The 2019 Budgetary Planning Report is devoted to analysing the 2019 Economic and Financial Document (EFD) and expands, with additional analysis, the text of the parliamentary hearing of 16 April conducted as part of the preliminary examination of the EFD.
The report is organised into four chapters. The first is devoted to an analysis of the EFD’s macroeconomic forecasts for the period 2019-2022. The second analyses the trend and policy scenarios for the public finances. The third chapter discusses issues concerning the short/medium-term sustainability of the public finances, while the fourth examines the policy objectives set out in the EFD in the light of national and European fiscal rules.
As regards the macroeconomic forecasts, in light of the information available and a broad reconstruction of the budget package outlined in the EFD, the PBO validated the 2019‐2022 policy scenario, highlighting however the risks associated with the international context (a slowdown of the Chinese economy, uncertainty about Brexit, intensification of geopolitical tensions, increasing financial imbalances and investors’ risk aversion), the domestic situation (weak economic activity) and the high degree of uncertainty that characterises, in this phase, the specification of the fiscal policy sketched out in the EFD.
The slowdown in the world economy, which in 2018 had mainly involved exporting countries, is continuing with the involvement of a larger number of economies. World trade is weakening, despite some easing of tensions over protectionist policies. The reduction in global demand has prompted the oil-producing countries to reduce their output of oil, thereby supporting oil prices. In Italy, economic activity remains weak. GDP decelerated last year and according to the latest national accounts estimates, the slowdown originated with domestic demand and, to a slightly lesser extent, net foreign demand. Private consumption has been held back by purchasing power, while at the end of the year investment had recouped only a small part of the large contraction registered in the summer. The uncertainty of households and firms also continues to rise. However, the picture delineated by the most recent economic indicators seems to signal, despite highly mixed developments, the first modest signs of recovery for the first quarter of the current year.
The EFD’s policy macroeconomic forecasts were broadly consistent with those of the PBO panel. However, the estimates reflect slightly higher assessments of the expansionary impact of the budget than those of the panel of forecasters. The policy scenario contains more optimistic projections for gross fixed investment in 2019 and those of the PBO panel, particularly for the machinery and equipment component. General government expenditure for 2020 also amply exceeds the upper bound of the PBO panel’s range, likely due to the different assessments made by the PBO panel and the EFD of the price/quantity breakdown of nominal public consumption. In 2021, however, it is the increase in household consumption that exceeds the upper bound of the panel’s estimates as a result of the different assessments of the impact of the safeguard clauses providing for increases in indirect taxes. The policy growth in nominal GDP falls within the forecasting interval, thanks in part to the deflator, which remains below the upper bound forecast by the panel.
In addition to the downside risks already mentioned, the scenario is still subject to a degree of uncertainty concerning the assessment of the impact that the possible increase in VAT rates would have on prices and on the level of economic activity.
In the EFD estimates, the output gap remains negative for the entire forecast horizon. It narrows slightly in 2018, before widening again in 2019 and stabilising at just below 2 points over the remainder of the forecast period. These estimates, based on the methodology agreed at European level, differ significantly from those of both the Update to the 2018 EFD and the European Commission formulated in its Autumn Forecasts 2018 in November (which expected a positive output gap already this year and further growth in the next). The uncertainty associated with measuring the output gap represents an additional risk factor in the budget policy scenario. The PBO is developing a procedure for estimating the output gap and the potential output of the Italian economy that is based on multiple estimated models combined into a composite measure with a plausibility range.
For the public finances, the report emphasises that the autumn budget package, as set out in the EFD, resembles a complex puzzle, which will require a clear identification of policy priorities. As already noted, this uncertainty over the design of budgetary policy is an important risk factor for the country’s economic prospects.
