Rome on Collision Course with European Allies, Financial Markets

The government’s spending plan would see Italy’s debt and deficit rise rather than fall.

Saint Peter's Basilica Rome Italy
Saint Peter’s Basilica in Rome, Italy at night (Unsplash/Matthias Mullie)

I cheered too soon. A few weeks ago, I reported that Italy’s populists were coming to terms with reality. Now they have introduced a spending plan that puts them on a collision course with the European Commission and financial markets.

Reneging on the commitment of the last government, the coalition of the anti-establishment Five Star Movement and far-right League, formed four months ago, proposes to run a deficit equal to 2.4 percent of GDP in 2019.

That is still below the EU’s 3-percent ceiling, but it is a reversal of the fiscal consolidation path followed so far and it means Italy’s public debt, already one of the highest in the world at 130 percent of GDP, will rise rather than fall.

What’s in the budget

My optimism stemmed from reports that the parties had shelved plans for a universal basic income and a flat tax. Italy cannot pay for either, let alone both.

The 2019 budget doesn’t include either policy in full, but it does call for a “citizens’ income” for the poor (so it’s not universal) and it has tax cuts (but not a flat tax).

It also lowers the retirement age and raises spending on infrastructure and welfare.

The former seems especially ill-advised when Italy has relatively more pensioners than all but two of the EU’s 28 member states and spends relatively more than any other EU country except Greece on its retirement schemes. The think tank Bruegel has more on this.

What’s next?

The European Commission will review the budget proposal, like it reviews those of other governments, and publish a recommendation in the middle of October.

The commission usually takes a hard line, but it would be up to national governments to decide whether or not to take action.

That is unlikely, but not impossible. Italy has gotten away with violating the bloc’s fiscal rules in the past. The difference is that it now has a government that relishes the confrontation.

The question for EU leaders will be: what’s worse? Punishing Italy (in the form of a fine) could boost popular support for the Five Star Movement and League. But letting it get away with this could embolden other countries that want to spend more, like Greece, as well as Euroskeptic parties in France and Germany.

Much will depend on how the markets react. Shares of Italian banks are down today and interest rates on Italian debt are up. If this continues next week, the ruling parties may feel pressured into watering down their proposals.

I’m not holding my breath. Luigi Di Maio, the labor minister and Five Star Movement leader, has argued that it’s up to the markets to adjust to the government’s plan, not the other way around.