2017 Budgetary Policy Report

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The 2017 Budgetary Policy Report examines the fiscal policy documents and the Budget Bill for 2017, re-presenting here the reports to the appropriate parliamentary committees in hearings held on 3 October and 7 November, with additions and further developments.


The Report is organised into four chapters. The first addresses the macroeconomic environment, while the second examines the trend and policy scenarios for the public finances and the structure of the measures in the 2017 Budget Bill. The third chapter assesses compliance with national and European fiscal rules and the fourth focuses on an analysis of the main budget measures.


The macroeconomic scenario set out in the Draft Budgetary Plan (DBP) is based on a more expansionary budget package for 2017 (0.3 percentage points) than that assumed in September in the Update to the Economic and Financial Document (the Update). The Parliamentary Budget Office (PBO) found that the macroeconomic forecasts proposed by the Government in the DBP were plausible, validating the macroeconomic scenario in the 2016-2017 DBP. At the same time, we found that the current economic environment contained risks that could affect the growth assumptions for 2017 and subsequent years. As part of the validation exercise, the PBO assessed the macroeconomic effects of the measures that make up the budget package: it would produce faster GDP growth, compared with the trend, of about 0.3 percentage points in 2017, compared with the difference of 0.4 percentage points assumed in the DBP.


The risk factors shadowing the macroeconomic scenario are mainly of external origin. The uncertainty has been heightened by the outcome of the recent US presidential election. The reaction of investors triggered a rapid increase in US long-term interest rates, with spillover effects on the yields of European government securities and a widening of spreads with respect to the German benchmark. It is still too early to assess the scope of these developments. When the uncertainty has moderated, it will be necessary to verify whether the macroeconomic scenarios produced before the US elections remain valid.


Compared with the trend developments in the public finances, the measures in the 2017 Budget Bill (supplemented by Decree Law 193/2016) increase borrowing by 0.7 points of GDP in 2017, 0.4 points in 2018 and 0.2 points in 2019. For 2017, easily the largest measure is the cancellation of the increase in VAT rates and excise duties (the so-called “safeguard clauses”), which amounts to 0.9 per cent of GDP (€15.4 billion). Taken together, the other measures will therefore produce a reduction in borrowing of 0.2 points of GDP, or about €7.3 billion in higher net expenditure and €10.6 billion in higher net revenue. The scenario for 2018 and 2019 reflects the retention of the increase in VAT rates in 2018 and a further increase of 0.9 points in the standard rate in 2019. Together, these measures should yield revenue of €19.6 billion in 2018 and €23.3 billion in 2019, equal to 1.1 and 1.3 per cent of GDP respectively.


Overall, the impact of the measures on the public finances is not without risk. Not so much because of the increase in deficit capital spending, given the non-permanent nature of these expenditure and the effects they could have on economic growth, but rather because of the creation of permanent commitments for current expenditure (especially for pensions and public-sector employment) only partially offset by permanent and certain revenue flows. In particular, retaining the increase in the VAT rate and, indeed, raising it further in 2019 in order to ensure the public finances remain sound makes it difficult to discern the medium-term budgetary planning objectives. For the second consecutive year, the most significant budget measure is the cancellation of the increase in VAT rates for the subsequent year. Assuming the Government intends to deactivate the clause again in the following years, the same scenario seems destined to be repeated in future budgets.


The consistency of the public finance scenario with the rules on the structural balance and expenditure depends on at least two factors associated with the European Commission’s assessment: a) the recognition of the costs associated with the flow of refugees and those relating to earthquake proofing as exceptional and their consequent exclusion from the structural balance; b) the size of the correction the country must make in relation to economic conditions‑ normal or bad times ‑ as measured by the output gap. In the event of a favourable solution to both of these issues (recognition of the impact of exceptional events and the fact that the country is going through bad economic times), the objectives in the DBP would represent a close-to-significant deviation for the structural balance rule and an insignificant deviation for the expenditure benchmark. If the events are not recognized as exceptional, the DBP objectives would be at risk of a significant deviation for both public finance parameters. The debt reduction objectives in the DBP do not appear consistent with any of the criteria used (backward-looking, forward-looking and adjusted for the cycle) to assess compliance with the associated numerical debt reduction rule. Compliance with that rule therefore depends on consideration of the relevant factors.


The Budget Bill and the Tax Decree contain, on the one hand, a number of broad provisions to support the capitalisation and growth of firms, increase the neutrality of tax treatment with respect to the legal form of taxpayers, foster a revival of investment and counter tax evasion. On the other hand, they also contain more piecemeal measures pursuing diverse objectives that are difficult to place within a comprehensive vision (those regarding families, young people and anti-poverty mechanisms). The quantification of the measures presented in the technical reports accompanying the Budget Bill and the Tax Decree, while generally plausible, are exposed to risks, especially on the revenue side.


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