In the EFD, the Government acknowledges that the deficit for 2018 exceeded forecasts and that the trend public accounts are on a less favourable trajectory as a result of the deterioration in the economy. According to official forecasts, without corrective measures net borrowing will rise to 2.4 per cent of GDP in 2019 (retaining the freeze on €2 billion of the appropriations for the ministries, provisioned as part of the amendments to the budget package at the end of December 2018), before decreasing to 2 per cent in 2020 and to 1.8 and 1.9 per cent in the two subsequent years.
The EFD itself indicates that the deficit with unchanged policies and excluding the increase in VAT envisaged with the safeguard clauses (€23.1 billion in 2020 and €28.8 billion from 2021) would rise as a percentage of GDP from 2.4 per cent in 2019 (€42 billion), 3.4 per cent in 2020, 3.6 per cent in 2021 and 3.8 per cent (€73 billion) in 2022. In this scenario, and also excluding proceeds expected from privatisations that seem difficult to achieve, the debt/GDP ratio would continue to rise after 2019 to reach over 135 per cent in 2022, up from 132.2 per cent in 2018.
The resources that need to be found to ensure a gradual decline of the deficit in the EFD policy scenario are: i) alternative measures replacing the VAT increases already provided for in existing legislation, which amount to €23.1 billion in 2020 and €28.8 billion starting from 2021; ii) resources to finance unchanged policies, amounting to €2.7 billion in 2020, €5.2 billion in 2021 and €7.8 billion in 2022 and to increase investment (about €2 billion a year); and iii) those necessary for a further correction of the deficit in order to achieve the policy targets, amounting to €6.5 billion in 2022 (conversely, in 2020 and 2021 the policy targets consist in an increase compared to the trend forecasts and therefore in a reduction in funding needs compared to the existing legislation of €2.5 billion and €0.1 billion respectively). Overall, it is therefore necessary to identify resources of about €25 billion for 2020, rising to about €36 billion in 2021 and €45 billion at the end of the period.
Additional initiatives announced in the EFD, such as the plan to continue the process of reforming income taxes (the “flat tax”) and the overall simplification of the tax system, to be implemented “in compliance with the public finance objectives specified in the document”, would require the identification of further compensatory measures.
On the basis of the limited indications provided in the EFD on the budget measures, finding the resources needed to achieve the policy objectives will be based on four main pillars, in addition to the “activation” of the “safeguard clauses” involving increases in indirect taxes as described above: the reduction and rationalisation of tax expenditures, countering tax evasion, the spending review and privatisation receipts. Each of these approaches has critical aspects.
The reduction of tax expenditures raises a number of issues that need to be addressed. Their elimination should be preceded not only by a quantification of the overall financial impact and the beneficiaries involved, but above all by an ex post analysis of the redistributive effects that the elimination of each subsidy mechanism would generate. Furthermore, some tax relief measures that are spread out over multiple years (for example, those for building renovations or for mortgage interest on primary-residences) would continue to cause revenue losses in future years and would therefore not immediately make resources available to fund other measures.
The resources needed to achieve the net borrowing targets for 2021 and 2022 amount to 0.1 per cent and 0.4 per cent of GDP, respectively, mainly generated by measures to fight tax evasion. Overall, the magnitude of the increase in revenue expected in 2022 seems rather ambitious when assessed in the light of the results currently achieved by the Revenue Agency. More specifically, just over €19 billion were collected in 2018, of which €16 billion deriving from “ordinary” control activities (i.e. as a result of assessments issued by the Revenue Agency, promotion of compliance and enforced collection) and the remaining €3 billion from “extraordinary” recovery measures (for example, the facilitated settlement of tax disputes and outstanding assessments, voluntary disclosure, etc.). It would therefore be a question of significantly increasing (by up to 50 per cent or so) the amount of revenue recovered from “ordinary” collection activity.
