636.58.0
197032.57.1
197539.39.2
198033.642.28.623.530.87.111.712.81.1
198538.651.212.628.841.412.514.014.10.1
199042.553.410.931.040.99.913.214.61.5
199143.653.910.231.441.29.814.014.70.6
199246.355.89.533.142.69.514.114.30.2
199348.057.69.633.743.19.313.614.10.4
Sources: Italian Statistical Institute (ISTAT), National Accounts, Conti delle Administrazioni Pubbliche e della Protezione Sociale, various issues, data for 1961 and 1966 from Rizzo (1985).

Consolidated figures—data net out flows between levels of government. Includes Social Security Administration.

Excludes Social Security Administration.

Revenue and expenditure for central and subnational governments are gross of grants and transfers between levels of governments. The revenue, expenditure, and deficit of the central and subnational governments do not add up to the corresponding columns of the general government because the latter show consolidated data and include the Social Security Administration.

Revenue and expenditure for central and subnational governments are net of grants and transfers between levels of government. The revenue, expenditure, and deficit of the central and subnational governments do not add up to the corresponding columns of the general government because the latter include the Social Security Administration. The vertical balance ratio is defined as the ratio between own revenue and expenditure, net of grants and transfers to other levels of government.

General Government1Central Government2,4Subnational Governments2,4
Own revenueOwn expenditureDeficitOwn revenueOwn expenditureVertical balance ratioOwn revenueOwn expenditureVertical balance ratio
196129.67.0
196636.58.0
197032.57.1
197539.39.2
198033.642.08.620.118.21.101.911.30.17
198538.651.212.624.024.01.002.314.00.17
199042.553.410.926.525.41.042.914.50.20
199143.653.910.227.325.61.063.014.60.21
199246.355.89.529.227.01.083.514.20.24
199348.057.69.629.929.01.034.214.00.30
Sources: Italian Statistical Institute (ISTAT), National Accounts, Conti delle Administrazioni Pubbliche e della Protezione Sociale, various issues, data for 1961 and 1966 from Rizzo (1985).

Consolidated figures—data net out flows between levels of government. Includes Social Security Administration.

Excludes Social Security Administration.

Revenue and expenditure for central and subnational governments are gross of grants and transfers between levels of governments. The revenue, expenditure, and deficit of the central and subnational governments do not add up to the corresponding columns of the general government because the latter show consolidated data and include the Social Security Administration.

Revenue and expenditure for central and subnational governments are net of grants and transfers between levels of government. The revenue, expenditure, and deficit of the central and subnational governments do not add up to the corresponding columns of the general government because the latter include the Social Security Administration. The vertical balance ratio is defined as the ratio between own revenue and expenditure, net of grants and transfers to other levels of government.

Sources: Italian Statistical Institute (ISTAT), National Accounts, Conti delle Administrazioni Pubbliche e della Protezione Sociale, various issues, data for 1961 and 1966 from Rizzo (1985).

Consolidated figures—data net out flows between levels of government. Includes Social Security Administration.

Excludes Social Security Administration.

Revenue and expenditure for central and subnational governments are gross of grants and transfers between levels of governments. The revenue, expenditure, and deficit of the central and subnational governments do not add up to the corresponding columns of the general government because the latter show consolidated data and include the Social Security Administration.

Revenue and expenditure for central and subnational governments are net of grants and transfers between levels of government. The revenue, expenditure, and deficit of the central and subnational governments do not add up to the corresponding columns of the general government because the latter include the Social Security Administration. The vertical balance ratio is defined as the ratio between own revenue and expenditure, net of grants and transfers to other levels of government.

The central government’s interest outlays increased partly because in the 1970s and 1980s, the central government often assumed responsibility for payment of arrears and debt repayment of the subnational governments (see the sections on Conditional Grants, Borrowing, and Budget Formulation and Expenditure Management). For this reason, the budgets of subnational governments report small amounts of interest payments (Tables 3 and 4). By 1981, excluding interest payments and transfers to other entities in the public sector, the central government was the final spender for only 33 percent of total expenditure of the public administration, compared with 65 percent in 1965 (Ghessi, 1984). This 33 percent included wages and was characterized by a high degree of rigidity; this rigidity was partly due to indexation—removed in 1993—and restrictions on the layoffs of civil servants. As a consequence, the scope for the central government to use expenditures as an instrument of macroeconomic stabilization was limited. The functions of the ordinary regions are laid out in the Constitution and in the regional implementing laws, while those of the provinces and municipalities were established in a comprehensive law (1934). The latter has been modified several times by national laws over the years, with the most important recent revisions in 1977 and 1990. Special regions have wider expenditure assignments than ordinary regions; each special region has determined, through constitutional laws, its own additional functions. Regions can delegate their functions, and transfer the necessary resources to perform them, to lower levels of government, although this has been done to only a limited extent’mainly for housing and public works.

Table 2.Italy: Economic Classification of Revenue and Expenditure of Central Government(In percent of GDP)
19901991199219911994
Total revenue32.932.534.434.532.3
Direct taxes14.014.116.016.314.7
Indirect taxes11.712.112.511.811.7
Other7.26.35.96.35.9
Total expenditure42.343.145.044.441.8
Personnel8,37.67.67.67.4
Purchases of goods and services1.61.41.51.61.6
Interest payments9.410.011.211.810.6
Direct investments1.00.90.90.90.5
Loans and share holdings (net)0.90.50.50.51.0
Of which: local governments10.80.30.30.20.4
Transfers19.620.921.720.519.2
To regions7.27.98.07.16.9
Of which: National Health Fund5.05.75.55.65.7
To provinces and municipalities2.93.02.72.31.8
To others9.510.011.011.210.5
Other expenditure1.51.71.61.41.6
Central government horrowing requirement9.410.510.69.99.5
Source: Bank of Italy, Relazione Annuale, 1994.

Includes regions, provinces, and municipalities.

Source: Bank of Italy, Relazione Annuale, 1994.

Includes regions, provinces, and municipalities.

Table 3.Italy: Economic Classification of Regional Budgets(In percent of GDP)
Ordinary RegionsSpecial Regions
19901991199219931990199119921993
Total revenue6.766.876.886.222.572.622.432.63
Current revenue5.495.966.125.542.232.262.242.41
Direct taxes
Indirect taxes0.110.150.170.360.010.010.010.01
Transfers5.365.795.935.152.182.222.212.36
Of which: from the state sector5.315.725.875.082.092.162.162.32
Other0.020.030.020.030.030.020.020.03
Capital revenue1.260.910.760.690.340.350.190.22
Transfers1.250.910.750.680.290.320.180.20
From the state sector1.240.890.740.650.290.230.130.17
From other public entities0.010.020.010.030.090.040.02
Other0.010.010.050.030.010.02
Total expenditure6.947.316.977.822.953.042.942.79
Current expenditure5.696.256.016.871.781.811.841.76
Personnel0.200.200.190.190.210.230.220.22
Goods and services0.170.180.190.160.170.170.160.17
Interest payments0.020.030.050.050.010.01
Transfers5.295.805.545.541.391.411.441.35
To families0.140.110.090.090.180.180.230.16
To enterprises0.410.460.410.430.160.140.130.12
To other public entities14.745.235.045.921.061.101.081.08
Other0.010.040.040.030.020.02
Capital expenditure1.251.060.960.941.171.231.091.03
Direct investment0.200.160.120.120.320.370.260.26
Transfers1.010.790.730.720.770.730.640.65
To families0.070.040.060.060.060.060.060.06
To enterprises0.290.320.290.270.220.190.250.26
To other public entities0.660.430.390.390.480.470.340.33
Loans and shareholdings0.020.030.020.020.080.130.170.09
Other0.010.090.080.080.010.010.020.03
Deficit−0.18−0.44−0.09−1.59−0.38−0.43−0.50−0.16
Source: Ministry of the Budget (1994).

Includes transfers to Local Health Units.

