Innovation in financial governance reforms: for better or for worse?

This paper focuses on a specific case of innovation in financial governance in Italy that aimed to minimize the effects of financial constraints on local government, while managing deficit control goals at the central level. It consisted in a system of agreements between levels of government based on exchanges of fiscal deficit permits. While this system keeps the aggregate government-wide deficit unchanged, it allows individual local governments to deviate from their initial fiscal targets by obtaining deficit permits from governments that have a surplus. The paper critically analyzes this innovation from three perspectives: the governance model inherent to this mechanism, the new financial management practices emerging locally, and the effectiveness of the mechanism with regard to declared goals and objectives. Our findings show that a critical element limiting innovation in fiscal governance seems to be the simplistic observation that the overall budgetary position of the country’s government results from the algebraic sum of all individual government bodies’ financial results. At the core of this understanding are collateral effects that occur when local priorities are distorted by the need to achieve top-down fiscal targets set by the central government, as exemplified by the unexpected investment crunch in Italy.