Letta Extends Italian Austerity by Adding Budget Cuts to Remedy

Italian Prime Minister Enrico Letta reshaped the country’s two-year commitment to austerity by approving a labor-tax cut and relying on 3.5 billion euros ($4.7 billion) of spending reductions to meet 2014 deficit targets.

The central government will bear 2.5 billion euros of the expense cuts and regional administrations will deliver 1 billion euros, Letta said in a press conference in Rome after his cabinet approved next year’s budget late today. The labor-tax cut will give an extra 1.5 billion euros to workers next year and a total of 5 billion euros through 2016, he said. Companies will get tax breaks of 5.6 billion euros in that span, he said.

Letta, Italy’s third premier since 2011, is shifting the burden from taxpayers to government bureaucracy in a bid to spur the stagnant economy as deficit-cutting continues. Public administration spending rose 0.6 percent in nominal terms last year to 801 billion euros as Letta’s predecessor, Mario Monti, counted mainly on tax increases to strengthen the budget and shield Italy from bond market speculation.

“They realized you can’t just focus on tax revenue,” Mario Spreafico, chief investment officer at Schroders Private Banking for Italy, said by telephone from Milan. “Now there’s a lot more attention on expenses.”

Bond Yields

Italian 10-year bond yields declined 1 basis point to 4.25 percent in Rome before the budget announcement. That’s down from more than 7 percent in late 2011.

Letta, 47, is continuing the austerity drive that began in earnest in mid-2011 with an intensification of the European debt crisis. The then prime minister, Silvio Berlusconi, set deficit reduction goals before being forced out in November by bond market speculation. Under Monti, the value-added tax and gasoline levies rose, while a new property tax was created.

The VAT increased under Letta on Oct. 1, to 22 percent from 21 percent.

The government said last month it plans to reduce the deficit to 2.5 percent of gross domestic product in 2014 from its target of 3 percent this year. Italy’s 2 trillion-euro debt is about 130 percent of GDP, the second-highest ratio behind Greece in Europe.

Labor Costs

“A decrease in labor costs will be positive but this is not the Italian problem,” Romano Prodi, a two-time Italian prime minister, said in an interview. “The problem is bureaucracy, the anti-business behavior of the public administration.”

Letta’s push for further spending reductions will be spearheaded by Carlo Cottarelli, who was hired by the government this month from the International Monetary Fund. He is scheduled to leave the IMF on Oct. 22 and assume the job of commissioner for public spending reform for the Italian government.

Italy’s 1.6 trillion-euro economy, the third-biggest in the euro area, has contracted for eight straight quarters as the tax increases curbed spending and investment. Letta, who leads a makeshift three-party coalition, has said his priority is to deliver on budget targets while bringing unemployment down from a record 12.2 percent.

Letta is taking greater control of his government’s policy as he consolidates his authority among his allies. He undermined Berlusconi, head of the coalition’s second-biggest party, in an Oct. 2 showdown that boosted Letta’s control over the government agenda. It was Berlusconi, 77, who pushed in August for a property-tax cut that was, at the time, the government’s biggest fiscal measure.

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