Source: Ministry of the Budget (1994).

Includes transfers to Local Health Units.

Table 4.Italy: Economic Classification of Local Governments’ Budgets1(In percent of GDP)
ProvincesMunicipalities
199019911992199019911992
Total revenue0.710.630.615.955.665.50
Current revenue0.550.530.524.494.344.35
Direct taxes0.050.040.040.870.830.98
Indirect taxes0.000.000.00
Transfers0.470.450.442.922.702.61
Of which: from the state sector0.390.380.362.602.392.30
Other0.030.030.040.690.810.76
Capital revenue0.160.100.901.461.321.14
Transfers0.130.080.070.910.760.65
From state sector0.020.010.010.260.180.14
From other public entities0.110.070.050.470.250.32
Other0.030.030.030.550.560.49
Total expenditure0.770.680.666.176.085.71
Current expenditure0.510.500.484.134.114.02
Personnel0.190.190.181.631.581.50
Goods and services0.190.180.171.531.541.55
Interest payments0.060.070.060.530.480.47
Transfers0.050.050.040.400.460.46
To families0.020.020.020.160.150.15
To enterprises0.010.010.010.020.020.02
To other public entities20.020.020.020.220.280.28
Other0.020.020.020.050.050.05
Capital expenditure0.260.190.182.041.971.70
Direct investment0.200.150.141.581.501.30
Transfers0.030.010.020.050.030.04
To families0.000.000.000.020.010.01
To enterprises0.020.010.010.030.010.03
To other public entities0.000.000.010.01
Loans and shareholdings0.020.020.010.370.310.31
Other0.010.000.010.050.120.04
Deficit−0.06−0.05−0.05−0.22−0.42−0.22
Source: Ministry of the Budget (1994).

Excludes autonomous provinces.

Includes transfers to Local Health Units.

Source: Ministry of the Budget (1994).

Excludes autonomous provinces.

Includes transfers to Local Health Units.

Expenditures of the ordinary regions accounted for 7.8 percent of GDP in 1993 (see Table 3). These regions are responsible—directly, or indirectly through the local governments—for most expenditure on health, welfare, agriculture, the handicraft industry, tourism, the environment, public housing, and vocational training. More than two thirds of these regions’ expenditures are on health and transportation (for example, they finance most urban and all interurban road transportation (Table 5)).7 Both are financed mainly through conditional grants (see below). Health alone accounted for around 71 percent of total regional expenditure in 1992 (see Table 5).

Table 5.Italy: Regional Current Revenue and Total Expenditure by Functional Classification1
Ordinary RegionsSpecial Regions2
19901991199219931990199119921993
(In percent of current revenue)
Own tax revenue2.02.92.76.60.70.60.60.6
Shared taxes58.858.361.365.5
Grants and transfers97.596.696.892.838.839.536.432.0
From the central government96.795.695.991.835.037.135.030.7
Of which: health payroll tax341.415.9
From other public administrations0.81.01.01.13.82.41.41.3
Nontax revenue0.60.50.40.61.71.61.61.9
Total100.0100.0100.0100.0100.0100.0100.0100.0
(In percent of expenditure)
General services and public
order and safety5.04.64.74.18.79.68.99.0
Education and culture2.93.53.12.69.39.28.99.5
Health68.571.871.175.032.232.233.332.3
Social security and welfare1.41.21.41.13.73.43.73.7
Housing1.41.01.31.14.73.94.34.6
Transportation and communications7.05.86.15.54.24.14.03.8
Other economic services12.710.810.39.026.827.324.526.1
Of which: agricultural5.84.64.33.510.29.19.29.7
Not classified1.01.22.01.610.510.412.511.1
Of which: interest0.30.50.80.60.10.10.30.3
Total100.0100.0100.0100.0100.0100.0100.0100.0
Of which:
Current expenditure82.085.486.287.960.259.662.963.2
Capital expenditure18.014.613.812.139.840.437.136.8
(In percent of GDP)
Memorandum items:
Current revenue5.56.06.36.12.22.32.22.3
Total regional expenditure6.97.37.07.83.03.02.92.8
Source: Ministry of the Budget (1994).

Commitment data.

Includes autonomous provinces.

Starting from 1994, health payroll taxes are classified as regional own revenue.

Source: Ministry of the Budget (1994).

Commitment data.

Includes autonomous provinces.

Starting from 1994, health payroll taxes are classified as regional own revenue.

Total expenditures of special regions account for about 3 percent of GDP (see Table 3). Special regions have chosen, apart from the functions performed by the ordinary regions, additional expenditure assignments (Table 6). Valle d’Aosta has the most comprehensive additional responsibilities, while Friuli-Venezia Guilia and Sardinia have the least. As is the case for ordinary regions, the largest component of expenditure for special regions is health, which accounts for 33 percent of their total expenditures (see Table 5).

Table 6.Italy: Additional Expenditure Assignments of the Special Regions1
Valle d’AostaTrentino Alto AdigeFriuli-Venezia GiuliaSicilySardinia
Disability pensions2
Primary and secondary education22
Subsidies to culture
Arts2
Registry office
Civil protection and fire department2
Transportation
Transfers to local governments2
Subsidies to Industry, commerce, and agriculture
Forestry service2
Statistics
Sources: Constitutional laws and statutes of regions.

These are the expenditures actually affected. The constitutional laws of the special regions provide for a larger range of responsibilities.

Shared with central government.

Sources: Constitutional laws and statutes of regions.

These are the expenditures actually affected. The constitutional laws of the special regions provide for a larger range of responsibilities.

Shared with central government.

Provinces are assigned relatively limited expenditure responsibilities, although the framework law for reform of local administration stipulates that their main function is to become one of territorial and economic planning and of coordination between the region and the municipalities.8 Their total expenditures do not exceed 1 percent of GDP (see Table 4). The largest components of provincial expenditure are education and culture (mainly provincial school buildings and their maintenance and provincial museums and libraries) and transportation (mainly maintenance of provincial roads) at around 32 percent and 25 percent, respectively in 1992 (Table 7). Municipal expenditures range between 6 percent and 7 percent of GDP.9 The largest components of municipal expenditure are social welfare and housing (around 34 percent in 1991), general public services (21 percent), and transportation and communications—mainly construction and maintenance of local roads—(14 percent) (see Table 7).

Table 7.Italy: Local Governments’ Current Revenue and Expenditure by Functional Classification1
Provinces2Municipalities
1988198919901991199219881989199019911992
(In percent of current revenue)
Own tax revenue8.89.18.58.48.214.719.619.520.622.5
Grants and transfers84.584.385.585.584.770.464.965.162.360.0
From the central government73.070.271.271.269.061.957.358.055.152.9
From regions11.311.011.111.012.38.17.36.86.86.8
From other public administrations0.33.13.23.33.40.40.40.40.40.4
Nontax revenue6.66.66.06.07.114.915.515.417.117.4
Total100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0
(In percent of total expenditure)
General public services and public order and safety15.515.215.217.017.218.419.220.620.521.1
Education and culture30.428.528.729.731.915.914.614.414.514.6
Social security and housing8.06.57.36.37.733.933.333.831.434.1
Transportation and communications30.032.930.728.525.316.215.314.114.413.6
Economic services10.910.711.311.711.54.95.35.26.35.7
Not classified5.26.26.76.96.310.712.311.911.211.0
Of which: interest8.18.08.67.98.2
Total100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0
Of which:
Current expenditure65.064.466.272.572.559.360.667.168.870.3
Capital expenditure35.035.633.827.527.540.739.432.931.229.7
(In percent of GDP)
Memorandum items:
Current revenue0.50.50.50.50.54.34.44.54.34.4
Total local expenditure0.80.80.80.70.76.96.86.26.15.7
Source: Ministry of the Budget (1994).

Commitment data.

Excludes autonomous provinces.

Source: Ministry of the Budget (1994).

Commitment data.

