Taxes rank alongside communists and magistrates in Silvio Berlusconis list of pet hates. The prime minister once famously said that he understood people who sidestepped taxes that were too high. And, putting his policy where his mouth is, he granted amnesties to those with cash stashed abroad to keep it from the ministero delle finanze, the Italian inland revenue. He also made cutting income tax a central plank of his Contract with the Italian People, which helped him get elected in 2001.
As a businessman-turned-politician, Berlusconi views excessive taxes as an infringement on the freedom to spend your money as you please. Forza Italia rejects the idea of a state which is arrogant, invasive, a bottomless pit which swallows everything Italians earn every year with their hard work, he told a meeting of his political party recently,
So, as Berlusconis Mediaset television channels have told us with much fanfare, people are now starting to feel the benefits of a e6 billion tax-cut package passed in the last budget. The government has reduced Italys five tax rates to three: 23 per cent, 33 per cent and 39 per cent. The top band came down from 45 per cent, although those earning more than e100,000 per annum are subject to a temporary additional four per cent solidarity tax.
As tax cuts go, it isnt exactly a bumper deal. The package is worth around e35 a month for the average family. Whats more, government critics have suggested that the true benefits are less than this small amount suggests. This is because the cuts have been financed in part by hikes in some indirect levies (such as cigarette duties), locally-imposed charges and property taxes. The state is giving with one hand, they say, but taking away with the other.
The cuts are not much, Berlusconi admits, but its what weve managed to do. In fact, the prime minister had a torrid time getting these timid reductions approved. With slow growth pushing the public deficit up to the maximum of three per cent of gross domestic product (GDP) allowed by the European stability pact*, the opposition and parts of the governing coalition claimed the money was not there for a tax giveaway. In the end the prime minister had to threaten to call early elections to persuade his coalition partners to accept the cuts.
Some economists, meanwhile, argue it would have been better to give the tax reductions to businesses rather than individuals. Part of the rationale for the cuts was that they will put more money in peoples pockets to boost flagging consumer spending and growth. But with consumer confidence at a low, experts say people will save a large slice of the cuts rather than injecting the cash back into the economy via spending. Furthermore, part of what they do spend will go on imports, thus helping foreign producers not Italian ones. In this situation, it might have been better, for example, to lower labour taxes in order to encourage home-grown companies to hire staff.
Nevertheless, Berlusconi aims to forge ahead. Having successfully pushed for a loosening of the stability pact at the European Union the three per cent budget deficit ceiling can now be breached in special circumstances, but countries must come back below it within five years and with general elections coming next year, the prime minister is promising more tax reform.
In March he said he intended to introduce a e12 billion tax cut, worth one per cent of GDP, in the 2006 budget. The aim is to bring the top rate down to 33 per cent, so that Italy has just two tax bands, 23 per cent and 33 per cent.
In many ways this is a sensible objective. A simpler tax system is easier and cheaper to administer and, at the same time, more difficult for evaders to wriggle out of. Its also true that lowering taxes by a certain per cent does not necessarily mean tax revenues will fall by the same degree. This is because lower taxes increase incentives for people to work harder to earn more money as a smaller part of the extra cash goes to the state and, therefore, they may actually pay more tax in total, albeit at a lower rate. Big cuts also decrease the incentive to dodge levies and should boost growth too, which in turn would generate extra tax yields.
However, these positive effects will only cover part of the bill, so Berlusconi still has to find a way to pay for the rest. He now has a little extra room for manoeuvre with greater budget deficit flexibility, although it would be unwise to finance the tax cuts entirely via a public borrowing bonanza. In which case hell have to slash spending to keep his promise, which is not an easy thing to do for a politician whos about to come up for re-election. It will be interesting to see what he comes up with.
* The stability pact is the set of rules that underpins the single European currency. According to the pact, budget deficits should not exceed three per cent of GDP, although this condition was recently relaxed to enable governments to borrow more in times of hardship. According to the national statistics institute ISTAT, the Italian economy grew one per cent in 2004, which means its virtually standing still. This is a problem for the state accounts, as government spending tends to increase in times of hardship, while revenue from taxes diminishes because of lower levels of economic activity. The European union statistics' agency Eurostat has refused to certify Italy's claim that the 2004 budget deficit is three per cent of GDP and says that it will soon be releasing its revised, and much higher figures.