Italian budget: Making the most of the new European fiscal rules

The Italian cabinet is about to send its 2016 budget plan to the European Commission. The initial indications in economist's possession are broadly consistent with European fiscal rules, in part because the government might be granted a number of exemptions, allowing a temporary deviation from the regular path towards the objective of achieving a structurally balanced budget.

Based on plausible yet optimistic projections, the 2016 Italian budget is set to be expansionary, as it foresees a variety of tax cuts designed to maintain economic momentum at a time when the global economy is struggling. In this respect, two elements may not be to the satisfaction of the European Commission: i) the spending cuts intended to offset the massive tax reductions are vaguely defined, to say the least; ii) the tax cuts are concentrated on the property side of the economy, whereas most experts recommend lowering taxes on labour.

"Countries that have not yet reached their Medium-Term Budgetary Objective (MTO - in the case of Italy, a balanced budget position in cyclically adjusted terms), must aim to improve their structural balance by 0.5% of GDP per year", notes Societe Generale.

The government should not need to implement 0.5% of fiscal tightening, as it may be granted various exemptions. It is unlikely, however, to obtain all the flexibility it is asking for. In any case, the deviation from the objective should not be significant enough for the Commission to ask for corrective measures.

In the preventive arm of the SGP, countries that have not yet reached their MTO need to contain the increase in government spending (net of discretionary revenue measures) at a rate below medium-term potential growth.

"We believe that ,it is highly unlikely that the Commission will base its opinion only on the expenditure benchmark and growth in real public expenditure should be contained at between -0.2% (if no exemption were allowed at all) and 0.6% (maximum flexibility, excluding migrant clause) in 2016. The government expects to do way better than that (-1.6%). However, the lack of clarity on spending cuts in the budget plan could be an issue", says Societe Generale.

The government's projections are not entirely compliant with the rule (e.g. debt does not decrease sufficiently in the forecasts), but this is attributable to the various exemptions that the Commission is likely to allow, leading to less fiscal tightening than would otherwise be needed. Importantly, the intention to speed up the privatisation plan for 2016-18 (with a gain of 0.5% of GDP estimated over the period) will favour adherence to the rule.