Excludes autonomous provinces.

Although per capita expenditure levels are quite similar among ordinary regions (Figure 1), the original objective of reducing inequalities in service provision through decentralization has not been achieved. There are still remarkable regional differences in institutional performance (Putnam, Leonardi, and Nanetti, 1992).10 Both northern regions and northern local governments are consistently better performers than their counterparts in the south. The cost of less efficient public services is borne by the local population. For example, the supply of public health care facilities is considerably lower in the south than in the center-north; nevertheless, utilization rates in public hospitals are lower in the south (ISTAT, 1995a).11 In the south, household demand for health care met by private suppliers is correspondingly higher, and households spend more out of their own pockets—especially for diagnostic and specialist services (ISTAT, 1995a). In 1977, the central government allocated grants to regions for establishing day care centers, but the regions’ response time in utilizing the grants varied considerably. By 1983—six years later—Emilia-Romagna (in the north) had one day care center per 400 children, and Campania (in the south) had one center per 12,560 children (Putnam, Leonardi, and Nanetti, 1992). This suggests that the matching of supply of local public services to local preferences (an objective of decentralization) is not ensured by the current system of intergovernmental fiscal relations. As discussed below, the financing arrangements and the budgetary procedures have not created the incentives to improve expenditure efficiency.

Figure 1.Italy: Per Capita Expenditure in Ordinary Regions, 1994

(In thousands of lire)

Since uniformity in service provision was not being achieved, the framework law reforming local administration stipulated that a standard level of services must be guaranteed to all citizens, as well as the principle of the responsibility of local managers (for example, directors of universities, managers of Local Health Units, and so on). This principle has so far found little practical application, partly because of overlapping expenditure responsibilities. The education sector is a case in point: the central government finances outlays for teachers’ salaries, equipment, and some operations and maintenance, while local authorities (provinces and municipalities) finance outlays for buildings and some services (such as energy and water). Responsibilities for administrative and support staff are even more dispersed among the levels of government.12

The power of local managers and the room for managerial decisions are limited. Many expenditure decisions are beyond their control, such as the copayment rates for drugs and the salaries of health workers; for hiring and firing, they must follow strict rules and lengthy procedures.13

The principle of managerial responsibility has not found easy application in health care partly because of the attempt to supply uniform services throughout the country. As outlined in the 1992 implementing law for the health care reform, the central government is responsible for financing—through the National Health Fund—part of the “guaranteed, nationally uniform” levels of health care services. The regions contribute to financing this standard level through the earmarked payroll tax. The regions “bear the financial consequences of supplying health care above this guaranteed uniform level, of setting up health units and beds above the set standards, and for the deficits of the Local Health Units.” Since no agreement was reached on what constitutes “uniform guaranteed levels of health care,” the latter have become synonymous with “financially affordable” health services. Each year, the budget law defines what is available for central financing of health expenditure through grants. Of course, the regions argue that their health sector deficits are not the result of poor management, but of supplying nationally uniform levels of health care services, and that the National Health Fund is not sufficient to finance this provision. This has legitimated the central government financing of the regional deficits in the health sector in the subsequent budgetary periods (see the section on Conditional Grants).

Revenue Arrangements

Regions and local governments rely for revenue on taxes, unconditional grants, specific grants, and borrowing. The current system is the result of over 20 years of legislation, sometimes of an emergency, piecemeal nature. Until 1992, the main feature of the subnational financing system was the low share of own revenue. Conditional grants were the most important source of financing for subnational governments. This was not at all the original constitutional provision, which prescribed own taxes, revenue sharing, and grants as sources of financing; however, the 1974 tax reform, which overlapped with the establishment of the ordinary regions, centralized taxes and their administration.14 Regional own revenue fell from 8–9 percent of total revenue in 1973 to 2 percent in 1979. Starting from 1992, several national taxes have been assigned to subnational governments, to foster fiscal responsibility at the subnational level. However, the current tax and grants system does not seem to be designed to promote fiscal effort.

Tax Revenue and Tax Administration

Until 1992, regional own tax and nontax revenue amounted to around 3 percent of regional revenue (see Table 5). Regions’ tax revenues were either shared taxes (only for special regions) or low-yielding own taxes. Until 1992, subnational governments could not levy taxes or modify tax rates, which were set by the central government.

In 1993, new own revenues were assigned to regional governments, although there were limits on how much local rates could diverge from the national standards. As a consequence, the share of own and overlapping tax and nontax revenue to total revenue of ordinary regions increased to 7.2 percent in 1993—and to 48.6 percent when account is taken of the revenue from the taxes that were transferred to the regions and earmarked to finance health expenditures.15 The health tax rates are set by the central government, though regions can increase them by a maximum of 6 percent. In principle, local rates must be increased if the region has a deficit in the health sector. Although health expenditure is by no means under control, regions have been reluctant to increase rates (Table 8). Since in the past regional deficits have ultimately been borne by the central government, a moral hazard problem has developed.16 The moral hazard is reinforced by the absence of credible penalties (that is, bankruptcy procedures) for regions.

Table 8.Italy: Main Taxes of Ordinary Regions, 1993
Registration Licenses and FeesRegional Tax on GasolineSurcharge on Car Registration FeeAdditional Tax on Gas MethaneCar TaxHealth Taxes
(In percent)(In lire)(In percent)(In lire)(In percent)(In percent)
National legislation allows rates to be increased by:20-10030 lire maximum20-80(20-50 lire)/m390-1106% maximum
Piemonteminimum30 lire28050100no
Lombardyminimumno8020100no
Venetominimumno3050100no
Liguria100no8050100no
Emilia-Romagnaminimumno8030100no
Toscana1001no8050110no
Umbriaminimumno2020100no
Marcheminimumno5530100no
Laziominimumno8020100no
Abruzzominimumno8050100no
Moliseminimumno2020100no
Campania1001no8050110no
Puglia100130 lire28050110no
Basilicataminimumno8050100no
Calabria1001no8050100no
Source: Giarda (1995).

With some reductions.

Not applied, owing to normative problems.

Source: Giarda (1995).

With some reductions.

Not applied, owing to normative problems.

As for expenditure assignments, revenue arrangements differ among special regions. Most of their revenues come from shared taxes—for example, about 66 percent in 1993 (see Table 5)—whose rates vary, depending on the extent of the region’s expenditure responsibilities. In some cases, special regions retain high percentages of the national taxes.17 All special regions also share in the National Health Fund and in other specific funds. Because tax assignments and shares of taxes differ, when national tax rates are changed, revenues of special regions are affected in different ways. This complicates national tax policy and multiplies claims for larger grants by the regions negatively affected by the tax changes.

To make local governments (provinces and municipalities) fiscally more autonomous, larger own financing sources were assigned to them during 1992-94.18 The main beneficiaries of this change were the municipalities, as the property tax has become the most important source of local financing (central government grants to municipalities were reduced by an amount equal to property tax collection). In 1992, 40 percent of municipal governments’ revenue came from own taxes and nontax revenue (29.6 percent in 1988), with the largest revenue coming from business tax and local duties and fees (see Table 7). Own revenues of municipalities are estimated to have increased to more than 50 percent in 1994, owing to the municipal property tax becoming their own revenue. The rates of local taxes can generally vary within minimum and maximum limits set by the central government, or overlap with national taxes. Moreover, provincial taxes often overlap with municipal taxes; for example, there are three different fees on electricity consumption and nine taxes on car ownership (Tremonti, 1994).

Tax administration has been fully centralized in Italy since the 1973 tax reform. By the early 1970s, there was broad agreement that a myriad of local taxes and fees had excessively complicated the tax system and contributed to distortions in resource allocation and that local tax administration was not particularly efficient in assessing, collecting, or auditing (Reviglio, 1976; Holmans, 1978). It is likely that this centralization contributed to the substantial tax revenue increase in real terms of the late 1970s and early 1980s (Ghessi, 1984).

