The Chairman of the Parliamentary Budget Office (PBO), Giuseppe Pisauro, testified (in Italian) today before the Budget Committees of the Chamber of Deputies and the Senate as part of the preliminary examination of the budget measures for 2020-22.
In his remarks, Chairman Pisauro analysed the contents of the budget measures – Law Decree 124/2019 and the Budget Bill – discussing the PBO’s assessment of their overall structure, of developments in the main public finance aggregates and of the main measures proposed and their effects, emphasising their strong points and critical issues.
Very briefly, the key points addressed during the hearing were the following.
Growth remains weak. ‒ Economic indicators have improved marginally since the publication of the Update of the Economic and Financial Document, although economic conditions remain weak. As anticipated by the PBO in its Report on Recent Economic Developments in October, in the third quarter of the year, GDP grew by 0.1 per cent on the previous quarter. The forecast, based on the short-term models of the PBO, points to a slight increase in GDP in the final part of the year. Overall in 2019, output is projected to expand by 0.2 per cent, marginally greater than expectations in the 2019 Update.
The PBO has conducted an analysis of the effects of the budget measures on economic activity over the next three years. According to the simulations, the budget would have an expansionary effect on real GDP over the entire 2020-22 period of 0.3 percentage points, slightly less than the 0.4 points estimated by the Ministry for the Economy and Finance (MEF) in the Draft Budgetary Plan (DBP).
Key figures of the budget package and the encumbrance of the safeguard clauses. – After a deficit in 2020 at the level of the last two years (2.2 per cent of GDP), the budget package allows the policy deficit to decline starting from 2021. However, the improvement forecast for 2021 and 2022 is solely attributable to the presence of a still significant proportion of the safeguard clauses providing for indirect tax increases. Only one-third and one-tenth of the latter’s impact is eliminated, and the remaining tax increases are expected to raise €19 billion in 2021 and €25.8 billion in 2022 (1.0 and 1.3 percentage points of GDP), with no policy indication about future developments being provided in either the Update or the DBP. Without the contribution of the clauses, the deficit – in purely mechanical terms – would be equal to 2.8 per cent of GDP in 2021 and 2.7 per cent in 2022. Furthermore, again in purely mechanical fashion, the clauses would account for more than half of the policy reduction in the debt/GDP ratio in the years 2021-22.
A second problematic aspect of the budget measures regards the highly divergent trends expected in overall expenditure and revenues. Net of the impact of the safeguard clauses, the increase in net revenues – equal to €7.5 billion in 2020 – gradually declines (to €5.3 billion and €3.9 billion in 2021 and 2022). By contrast, the increase in net spending, which is much smaller in the first year (€0.7 billion), instead expands significantly, reaching €8.5 billion in 2021 and €11.3 billion in 2022, with a preponderance of current expenditure. The budget envisages a net decrease in spending on capital account in 2020, and increases of €2 billion and €4 billion in the following two years, as the increases provided for in Section I of the Budget Bill are limited by the reduction of other budget appropriations in Section II.
Fewer uncertainties but risks remain. – Compared with the assumptions in the Update, the budget package removes a number of sources of uncertainty. In particular, the expected contribution of measures to combat tax evasion has now been quantified at a more prudent and realistic level, having been reduced from the original €7 billion planned for 2020.
Nevertheless, the public finances remain exposed to risks and uncertainties connected with macroeconomic conditions. A sharp deterioration in the international context could adversely impact foreign demand for Italian output and therefore GDP growth, which could be slower than that envisaged in the policy scenario in the Update. Moreover, the favourable interest rate conditions created with their recent decline are also exposed to uncertainty, threatening to impact interest expenditure on the debt.
From the fight against tax evasion to incentives for traceable payments. – Within the budget package, revenues of €3 billion in 2020, €3.7 billion in 2021 and €3.5 billion in 2022 are expected to be generated by the measures introduced with the Tax Decree to combat tax evasion and to encourage the use of traceable payment methods. These measures appear to be acceptable from a substantive perspective, and the valuation of their financial impact is sufficiently prudent. These provisions are accompanied by the measures to counter tax evasion envisaged in the Budget Bill, which are projected to increase expenditure by €3 billion in each year of 2021-22 and boost revenues by €0.2 billion in 2020, €1.3 billion in 2021 and €1.1 billion in 2022.
The measures, which do not include any form of tax amnesty, can be divided into four different types employed for four different purposes: 1) to counter specific areas of VAT and excise duty fraud; 2) to prevent undue tax offsetting; 3) to increase the amount and timeliness of the information available to the Revenue Agency and the Guardia di finanza (Finance Police); and 4) to encourage the use of non-cash forms of payment.
