Italy: Renzi reveals 2015 budget, pledges to reduce deficit to avoid confrontation with European Commission
October 28, 2014
The tax-cutting budget for 2015 that the Cabinet of Prime Minister Matteo Renzi approved on 15 October could be rejected by the European Commission (EC) as the Commission believes that the government has not focused enough on improving the country’s weak public finances. In fact, a week after submitting the budget for revision, the EC requested clarifications regarding why the government has deviated from the budget targets agreed upon with the European Union (EU). Such a request is the first step toward the EC rejecting the budget. In an attempt to avoid a confrontation with the Commission, the government recently declared that it has set aside some buffer money in the budget to meet EC’s requests.
The proposed budget envisages a EUR 18 billion reduction in labor and personal income taxes. The biggest chunk in tax reductions will come from a EUR 5 billion cut in the business tax levied by the regions (IRAP). All companies, regardless of their size, are entitled to the benefit. The budget proposal also includes reductions in businesses’ social security obligations, a decision that is expected to cost the government EUR 2 billion a year. In addition, the proposed bill makes permanent the EUR 80 per month tax deduction for low-income workers, which was approved in May of this year.
The decision to markedly cut taxes reflects that the government is trying to counteract the disappointing performance of the Italian economy. Recent GDP data, which were revised in accordance with the new ESA 2010 methodology, show that the economy has not grown since Q3 2011. Against this backdrop, the government hopes that the new budget, combined with structural reforms, will kick-start Italy’s economy.
On the expenditure side, the government is proposing a EUR 15 billion reduction in expenditure in order to make up for the tax cuts. The spending cuts will be linear, as all levels of government will have to contribute with a 3.0% reduction in spending. The government will, however, increase expenditure in a number of areas—such as education and unemployment benefits—in an effort to give a boost to the labor market.
The government is left with a shortfall for next year even after the spending reductions and the extra revenue it hopes to garner by tackling tax evasion. As a result, the government increased the 2015 deficit target from 2.2% to 2.9%, which is just barely below the 3.0% of GDP threshold set by the EU deficit rules. For this year, the government is targeting a shortfall of 2.8% of GDP. Marco Valli, Chief Eurozone Economist at UniCredit Research, comments:
“The overall size of the measures is larger than generally expected and, in the government projections, will leave the 2015 deficit at just below the 3% mark [..].The [budget] goes in the direction of tackling some of Italy’s main structural problems—especially the excessive tax pressure where this is most distortionary—and puts money on the table to ensure the labor market reform can bring the desired changes in terms of shifts towards permanent employment and flex security. The main areas of uncertainty are the lack of concrete details on spending cuts […]—and the compliance with the [Stability and Growth Pact].”
Although Italy did not technically breach EU deficit rules, the government does plan to reduce the structural budget deficit—adjusted for the business cycle—more slowly than promised. Renzi announced that his administration will aim for a balanced budget in structural terms in 2017, two years later than the EC’s rules require. This, in turn, means that the government is also postponing reducing its high public debt.
Postponing balancing the budget could cause the EC to reject the budget as it sees the government deviating from the budget targets agreed with the EU. However, in an effort to avoid conflict with the Commission, Italy stated that it has set apart some buffer money in its budget, which will help the government reduce the structural deficit sooner than initially planned. The EC has until the end of this month to issue a more detailed analysis on Italy’s budget.
Author: Dirina Mançellari, Senior Economist