Each special region has its own different regulations for tax administration. Sicily autonomously collects all taxes, mostly through private tax collection agencies.19 In Trentino, taxes are collected by the central government, but nine-tenths of revenue remains with the regional government. Valle d’Aosta and Friuli-Venezia Giulia have a similar arrangement. Sardinia has its own tax collection agency but it is used only for some taxes.

A general problem that arises with revenue centralization is that local residents do not know how much local services cost. With the revenue centralization of the 1970s, the link between taxation and spending was loosened, and fiscal illusion weakened the perception of the real cost of local public goods. This generated excess demand for locally provided public goods, which was initially accommodated. Brosio, Hyman, and Santagata (1980) find that per capita expenditure was positively affected by the removal of taxation powers and the decentralization of expenditures during the early 1970s. Econometric evidence supports the view that expenditure decentralization, without the corresponding fiscal responsibility at the local level, has increased overall public expenditure in Italy (Rizzo, 1985). However, as fiscal illusion declines over time, so does the positive effect of the separation of expenditure and taxing decisions over consolidated public expenditure (Brosio, 1985).

Unconditional Grants

Ordinary regions receive unconditional grants from two sources: the Common Fund and the Regional Development Projects Fund. Their economic importance is quite small, as they account for only 3 percent of total revenue of ordinary regions.

The Common Fund was originally funded from a quota of excise revenues, to enact the constitutional provision of tax sharing. However, its actual size is in fact determined each year through an informal bargaining process between the central and the regional governments. After reaching an agreement on the size of the fund, the percentage of the mineral oil tax rate that goes into the fund is set to equal that amount. Therefore, the regions do not know the amount of resources available from the Common Fund until the national budget is approved by parliament—which may happen a few months into the financial year. The distribution formula is strongly redistributive.20 The poorest region, Calabria, which has less than half the per capita income of Lombardy (the richest region), has a per capita transfer from the Common Fund that is 2.4 times greater than that of Lombardy. The weights of the various factors entering the distribution formula—and therefore the regions’ shares in the Common Fund—have been frozen since 1976, as the central and regional governments have been unable to agree on different parameters reflecting changed economic and social conditions. Since 1993, regional shares are net of the regional vehicle tax. This has increased the redistributional nature of this grant, since vehicle tax collection is lower in poorer regions.

The Regional Development Projects Fund is financed from general revenue and was set up to equalize the stock of public infrastructure by region. Therefore, 60 percent of its resources was to be distributed to the southern regions. However, since regions have repeatedly not prepared their investment plans, the distribution formula now follows the weights of the Common Fund. The Regional Development Projects Fund is composed mainly of contributions for multiyear expenditure or for the repayment of interest on debt for investments (Degni and Emiliani, 1995).

Following the implementation of the framework law reforming local finances, the grant system to local authorities was restructured in 1994. The amount and distribution of current grants are determined by the previous years’ level and distribution of expenditures and are set net of the collections of municipal property tax. Municipalities now receive three types of current grants: from the recurrent fund (which finances essential ordinary expenditures), the conditional fund (for specific expenditures, such as youth employment), and the equalization fund (which compensates for local differences in the tax base).21 The recurrent fund is supposed to finance those “essential” services that have been decentralized from the central government to the municipalities.22 It is distributed according to “objective” criteria that reflect the municipality’s population, territory, and socioeconomic conditions—according to parameters of which little is known outside the Ministry of the Interior. The recurrent fund accounted for around 77 percent of current grants to municipalities in 1994. The conditional fund’s size and distribution depend on ad hoc laws; this fund accounted for around 25 percent of current grants to municipalities in 1994. To foster fiscal effort, the equalization fund is supposed to be distributed on the basis of the inverse of the tax base of own local taxes. Although the equalization fund was the smallest of the funds in 1994—accounting for around 4 percent of current grants—it will become much more important. While the recurrent fund will be fixed in nominal terms, its increase in line with programmed inflation will be added to the equalization fund. The latter is also supposed to close any local financing gaps that may arise. The conditional fund is supposed to remain fixed in nominal terms.23

Two problems are associated with the new system of grants to local governments. First, since the local tax base is mostly unknown, actual collections are used as proxies to determine the distribution of the equalization fund. This distribution mechanism effectively rewards those municipalities opting for lower local tax rates and is a disincentive to fiscal effort—certainly not the result that the reform wanted to achieve. There seems to be an inconsistency between the intention to assign fiscal autonomy to local governments through local taxes and the guarantee of a minimum level of resources, independent from the fiscal effort.

The second problem is the wide disparity in municipalities’ ability to generate own resources. For example, the collection of municipal property tax—the largest source of own revenue—varied from Lit 145,000 a person (about US$90) in the central regions, to Lit 71,000 a person (US$44) in the southern regions (the northern regions collected Lit 138,000 (US$86)). While the richer municipalities may actually generate own resources equivalent to around 80 percent of expenditure, the poorer ones may generate only around 20 percent. Therefore, although the new financing arrangements will reduce the importance of grants, their redistributive role may actually increase. This may lead to grievances from the richest local governments with regard to the size and distribution of the equalization fund, and thus to delays in the fund’s appropriation. As in previous arrangements, the current grant system does not seem designed to reduce budgeting uncertainty.

Grants for local investments have also changed. Before 1986, the distribution of the Investment Grant—whose size was negotiated between the central and local governments—responded to the applications received from local governments on a first-come, first-served basis. This system suited the administratively more efficient municipalities. Starting in 1994, the central government’s contribution to new local investments is limited to a one-time per project amount, set according to the average per capita investment expenditure in 1994. The appropriation for this grant, only 0.02 percent of GDP in 1994, raises questions about its adequacy for new local investment projects. In the past, local governments’ investment expenditures have usually been higher than the ex ante available resources—central grants plus own financing. For this reason, local governments have been allowed to borrow from banks and the Deposit and Loan Fund (a government bank), and the central government has picked up a portion of the bill through a new grant established in 1984. The specific grant for repaying these loans (capital plus interest) is larger—at around 0.7 percent of GDP in 1994—than the actual Investment Grant.

Conditional Grants

Conditional grants are by far the largest source of revenue for ordinary regions, accounting for around 87 percent of total revenue in 1992.24 The central government thought that conditional grants would be better suited for influencing the level and distribution of subnational expenditure of national concern (such as health and public transportation). However, heavy reliance on conditionality has led to lack of accountability of funds spent, because the central government has not been able to clarify its objectives, establish and enforce efficiency criteria, and audit performance.

The National Health Fund and the National Transportation Fund are the two main earmarked funds.25 Health services and local public transportation are not provided directly by the regions: health services are provided by the Local Health Units, and transportation services by a host of public and private enterprises, most of them municipal corporations. Both also use fees and tariffs but, for social and political reasons, these are never set to finance substantial portions of their expenditures.26 Though reference was made to “objective” parameters, which were supposed to increase expenditure efficiency (for example, the number of hospital beds or their utilization rates, the coverage of the local bus network, and the age of the existing buses), the size of the funds and their regional distribution is actually determined each year through informal negotiations between the central and regional governments. Essentially, the funds’ size and distribution have been set in line with previous years’ expenditures (so-called historic expenditure criteria), which implicitly rewarded the inefficient and/or high spenders.

