Tax Cuts Could See Renzi Clash with Commission

The commission would have to overlook Italy’s budget transgressions, once again, if it cuts €35 billion in taxes.

Italian prime minister Matteo Renzi answers a reporter's question in Berlin, Germany, July 1
Italian prime minister Matteo Renzi answers a reporter’s question in Berlin, Germany, July 1 (Palazzo Chigi)

Italian prime minister Matteo Renzi’s proposal for €35 billion worth of tax cuts over the next three years could see his country once again at odds with the European Commission over fiscal policy.

The Financial Times reports that Renzi, who took power last year after leading a coup against the former Democratic Party leader, Enrico Letta, wants to reduce taxes on first homes next year, corporate taxes in 2017 and income taxes in 2018.

Italy’s top corporate tax rate is now 27.5 percent against an average of 22.6 percent in the European Union. Its top income tax rate is 43 percent — which is lower than most.

Taxes altogether equal 44 percent of economic output while government spending is nearly 50 percent.

The 2015 Index of Economic Freedom, compiled annually by the Heritage Foundation, a right-wing American think tank, and The Wall Street Journal, puts Italy in the bottom tier of European countries when it comes to limited government.

But it also argues that bigger impediments to growth — which only returned this year after three years of recession and stagnation — are Italy’s rigid labor laws, unreliable contracts and slow court procedures.

The European Commission has long urged the country, which has the third largest economy in the eurozone after Germany and France, to tackle these very issues. It made no fuss earlier this year when Italy delayed bringing its deficit into structural balance until 2017 — although it could have fined the country — seeing that Renzi was pushing legislation to liberalize the labor market.

Reforms are long overdue. Unemployment hasn’t been below 10 percent in three years. Nearly one in two Italians under the age of 25 is out of work. Older Italians tend to have secure contracts that are almost impossible to break but many younger workers can only get temporary jobs that offer no employment rights and protection.

At €27 per hour, Italy’s labor costs are not far above the European average. But social contributions and other nonwage costs make up nearly 28 percent of the average salary, compared to 22 percent in Germany.

Italy is also among few countries where labor costs continued to rise during the European sovereign debt crisis and it costs more than the average annual income to start a business in the country.

Renzi has proposed making it easier for firms to dismiss workers, hoping that will encourage hiring. But his left-wing party is critical while the conservative opposition, which otherwise supports Renzi’s labor reforms and worked with him to overhaul the nation’s voting system, is still outraged that he pulled out of a pact with their leader, former prime minister Silvio Berlusconi, when parliament needed to elect a new president.

Although Renzi said in April that €10 billion worth of budget cuts would take effect next year, bringing cumulative savings for the 2014-2016 period to €28 billion, he also announced at the time that €1.8 billion had been found “left on the side” and would be used to finance new stimulus measures.

Yoram Gutgeld, one of the prime minister’s economic advisors, told the Financial Times that new tax cuts would be offset by “a very significant portion of spending cuts.” But he also admitted that they would require “a little more flexibility” from Brussels.

Last year we got a flexibility bonus and this year we will ask for a somewhat bigger bonus given that reforms are continuing and we are in much better shape in terms of credibility.

The European Commission might take a less generous view, especially as the planned tax cuts would come on top of €18 billion in tax relief Renzi has pushed through since last year while his labor reforms are stalled. He has also made little effort to streamline the judiciary.

The timing and substance of the latest tax cuts would be politically convenient for the Italian leader. His Democratic Party did poorly in regional elections last month. He needs the support of centrists, who gave his party a huge victory in last year’s European Parliament elections, to win the municipal elections that are due in 2016 as well as a possible referendum on constitutional reforms.