Italian Populists Fight Over Tax-Cut Plan That May Well Fail

(Bloomberg) --

Italy’s populist government is struggling to reach agreement on a tax-reduction plan that could extend the country’s indebtedness and lead to another clash with the European Union.

Through a “flat-tax” program that would probably reduce revenue at least in the first year, the ruling coalition is trying to square the circle of stimulating growth while keeping its perilous finances from weakening further.

The leaders can justify trying to do the former since taxation in Italy is among the highest in Europe. But pushing out the deficit could lead to another round of fighting with the EU. Just this week, European Commission Vice President Valdis Dombrovskis urged the government to review its fiscal position.

“The flat tax is the main item the coalition believes will stimulate the economy and please the electorate,” said Raffaella Tenconi, founder of London-based consultancy ADA Economics. “Bringing it back to the front page is needed for political reasons as well as being part of the budget process and the negotiations with Brussels.”

Italian Populists Fight Over Tax-Cut Plan That May Well Fail

The Five Star Movement and the League agreed to the plan as part of their coalition deal in 2018. Deputy premier and League leader Matteo Salvini says a partial implementation will cost between 12 billion euros ($14 billion) and 15 billion euros in next year’s budget. Other estimates in the Italian news media are much higher.

Salvini Ahead

Already powering ahead in polls, Salvini may be using the flat tax to cement his popularity with voters before European Parliament elections in May. He may also have one eye on a national vote, with some saying Italy’s government may not last much longer.

“Though this was part of the coalition’s program, the government has so far failed to deliver,” said Federico Santi, a political analyst at Eurasia Group in London. “It could also be seen as a move by Salvini to lay the groundwork for a government collapse and new elections, aware of the fact that the government cannot deliver a tax reform on the scale he has advertised.”

The plan envisions eventually moving to two income tax rates, one at 15 percent and the other at 20 percent for both companies and individuals. The government refers to the two-tier system as a “flat tax” plan, using the English-language term.

Romania, Slovakia

Radical tax-cut measures implemented in other EU nations may be of little guidance for Italy given the size of its huge public debt and an economy that slipped into recession at the end of last year. Still, two European countries -- Slovakia and Romania with its low tax revenue as a ratio of GDP -- have had such measures and saw tax revenue increase.

Italian Populists Fight Over Tax-Cut Plan That May Well Fail

Slovakia introduced a 19 percent rate in 2004 that helped attract foreign investment. The new levy coincided with its EU membership, which also helped. In 2012 the flat tax regime was revised and higher rates were introduced.

Italian Populists Fight Over Tax-Cut Plan That May Well Fail

Weaker-than-forecast output already hinders Italy’s ability to meet its budget commitments that were made to the European Commission last December after lengthy talks on a revised spending plan for this year.

Tax Evaders

Part of the success of Italy’s tax cut plan also hinges on the perennial dream of squeezing more money out of tax evaders, though officials acknowledge the 19 billion euros they raised from cheaters last year was down from 2017.

Italian Populists Fight Over Tax-Cut Plan That May Well Fail

Finance Minister Giovanni Tria said this week that his experts have been assessing several options for flat-rate regimes.

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