Each year, both funds are deliberately underfunded, to limit the deficit of the general government at the time of budget approval. All negotiating parties are aware of this underfunding. This system has proven useless in stemming the growth of expenditure and deficits and in increasing efficiency in these two sectors. The deficits are financed through arrears to suppliers and through borrowing from banks—which are outside the targeted borrowing of the state sector. These debts are eventually cleared by issuing government bonds, which increases the outstanding debt of the central government without affecting the deficit in the current year;27 it is only in the following years, when the corresponding allocation for interest payments is made in the national budget, that the subnational deficit has an effect on the central level. This has happened every one or two years for health expenditure, and every three to five years for transportation expenditure. The National Transportation Fund deficits of the period 1982-86 were cleared in 1987 by the central government, and the deficit of the 1987-93 period was cleared by a 1995 decree. The percentage of overspending in the transportation sector has been growing steadily since 1987 (Table 9). Starting in 1993, the amounts granted to each region through the National Health Fund have been determined by the region’s population size, the difference between the per capita standard costs of providing health services and the regional payroll tax base, and patients’ mobility between regions. If a region’s health costs are higher than the national average, regional health taxes should be increased to finance the deficit. Though this new formula has been designed to increase efficiency, it has proven difficult to define per capita standard costs, and funds continue to be allocated on the basis of past expenditures. Currently, as in the past, this uncertainty is reason enough for regions to ask that their health deficits be financed by the central government. Indeed, this took place in 1993 and 1994, when no region increased the rates of its health taxes, although deficits have since developed. This inaction was also due to the fact that regions did not know the amount of payroll tax that each one would receive, because the first two to three years of the reform were transitory years, during which the health taxes continued to be collected by the central government.

Table 9.Italy: National Transportation Fund and National Health Fund—Budgetary Appropriation and Deficit in Ordinary Regions(In billons of lira)
19871988198919901991199219931
National Transportation Fund
Budget appropriation4,0514,2944,2944,2074,4114,7644,764
Deficit8931,2491,8091,8592,3292,7252,861
Deficit (as percent of budget appropriation)22.029.142.144.252.857.260.1
National Health Fund
Budget appropriation84,019249,44355,35067,18471,04471,311
Deficit13,13926,23513,6889,8805,3165,545
Central government loan11,12624,7849,8898,7935,316
Deficit as percent of budget appropriation15.6212.624.714.77.57.8
Central government loan
(as percent of deficit)84.7276.772.289.0100.0
Source: Degni and Emiliani (1995).

Estimated.

This column refers to 1987–88.

Source: Degni and Emiliani (1995).

Estimated.

This column refers to 1987–88.

The same problem has arisen in the transportation sector. Though the National Transportation Fund was to be distributed to the transportation enterprises based on deviations from “objective standard costs” (Law 151/1981), these costs have never been defined. Therefore, actual average costs came to be used; actual costs, however, are ill suited to improving efficiency. Moreover, the National Transportation Fund was often distributed to the regions with long delays into the financial year, making it impossible to distribute it ex ante to the transportation companies. As in the health sector, these delays have substantiated regions’ demands to the central government for additional allocations (at end-year) to finance the deficits of the transportation enterprises.

The current grants system is at odds with the central government’s objective of reducing interregional differences in service levels. Most grants are demand driven, as the size and distribution of most are decided on the basis of past expenditure. Demand-driven grants reward inefficiencies in expenditure—particularly if, as in Italy, there is no appropriate system of expenditure monitoring and budgetary constraints (see the sections on Borrowing and Budget Formulation and Expenditure Management).28

Borrowing

Although legal limits on borrowing by subnational governments exist, they are bypassed by resorting to temporary arrears accumulation, recourse to bank credit by entities supplying local public services (for example, Local Health Units and transportation enterprises) to the subnational governments and by later shifting responsibility for the deficits to the center. For these reasons, the magnitude of the debt of subnational governments—around 11 percent of GDP in 1993–94—is not large (Table 10).

Table 10.Italy: Composition of the Stock of General and Local Governments’ Debt(In percent of GDP)
1985198619871988198919901991199219931994
General government82.386.390.592.695.697.7101.2108.3117.3121.4
Medium- and Long-term bonds35.941.042.743.444.346.350.653.061.466.7
Short-term bonds18.818.019.622.024.124.623.726.225.824.2
Post office deposits7.47.98.58.79.29.49.49.710.311.2
Bank loans4.13.93.73.53.53.54.34.75.55.5
Of which: subnational governments13.53.33.12.82.82.93.53.64.54.3
Other domestic debt0.30.30.30.30.20.20.20.20.20.2
Debt issued abroad1.51.41.82.02.33.03.13.44.75.1
Debt to Bank of Italy14.313.813.812.811.910.79.911.09.38.4
Memorandum items:
Debt of subnational governments to Deposit and Loan Fund25.36.66.86.66.56.56.6
Total debt of subnational governments8.19.49.710.110.111.010.9
Source: Bank of Italy (1994).

Includes regions, provinces, and municipalities’ debts to banks.

The Deposit and Loan Fund is included in the general government; therefore, the debt of subnational governments to the Deposit and Loan Fund is netted out when the debt of the general government is consolidated.

Source: Bank of Italy (1994).

Includes regions, provinces, and municipalities’ debts to banks.

The Deposit and Loan Fund is included in the general government; therefore, the debt of subnational governments to the Deposit and Loan Fund is netted out when the debt of the general government is consolidated.

Currently, regions are permitted to borrow only for the capital budget and for share participation in regional enterprises, with the proviso that capital charges (interest plus principal repayment) not exceed 25 percent of the sum of regional own revenue, net of health contributions, and the Common Fund. Regions cannot borrow to finance current expenditure. However, the Local Health Units and transportation companies (which account, through the National Health Fund and National Transportation Fund, for around 80 percent of regional expenditure) can borrow from commercial banks, and eventually it is the central government that foots the bill, through periodic deficit clearing (see the section on Conditional Grants). Therefore, regional budgets report little interest outlays.

The previous section discussed how payment arrears to suppliers in the health sector have been allowed to build up and how Local Health Units have been authorized to borrow from commercial banks to pay suppliers’ hills.29 This is usually timed so that arrears are not paid until the following financial year, at the earliest, and until additional financing is forthcoming. This occurred in 1983, 1986, and 1987, then every one to two years until 1993. As in previous years, in 1993 the regions were authorized to borrow from the Deposit and Loan Fund to repay outstanding arrears, but this resulted instead in higher current spending, and outstanding arrears were not reduced. The interest on the 20-year loans contracted by the regions with the Deposit and Loan Fund is borne by the central government. The 1993 settlement of overdue debt is supposed to be the last one for the health care sector and was considered a precondition for Local Health Unit managers—and ultimately regions—to assume responsibility for their units’ economic results. Similar problems were encountered by some transport authorities.

For local governments, in the early 1970s, there were few controls on the sources, amounts, and conditions of their borrowing, which led to the accumulation of large commitments for interest payments.30 Rising domestic interest rates required emergency financing from the Treasury in 1976, and, in March 1977, parliament decided to convert all short-term debt of local governments into 10-year treasury bonds.

Since the financial crisis of the 1970s, local governments have not been allowed to borrow short term from the banking system to finance current expenditures—except for temporary liquidity shortages; strict limits have been imposed on the rate of spending increases—especially for personnel; and a balanced budget requirement—including grants—has been introduced. During the 1980s, a system of ex ante determination of the overall available revenue, including grants, was introduced. This system of ex ante ceilings was effective in reducing local government expenditures. For investment projects, provinces and municipalities may borrow from banks, the Deposit and Loan Fund, and other public banking institutions, if they provide a repayment plan. Local governments have often been encouraged to divert some borrowing from the Deposit and Loan Fund indirectly to the suppliers through arrears, again, to meet the targeted borrowing figures by pushing more borrowing outside the budget concept. Suppliers obtain loans from banks to finance these arrears and use the local governments’ commitments to secure these loans.

The current system of ineffective controls on borrowing has serious economic costs. Uncertainty about the actual availability of cash resources for program managers undermines normal budget management discipline. Delaying provision for local capital projects can increase their costs, when it results in suboptimal phasing of work or the expensive renegotiation of contracts. Diverting borrowing from the Deposit and Loan Fund to commercial banks adds to financing costs and may allow uneconomic capital projects to proceed if commercial banks believe there is an implicit government guarantee on the loan. Allowing Local Health Units to go into arrears not only adds to borrowing costs but encourages suppliers to add a premium to their prices, in the expectation of delayed payment.