The new measures include a provision of the Budget Bill that would allow the Revenue Agency to supplement, after pseudonymisation of personal data, the databases it already maintains with data from the financial transactions database to develop risk profiles that can be used in identifying positions to be investigated or to encourage voluntary taxpayer compliance. The innovative scope of the provision lies in the possibility for the Revenue Agency to move from deductive reasoning to an inductive approach in its own control activity, thanks to the automated processing of large volumes of data upstream of the determination of risk criteria. However, the effectiveness of the measure depends crucially on: 1) the ability of the Agency to exploit the information resources that it will have at its disposal, i.e. to have access to appropriate statistical-IT skills and staff suitably trained for these tasks; and 2) effectively resolving issues connected with the processing of personal data. With regard to the latter aspect, the Budget Bill would include activities to prevent and combat tax evasion among those for which the data rights of the parties involved may be restricted. Further investigation is required to determine whether the provision as drafted in the Budget Bill is sufficient to enable the limitation of rights, i.e. if all the conditions required by Article 23 of the General Data Protection Regulation are satisfied.
With the introduction of a general obligation for the storage and electronic transmission of sales data, the entry into force of the receipt lottery, the increase in chances to win the lottery where traceable payment methods are used, the establishment of penalties for evasion of the obligation and the limitation, albeit a relatively mild one, on the use of cash continues in the direction of countering evasion by focusing attention on the last stage of the retail chain (final consumers). In particular, the provisions focus on the part of tax evasion connected with the failure to submit returns. All of these tools to expand the availability of information and increase its timeliness can help improve tax authorities’ capacity for analysis and preventive control and increase voluntary compliance. However, such measures could encourage forms of collusion to commit tax evasion (consensual arrangements in which there is an agreement between buyer and seller), expanding rather than reducing evasion in transactions with final consumers. This type of evasion, which is certainly more difficult to combat, has not yet been tackled with determination. With the emergence of costs fostered by mandatory electronic invoicing and the electronic transmission of receipt information, an increase in consensual tax evasion could even lead to a loss of tax revenue. This phenomenon should be countered by establishing appropriate mechanisms for monitoring the stability and credibility of margins.
A mechanism that exploits opposing interests to discourage collusion to commit tax evasion in the final stage of the transaction chain must necessarily provide for substantial incentives to use means of payment other than cash and impose stringent limits on the use of the latter. It is also advisable to achieve general consensus on the need to reduce the costs of using traceable payment methods, especially for very small amounts.
Corporate taxation. – Overall, in 2020 the budget package will increase corporate taxation by €1.9 billion. In the subsequent years, the effects of the various measures essentially offset each other and from 2023 they reduce revenue by €1.2 billion. In general, the approach adopted is similar to that used in recent years: the higher revenue in the initial year is produced with extraordinary measures; incentives for investments are extended and expanded to support enterprises (e.g. “super-” and “hyper-depreciation” and the tax credit); and finally, for the third time in a year, the IRES (corporate income tax) system has been modified. As from 2019 the Budget Bill reintroduces the ACE (allowance for corporate equity) system and at the same time repeals the reduced rate for the portion of profits allocated to reserves introduced with Law Decree 34/2019. Although the rules for 2019 have been amended three times, on the substantive level the ACE has remained in effect without interruption. The only difference is that the notional rate used to quantify the figurative return on capital has been reduced from 1.5 to 1.3 per cent.
Using its own microsimulation model, the PBO has quantified the redistributive effect on both non-financial and financial companies of the changes in the IRES system and the extension of super- and hyper-depreciation. The simulations show that in 2020 non-financial companies as a whole would experience a tax increase of 0.7 per cent. In particular, the additional tax deriving from the abolition of the reduced rate is only partially offset by the benefits of the reintroduction of the ACE (mitigated by the reduction in the notional rate of return on capital) and by the extension of super- and hyper-deprecation. Medium-sized and large non-financial companies would incur the greatest increase (around 1.3 per cent of tax revenue), despite being the enterprises that reap the greatest benefits from the extension of super- and hyper-deprecation (between 0.6 and 0.8 per cent of revenue). Symmetrically, smaller non-financial companies receive the greatest benefit (between 0.4 and 1.4 per cent), essentially due to the positive impact of the ACE (on the order of 3-4 per cent of tax revenue). Finally, financial companies, which do not qualify for the subsidised treatment of undistributed profits, fully benefit from the reintroduction of the ACE, although the impact is mitigated by the lower notional rate of return on capital (6.7 per cent of tax revenue).
Tightening the substitute tax mechanisms for holders of VAT registration numbers. – The Budget Bill introduces a number of changes to the substitute taxation mechanisms envisaged for sole proprietors and self-employed workers in the 2019 Budget Act. On the one hand, it repeals the mechanism for self-employed workers and sole proprietors with revenues of between €65,000 and €100,000 that was to come into force in 2020. On the other, it introduces a number of limits to reduce the scope for tax avoidance under the single-rate system for self-employed workers and sole proprietors with revenues of less than €65,000. Despite the measures introduced, the tax differential between self-employed workers and payroll employees remains very wide at any given income level. Furthermore, the contrast with the original spirit underlying the introduction of the initial single-rate mechanism – simplifying administration and reducing the tax burden for micro-enterprises only ‑ persists.