Taking account of developments in primary expenditure in nominal and real terms since 2010 (primary expenditure has increased by a total of €50.4 billion in nominal terms, while it has decreased by €14.7 billion in real terms), recourse to expenditure cuts is challenging for a number of reasons. More specifically: 1) in the area of public employment, measures to contain expenditure such as a new freeze on turnover would run up against the already reduced number of staff and the aging of employees. These factors have inevitable repercussions for the overall efficiency of government administration and the use of technological innovation, unless reforms of the functioning of the public administration are implemented, whose effects nevertheless take a considerable time to unfold; 2) the risk that further cuts in healthcare spending will affect the quality of the services delivered or the scope of public involvement in this sector; 3) the welcome commitment of the Government to increase the financial resources for investment available to central and local governments, including addressing the critical issues connected with the application of the new legislation governing public tenders; and 4) the Government’s recent increase in pension expenditure with the introduction of the quota 100 mechanism (sum of age and years of contributions) and the Citizenship Income.
The 2019 EFD retains the assumption, adopted in the 2019 DBP, of privatisation receipts equal to 1 percentage point of GDP in 2019 and 0.3 points in 2020, equal to about €17.8 and €5.5 billion respectively. Comparing the disposals envisaged in the 2015-2018 EFDs and the corresponding actual figures, however, it is clear that the only year in which the results met expectations was 2015 (when disposals implemented amounted to €6.6 billion). Before 2015 disposals of more than €10 billion were recorded on only three occasions (1997, 1999 and 2003), while in those following 2015, the results obtained were significantly below expectations: in 2017-2018, with forecast disposals of 0.3 points of GDP per year, actual receipts amounted to €58 million in 2017 and €2 million in 2018. In light of the increase in the forecast for privatisation receipts, the PBO therefore reiterates even more strongly its previously expressed conclusion that the public finance policy scenario is exposed to the real risk that the privatisation programme may prove to be totally or partially unfeasible.
As regards the public debt, the report presents a number of simulations to analyse the sensitivity of the debt to GDP ratio in the EFD policy projection in alternative scenarios. In the extreme case in which trend net borrowing increased by the effects of unchanged policies is not financed through the activation of the safeguard clauses and the budget measures envisaged in the EFD, and in the absence of privatisation proceeds, the debt ratio would increase to 134.7 per cent in 2021 and 135.4 per cent in 2022.
The final chapter of the report focuses on compliance with national and European fiscal rules and on the new medium-term objective (MTO) for Italy as from 2020.
Despite the more unfavourable nominal deficit targets than previously indicated, the policy scenario in the 2019 EFD envisages, due to more pessimistic macroeconomic assumptions, a slightly more ambitious structural adjustment path towards the MTO compared with the policy scenario in the Aggiornamento del Quadro Macroeconomico e di Finanza pubblica published in December 2018. Nevertheless, deviations from the adjustments required by the fiscal rules persist for almost the entire planning horizon in addition to 2018, both for the structural balance rule and the expenditure benchmark. The European Commission, using its Spring 2019 forecasts, will conduct an overall evaluation to determine whether the preventive arm of the Stability and Growth Pact has been complied with and assess the possibility of opening a significant deviation procedure for the deviation estimated for 2018. In addition, there is no compliance with the debt reduction rule in 2018 or in the planning period, despite the decline in the debt to GDP ratio envisaged by the Government for the 2020-2022 period. The failure to comply with the debt rule in 2018 makes it possible that the Commission could prepare a new report to evaluate the possible opening of an excessive deficit procedure against Italy for non-compliance with the debt criterion.
Italy’s new MTO starting from 2020 is indicated in the EFD. It is equal to a structural surplus of 0.5 percentage points of GDP, a more stringent target than that declared in previous policy documents, which called for a zero structural budget balance. Note that previous documents, in specifying the structural balanced balance as the MTO, set a more ambitious MTO than the minimum determined using the EU methodology, which until the recent revision produced an MTO for Italy equal to a structural deficit of 0.5 per cent of GDP. The revision of the MTO according to the European method is therefore equal to 1 percentage point of GDP and is due both to the deterioration in the public finance scenario and to the increase in the forecast for long-term developments in public expenditure linked to the ageing of the population (“ageing cost”).