Budget Formulation and Expenditure Management

Regional budget formulation often ends nearly three months after the new fiscal year begins.31 Only when the central government budget is approved by parliament and grant amounts and reference rates of regional taxes are known can the regional administrations estimate their total revenues and finalize their budgets. Regional budgets are transmitted to the central government, which has a 30-day statutory period to approve or comment on them—with no power to reject them. Meanwhile, the first quarter’s operations are conducted on the basis of the appropriations for the first quarter of the previous fiscal year. This lengthy process creates uncertainties for budgeting.

Although grants from the central government should be released regularly, in practice, the releases require protracted correspondence and continuous prodding by the regional governments. The Treasury account regularly provides advances to cover the deficit of the national pension system. One source of these advances is the delayed access of other agencies, including subnational governments, to their funds deposited in the account.

All controls on the regional expenditure process are formal, rather than substantial. Regional quarterly cash reports are sent to the General Accounting Office for information purposes only. There is no standard reporting format, and budgetary practices have evolved regionally to satisfy specific needs. Each region’s budget is different, so they are almost impossible to compare.32 Transparency of budgetary information and, therefore, expenditure control and management, have suffered.

The format and the accounting rules of provinces and municipalities’ budgets are specified by law in minute detail. Data are collected on a cash basis, and reporting formats do not distinguish costs from expenditures, so that it is difficult to know the actual economic cost of any specific service. Budgets, once approved, are reported to the General Accounting Office for information purposes only and to the Regional Control Committee for formal control—basically, to verify that the budget has violated no laws. Although a local accounting officer has to authorize that spending is formally consistent with the budget, no organization has jurisdiction on budget substance.

Auditing, under the guidelines of the 1934 comprehensive law, was strictly internal, performed by three elected councillors (not necessarily professional accountants or auditors), and essentially of a formal and financial nature—at best, checking that public money was spent in accordance with the budget. The 1990 framework law provided for an external Board of Auditors, consisting of professionals who are to evaluate results achieved and advance proposals to the municipal and provincial councils to improve performance. All public entities should use cost accounting and, while still retaining the cash reporting, also use accrual accounting. However, apart from a few attempts limited to few services, these mandates have not been put into action.33 As a consequence, the auditors—in those municipalities that have actually established an external Board of Auditors—do not have the essential accounting tools for managerial control or for evaluating efficiency of expenditure programs, and the political representatives are not in a position to take into consideration the economic consequences of their choices.34

Subnational governments are therefore not accountable—apart from a general, formal accountability—to local taxpayers. As discussed above, lack of accountability also stems from the limited ability of the former to make economic choices (their financial resources being largely provided by the state through conditional grants, and the rules and methods of service provision imposed from above). Citizens have diverted their dissatisfaction with the services rendered by the subnational governments to the central government, which they blame for cutting and delaying grant disbursements and for imposing inflexible rules on the use of these funds and the provision of services. To be sure, regions do accumulate substantial uncommitted allocations, but this is partly due to the fact that all expenditures are committed to specific objectives and funds cannot, in principle, be shifted from one expenditure chapter (for example, personnel, drugs, and machinery) to another. This problem is more acute in the areas where central government grants are conditional because the grant appropriation law usually specifies—in minute detail—how funds should be spent.

Another consequence of these arrangements has been that the innovative ability of the subnational governments—one of the presumed advantages of decentralization—could not be fostered. The subnational governments’ managers were accountable only if they failed to guarantee financial compliance with formal rules. Issues of quality, efficiency, and effectiveness in the provision of services needed to be raised by the managers on their own initiative; since they were concerned instead with measuring the financial compliance with legislative standards, little interest to innovate has been generated. However, in this area as well there have been considerable differences between the northern and southern regions’ ability to produce innovative legislation.35 To be fair, the traditional concept of accountability is changing due to the latest reform laws on local administration: the tasks of managers and politicians are now, at least in principle, separate, and the managers are directly responsible for administrative fairness and efficiency in obtaining their units’ objectives. However, accounting methods and budgetary practices have not yet changed, and the local politicians have not yet fully used their expanded revenue-raising powers.

Regional and local authorities are the major providers of public services, and their expenditures are an important element of public spending; yet, the institutional and regulatory setup is such that the central government does not collate information on their aggregate budgets nor monitor prospective or actual spending in-year. Although the unified treasury account for subnational governments allows a quarterly reporting of their cash positions and it enables a certain control over local authorities’ cash sources by regulating disbursements of the central government’s grants and transfers, this does not constitute control over their spending because of the lack of reporting of and controls on commitments. Responsibility for distributing grants to, for collecting data on, and for controlling regional and local governments rests with the Treasury and the Ministry of the Interior, respectively; however, there is little coordination or exchange of information on subnational government matters between the two. At the beginning of each year, the Treasury (for the regional governments) and the Ministry of the Interior (for the local governments) know the subnational governments’ expenditure commitments from their budget estimates. However, during the course of the year, the ministries collect no information on changes in expenditure commitments. subnational expenditure data are not satisfactorily broken down by economic and functional categories, making expenditure analysis difficult.

Conclusions and Policy Implications

The system of intergovernmental fiscal relations in Italy has impaired allocative efficiency and accountability in the use of public resources and has contributed to the growth of public expenditure, deficit, and debt by promoting fiscal irresponsibility at the subnational level. Decentralization has not yet yielded the results predicted by theory. What has instead happened is the following. First, subnational governments have been able to match the supply of local public goods with local preferences with varying degrees of success—higher in the north. Second, decentralization per se may have not allowed greater experimentation in the provision of output, because the degree of central government control on resource allocation has remained high and because local administrative capabilities are not uniformly distributed. Third, subnational management practices have not evolved: budgetary practices, expenditure monitoring and control, and budget transparency have not improved. Indeed, it is arguable that these have worsened as expenditure was decentralized.

In fact, intergovernmental fiscal relations have contributed to various structural macroeconomic problems. First, subnational governments have been a source of hidden debt for the central government. Second, the central government has had less margin to use expenditures for fiscal policy, as most of these are either of subnational responsibility or entitlement and interest outlays. Third, national budget transparency and the national public expenditure management system have suffered, as the central government resorted to accounting expedients to limit its cash borrowing requirements.

Although the latest measures taken to foster subnational fiscal responsibility may not suffice in dramatically changing subnational fiscal behavior, there is a considerable degree of consensus in Italy in favor of a further expansion of regional expenditure competencies and tax autonomy and of a reduction in conditional grants. However, in the political debate on how to achieve these objectives, three crucial elements are missing: the administrative constraints, the budget management and the issue of accountability, and the regional disparities.

The first element, administrative constraints, is virtually lacking in the Italian debate on how to achieve further decentralization. Most proposals tend to allocate new functions to the regions without taking into consideration that administrative support may be unevenly distributed at the subnational level: overstaffing and poor training, inability to tap available funds (especially those provided by the European Union), lack of development plans in key economic (for example, agriculture, transportation, and environment) and social (for example, health and vocational training) sectors. Also, the capacity of regional and local government to administer current and potential resources of revenue needs to be strengthened. Administrative capabilities at the subnational level may prove to be an obstacle to further devolution of expenditure responsibilities.

The second element is budget management and accountability. Fiscal responsibility may be difficult to achieve without a marked improvement in budgetary practices. The first step could be the publication of the subnational budgets, so that the taxpayers would clearly see the connection between their fiscal efforts and the public goods and services supplied to them, and local administrators would become more subject to public scrutiny. To prevent subnational autonomy from becoming synonymous with incomprehensible policies, uniform standards for transparent budget classification and new accountancy rules need to be set. For example, there is a clear link between the transparency of the budget and the control of subnational borrowing. The cost of borrowing should be transparent and made known to the citizen/taxpayer as well as to the central government. Improvements in national budgetary practices and expenditure management are also necessary. For example, the first National Health Plans that were prepared were approved only after long delays, were ambiguous in their prescriptions, and difficult to implement. The distribution of the National Health Fund continued, therefore, to be based on past expenditure levels and bargaining. Likewise, central monitoring of subnational budget execution has not adjusted to the reality of an increasingly decentralized government.

