Direct democracy and local public finances under cooperative federalism

This paper exploits the introduction of the right of referenda at the local level in the German state of Bavaria in 1995 to study the fiscal effects of direct democracy. In the first part of the paper, we establish the relationship between referenda activity and fiscal performance by using a new dataset containing information on all 2500 voter initiatives between 1995 to 2011. This selection on observables approach, however, suffers from obvious endogeneity problems in this application. The main part of the paper exploits population dependent discontinuities in the signature and quorum requirements of referenda to implement a regression discontinuity design (RDD). To safeguard against co-treatments that might affect fiscal outcomes simultaneously at the same thresholds, we validate our results by extending the RDD approach to a difference-in-discontinuity (DiD) design. By studying direct legislation in an archetypical cooperative federation as Germany, our paper extends the literature to a novel institutional setting. The results indicate that in our setting - and in contrast to most of the evidence from Switzerland and the US - direct democracy causes an expansion of local government budgets.