Chairman Giuseppe Pisauro testified (in Italian) today before the Budget Committees of the House and Senate as part of the preliminary examination of the budget measures for 2017-2019.
In his remarks, Chairman Pisauro offered a comprehensive analysis of the budget package, discussing the PBO’s assessment of the measures it contains and the consistency of the public finance objectives with the fiscal rules.
The most recent economic information points to a continuation of the uneven but slow recovery in 2016 (+0.2 per cent in the third quarter and +0.1 per cent in the fourth, according to PBO estimates). The deceleration at the tail-end of the year would provide only a slightly positive boost to growth next year (0.2 per cent): achieving growth of 1 per cent in 2017 would require a stronger (and more continuous) average quarterly recovery than that experienced in 2016. In addition, the outlook for next year is primarily coloured by risk factors of international origin, first and foremost uncertainty about the growth of world trade.
In the Draft Budgetary Plan (DBP), the Government has revised the policy scenario for the public finances set out in the Update to the Economic and Financial Document (the Update), raising the deficit in 2017 from 2 to 2.3 per cent of GDP, three-quarters of the additional margin requested in the Report attached to the Update and authorised by Parliament.
The Budget Act and the Tax Decree are characterised by a number of broad provisions (particularly in support of private investment) and numerous piecemeal measures pursuing diverse objectives that are difficult to place within a comprehensive economic policy structure. Compared with the trend developments in the public finances, the provisions contained in the two measures increase the borrowing requirement by 0.7 points of GDP in 2017, 0.4 points in 2018 and 0.2 points in 2019.
For 2017, however, easily the most significant measure is the deactivation of the safeguard clauses (automatic increases in VAT rates and excise duties), which is worth 0.9 per cent of GDP or €15.4 billion. Taken together, the other measures have a restrictive effect, involving an estimated reduction in borrowing of 0.2 percentage points of GDP.
The scenario for the two following years 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 will 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 first application of the new format of the Budget Act gives a more compact and readable framework for revenue and spending decisions within the overall budget package but requires an improvement in the information available to policy-makers.
More specifically, the budget measures contain a number of problems:
- measures with essentially one-off effects (from the facilitated settlement of 2000-2015 tax arrears to the acceleration of VAT payments, the extension of the voluntary disclosure scheme, the auction of radio frequencies) account for about half of the higher net revenue (a total of €6.3 billion in 2017);
- the revenue to be generated by the second voluntary disclosure scheme could well be overestimated, given that the eligibility criteria for participation are substantially unchanged on those for the first edition of the measure, while the amnesty excludes those who have already taken advantage of the relief;
- the introduction of quarterly reporting of detailed VAT data by those subject to VAT reporting requirements is a step in the right direction, but to strengthen the anti-tax-evasion nature of the measure, it would be desirable to extend the scope of electronic invoicing and the reporting of fees for persons who are not required to issue an invoice;
- the amnesty for tax arrears for 2000-2015, allowing taxpayers to pay off their tax liability net of penalties and default interest, ends up rewarding less deserving taxpayers, and thus serves to weaken taxpayers’ sense of a tax compliance duty;
- the measures to support families are of modest scale, fragmented and insufficiently means tested, and would accompany, and in some cases be in addition to, existing programmes, subtracting resources from efforts to achieve other unmet objectives;
- the measures for the pension sector, including the introduction of the early retirement loan mechanism and the extension of additional pension payments to a larger group of beneficiaries, deal specifically with certain emergency situations (workers who entered the labour force very early, have physically demanding jobs or left work early under an early retirement scheme but are no longer eligible for a pension following pension reform) but are not integrated within any comprehensive policy.
The consistency of the public finance scenario with European rules depends on two factors: a) the recognition of costs related to the substantial flow of refugees and those relating to earthquake proofing as caused by exceptional events in view of their impact on the adjustment path towards the medium-term objective; 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, the objectives in the DBP would represent a close-to-significant deviation for the structural balance rule and an insignificant deviation for 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. An additional element to consider for the purpose of compliance with the rules is the risk of reclassification of the revenue generated by some measures from structural to one-off (for example, the proceeds of the tax arrears amnesty).
On the basis of current information, it is not possible to predict what the Commission’s decision will be. The criteria for calculating the output gap are also being discussed in the appropriate technical fora at the urging of the Italian Government. As for the influx of refugees, last year the Commission had already recognized that it qualified as an exceptional event, allowing the exclusion of any expenditure in excess of such spending the previous year. The decision for 2017 would therefore not appear to regard the nature of the phenomenon but rather the amount of expenditure to be excluded. As regards the earthquake proofing effort, there are no precedents for exclusion from the required adjustments of expenditure on prevention measures. The increased frequency of earthquakes may correspond to greater risk in many areas of the country, making extraordinary preventive action necessary.
There are a number of challenges in placing an extraordinary plan for enhancing earthquake resistance within the scope of the exceptional events exception for the purposes of the European rules. The room for additional expenditure requested (0.2 percentage points of GDP) includes not only new resources but also the impact on the accounts of measures taken in previous years (already in the current-legislation budget) associated with more general building renovation and energy efficiency efforts. Moreover, the request to exclude expenditure for 2017 only does not appear consistent with the necessarily long-term nature of any seismic upgrading plan.
As regards the debt/GDP ratio, the divergence between the level projected by the Government, and the target value for compliance with the numerical rule has expanded (1.8 percentage points, compared with a 0.2 point gap in the EFD). The PBO’s assessment of debt sustainability suggest that even with less favourable macroeconomic assumptions, the public finance objectives in the DBP are still relatively likely to ensure the reduction of the debt/GDP ratio in the medium term, provided that large primary surpluses are maintained in the years beyond 2019.