October 5, 1999

Fiscal Troubles Loom in Italy

By Angelo M. Petroni, professor of sociology at the University of Bologna and a columnist for Il Sole 24 Ore and for Il Tempo of Rome.

Italy's current government is the first in its history to be led by a man who was once a Communist, Massimo D'Alema, and is made up of an assortment of leftist parties. Yet last week, Mr. D'Alema's government announced a fiscal policy that seemed out-of-keeping with his left-wing pedigree: It included a reduction in government spending and a tax cut. Unfortunately, on closer look the government's economic program is no great departure from the profligate policies that weigh on the Italian economy.

The double cuts came in the 2000 budget, or Legge Finanziaria, which the government approved on Wednesday, but the full text of which was not revealed until Friday. The problem is that, in Italy, the budget is not the last word on the subject of state spending, but rather the first. While the government can propose, all budgetary measures have to be approved by the Parliament. During this process, a lot of unexpected items --usually expenses -- are added by parliamentarians. On the other hand, parliamentarians are generally opposed to reforming the welfare state; so unless reforms to, say, pensions or health care are proposed by the government (they were not this year), they will not appear in the final budget.

The parliamentary phase is so important that on the day the budget reached Parliament, Italy's top financial officer, state auditor Andrea Monorchio, suggested that the very institution of the Legge Finanziaria could be simply canceled. In most countries, the legislative branch does debate and amend the government budget. The difference with Italy is that all the substantial decisions are made by the Parliament and not by the government.

Even assuming the Italian Parliament approves the government's tax and spending plans, the bad news is they won't amount to any real relief for Italian taxpayers, or the debt-ridden Treasury.

in last year's budget, the government promised that taxes would be reduced by 0.3% of GDP (rather than promise a tax cut, the government slyly promised simply a reduction in tax revenue collected). But in fact, tax revenue increased by 1% of GDP, or by between 20 trillion to 25 trillion lire ($11 billion to $14 billion). This was largely due to an enlargement of the tax base. If no changes had been introduced in the 2000 budget, the tax revenue collected by the government would have been expected to rise by an additional 9.3 trillion lire. Even if the tax cuts announced by Mr. D'Alema last week go through, the effective tax reduction for the year 2000 will be a mere 1 trillion lire, or 0.04% of next year's expected GDP, a negligible amount indeed. This is due to the expansion of the tax base in last year's budget.

There's no certainty that even the modest tax cut announced will be implemented. For example, the government has decided that local authorities will have the power to raise new personal income and corporate taxes from next year. In other words, the tax burden is likely to be the same or greater after the government's "cuts."

The spending cuts also look dubious. Almost a third of the 15 trillion lire in cuts is to come from selling state-owned housing to tenants and to the general public. While in itself a good thing, there is widespread skepticism that such a large and complicated procedure will be completed in a single year by the notoriously inefficient Italian public administration, or that it will bring in the announced amount of money.

An additional 2.4 trillion lire in cuts should come from a re-negotiation of state loans. This looks very optimistic, especially when taking account of a likely interest-rate hike by the European Central Bank in the near future. The rest of the reduction in expenditures should come from a variety of measures, including a 1% reduction in government payrolls by 2001 from what they were in 1997. (In the past, pledges of this kind have been cancelled due to political and trade-union pressure, so it remains to be seen if the government will stick to its script this time.)

The real budget busters are the economic assumptions that are built into the document. The government, for example, has assumed that in the year 2000 the Italian economy will grow by 2.4%. This looks very optimistic indeed, especially when one considers that this year's economic growth is not expected to exceed 1.2%. If the economy doesn't grow at least the officially expected 2.4% next year, the government will then have to raise taxes or run afoul of the deficit limits imposed by the EU's Maastricht Treaty.

The much-lauded improvements in Italy's fiscal outlook in thelast few years -- declining deficits, for example -- are misleading. They were made possible by tax increases (in the corporate tax base and the corporate tax rate) and by reductions in debt-servicing costs after membership in the single currency brought Italy lower interest rates. There has been no structural reduction of public expenditures. Taxation, especially on labor and on capital, remains high and poses very serious problems to the competitiveness of Italian firms.

Foreign investment in Italy has decreased to an unprecedented low in comparison with the other European countries. Just a few numbers: Foreign direct investment in Italy in 1997 was $3.7 billion, decreasing a year later to $2.6 billion. In the U.K., by contrast, the numbers were $37 billion and $63.1 billion, while in France they were $23.2 billion and $28 billion.

Since the advent of the euro, Italy has been unable to rely on devaluation as an easy way out. Even the governor of the Bank of Italy, Antonio Fazio, a highly respected economist, has called on the government to open up the labor market, reduce taxes substantially and cut expenditures.

Unfortunately, Italian politics, dominated by left-wing parties and vested interests, seem determined to ignore such advice.

Indeed, despite the apparent change of tone in last week's announcement, the state is expanding in Italy. In health care, we are witnessing an expansion of the regulatory power of the state, which is trying to reduce the scope of private medicine.

Instead of being privatized, large state-owned conglomerates such as electrical company ENEL are expanding, buying television stations as well as telephone and water companies.

Trade unions can still veto serious labor-market reforms.

Desperately needed pension reform -- including the introduction of privately funded pensions -- are repeatedly put off.

In the near future, perhaps Italy's only chance of liberalizing lies with the different referenda promoted by organizations such as the Radical Party (which wants a ballot on opening the labor markets and reforming the welfare state). Contrary to the hopes of many Italians, having been admitted to the euro club has by itself not proved to be an effective way to solve the country's basic problems.