This paper focuses on selected aspects of Italy’s fiscal situation, its origins, and its pervasive economic consequences. The paper analyzes different aspects of regional duality and the unbalanced recovery. The paper highlights that regional duality is a salient feature of the Italian economy. In the south, average incomes and consumption are lower, unemployment rates higher, and the percentage of the population living in poverty larger than in the center and north. The paper also examines fiscal performance of Italy during 1986–95.

Abstract

This paper focuses on selected aspects of Italy’s fiscal situation, its origins, and its pervasive economic consequences. The paper analyzes different aspects of regional duality and the unbalanced recovery. The paper highlights that regional duality is a salient feature of the Italian economy. In the south, average incomes and consumption are lower, unemployment rates higher, and the percentage of the population living in poverty larger than in the center and north. The paper also examines fiscal performance of Italy during 1986–95.

III. Fiscal Adjustment: Past Performances and Prospects 1/

The pace of fiscal adjustment accelerated significantly in 1995. In a single year, the state sector deficit narrowed by 2.2 percent of GDP (from 9.5 to 7.3 percent of GDP), almost matching the cumulative decline of only 2.6 percent of GDP over the previous eight years (from 12.1 percent in 1986 to 9.5 percent of GDP in 1994). The primary surplus--which rose from 1.1 to 3.5 percent of GDP--fully accounted for the improvement in the overall balance, more than compensating for higher interest payments (Chart 1, left panels). 2/ A similar adjustment was realized at the general government level, indicating that the accounts of public entities outside the central government remained broadly unchanged (Chart 1, right panels).

CHART 1
CHART 1

ITALY Overall Balance, Primary Balance arid Interest Payment

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 035; 10.5089/9781451819694.002.A003

Sources: Ministry of Budget, Documento di programmozione economico-finanziaria 1995-97, and staff calculations.

This chapter contrasts Italy’s recent fiscal adjustment with that of earlier years; estimates the contribution of one-off measures and of higher-than-expected growth and inflation to the 1995 outcome; and briefly discusses the prospects for 1996-98.

1. Fiscal performance over the period 1986-95

One of the more welcome aspects of Italian fiscal adjustment has been the decisive shift from revenue-based adjustment from 1986 to 1993 to expenditure-based adjustment since then. Up to 1993, the improvement in the primary balance was entirely due to repeated revenue increases which in seven years raised the revenue-to-GDP ratio by about 5 percent of GDP at the state sector level and almost 9 percent of GDP at the general government level (Chart 2, middle panels). Over the same period, the primary expenditure-to-GDP ratio remained approximately constant at the state sector level while it kept rising at the general government level (Chart 2, bottom panels). 3/ In contrast, in the two years 1994-95, the primary expenditure-to-GDP ratio for both levels of government fell steeply (by almost 5 percent of GDP at the state sector level and by some 4 percent of GDP at the general government level), more than offsetting the decline in revenues--at least in 1995. The savings affected both capital and primary current spending; within the latter, the main declines were in the wage bill--with wage restraint and a freeze on hiring--and in purchases of goods and services--in part reflecting initial reforms in public administration; and, for the state sector, there were major reductions in transfers to local authorities and other public entities, including through cost-cutting in health care and the steps toward pension reform taken in 1992. This recent emphasis on expenditure reduction is particularly welcome in the light of international evidence suggesting that improvements in the fiscal balance tend to be permanent only when implemented via cuts in transfer programs and compensation of government employees. 1/

CHART 2
CHART 2

ITALY Revenue and Primary Expenditure

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 035; 10.5089/9781451819694.002.A003

Sources: Ministry of Budget, Documento di programmazione economico-finanziaria 1995-97, and staff calculations.

2. 1995 fiscal adjustment 2/

Fiscal performance in 1995 was noteworthy in recording an improvement on previous medium-term plan targets. As shown in Tables 1 and 2, targets for the overall balance have been missed regularly in recent years (with the sole exception of 1990), even though the objectives were made less ambitious with each successive plan. This underperformance was the result both of primary balances that fell short of their targets (from 1991 onward) and optimistic interest rate assumptions that led to under-estimates of interest payments in virtually every year. In contrast, in 1995, the outcome was not only better than the target of the 1995-97 plan but also improved on the more ambitious target of the 1994-96 plan. In addition, this result was achieved with a primary surplus 1.5 percent of GDP above target (3.5 percent against 2 percent of GDP), which more than compensated for the overrun in interest payments (10.8 percent against 10 percent of GDP).

