Italy Passes $68 Billion in Budget Cuts to Stop Contagion

Italy's prime minister Silvio Berlusconi
Italy's prime minister Silvio Berlusconi. Photographer: Jock Fistick/Bloomberg

Prime Minister Silvio Berlusconi is seeking to shield Italy from debt-crisis contagion with 47 billion euros ($68 billion) in deficit-cutting measures intended to balance the budget by 2014.

The Cabinet passed the legislation yesterday, and the government will seek to push it through parliament in a confidence vote by the end of summer, Berlusconi told a press conference in Rome. He called on the opposition to back the measures, the bulk of which -- 40 billion euros -- will come in 2013 and 2014.

“Without a balanced budget, there can’t be development in the future,” Berlusconi said. “We all agreed on this.”

Finance Minister Giulio Tremonti has managed to keep the budget deficit under control, shrinking the gap to 4.6 percent of gross domestic product last year, less than the euro-area average of 6 percent. With Europe’s second-biggest debt after Greece, Tremonti’s fiscal discipline hasn’t been enough to completely shield Italy’s financing costs from the fallout caused by the region’s crisis.

Both Standard & Poor’s in May and Moody’s Investors Service last month have warned that they may downgrade Italy’s credit rating, citing growth challenges and saying the government may miss its revenue and deficit targets. The Moody’s warnings helped boost the risk premium or spread investors demand to hold Italy’s 10-year debt over German bunds to a euro-era high of 223 basis points on June 27.

‘Debt Risks’

Italy still faces a possible downgrade even after approving the budget plan, S&P said in an e-emailed statement today. The company reiterated a “one-in-three likelihood that the ratings could be lowered within the next 24 months.” Italy’s spread widened three basis points to 188 after S&P’s note.

The Cabinet also approved measures to overhaul the tax system “to overcome forms of evasion,” Tremonti said at the Rome news conference yesterday. The legislation will cut income-tax brackets to three from the five. Top earners will pay a marginal rate of 40 percent, down from 43 percent, he said.

The budget plan may cut funding to regional governments, extend through 2014 a wage freeze for civil servants, and push up the retirement age for woman to 65 years by 2032, and force Italians to contribute more to some health-care services, newspapers including Corriere della Sera reported, citing a draft.

Financial Tax

The final draft may have dropped a financial transaction tax of 0.15 percent that the Italian stock exchange called “profoundly worrisome,” and limited the planned increase in tax on trading profit, Il Sole 24 Ore reported today. A final copy of the plan may be released later today.

“That’s positive news for the banks that would have had a negative impact from the budget plan in the order of 3 to 4 percent of earnings per share, according to our estimate,” analysts at Intermonte said in a note this morning.

The package is a “balanced budget plan” that mixes higher revenue and spending cuts, Tremonti said. “We’ve done all we needed to do to reach the deficit target for 2011, and with this budget plan we are on course to reach the target for the next years,” he said.

The measures may also include cuts in compensation and benefits for Italy’s politicians. Tremonti said Italy would seek to recalculate official salaries based on the average wages paid in the six biggest euro nations. Access to state aircraft and cars would also be limited, he said, adding that the measures would take effect starting with the next legislature.

No Wage Cuts

“We’ve managed to avoid what other countries have done,” Berlusconi said. “In some countries, they have cut state employees and their salaries by 15 percent,” whereas “we haven’t put our hands in the pockets of Italians.”

Berlusconi, who has a record-low approval rating with two years left in his term, has come under increasing pressure from allies to cut taxes and adopt other policies aimed at sparking growth in the $2.3 trillion economy. Berlusconi’s ruling coalition was defeated in local elections in May and a June referendum overturned a series of policy initiatives.

Tremonti has repeatedly said the country can’t afford to reduce taxes and that any change to the system must not affect efforts to eliminate the deficit. Tensions over the deficit plan prompted Tremonti on June 24 to deny press reports that he had threatened to resign over demands by ministers to ease the austerity measures.

Government at Risk

Umberto Bossi, leader of the Northern League party that is key to Berlusconi’s parliamentary majority, said the government will remain at risk until the budget plan is passed by the legislature. The vote is likely before the August recess.

The European Commission forecasts Italy’s budget gap will fall to 4 percent of GDP this year, less than half the Greek shortfall and narrower than France’s 5.8 percent spending hole. Italy’s debt is forecast to peak at 120 percent of GDP in 2011 compared with 158 percent for Greece.

The goals for balancing the budget are to “progressively have a primary surplus, cut the debt and cut debt-servicing costs,” Tremonti said.

Tax Overhaul

Tremonti, who until now has kept economic policy focused on containing the deficit, opened the door to tax changes earlier this month, saying that easing levies on income was the best way to fight evasion. He added that reducing Italy’s tax brackets could be financed by eliminating deductions.

Italian economic growth averaged 0.6 percent in the past decade, less than half the 1.4 percent rate for the euro area. The economy grew just 0.l percent in the first quarter of this year, a fraction of the region’s 0.8 percent expansion.

Berlusconi’s popularity fell to a record low in June and his coalition would lose if elections were held today, an IPR marketing poll showed on June 15. Confidence in the billionaire premier dropped to 29 percent from 31 percent in April, the lowest since he took office in 2008, Rome-based IPR said.

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