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The following OECD assessment and recommendations summarise Chapter 3 of the Economic survey of Italy published on 4 June 2007.
How should fiscal policy consolidate?
Buoyant tax revenue helped the budget last year, in combination with greater spending restraint. The general government deficit reached 4.5% of GDP, but adjusted for deficit-increasing special transactions (VAT refund ordered by the European Court and high speed railways debt forgiveness), it was only 2.5% of GDP on a national accounts basis (4.4 and 2.4%, respectively, on Maastricht definition), while subtracting all one-off measures it was 3¼ per cent, in any case better than expected. The strong outcome during the past year reflects to some extent the cyclical upswing and its effect on tax collection, as well as stricter control on current expenditure. In addition, the regular automatic stabilizers were magnified by special factors such as the high VAT receipts on energy products (which are difficult to evade), higher business profits and the exhaustion of earlier years’ loss carryover provisions. As well, measures in the 2006 Budget to improve compliance gave better than expected results in a context of growth optimism, notably with respect to revaluation of firms’ assets. A residual in the buoyancy of revenue is yet to be explained. There are indications that the government’s tough stance against tax fraud and the welcome decision to bring tax amnesties to an end may well have generated greater compliance across the board, and to that extent the benefits would be permanent rather than transitory. Revenue inflows have remained strong in the first months of 2007, confirming that the revenue buoyancy appears to be continuing. Nevertheless, there is some degree of uncertainty which the budget takes into account, as to how much of this buoyancy will be repeated in the year as a whole.
Based on the approved budget, things are looking up for fiscal performance in 2007. Preliminary indications for the first few months suggest that some of last year’s tax buoyancy might carry forward to this year. The budget will also be helped by new measures to raise revenues. This includes a mix of higher tax rates, further steps in the fight against evasion and the transfers of part of the flow of worker severance pay contributions (trattamento di fine rapporto or TFR) to the government. The overall rise in tax pressure is being held down by cuts in the company value added tax (IRAP) amounting to 3 percentage points of the overall tax wedge for the average worker, more generous for poorer regions, but targeted to companies hiring workers on permanent contracts. The TFR transfers are earmarked to specific projects, mainly infrastructure, set out in the 2007 budget, while at the same time representing general government revenue. However, their positive budgetary impact is expected to fade away over the next 8-9 years, when additional revenues and expenditure obligations attached to TFR liabilities will balance out. At the occasion of its periodic review of budgetary prospects, in March, the government reduced its budget deficit projections from 2.8% to 2.3% of GDP, reflecting the strong outturn of the past year and upward revisions in the growth projection. The authorities should seek to build on last year’s fine outcome and make further consolidation in 2007, so as to preserve hard-won gains and make further steps towards achieving fiscal sustainability. This will not be easy, as there is already political pressure for a boost to spending, or early tax reductions. The parliamentary commitment to enact tax cuts for the amount of extra revenues coming from the fight against tax evasion, is a source of concern. Such policy changes would be premature and would make the medium-term budgetary prospects more difficult, in particular if the revenue windfall gains turned out to be temporary. Insofar as revenues continue to over-perform in the present budget, this should be entirely used to reduce the deficit further rather than for ratcheting up public spending or cutting taxes, in view of the still high level of public indebtedness.
Beyond these short-term prospects, the government aims at increasing the primary surplus to 5% of GDP by 2011, its level upon EMU entry, which would accelerate the projected downward trend in the debt ratio. This is a welcome objective because Italy’s public debt ratio of 106.8% of GDP – the second highest in the OECD – most likely impedes growth. The budget has performed more strongly than expected since this medium-term objective was adopted. Therefore, it should be possible to reach the 5% target ahead of time. Responding to recent calls for increased spending in social protection, day care, education, research, and infrastructure – areas that suffered from past budget stringency – would make this objective more difficult to undertake. The ratio of primary spending to GDP has risen inexorably since EMU entry and is now at a post war high, illustrating the importance of strengthening the fiscal stance. It is therefore important that the fiscal consolidation hinges on expenditure discipline, notably in pensions, public employment, health and local spending as stated in the DPEF, in view of high tax pressure and low potential growth. The initiative of the Italian authorities to carry out a “spending review” and to reform the budgetary process, in order to improve efficiency and effectiveness of non-entitlement public spending, is welcome. Within this process, the government should consider introducing medium term expenditure caps to constrain the growth of primary spending – for example, a ceiling consistent with zero real increase in central government primary spending until the primary surplus reaches 5% of GDP. Future tax cuts should be strictly matched by lower spending over and above that which is needed for deficit reduction.
Is the pension system sustainable?
In this context, it will be particularly important to enact already legislated pension reforms, namely: i) the step increase (scalone) in the minimum age to receive seniority pension benefits, from 57 currently to 60 (61 for the self-employed) in 2008 and rising further to 62 (63 for the self-employed) starting from 2014; and ii) the 10-yearly adjustment in the actuarial transformation coefficient to account for rising life expectancy, the first one having been due in 2005 but not yet enacted. However, these are being called into question by the trade unions and are currently the subject of discussions with the government. The authorities have estimated that failure to enact the reforms would boost pension spending by almost 2% of GDP over the long term, which would further raise the required fiscal effort. Both reforms are essential to achieve budget control in the medium term and fiscal sustainability in the long term. By encouraging (even mandating) longer working lives, they also underpin adequate retirement income in the actuarially fair system. Hence, the adjustment to life expectancy should be made automatic and more frequent. The development of a fully-funded private pension pillar will likewise be important to the success of reform, so as to create a new source of pension income. Moving in this direction will send an adequate signal to younger workers that it is important to start saving for their retirement. The government’s decision to allow allocation of deferred compensation (TFR) funds to private pension schemes, on a voluntary basis, is promising because it will encourage the development of private pension funds, although that part of TFR that workers decide to keep with firms will potentially hold down the amount available for private pension funds.
An important step towards public administrative reform has been the signing of a memorandum by the trade unions on labour contracts for the government workforce. The unions have accepted to consider the introduction of important changes, including performance-based remuneration, merit-based career advance and the reduction of the workforce by attrition. In exchange, they have obtained a reduced usage of fixed term contracts and the conversion of some existing fixed term contracts into more secure, permanent contracts, but also a significant say on how some of these reforms are to be implemented in practice. There is also a political commitment for additional financial resources for national public employment working contracts. The authorities are hopeful that this memorandum will enhance flexibility in the public administration, and improve the quality of public services as well as promoting cuts in the wage bill. It is important that the memorandum be implemented without delay, making use of international best management practices, so as to facilitate control of the budget’s single biggest spending item and to improve the quality of government.
Two tales of fiscal consolidation, Italy(1) and Belgium
As a percentage of GDP
1. Italy’s net lending position unadjusted for special operations in 2006.
2. Primary balance required for an annual debt reduction comprised between 2% and 4%.
Source: OECD (2007), preliminary Economic Outlook No. 81 projections.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of Italy 2007 is available from:
For further information please contact the Italy Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by Alexandra Bibbee and Benoît Bellone under the supervision of Patrick Lenain.