Table 1.

Italy: Medium-Term Fiscal Plans

(State sector: in billions of lire)

article image
Source: Ministry of Budget, Documento di Programmazione Economico-Finanziaria, (DPEF), various years.
Table 2.

Italy: Medium-Term Fiscal Plans 1/

(State sector: in percent of GDP)

article image
Sources: Ministry of Budget, Documento di Programmazione Economico-Finanziaria, (DPEF), various years.

The ratios to GDP are based on officially-projected GDP for the targets and actual GDP for the outcomes.

To assess the underlying fiscal effort it is, however, necessary to take account of the contribution of one-off measures and of higher-than-expected growth and inflation. The 1995 budget included several one-off measures, notably on the revenue side: amnesties for illegal buildings and unpaid social security contributions, and new tax assessment procedures for 1989-93 self-employment incomes (concordato). In addition, relative to the macro-scenario underlying the budget, real GDP growth was higher than forecast both in 1994 (2.2 percent instead of 1.4 percent) and 1995 (an estimated 3.2 percent instead of 2.7 percent); and inflation was also higher than targeted--by a small margin in 1994 (3.9 percent versus 3.5 percent) and a larger one in 1995 (5.4 percent versus 2.5 percent).

Chart 3 presents two perspectives on the nature of the fiscal adjustment undertaken in 1995: one based on the change in the primary balance from 1994 to 1995 (left panel) and one based on the change relative to a current services baseline or tendenziale (right panel).

CHART 3
CHART 3

ITALY Fiscal Adjustment in 1995

(State sector, in percent of GDP)

Citation: IMF Staff Country Reports 1996, 035; 10.5089/9781451819694.002.A003

Sources: Ministry of Budget, Documento di programmazione economico-finanziaria 1995-97, and staff calculations.1/ In this and subsequent charts, the “expected outcome” is defined as the outcome that should have prevailed had the yield of the measures taken in 1995 been in line with initial official estimates, given higher-than-anticipated growth and inflation.

The left panel of Chart 3 breaks down the 2.4 percent of GDP adjustment in the primary balance between 1994 and 1995. Two-thirds of the improvement is attributable to higher-than-forecast growth and inflation (0.7 percent of GDP) 1/ and to one-off measures (0.9 percent of GDP), while only one-third is the estimated underlying adjustment (0.8 percent of GDP). 2/

In contrast, as in the authorities’ presentation, the right panel of Chart 3 shows the adjustment in manovra terms against the original current services projection (tendenziale). 3/ On this basis, the fiscal adjustment seems much larger, with an estimated yield of permanent measures of about 2.5 percent of GDP. However, most of these measures were needed only to avoid the deterioration of the tendenziale primary balance (estimated at 1.7 percent of GDP), that would have otherwise taken place as a result of the expiration of one-off measures taken in previous years as well as the trend weakness resulting from low assumed elasticity of some components of revenues. 4/ Thus much of the proposed fiscal adjustment in the authorities’ presentation involves treading water, with large ostensible effort required simply to stay in place. Clearly, this presentation standard in discussions of Italian fiscal policy overstates the extent of the economic adjustment. Barring agents’ expectations of fiscal backtracking along the lines of the tendenziale, the economic adjustsment and its effect on behavior is more realistically portrayed by the year-to-year change in the primary balance showed in the left panel. However, the size of the corrective package (manovra) announced each year, which is measured against the tendenziale undoubtedly has a political dimension and underlies indications of adjustment fatique.

The right panel of Chart 3 also indicates that, if the measures taken (in the 1995 budget and the March supplementary budget) had yielded as much as expected by the government (3.9 percent of GDP), the expected outcome--given the better-than-forecast macro-scenario--should have been a primary surplus of some 0.5 percent of GDP above that actually obtained. 5/

Chart 4 illustrates that the 0.5 percent of GDP shortfall of 1995 measures is the result of severe underperformance of revenue measures (revenues were 1.7 percent of GDP below the expected outcome) and strong over-performance of expenditure measures (primary expenditures were 1.2 percent of GDP below the expected outcome).