Related to the budgetary practices is the issue of accountability of individual managers (at both the central and the subnational levels). Too much emphasis is currently placed on legal compliance. Managers should be made responsible for their respective cost centers, and the accountancy rules should be modified to allow them to monitor costs—rather than cash expenditures and formal application of the law. External auditing and a value-for-money approach to performance should be used to facilitate the evaluation of efficiency and effectiveness in service provision. A central value-for-money agency could be responsible for making reviews and comparisons, drawing out the best practices, and offering general guidance on how to improve management.

With increased accountability should come the imposition of harder budget constraints on regional and local governments, including tighter controls on borrowing and a firm refusal of bailout by the central government. These limits should be set in standing rules, incorporated in the law rather than through the annual budget process, which offers opportunities for bargaining. These standing rules cannot be effectively applied until the monitoring system of the consolidated budget is first improved. Accurate and timely information on borrowing of all levels of government should be disseminated to financial markets. Arrears and debts to suppliers should be centrally monitored.

The third element is the constraint imposed on further decentralization by the large disparities in income and in institutional performance between the northern and the southern regions—even after 20 years of a decentralization policy designed to reduce these differences. Although the transfer system, notwithstanding large differences in fiscal capacity, has resulted in a rather uniform level of per capita expenditure in the ordinary regions, this has not implied the same level of effectiveness in the delivery of local public services. The policy implication is that it is meaningless to prescribe a guaranteed standard level of expenditure for each person. The recent reform of health care financing has explicitly set government grants at a level that ensures a uniform per capita expenditure, independent from the revenue collected by each region through the health taxes and from the level of effectiveness in providing health services. Rather than referring to an as yet undefined level of “necessary” services that the central government should finance, a definition in terms of functions, for example preventive and public health, should be sought.

The literature on fiscal federalism offers considerable theoretical and practical guidance concerning the assignment of tax and expenditure responsibilities to the subnational governments and the appropriate systems of intergovernmental transfers designed to support them (see Chapters 2 and 3 for an extensive discussion of these issues). Here, only some observations relevant to Italy are presented. First, progress in building an effective revenue-raising capacity and in strengthening budget management and accountability at the subnational level should precede further devolution of expenditures.

Second, given the existing marked regional differences highlighted above, if a path of increased decentralization is chosen, it should also be openly recognized and accepted that even more pronounced regional differences in the delivery of local public services may result. It should be realized that there is an inherent inconsistency between the current desire for both increased decentralization and service uniformity throughout the country. Disparity in the provision of local public services is a normal occurrence in a decentralized system; and it is even more so in a country characterized by sharp regional differences in fiscal capacity, unless the system relies on large-scale interregional redistribution of resources.

Thus, it is crucial that the government decides on the objectives of increased decentralization. Only then can the instruments for achieving such objectives be designed. For example, the government should first choose what degree of regional disparity in the provision of local public services is acceptable; then it can determine what tax assignments, tax sharing arrangements, and equalizing grants would be appropriate to support that choice.

Latest Developments

With the 1997 Financial Law, and the accompanying laws, parliament has delegated the government to change, with effect from 1998, the regional financing system through the establishment of (1) a regional income tax surcharge (between 0.5 percent and 1 percent); (2) a regional tax on productive activities (with a rate variable between 3.5 percent and 4.5 percent);36 and (3) an interregional equalization transfer system (whose revenue sources and objectives are yet to be specified). These new taxes will replace all regional taxes on business income, the health payroll tax, the health income tax, and several other minor regional taxes. During a transitory period of three years (1998–2000), the new taxes will be managed by the central government, which will set the tax rates and allocate the revenue among regions according to parameters yet to be specified. Only after the year 2000 will regions be able to set rates—within the centrally mandated limits.37 Between 65 percent and 90 percent of the IREP will be earmarked to finance regional health care expenditures. Any resulting ex ante financing gap for National Health Fund will be financed through transfers by the central government, as in the current system. Finally, the government has approved the creation of a Bicameral Commission aimed at elaborating reforms in intergovernmental fiscal relations by June 1997.

It is too early to assess the implication of these measures, as several crucial aspects have yet to be determined. However, a few general observations can be made. First, the introduction of the IREP and income surcharge are a step in the right direction, as these should simplify the tax system and make it less distortionary and will provide regions with large and autonomous revenue sources—although the autonomy to set rates will be reached only in 2001. Second, crucial to the success of the reform is that several key aspects currently undetermined be solved expeditiously, including how to distribute the new revenue among regions, and the interregional equalization transfer system. In particular, as discussed in the previous section, the government should first choose what degree of regional disparity in the provision of local public services is acceptable; only then can it determine the parameters that should be chosen to calculate a region’s payments or withdrawals from the equalization fund. As in recent years, failure to settle these issues may lead to a distribution of revenue and of equalization funds on the basis of the past trends. Third, the recent measures still fail to address the concerns raised in this chapter with regard to budget management and the issue of accountability (both of them are problematic at the central and decentralized level). In particular, the recent measures do not reduce budgetary uncertainty for the regions, nor do they reduce moral hazard for regions.

In this chapter, the term subnational governments refers to regional and local governments. Local governments include provinces, municipalities, and Local Health Units.

In the Italian legal system, a framework law establishes general principles that subsequent implementing laws actually put in practice.

The Constitution gave regions legislative autonomy in specific areas (see section on Expenditure Assignments). Provinces and municipalities have no legislative autonomy.

The Constitution defines health care and education as “universal” rights of citizens. Subsequent legislation has interpreted this to mean that access to health care and education should be uniform for all.

In 1992, the richest Italian region (Lombardy) had a GDP pet capita of 126.5 (Italian average equal to 100), compared with 57.7 for the poorest (Calabria). These regions occupied the same relative position in 1982, when the corresponding figures were 128.8 and 58.8 (ISTAT, 1995a).

Interest and personnel outlays are the central government’s first and third largest expenditure components, respectively (Table 2).

Since 1970, ordinary regions have the legislative authority (within the limits of national laws) for local police, social welfare and related activities, medical and hospital services, labor training, public assistance to school children (the authority for education rests with the central government), urban planning, inland waterways and lake ports, tramways and road systems, water supply, and public works of regional importance. In the economic sphere, these regions are responsible for regulating fishing and hunting, agriculture and forestry, mines, and the handicraft industry, while the central government has retained responsibility for regulating industrial development, labor relations, and salaries of most public employees. Some of these functions (such as local police and social welfare) were assigned in 1977 to local governments, which now receive the corresponding grants from the central government. Other functions (for example, labor training and housing) have been delegated to the local governments by the regions. The grants to finance these functions come from the regional budgets.

The main provincial responsibilities are the maintenance of provincial highways, as well as lake, river, and mountain transportation; environmental protection; nonsolid waste disposal; air and water pollution control; and education of provincial interest.

The main functions assigned to municipalities include local police, public hygiene, social welfare, provision and maintenance of buildings for the judiciary, education, construction and maintenance of municipal streets, solid waste collection, street cleaning, urban planning, zoning and regulation of commerce, operation of urban public transportation, supply of gas and electricity, and often the processing and supply of milk. The last three functions are provided mostly through municipal public enterprises. Some of these functions were statutorily assigned to the municipalities in 1935, others have been gradually transferred to them by the central government and the regions.

This study evaluates institutional performance of subnational governments on the basis of 12 variables expressing the efficiency of their internal operations, the creativeness in their polity initiatives, and the effectiveness in implementing these initiatives.

