Since Matteo Renzi became Italy’s prime minister last month, there has been much curiosity over his economic plans. The hope was that the young leader of the leftwing Democratic party could inject some of his dynamism into Italy’s sputtering economy. While growth has finally returned, the outlook remains fragile. Unemployment is stuck near 13 per cent and industrial production is 25 per cent below its pre-crisis level. Two years of recession have badly hit the banks, which are struggling under a pile of bad loans.
On Wednesday the prime minister unveiled his recipe for Italy. It includes €10bn in tax cuts targeted at the least well off, as well as a 10 per cent reduction in regional business taxes. The exact details behind these measures still need to be approved by the government, let alone be passed by parliament. Yet the prime minister has committed to begin implementing them by the end of April. Backtracking on his plan would be a heavy blow to his credibility as a politician who gets things done.
Mr Renzi aims to fund some of his giveaways through a combination of spending cuts and higher taxes on capital income. This makes sense. Italy’s public administration is notoriously inefficient. There is much fat to be trimmed without affecting the quality of services. Taxes on investment income in Italy are generous by European standards. That the extra revenue levied on savings will be used to give some breathing space to businesses should help to boost growth.
This cash, however, will only fund a portion of the promises that Mr Renzi has made. He has earmarked €7bn of spending cuts, but as a senior civil servant has made clear this week, it will be hard to squeeze more than €3bn out of the system. True, thanks to the sharp reduction in interest rates, the Italian treasury may be able to fund its debt more cheaply than it had planned. This would free some resources. But, as the prime minister conceded on Wednesday, some of the funds needed will have to come through extra borrowing.
The idea that Italy wants to push above the deficit target forecast by the EU – 2.6 per cent of national income – will send shivers down the spine of policy makers in Brussels and Berlin. Italy should try to cut its €2tn public debt, not add to it. Yet were Mr Renzi’s measures able to jump-start the economy, the fiscal outlook would improve too. The central question is how he will spend the money that he intends to borrow.
Cutting income tax for low earners makes good political sense. As Mr Renzi shamelessly admitted, this should boost his Democratic party in the elections for the European parliament in May. But it will do little to solve Italy’s competitiveness crisis. Economists believe that about one-third of the extra income will be spent on imports. Some may be saved. It would have been better to concentrate the limited firepower to help businesses, cutting the taxes they pay more deeply. This would allow them to price their goods abroad more cheaply and hire more workers.
Mr Renzi has to find other ways to make Italy more competitive. One is to reform the labour market, which gives excessive protection to powerful insiders at the expense of the young. On Wednesday, alongside his fiscal plans, Mr Renzi announced changes to the rules governing apprenticeships and short-term contracts. These should make it easier for companies to hire. But the prime minister should go further, for example increasing the flexibility companies have to set their own wages rather than having to rely on countrywide agreements.
A strong drive to reform the labour market would make it easier for Italy’s EU allies to agree to extra borrowing. It would also show that Mr Renzi cares about fixing Italy’s economy as much as winning votes.
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