CHART 4
CHART 4

ITALY 1995 Fiscal Adjustment

(State sector, in percent of GDP)

Citation: IMF Staff Country Reports 1996, 035; 10.5089/9781451819694.002.A003

Sources: Ministry of Budget, Documento di programmazione economico-finanziaria 1995-97, and staff calculations.

Charts 5 through 8 provide a further breakdown of the 1995 result. Chart 5 shows that 1.1 percentage point of GDP of the revenue shortfall was attributable to lower-than-expected tax revenues; here, the underperformance of direct taxes was clearly the main culprit, while indirect taxes were almost in line with expectations. The key elements were probably the smaller-than-anticipated yield of the new tax assessment procedures (concordato) 1/ and the tax on interest income, given the slow growth of bank deposits. The remaining 0.6 percentage points of GDP of the shortfall can be ascribed to non-tax revenues, including, in particular, the smaller-than-expected yield of the tax amnesty on illicit buildings and lower-than-expected contributions to the public health system.

CHART 5
CHART 5

ITALY Revenues

(State sector, in percent of GD

Citation: IMF Staff Country Reports 1996, 035; 10.5089/9781451819694.002.A003

Sources: Ministry of Budget, Documento di programmazione economico-finanziaria 1995-97, and staff calculations.

Chart 6 (note differences in scale) shows that both primary current and capital expenditure measures over-performed. While the slowdown in capital expenditure was partly due to the effects of the scandals and the recent judicial investigations, which have delayed public works, the fall in primary current expenditure was particularly auspicious. The continued savings in the wage bill (Chart 7, top panel) were the result both of the hiring freeze and of a stringent incomes policy, which kept wage increases in line with the original inflation target of 2.5 percent, while actual inflation reached 5.4 percent. Purchases of goods and services (Chart 7, bottom panel) were hit by across-the-board cuts introduced in the March mini-budget. Transfers (Chart 7, middle panel) also declined: transfers to firms and to Municipalities and Provinces were smaller than expected, in part because of these entities’ inability to spend promptly the resources they were allocated, while transfers to Regions were as expected and those to social security institutions were larger than expected (Chart 8).

CHART 6
CHART 6

ITALY Primary Expenditure

(State sector, in percent of GDP)

Citation: IMF Staff Country Reports 1996, 035; 10.5089/9781451819694.002.A003

Sources: Ministry of Budget, Documento di programmozione eeonomico-finanziaria 1995-97, and staff calculations.
CHART 7
CHART 7

ITALY Primary Current Expenditure

(State sector, in percent of GDP)

Citation: IMF Staff Country Reports 1996, 035; 10.5089/9781451819694.002.A003

Sources: Ministry of Budget, Documento di programmazione economico-finanziaria 1995-97, and staff calculations.
CHART 8
CHART 8

ITALY Transfers

(State sector, in percent of GDP)

Citation: IMF Staff Country Reports 1996, 035; 10.5089/9781451819694.002.A003

Sources: Ministry of Budget, Documento di programmazione economico-finanziaria 1995-97, end staff calculations.

In sum, while the almost 2½ percentage point of GDP improvement of the state sector primary balance in 1995 was substantial and unprecedented in Italy, it was due in large part to one-off measures and higher-than-forecast growth and inflation. In addition, revenue performance was somewhat unsatisfactory but compensated by larger-than-planned expenditure savings. This emphasis on expenditure reduction is welcome, and marks a turning point in the recent history of Italian fiscal adjustment. There is now a need to consolidate the positive results of 1995 by reducing recourse to one-off measures and introducing measures with a reliable yield.

3. Prospects for 1996-98

Chart 9 briefly summarizes the prospects for 1996-98 by contrasting the government’s medium-term plan with the official current services projection before the 1996 budget and the staff’s current services projection after the 1996 budget. The yield of the measures planned by the government is represented by the gap between the government’s targets and its current services projection. The staff’s current services projections are derived by correcting the government’s tendenziale for the different macro-economic scenario and the measures included in the 1996 budget net of slippages expected by the staff (i.e., divergences between staff and official budget projections of their yields).

CHART 9
CHART 9

ITALY Medium–Term Prospects

(State sector, in percent of GDP)

Citation: IMF Staff Country Reports 1996, 035; 10.5089/9781451819694.002.A003

Sources: Ministry of Budget, Documento di programmazione economico-finanziaria 1995-97, end staff calculations.