According to 1992 data, public hospital utilization rates vary from 73.8 percent in Piemonte (In the north) to 59.9 percent in Campania (in the south). Variability is higher among the special regions, ranging from 85.3 percent in Valle d’Aosta (in the north) to 53.3 percent in Sardinia. The Italian average is 69.6 percent.

Municipalities are responsible for the salaries of the nonteaching personnel of kindergartens and of elementary and scientific high schools; the provinces are responsible for the nonteaching personnel of technical high schools; the central government is responsible for nonteaching personnel of junior high schools, teaching institutes, classical high schools, professional and industrial schools, and the administrative personnel of kindergartens and elementary schools.

For example, the 1990 budget appropriated grants for Lit 4.2 billion (3.2 percent of total grants disbursed that year) to pay for the deficit of local transportation companies. That same year, the government agreed to increase the salaries of employees of all—including local—transportation firms. Though the central government appropriated additional transfers, both in 1990 and 1991, to the regions to share the financial burden, the regions were also authorized in 1991 to arrange 15-year bank loans (with interest paid by the central government), to cover the remaining salary costs from 1990. This example highlights two issues. First, poorly defined expenditure responsibilities have affected the transparency of the central government budget. Second, centralized salary negotiations make it impossible to distinguish what share of a local company’s deficit is due to a centralized decision or to local mismanagement.

In fact, the actual degree of revenue centralization went beyond the reform plan and taxes originally planned for the subnational governments (local tax on income and capital gains tax on property) were assigned to the central government.

Two kinds of taxes have been earmarked to finance health expenditures (hereafter, health taxes). The health payroll tax is paid by the employer (9.6 percent) and the employee (1 percent). The income health tax is paid on income from self-employment and property and the rate schedule varies from 1.6 percent to 5.6 percent. Since 1993 was considered a transition year, revenues from health taxes were still paid into the central government budget and then transferred to the regions—though the latter had control of their rates. The major regional own revenues are the vehicle tax, the annual vehicle surtax, the special tax on diesel cars, the health taxes, the university fee, and other minor taxes and licenses. In addition to its own taxes, a region may levy the following overlapping taxes: on car registration, on consumption of natural gas, and on gasoline. Rates of own and overlapping taxes may vary within centrally prescribed limits.

See the section on Conditional Grants for a discussion of the central ex post financing of regional deficits in the health and transportation sectors, and the sections on Borrowing and Budget Formulation and Expenditure Management for central ex post financing of local government borrowing.

For example, Sicily retains 100 percent of the taxes collected in its territory, except from lotto and excise duties. Moreover, it receives a solidarity grant that compensates for its low per capita income.

Municipal own taxes are the municipal property tax (ICI), the municipal tax on enterprises, arts, and professions (ICIAP), the tax on use of public land, the waste disposal fee, the tax on advertising, the surcharge on electricity consumption, the sewer fee, and several minor taxes on concessions. Provincial own taxes are the supplemental fee on waste disposal services, the provincial vehicle registration tee (an amount equal to the national tax), the provincial tax on use of public land, and the provincial surcharge on electricity consumption. Though the government was given in 1993 a parliamentary mandate to draft a regulation for a municipal supplement on the personal income tax, this mandate has not been used.

In the 1980s, the private collection agency in Sicily retained 10 percent of collection, on account of collection costs, though average collection costs in Italy are estimated at around 3 percent (Stille, 1995).

The grant is distributed as follows: 610 according to the population of each region, 110 according to the territorial size, and 310 according to the emigration rare, the unemployment rate, and the inverse of the per capita revenue of the personal income tax,

The grant system for provinces is effectively the same as for municipalities.

These essential services for the municipalities are the Registry Office, statistical services, local law enforcement, the army draft, and primary and secondary education—for that part under municipal responsibility. The essential services for the provinces are the Office of the Provincial Directorate of Education and expenditures of provincial responsibility within scientific and Technical secondary education.

However, since salaries of local government employees were increased in 1995 as part of a collective bargaining agreement settled at the national level, local governments claim that the grant allocations in 1995 were not sufficient to cover recurrent expenditures.

With the transfer of the payroll tax to regions, the earmarked fund for health expenditure was reduced accordingly in 1993. Nevertheless, conditional grants remain the largest revenue source (around 44 percent of total in 1993).

The economic importance of the other specific purpose grants is small. At present, agriculture, forestry, environmental protection, and mountain communities are the most important destinations for these grants.

The ratio between own income and expenditures for urban public transportation was 25 percent in 1987. The percentage of cost recovery in transportation is highest in the north (34 percent) and lowest in the south (16 percent), with the central regions close to the average (24 percent) (Brosio and Piperno, 1992). Own income of Local Health Units generated by user fees does not exceed 3 percent of their total expenditure (Degni and Emiliani, 1995). Though health contributions represent, on average, 55 percent of the Local Health Units’ total income, their importance varies among regions: in Lombardy, it is equal to 67 percent, and in Calabria, 35 percent. The Local Health Units’ income from user fees is higher in the north.

The debt liability so created for the central government is referred to as “hidden debt” in Italy.

Starting from 1996, the National Transportation Fund (and other smaller conditional grants), the Common Fund, and the Regional Development Projects Fund have been removed and replaced by unconditional financial resources funded through a quota of the excise on gasoline and by an equalization fund. In 1996, these two new financing sources together equal the amounts that would have been allocated through the replaced funds. From 1997, each region will receive the quota of excise collected in its territory. The allocation for the equalization fund will increase with programmed inflation. This increase will be distributed approximately as an inverse function of the excise on gasoline collected in each region. This new system provides more certainty to regions with regard to their revenue and reduces the scope for bargaining, although the distribution formula of the increase of the equalization fund is complex and Lacks transparency.

For example, the average delay between the delivery of drugs by suppliers and the issue of payment warrants by Local Health Units is around one year (average for the period 1991–94). However, Piemonte (in the north) paid in 146 days, on average, while Campania (in the south) paid within 597 days. Before the 1993 debt-clearing operation, one region in the south had recorded payment delays of 720 days (Carli, 1995).

In 1975, about 50 percent of the subnational government deficit was financed by banks and special credit institutions; around 42 percent was financed by the Deposit and Loan Fund.

During 1979–85, the average approval date for regional budgets ranged from January 27 (Friuli-Venezia Giulia, in the north) to August 7 (Calabria, in the south) (Putnam, Leonardi, and Nanetti, 1992).

For example, each region classifies grants from the central government in different ways. Some regions include their share of the National Health Fund under one heading only, while others split it among headings. Another example relates to the transfers from the central government to meet the outstanding arrears of the Local Health Units. These are entered in the regional budgets as revenue in a variety of ways, sometimes simply as “transfers in accordance with law” (the decree allowing that particular transfer), sometimes simply as “transfers to cover deficit”; never do these budgetary entries report the amount of Transfers that covers interest payments to banks as opposed to payments to suppliers. The Italian Statistical Institute (ISTAT) collects the revised budgets of the subnational governments, but these are published with a delay of more than two years (March 1995 for 1992 outcome).

Local government accounting is still regulated by a 1934 state law, which means that additional national implementing legislation is needed to establish accrual accounting. Though cost accounting is mandated by an implementing law (29/1993) of the framework law, local administrators have generally been unable to solve the technical difficulties in implementing a cost-based accounting system (Mussari, 1994).

The new “Audit Handbook” (a guideline for the Board of Auditors), which was to be prepared by June 1993, is not yet available.

Putnam, Leonardi, and Nanetti (1992) track 12 areas of regional competence on which similar laws appeared in many regions and find that most regions were either consistent leaders or consistent laggards in introducing new legislation. The highest score was recorded by Emilia-Romagna (in the north) and the lowest by Calabria (in the south).

IREP (the Italian acronym for this tax) is a direct tax on the value added produced by enterprises and the self-employed. Local governments will share—a yet undefined—portion of the IREP revenue to compensate for the abolition of the local tax on enterprises, arts, and professions (ICIAP).

It has not yet been decided if the regions will administer the new taxes.

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