Tax expenditures. – For some time now tax expenditures have received particular attention both in legislation (analysis and monitoring for their reorganisation and rationalisation) and in the policy debate (as a possible source of resources for new measures). As in the budgets of the past few years, that for 2020-22 shows no trace of any reorganisation or rationalisation of tax expenditures. On the contrary, the budget package extends various tax expenditure programmes (for example, those on building renovations and energy efficiency upgrading), increases the scale of certain others compared with current legislation (for example, the flat-rate taxation mechanism for rental income in municipalities with high population densities), and introduces new programmes (as in the case of the tax credit for building façade repairs). However, the budget measures do contain a tentative initial attempt to reduce tax expenditures connected with personal income tax by limiting the 19 per cent tax credits for certain expenditures above certain level of income, with very limited revenue-generation impact.
Flat-rate taxation of rent-controlled accommodation. – The Budget Bill makes permanent the rate of the flat-rate tax on rental income from properties leased at controlled rents in municipalities with high population densities and in provincial capitals and neighbouring municipalities.
The number of taxpayers with income taxed at a substitute flat rate (both ordinary and subsidised rates) has gradually increased over time. The pace of that growth is showing signs of slowing down, but does not yet appear to have ceased. Tax returns filed in 2018 indicate that in high-density municipalities taxpayers paying a reduced flat rate as a proportion of all taxpayers paying a flat rate is 38.3 per cent. The greatest proportion of taxpayers benefitting from the facilitated rate is found in the North-East (in particular, in the municipalities of Emilia-Romagna), where rent-controlled leases account for more than half of the total. The lowest proportion is found in the North-West and in the South and, in general, in municipalities that are not provincial capitals. Among provincial capitals, the facilitated mechanism generally seems less common in regional capitals, especially in the South.
The use of flat-rate substitute taxation (at both ordinary and facilitated rates) mainly benefitted taxpayers with higher incomes: more than half of the taxable income under the flat-rate mechanisms is in fact received by the richest 10 per cent of taxpayers. The flat-rate system may however be less regressive if part of the tax savings has been passed through to rents, as would appear to be the case in a number of preliminary analyses.
Limitation of 19 per cent personal income tax credit. – The budget measures eliminate tax credits for such expenditure for taxpayers with a gross income of more than €240,000 and partial credits – determined using a coefficient that decreases linearly with respect to income – for taxpayers with incomes of between €120,000 and €240,000.
For all taxpayers, the expenditures affected by the measure (i.e. the amounts on which the 19 per cent credit is calculated) amount to €23.5 billion. These correspond to tax credits (tax savings) of about €4.5 billion, 11.4 per cent of the total tax expenditures involving personal income tax, equal to €39.3 billion.
The selection criterion adopted involves an extremely small group of high-income taxpayers, meaning that the measure does not significantly impact the overall value of tax credits. Those with an income exceeding €240,000 represent only 0.1 per cent of all taxpayers, while those with an income of between €120,000 and €240,000 represent just 0.6 per cent. Accordingly, the tax credits affected by the reform represent only 2.9 per cent of the total, despite the fact that the share of taxpayers in these income brackets who benefit from the credits is almost double that for incomes below €120,000 (over 80 per cent, compared with 48 per cent) and that the average amount of the tax credits is much higher (double if not triple than that of taxpayers with incomes below €120,000).
Measures for families. – The Budget Bill contains various measures to support families, some of which are temporary, while others are of a structural nature. Overall, they increase current expenditure by €612.2 million in 2020, €1,044 million in 2021 and €1,244 million in 2022.
Temporary measures include the extension and expansion of two birth-related measures, namely the “baby bonus” allowance and mandatory parental leave for fathers. Structural measures include the establishment of a fund for the universal family allowance and childcare services, as well as an increase for families with a low equivalent economic status indicator (ISEE) in the allowance for the payment of public and private childcare fees. Other indirect support for families is provided by the capital grant for municipalities to fund the construction, renovation and safety upgrading of childcare facilities. The need for coordination between the policies supporting demand for and public supply of childcare services should be underscored, with appropriate measures to reduce territorial differences in the supply of public nursery schools in order to avoid the concentration of a double benefit, on both the supply and demand side, in favour of those residing in areas with childcare services to the detriment of those residing in areas without such services.
Funding for investment and the “34 per cent clause” for the South. – The budget package includes a number of measures concerning investment spending and investment grants that also regard appropriations for the current year. Overall, in terms of general government net borrowing, the resources allocated for these purposes are reduced by over €500 million in 2019 and by over €1.1 billion in 2020, while they are increased in 2021 and 2022 by about €0.9 billion and €2.7 billion respectively.
For 2020, the measures also contain provisions to support the regions of Southern Italy and to reduce territorial differences by reinforcing the allocation of resources for ordinary capital expenditure on the basis of population, shifting from an exclusively ex post perspective to compliance with the principle of territorial rebalancing at the resource allocation stage. However, the exclusion of appropriations under laws that refer to “previously specified allocation criteria or indicators” from the scope of application of the 34 per cent rule could, in fact, reduce the effectiveness of the rule in achieving the stated objectives.