Italy’s Budget Standoff with the European Commission Explained

The commission can’t force Italy to change its spending plan, but its objections do matter.

Italian prime minister Giuseppe Conte and Five Star Movement leader Luigi Di Maio listen as Finance Minister Giovanni Tria answers a question from a reporter in Rome, October 3
Italian prime minister Giuseppe Conte and Five Star Movement leader Luigi Di Maio listen as Finance Minister Giovanni Tria answers a question from a reporter in Rome, October 3 (Governo Italiano)

The European Commission has told Italy to revise its budget for 2019, accusing it of “openly and consciously” reneging on the commitments it has made.

This has been reported as the commission “rejecting” Italy’s budget proposal, but that is too strong a term. It has no such power.

Here is what’s really going on — and what is likely to happen next.

What are the rules?

By treaty, all the nineteen countries that use the euro are forbidden from running a deficit higher than 3 percent of their GPDs and from having a debt higher than 60 percent.

Most countries have broken one or both rules at some point. Italy has been in violation of the debt rule from the start of the currency union.

During the euro crisis, the bloc tightened the rules. The commission now reviews national budgets at the end of each year and can ask governments to rewrite their plans if it looks like they might threaten the stability of the single currency as a whole.

That is the point where we are at right now. It is only the first time the commission has told any government to rewrite its budget.

What’s wrong with Italy’s budget?

Italy has for years been allowed respite from the rules on the condition that it would gradually reduce its deficit and debt.

Now the ruling parties in Rome — the anti-establishment Five Star Movement and the far-right League, who came to power five months ago — are proposing to increase the deficit, to 2.4 percent of GDP next year.

That is still below the EU’s 3-percent ceiling, but it is three times higher than what Italy committed to last year, under a center-left government, and it would mean that Italy’s debt, now at 130 percent of GDP, would rise rather than fall.

The commission argues that higher debt would lead to higher interest rates, which would make it more difficult for Italians to buy homes and finance their businesses.

Why the extra spending?

The Five Star Movement wants to introduce a “citizens’ income” for the poor. It calls this a universal basic income, but it really isn’t.

The League wants tax cuts.

Both parties want to lower the retirement age and raise spending on infrastructure and welfare.

For context, know that Italy has relatively more pensioners than all but two of the EU’s 28 member states and spends relatively more than any other European country except Greece on its retirement schemes.

What will happen next?

Lucas Guttenberg, the deputy director of the Jacques Delors Institute in Berlin, explains:

  • If Italy does not change its spending plan — as seems likely — the commission will report this to the Eurogroup, the conclave of eurozone finance minister.
  • The commission has little leverage of its own to force Italy, or any country, to change its budget. But it can signal its objections to other political actors, the public — and the markets.
  • If the commission wanted to, it could open a so-called excessive deficit procedure based on Italy’s already-high debt. But that would be politically controversial and even an excessive deficit procedure does not automatically trigger sanctions.
  • Sanctions can only be applied based on outcomes, not plans, which means that the earliest Italy could face a fine of up to .2 percent of its GDP would be the spring of 2019. With European elections due in May of that year, Guttenberg expects that a decision won’t be taken until June — assuming Italy’s current government lasts that long.

So does any of this matter?

“It does for markets and it does for the credibility of the rules,” argues Guttenberg.

The hope in Brussels is that when investors start demanding higher interest rates on Italian debt, it will force the politicians in Rome to bend to their will — just as it did at the height of the euro crisis in 2011, when fear that Italy would fall next drove Silvio Berlusconi from office.

I wouldn’t bet on history repeating itself. Matteo Salvini, the interior minister and leader of the League, is ever defiant, saying, “We won’t subtract one single euro from the budget.” Luigi Di Maio, the labor minister and Five Star leader, has argued that it’s up to the markets to adjust to the government’s plan, not the other way around.