Fiscal federalism can be an important complement to structural reforms and budget consolidation. Empowering sub national governments, while at the same time making them accountable to local citizens in the uses of tax money, could improve the allocation of public resources and promote catch up of the lagging regions. Italy has launched itself in the federalist direction by decentralising spending, regulatory and tax powers in the late 1990s and reinforcing growing lower level responsibilities with a constitutional reform in 2001. The constitution has yet to be fully implemented, though the government has signaled its intention to do so. A stronger focus should now be put on the financing side, i.e. getting a better match between spending responsibilities and taxing powers so as to boost local autonomy and responsibility in line with the goals of federalist reforms. As the lower levels are fully in charge of health and long term care, they will face intense pressures due to population ageing, which is especially rapid in Italy, so that more tax bases should be devolved to them, especially as pension reform has reduced such pressures on central government. Redistributive mechanisms should be redesigned to improve fiscal effort, and Italy must decide in that context to what extent it can really afford to guarantee uniform national service levels--and conversely, how much regional differentiation of services it will tolerate in pursuit of higher efficiency. Framework conditions need to be strengthened, notably accounting standards which need to be upgraded and unified. Fiscal discipline under the Internal Stability Pact should be strengthened via better "ex ante" co-ordination and tougher sanctions "ex post." (A bibliography is included. Internal Stability Pact information is annexed. Contains 54 footnotes, 8 figures, 6 boxes and 8 tables.)