The top panel of Chart 9 shows that, after taking into account the different macro-scenario and the slippages, the 1996 primary balance is expected by the staff to be only marginally below target. 1/ However, in the absence of additional measures, the primary balance is expected to deteriorate once again, returning in 1998 to close to its 1995 level, largely as a result of expiring one-off measures. In the authorities’ plans, this deterioration would be offset through additional measures that would raise the primary surplus to 6 percent of GDP by 1998.

The middle and bottom panels of Chart 9 clearly show how the authorities’ plans have been overtaken by events, notably the 1995 results. The ratio of primary expenditure to GDP in 1995 was already below the target for 1996 (bottom panel), while 1995 revenues were weaker than the 1996 current services projection (middle panel). If the revenue and primary expenditure-to-GDP ratios in the plan were left unchanged, most future measures would have to be taken on revenues, since it is on that side that there is the largest gap between the plan’s targets and the staff’s current services projection.

References

Chapter III

  • Alesina, A. and R., Perotti (1995), “Fiscal Expansions and Adjustments in OECD Countries”, Economic Policy (October).

  • Italy, Ministry of Budget, Documento di Programmazione economico-finanziaria, various years, Rome: Ministry of Budget.

1/

Prepared by Alessandro Prati.

2/

The data in this chapter may differ slightly from those included in the staff report, reflecting information received after its issuance. However, not all the data in this chapter are final: at the time of writing, official figures were available only for the overall balance and the primary balance of the state sector; as a consequence, all general government figures and the breakdown of the primary balance of the state sector into its revenue and expenditure components are staff estimates.

3/

The different behavior of revenues and expenditures in the two definitions of government is explained by the fact that revenues of entities outside the central government (such as social security contributions and local taxes) appear as lower expenditures at the state sector level (i.e., lower transfers to public institutions outside the state sector).

2/

The analysis of this section is limited to the state sector definition of government since it is the one to which all medium-term plans and official current services projections usually refer. Targets for the general government were also included for the first time in the most recent three-year plan presented in the Documento di Programmazione Eonomico-Finanziaria 1996-98, issued in May 1995.

1/

The macro-effect has been estimated by the staff on the basis of elasticities of state sector revenues and of expenditures to GDP growth and inflation provided by the Ministry of the Treasury (Ragioneria Generale dello Stato) during the 1994 Article IV Consultation.

2/

It should be noted, however, that the figures for 1995 do not show the effects of an important structural measure taken in the course of the year, i.e., the reform of the pension system, which became effective as of January 1, 1996 (see Chapter IV).

3/

The current services projection (tendenziale) was formulated in July 1994 before approval of the 1995 budget; it corresponds to the outcome expected at that time given existing legislation and the macro-assumptions of the medium-term plan (Documento di Programmazione Economico-Finanziaria 1995-97).

4/

For instance, excise tax rates are assumed to be fixed in nominal terms.

5/

The expected outcome is calculated by adding to the original tendenziale corrected for the better-than-forecast macro, the yield of the measures indicated in the government’s documents. Note that this estimate should be interpreted with caution since it is affected by possible errors in the original tendenziale or in the elasticities used to derive the ex-post current services. For example, it is certain that part of the shortfall in revenues was due to a growth of bank deposits lower than assumed in the tendenziale. However, for simplicity, in the rest of the chapter we will refer to the difference between the expected outcome and the actual outcome as “shortfall.”

1/

Although the final outcome was in line with the revised estimate of Lit 7 trillion, the original budget was significantly higher (Lit 11.5 trillion).

1/

However, a larger shortfall is expected on the overall balance because of an expected overrun of interest payments. Note that Chart 9 refers to the state sector. As a consequence, the shortfall projected by the staff in 1996 (the gap between the government’s target and the staff current services) is smaller than the one shown in Chart 10 of the staff report, which refers to the general government. In fact, some additional expenditures not accounted for in the budget (back payments under the Constitutional Court sentence on pensions and postponement of tax refunds initially planned for 1995) are recorded below the line in the state sector accounts, while they contribute to the total expenditure and therefore to the deficit in the general government accounts, to which Maastricht criteria refer.

Italy: Background Economic Issues
Author: International Monetary Fund