2018 Budgetary Policy Report

Updating of the short/medium-term economic forecasts. Assessment of the policy scenario of the DBP and the main measures of the budget package. Consistency between developments in the public finances and the European fiscal rules. Analysis of the effects of the main measures of the Budget Bill. The 2018 Budgetary Policy Report develops, extends and supplements with ad hoc analysis the testimony given at the hearings before the Budget Committees of the Chamber of Deputies and the Senate of 3 October and 7 November.

 

The Report is organised into three chapters: the first assesses the macroeconomic environment, recent economic developments and the outlook for the coming years; the second provides an overview of the budget package and its contents, the potential risks to achieving the public finance objectives and the consistency of the policy scenario with the EU fiscal rules concerning the structural balance, expenditure and the debt; and the third examines the most significant measures in the budget package.

 

The main economic indicators signal the continuation of the recovery at the international level and of the Italian economy. The Government confirms the forecast for real GDP growth of 1.5 per cent in 2017 and 2018. The update of the PBO forecast that takes account of recent domestic and international economic developments and the composition of the budget package set out in the Budget Bill and Decree Law 148/2017 strengthens the forecast for real GDP growth in 2018 (to 1.3-1.4 per cent, compared with the projection of 1.3 per cent formulated in September). For the two subsequent years, the PBO’s September forecasts are essentially unchanged (with GDP growth of 1.4 per cent and about 1 per cent in 2019 and 2020 respectively). The analysis of the macroeconomic scenario is completed with an assessment, conducted on the basis of the econometric model used by the PBO, of the impact of the budget measures on GDP growth. In the PBO’s projection, the package would add 0.2 per cent of growth compared with the trend scenario in both 2018 and 2019. In 2020, the contribution of the measures would be just under one-tenth of a point.

 

The public finance package for 2018-2020 (Decree Law 148/2017 and the 2018 Budget Bill) – which increases general government net borrowing compared with the trend on a current legislation basis by 0.6 points of GDP in 2018 and 2019 and 0.1 point in 2020 ‑ contain expansionary measures that decline in size over the planning horizon, going from 1.6 per cent of GDP in 2018 to 1.3 per cent in 2019, before dropping more sharply in 2020 (0.8 per cent). Net of the sterilisation of the safeguard clauses for VAT and excise taxes (worth €15.7 billion in a total budget package of €28 billion in 2018, of which 70 per cent financed with an increase in the deficit), the values decrease to 0.7-0.9 per cent of GDP. The resources to cover the measures are equal to 1 per cent of GDP in 2018 and 0.6 per cent in the two following years.

 

Comparing the public finance forecasts in the DBP with those published by the European Commission on 9 November, significant differences emerge. While actual net borrowing is very similar, the level of structural net borrowing estimated by the European Commission is much less favourable than that forecast in the DBP. If we shift our attention from levels to changes in the structural balance – which are less affected by the different estimates of the output gap adopted by the Government and the Commission – in 2018 the improvement expected by the European Commission is only one-tenth of a point of GDP, smaller than the three-tenths forecast by the Government. Examining the components, we find that – as the expected improvement in interest expenditure in 2018 is the same for both the Government and the Commission at two-tenths of a point – this difference is a consequence of the disparity in the forecasts for the structural primary balance, which is expected to improve in the DBP (by a tenth of a point) and deteriorate in the European Commission’s forecast (by a tenth of a point), The difference expected for 2019 is even greater: different forecasts for the cyclically adjusted primary balance prompt the Commission to project a deterioration of four-tenths of a point in the balance with respect to 2018, compared with a forecast for an improvement of four-tenths of a point in the DBP. This primarily reflects the Commission’s decision to exclude the VAT and excise tax increases provided for under the safeguard clauses from its assessments as similar current-legislation increases have repeatedly been cancelled in the recent past.

