The Berlusconi reforms: A first assessement

By: Marco Valli

The first moves of the new Italian government in terms of fiscal policy have been generally well received by the public opinion. Polls show that the popularity of PM Berlusconi has increased during his first month in charge, and May saw the largest one-month jump in consumer confidence since December 2006. Also sentiment among manufacturing firms improved after several months of severe declines. In a nutshell, the government decided to abolish the municipal tax (ICI) on first house and reduce significantly the tax burden on overtime and productivity bonuses. The latter measure is experimental in nature – it’s supposed to last six months, at the end of which the government will decide whether to roll it over – and envisages a 10% flat tax rate for overtime and productivity bonuses for private sector workers earning a gross salary that doesn’t exceed EUR 30,000. A third important area of government intervention was the mortgage market. Economy Minister Tremonti has recently reached an agreement with the banking sector that will make it possible for households that entered a floating-rate mortgage contract before 2007 to re-negotiate conditions and switch to a fixed rate scheme that implies a lower monthly payment (but the repayment period will be longer if rates won’t fall sufficiently in coming years). This will be a breath of fresh air for many households with stretched balance sheets because of rising interest rates.

 

Below I focus on the first two measures – their estimated cost is about EUR 3-4 bn – which were the ones having top priority in Berlusconi’s agenda during the electoral campaign. A more detailed assessment necessarily needs to take into account Italy’s tight budget constraints and the need to destine the little resources available to the most efficient uses. So the question to answer is not so much whether the government’s decisions can have positive economic implications (the answer is: yes), but if public money could have been spent better. The answer to this second question is: probably yes. Let’s see why.

I think the issue of the lighter tax burden on overtime needs to be assessed separately from the one on productivity bonuses. Lower taxes on overtime aim mostly at increasing the workers’ take-home pay, with a positive impact on productivity that is limited to those cases where longer working times allow for a more efficient use of plants and machinery, or to those sectors that typically see strong fluctuations in the order flows and therefore need more flexibility to better face changing demand conditions. Note, however, that more often those who decide to work overtime are male employees with a permanent job contract. Therefore, the two categories of workers that need more support, namely workers with a fixed-term contract (because of a lower average salary and little or no social security cushions) and women (the employment rate among women is the second lowest in EU27), risk being in large part excluded from the benefits of the measure. Probably, a more far-reaching policy would have consisted in using the same resources to improve the social security cushions – key in a truly flexible labor market – and finance interventions intended to encourage women employment. In contrast, we totally agree on the idea of lowering the tax burden on productivity bonuses: enhancing productivity is probably the most important challenge Italy currently faces, given the very low potential growth rate that hovers just above 1%. I think that lower taxation on productivity bonuses is one step toward a more flexible labor compensation framework, which should guarantee the right mix between the need to keep unit labor costs in check (and therefore safeguarding firms’ competitiveness) while increasing workers’ take-home pay. In such context, national wage contracts would progressively lose relevance and remain a “safety-anchor” for workers employed in poorly performing companies, while the higher-productivity part of the system would increasingly move toward firm-specific salary agreements.

Let’s now come to the abolishment of the municipal tax on first house. While ICI on first house is widely perceived by people as one of the most hated taxes because it hits non-income-generating real estate, it is also true that the benefits of the government’s intervention will be felt by middle and higher-income households, given that the Prodi cabinet had already erased ICI for lower-income households (about 40% of the total). My personal idea is that, rather than coming to the rescue of those that already own a house and are not in the lower part of the income scale, it would have been more appropriate to use the same resources to finance measures aimed at improving the functioning of the rent market, which suffers from a structural lack of supply – there’s often little incentive to rent a house because rent incomes are subject to the personal income tax rate – and a huge degree of tax evasion. By extending tax deduction on rent payments for low-income households and young people and concurrently lowering dramatically taxes on rent incomes, the government could have supported the households that can’t afford buying a house while at the same trying to unfreeze the rent market. The latter would be a very important factor to increase (so far low) labor mobility. One final word on the financial coverage of the ICI abolition. The latest available information suggests that resources could be found by cutting infrastructure spending in Southern Italy: if this were to be the case, we would regard it as a clearly negative factor.

 

The government is now working at a multi-year budgetary plan that will allow Italy to balance the deficit in 2011. Concurrently, the cabinet is studying a series of zero-cost policies intended to give GDP a permanent boost. On this front, we hope a massive liberalization effort will be at the top of the government’s list of things to do.

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