Blog Post

Renzi’s risky budget strategy

Last week the Renzi government approved the 2016 budget law proposal. Although the detailed text is not available yet, the broad picture is clear.

By: Date: October 21, 2015 European Macroeconomics & Governance Tags & Topics

The Italian government intends to postpone the fiscal adjustment decided last year in accordance with European authorities, and to increase instead the budget deficit in 2016 by about 0,8 GDP points, from an estimated 1,4% to 2,2% (or even to 2,4%, depending on whether the Commission will grant some extra budget flexibility to cope with the refugee crisis). The extra fiscal space will be used to avoid an automatic tax rate increase in VAT and other excises for about 1% of GDP, to eliminate the property tax on the main house of residence of taxpayers (about 4 billion euro), and to offer a tax incentive to private companies to promote investments.

Apart from the increased deficit, the funding comes from a limited spending cut of about 5,8 billion, half of what was planned in the official budget documents just few months ago; from the one-off tax revenues of the “voluntary disclosure” on capital illegally transferred abroad; and by the expected extra revenues generated by increased economic activity, with real GDP assumed to grow by 1,6% in 2016. The fiscal adjustment is postponed to 2017 and 2018, when, according to the Government, a very optimistic rate of GDP growth and the consequent booming tax revenues will allow Italy to respect European rules and reduce the public debt over GDP ratio according to the 1/20 rule.

According to the prime minister, this is a budget law aimed at improving and consolidating the trust of citizens in the country’s ability to recover after the long recession. It has therefore to be more expansive even with respect to what was foreseen just few months ago (although public deficit should still fall in 2016 with respect to 2015, thanks to the improved economic conditions).

How can one explain this abrupt turn in policy orientation? Partly, it has to do with the electoral cycle. With the definite approval of the Constitutional reform this month (assuming, as is likely, that it will be confirmed by national referendum next year) and of the electoral rule reform in May 2015, all pieces of the institutional puzzle that the Prime minister has carefully tried to solve since coming to power finally are coming into place.

Matteo Renzi might now attempt to call for national elections next year or at the beginning of 2017 (the legislature will end in 2018), thus finally producing a Parliament more in line with the premier’s wishes and more willing to support his government’s policies. It should be recalled in fact that the present Prime Minister replaced Enrico Letta as a result of his successful campaign for leadership inside the Democratic Party, but the Party’s elected MPs – the cornerstone of Renzi’s majority in Parliament– largely reflect the former leadership and are only partly loyal to the new leader. Good economic performance in 2016 is just what the Italian prime minister may need to be successful at the next elections.

Electoral considerations also explain some of Renzi’s otherwise puzzling choices, like the abolition of the property tax on the house of main residence of taxpayers. This is a decision taken by the premier alone, against the advice of all his economic consultants and the wishes of most of his party members, let alone the European Commission. The explanation is political.

The elimination of the housing property tax has been a political symbol of the centre-right for a long time, successfully used by Silvio Berlusconi on several occasions to dampen the victory of his opponents, including during the last national elections in February 2013. At a relatively cheap cost (only about 4 billion euro), Matteo Renzi has eliminated one of the most powerful electoral arguments available to his opponents. Electoral considerations probably also explain some of his most recent statements, which have been unusually harsh towards the European Commission (“if they reject our budget law, we will send it back as it is”). Statements like these, appealing to national pride, attract those who vote for his most dangerous opponents in the electoral context, like Beppe Grillo’s Five Star Movement or Matteo Salvini’s Lega North, who are typically anti-Europe and anti-Euro.

But this is only part of the story, albeit an important one. This budget law also represents a deliberate strategy to attempt to modify the European budget rules by pretending to formally respecting them. As the policy option of proposing an explicit reform of the European Fiscal Compact is not available due the opposition of Germany and other northern European countries, Renzi seems convinced that he can reform the rules by bending them, forcing everybody, including the EU Commission, to interpret them so loosely as to eliminate most of their bite, except for a general adherence to the 3% deficit budget rule. He seems also to count on political neutrality from the German chancellor, now weakened by the refugee problem and more in need of finding alliances with Southern European countries.

It is a very risky strategy. First, it might simply not work. Rules circumvented today might have to be respected even more strongly in the future. In that case, Italy might find itself devoid of useful fiscal space if, especially if, any of the current exceptionally positive circumstances (low interest rates, falling exchange rate, low prices for oil and other raw materials, sustained international growth etc.) were to be reversed.

Second, it is a strategy that risks creating political difficulties for the European Central Bank. The ECB needs to show that countries in the periphery are delivering to maintain the expansive monetary policy that is essential to keep the interest rates on Italian public debt at the present low level.

Finally, and for the same reasons, it might contrast with the Italian agenda on other important European matters. For instance, it might jeopardize attempts by the Italian government, to complete the banking union with a more explicit risk sharing provision on deposits, and introduce some form of European insurance mechanism on unemployment. More fundamentally, even if one is convinced that the Euro area would benefit from a more expansive fiscal policy, it is not Italy, with its public finance situation, that can play this role and certainly not alone.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read about event More on this topic

Upcoming Event

Jun
7
12:30

Internet taxation: challenges and policy recommendations

As the economy moves online, it becomes more difficult for national tax authorities to collect revenue. How great is the impact, and what should corporate taxation look like in the digital age?

