Italian budget: How to squander the revenue surplus

Tito Boeri and Pietro Garibaldi

The Italian Senate voted last Friday the 2008 Budget Law and a package of fiscal measures effective already in the last quarter of 2007. For the first time since 1992, an Italian budget law worsen public finances with respect to the baseline scenario, at unchanged policies. The large revenue surplus materialized in 2006-7 has been squandered financing more public expenditure. It is a pure lesson of “tax push”.

The set of fiscal policy measures for 2007 and 2008 recently voted by the Italian Senate will worsen public finances – and not insignificantly – compared to where they would be without it. They involve an increase in the deficit – by half a point of GDP, as acknowledged by the Government (see the table below, reproduced from the website of the Government, www.palazzochigi.it). From the perspective of Eurozone commitments, Italian public finance would look better if the budget law were not to be approved by the lower Chamber by the end of the year. The deterioration of public finance with respect to the baseline scenario comes mainly from increased public expenditure, rather than tax reductions. Thus, it cannot be justified as the government “giving back” the increased tax revenues of 2006 and 2007 to Italians. The deficit reduction is postponed until 2009-2011, despite an anticipated economic slowdown and the proximity to a new electoral turnout. It is simply hard to believe that this adjustment will ever be made.

A wasted opportunity

Last year, analysing the 2007 budget law, we documented that the deficit reduction occurred only on the revenue side (http://www.lavoce.info/articoli/-categoria27/pagina2374.html). So, we said, it would have not lasted: sooner or later, as with traditional text book “tax-push” mechanisms, greater tax revenues would have induced new expenditures. Sadly the simple prophecy has come true. So 2007 will go down in history as the year of the great wasted opportunity.

The revenue surplus in 2007 exceeded 1 per cent of GDP. It was largely associated (€13 billion out of 16) with increased tax revenues. More than two thirds of this revenue surplus (€11billion) has been used to fund additional expenditures that were quickly introduced during the year, assuming that the increased revenues were structural. It was current public expenditure. Public investment actually went down.

This is like a textbook application of the “tax push” mechanism: whenever tax revenues increase, some way to spend these additional resources is always found. For this simple reason, any fiscal consolidation based on the revenue side cannot be long-lasting. There is just no alternative: debt reduction and the convergence to a non-negative fiscal balance requires public spending to be reduced. It is instead a racing train: it keeps going up by 2% in real terms every year, regardless of the government in office.

Pro growth?

The French Budget Law also postpone fiscal adjustment in a deliberate attempt to buy time to carry out structural reforms and boost the economy. Is it something similar happening in Italy? There are no further plans of structural reforms on the pipeline and Italy has a public debt to GDP ratio which is twice as large as the French one. It is therefore hard to believe that a Keynesian boost to growth via increased public expenditure may work in Italy.

The strong offering of measures supposedly meant to push growth in the Budget Law is represented by the reduction of enterprise taxation. But the revenues from these taxes is supposed to remain constant (in terms of GDP), notwithstanding a reduction of the corporate profit tax rate from 33 to 27.5% and of a value added tax (IRAP) to 3.9%. It is certainly important to broaden the tax base, but we should not expect from this a strong stimulus to the economy. There are no supply oriented tax reductions, such as social security reductions for low-wage earners or measures reconciling family and work, such as a long waited plan to expand public childcare and tax reductions for working mothers.

The Government recently issued a Green paper outlining potential public expenditure cuts. It is bound to remains a document with the colour of hope.

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3 Responses to "Italian budget: How to squander the revenue surplus"

  1. Guest   November 21, 2007 at 2:43 pm

    Any chance the Italian goverment will do what you suggest? Or is it too weak to follow such advice?

  2. Richard   October 20, 2008 at 11:18 am

    Hi,I read there were a lot of new taxes proposed on insurance.Is this right? Do you know where I can find any details?KrRichard

  3. Serge Lewithin   December 18, 2008 at 7:50 am

    Dear Dr. Boeri, Anyone with common sense must agree with your analysis that cost-reduction of macro and micro public spending needs a systemic improvement in efficiency. The question is “HOW?”. No Italian government has ever attempted to rationalize the public sector by introducing simple, efficient and transparent rules re independent, effective and rapid control. There are no all-inclusive answers but control could begin at the local-elected level before attempting to go after the macro picture. Its a bottom-up approach over which the elected is responsible to its local electorate that is empowered to accept or dismiss its administrators.