 

Assessed over a multi-year horizon, the public finance scenario incorporating the effects of the budget package features a number of elements that have also characterised the recent past. Essentially, in the first planning year, the impact of the safeguard clause is sterilised, avoiding an increase in tax rates, thanks in part to an increase in the deficit, as part of the dialogue with EU institutions concerning a more flexible interpretation of the Stability and Growth Pact rules. In the subsequent two years, a sharper reduction in the nominal deficit and the “substantial” achievement of structural balance – albeit more gradually than indicated in the EFD last April – still depend on the activation of significant safeguard clause resources: 0.7 per cent of GDP in 2019 and 1 per cent in 2020. Without the clauses, the policy deficit in 2019 would remain at virtually the same level forecast for 2018 (1.6 per cent del GDP) and in 2020 would decline by a few tenths of a point (1.2 per cent of GDP), in line with developments in the recent past. This is attributable to the fact that, net of the clause, the budget package contains revenue measures whose overall impact is temporary (declining from about €6.4 billion in 2018 to €1.7 billion and €1.6 billion in 2019 and 2020) combined with others that increase expenditure (about €1.6 billion in 2018, €6.9 billion in 2019 and €4.2 billion in 2020). Without considering the deactivated clauses, the budget measures presented in Parliament improve the deficit only in 2018, by 0.3 per cent of GDP, and worsen it in the two subsequent years, by 0.3 per cent and 0.1 per cent respectively.

 

The policy measures in the budget documents appear characterised by “short-termism”. In the medium term, the provisions remain characterised by uncertainty about the composition and scale of the measures that will actually be implemented, since fiscal policy is currently based on an increase in VAT whose deactivation in 2019 is less than that indicated in the Update, even if the DBP promises progress on alternative policies that are essential to avoid the activation of the rate increases (the spending review, measures to counter tax evasion and avoidance for 2019-2020). In the short term, for 2018, the postponement of the introduction of IRI (proportional taxation for sole proprietorships and partnerships) changes expectations about the characteristics and level of taxation of business. For the entire three-year policy horizon, and even for the current year, there is no information in which sectors the Government intends to conduct privatisations. These factors threaten to undermine the credibility of the public accounts, the predictability of the macroeconomic framework and, above all, engender uncertainty in expectations and, therefore, in the decisions and behaviour of economic agents.

 

The assessment of the fiscal rules reveals considerable problems for both 2017 and 2018. For 2017, the estimates presented in the DBP imply a risk of significant deviation both for the structural balance rule and the expenditure benchmark. These risks are also underscored by the recent opinion of the European Commission on the DBP. If these developments should be confirmed by outturn data, the budget balance correction procedures envisaged in national legislation on budget balance and, at the EU level, by the Stability and Growth Pact could be activated. For 2018, the structural adjustment envisaged by the Government in the DBP (0.3 percentage points) could be sufficient to ensure compliance with the fiscal rules considering that the Commission has acknowledged the need to avoid hindering the still uncertain recovery in Italy with an excessively restrictive fiscal stance. Nevertheless, that adjustment must be considered a minimum objective and, according to current Commission forecasts, there is a gap of 0.2 percentage points. Finally, the public debt rule is not complied with in 2017-2018 under any of the criteria provided for in the rules. For subsequent years, the sharper reduction in the debt/GDP ratio in the DBP is based on a highly uncertain current legislation scenario, partly due to the fact that VAT rate increases have been cancelled on multiple occasions in recent years. In its opinion on the DBP, the Commission asked the Government for clarifications on its strategy and the actual steps it intends to take to reduce the debt/GDP ratio and ensure compliance with the associated rule.

 

Excluding the usual measures for the total and partial sterilisation of the impact of the VAT and excise tax safeguard clauses in the first and second planning years, the budget is characterised by a number of measures of significant importance from a financial standpoint and the general design of economic policy and by a large number of small sectoral measures.

 

Relatively substantial resources are appropriated for public employees (totalling €2.1 billion in 2018 and €2.3 billion in 2019), with the renewal of contracts and the targeted hiring of personnel in specific segments of government. Other provisions include measures to support employment (mainly through contribution relief measures), help families and fight poverty, support businesses (including an extension of so-called hyper-and super-depreciation), and support public investment, which has been decreasing almost without interruption since 2010 (appropriations are planned to increase by €940 million in 2018, €1.94 billion in 2019 and €2.55 billion in 2020, with an impact on the general government accounts estimated at €170 million in 2018, €1.14 billion in 2019 and €1.37 billion in 2020).

