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Italian Financial Stability Budget Threatens Tax Reforms

by Ulrika Lomas,, Brussels

19 July 2011

Having passed through parliament in record time, Italy’s latest budgetary measures, which are aimed at eliminating the country’s fiscal deficit by 2014, were gazetted on July 16, and entered into force a day later.

Before the recent extension of the Eurozone crisis to involve Italy, the government promulgated its new ‘financial stability’ budget to reach the deficit target it had agreed with the European Union - of reducing it from the 3.9% of gross domestic product (GDP) expected for this year, to 0.2% in 2014.

While the most substantial measures within the deficit reduction have still been pushed forward into 2013 and, in some cases 2014 - beyond elections which could be held next year - the budget has changed markedly over the two-week period since the original decree was approved by the government on June 30. In particular, the total value of the programmed cuts has now reached EUR80bn (USD113bn) over the four fiscal years to 2014, up from the EUR47bn announced at the end of June.

The original programme had foreseen deficit cuts of EUR1.8bn and EUR5.5bn in 2011 and 2012, followed by some EUR20bn per year in 2013 and 2014. By the time the decree had been finally approved, while the reductions for 2011, 2012 and 2013 had increased to EUR2.1bn, EUR5.6bn and EUR24.4bn respectively, the swingeing cuts planned for 2014 had reached EUR47.9bn (or around 2.7% of GDP) in that year alone.

It has been felt prudent to include explicitly, in the budgetary calculations, the large amount of funds that should be found out of future reforms to Italy’s social security and welfare system, the framework for which had already been released at the same time as the budgetary decree, but the approval of which is unlikely to be received until, at the earliest, next year.

At the same time, although measures in the decree curtail the annual rise in higher pension rates and make a further attack on central and local government spending, it has also been necessary to provide a fall-back provision in case the social welfare reforms are not in being by 2013, or if sufficient funds are not released from them.

A clause has therefore been added to the decree that, if the social security and welfare reforms have not been approved by the end of September 2013, the resultant gap in the budget would be covered by percentage cuts to all of the 483 various tax deductions, allowances, special regimes and reduced rates in Italy’s current tax system.

The cuts would be of 5% in 2013 and 20% in 2014, and the consequent amounts available to reduce the deficit would be EUR4bn in 2013 and EUR20bn in 2014. While the government will decide eventually how the reductions will be applied, a whole range of benefits, including those to families, would be affected.

It has now, however, been pointed out that, if additional revenue does have to be found from cutting tax allowances and deductions to finance future deficit reduction, not only would the already-high Italian direct tax burdens then be further increased, but it would also decrease the likelihood that resources could be released from a simplification of the Italian tax code in future tax reforms for any reduction of tax burdens in the near future.

Before Italy’s involvement in the latest blow-up of the Eurozone financial crisis, the government had been receiving rising demands from all sectors of the economy for reduced tax burdens, and had itself issued a tax reform framework, in order to provide for increased economic growth. While the crisis may abate, the need to have mortgaged part of the means by which reduced tax rates could have been provided may well restrict the scope for action by a future government.

TAGS: tax | economics | tax incentives | fiscal policy | budget | legislation | social security | Italy | tax reform

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