Speakers: Francis Bloch, Dmitri Jegorov, Helena Kiurusalmi, J. Scott Marcus and Georgios Petropoulos Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Silvia Merler

Italy's Atlas bank bailout fund: the shareholder of last resort

Italy’s new bank fund Atlas might be what is needed in the short run, but in the longer term the fund will increase systemic risk. What ultimately matters is how this initiative will affect the quality of bank governance, a key issue for the future resilience of the system.

By: Silvia Merler Topic: Finance & Financial Regulation Date: April 22, 2016
Read article More on this topic

Blog Post

Pia Hüttl
Alvaro Leandro

The implications of the Panama Papers

What’s at stake: The Panama Papers leaked last week raised important questions about the role of tax havens. We explain the mechanics of tax evasion and review the most important lessons to take away from the leaks.

By: Pia Hüttl and Alvaro Leandro Topic: Finance & Financial Regulation Date: April 18, 2016
Read article More on this topic

Opinion

Grégory Claeys
Zsolt Darvas

How to reform EU fiscal rules

The current inefficient European fiscal framework should be replaced with a system based on rules that are more conducive to the two objectives of public debt sustainability and fiscal stabilisation.

By: Grégory Claeys and Zsolt Darvas Topic: European Macroeconomics & Governance Date: April 12, 2016
Read article More on this topic

Opinion

fratzscher-03
Reint_Gropp_m
p2-Kotz
jan-pieter-krahnen
odendahl-june14-1409577172
Beatrice Weder di Mauro
Guntram B. Wolff

Mere criticism of the ECB is no solution

What would happen if the ECB failed to respond to the excessively low inflation and the weak economy? And what economic policy would be suitable under the current circumstances, if not monetary policy?

By: Marcel Fratzscher, Reint Gropp, Hans-Helmut Kotz, Jan Krahnen, Christian Odendahl, Beatrice Weder di Mauro and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 10, 2016
Read article More on this topic More by this author

Blog Post

Zsolt Darvas

The structural budget balance limbo

A key indicator in the EU’s fiscal framework is the structural budget balance, but estimates of the indicator by the European Commission, IMF and OECD are revised a lot from one year to the next, sparking concerns among some EU finance ministers.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: April 7, 2016
Read article More on this topic

Opinion

Agnès Bénassy-Quéré
Guntram B. Wolff

ECB decisions put lack of fiscal union in the spotlight

Fiscal policy in the euro area is hardly supporting the recovery and the ECB. The EU needs a a proper fiscal union in order to stabilise the economy and inflation. We see four main avenues for achieving a viable fiscal framework.

By: Agnès Bénassy-Quéré and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: March 30, 2016
Read article Download PDF More on this topic

Policy Contribution

A proposal to revive the European Fiscal Framework

A proposal to revive the European Fiscal Framework

The current European fiscal framework is inefficient. It should be replaced with a system based on rules more suited to the two core objectives: public debt sustainability and fiscal stabilisation. The rules should be more transparent and easier to implement. These reforms would promote greater compliance.

By: Grégory Claeys, Zsolt Darvas and Alvaro Leandro Topic: European Macroeconomics & Governance Date: March 29, 2016
Read about event More on this topic

Past Event

Past Event

Stability of EMU and prospects for fiscal union

How can Europe make progress with EMU and move towards a Fiscal Union?

Speakers: Fernando Fernandez, Pia Hüttl, José Leandro, Javier Méndez Llera, Fernando Navarrete and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 9, 2016
Read article More on this topic More by this author

Blog Post

Nicolas Véron

Market turbulence highlights bumpy transition to Europe’s new bank policy regime

Concerns about Europe’s banks contributed to turmoil in global financial markets in February, but Europe’s new banking sector policy regime should gradually help reduce uncertainty.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: March 8, 2016
Read about event More on this topic

Past Event

Past Event

A fiscal framework for the EU

Doubts about the fiscal sustainability of various member states have led Europe to enact greater coordination and surveillance. But are these policies effective? And what fiscal framework can best support Europe back to growth?

Speakers: Zsolt Darvas, Svend E. Hougaard Jensen, Kathrin Muehlbronner, Lucio Pench, Focco Vijselaar and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 3, 2016
Read article Download PDF More on this topic

Policy Contribution

WhIch fiscal union for the euro area?

Which fiscal union for the euro area?

At the current level of political and societal integration, a large federal budget is unrealistic in the euro area. The authors make three recommendations that would lead national fiscal policies to be more stabilising with respect to the economic cycle, while achieving long-term sustainability. They also recommend a move towards a European unemployment insurance scheme targeted at ‘large’ shocks, and a minimum set of labour-market harmonisation criteria.

By: Agnès Bénassy-Quéré, Xavier Ragot and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: February 18, 2016
Load more posts