 

The main contribution to funding these measures comes from the postponement of the introduction of the new tax on entrepreneurial income (IRI) to 2018 (€2 billion in 2018 and €0.75 billion in 2019) and measures to counter tax evasion and strengthen tax collection (from €1.7 billion in 2018 to €3.4 billion in 2020). With regard to the latter measures, they continue the trend towards the introduction of preventive measures that on the one hand facilitate the acquisition of information necessary for targeted controls by tax authorities and on the other encourage tax compliance and the resolution of disputes. In the case of the extension of the time limit and persons eligible for the facilitated settlement of tax arrears, a measure similar to a tax amnesty has been proposed, which by eliminating penalties and default interest rewards the less deserving taxpayers and weakens voluntary compliance.

 

The most important measures include permanent contribution relief for hiring young people, meeting the dual need to encourage the employment of a population segment with the highest rates of unemployment and greater career uncertainty and, at the same time, gradually phase out the two temporary contribution relief mechanisms adopted in 2015 and 2016, which will terminate in 2018 and had achieved significant results for young people as well.

 

This measure has the virtue of being permanent, which on the one hand interrupts the series of temporary measures and fosters the normalisation of the labour market and, on the other, plays a role in the gradual reduction in the tax wedge on labour. The mechanism also ensures more accurate targeting of both workers (young people and students) and employers (firms that have not cut their workforces either before or after obtaining the benefit).

 

With regard to the Inclusion Income, the Budget Bill gradually expands the pool of potential beneficiaries and increases the maximum amount of the benefit. The elimination of the category-based eligibility requirements makes the measures a universal programme, even if means testing remains and beneficiaries must participate in a customised job search and social inclusion programme. Additional limitations are the temporary nature of the scheme even if the beneficiary remains in a state of need and the fact that the benefit is restricted by the resources appropriated for the programme (€1.7 billion in 2018 and about €2.2 billion as from 2019).

 

The impact of the new Inclusion Income seems significant in relation to the scale of absolute poverty in Italy, although it is still insufficient to eliminate the problem. Beneficiary households account for about 44 per cent of households in a state of absolute poverty and the households whose poverty is most alleviated by the programme include those resident in Southern Italy and the Centre, those that do not own their home, and those whose household head is an Italian citizen, unemployed and aged up to 40 years old.

 

Assuming that the Inclusion Income targets only households in a state of absolute poverty, the poverty gap (average difference between the income of the poor and the benchmark threshold) would narrow from 20.7 to 11.2 per cent, but the measure would not have an impact on the poverty head count ratio (the number of the poor as a proportion of the total population), as the benchmark income of the Inclusion Income programme, which is equal to the resources a household would have after having received the benefit, generally appears lower than Istat’s absolute poverty line. In terms of the impact on overall inequality in the distribution of disposable income, the introduction of the Inclusion Income would reduce the Gini coefficient by 0.4 points.

 

Finally, one of the most significant measures to combat tax evasion is the introduction of mandatory electronic invoicing, an important step in the digitisation of systems for taxpayer compliance and tax authority controls. It represents an additional improvement in the tools available to reduce tax evasion without collusion (i.e. where there is no agreement to evade between buyer and seller) in business-to-business transactions.

 

However, the risk remains that this measure could encourage VAT number holders to seek out opportunities for collusive tax evasion more aggressively and expand evasion in business-to-consumer transactions. Exposing costs through mandatory electronic invoicing could be accompanied by a loss of revenue that, however, could be countered with appropriate controls of firms’ margins. With regard to the final stage of the chain of commercial transactions, it would appear essential to extend the requirement for electronic invoicing and the notification of revenue to include taxpayers that are not required to issue invoices (retailers, restaurants etc.). Combining electronic invoicing with more stringent limits on the use of cash than are currently in place could make a significant contribution to combatting collusive tax evasion.