Italy: Fiscal Consolidation and its Legacy

Abstract

Balassone, Franco, Momigliano and Monacelli examine the process of fiscal consolidation in Italy during the Nineties. They highlight its success in reversing a trend that could have led to public debt default, and in ensuring the early participation of Italy to monetary union. The authors argue that some features of the process may have amplified its costs and may have left the country with a difficult legacy. The adjustment relied on significant tax increases, capital spending reductions and the rationing of transfers to local governments. Balassone et al. examine the reforms introduced in the pension system in order to contain expenditure growth, reducing distortions in the labour market and increasing the role of funding. They acknowledge that much has been achieved but point to some aspects that still remain problematic. They also analyse the changes introduced in the tax system and highlight the persistent contrast between the need to maximise revenue and that of minimising distortions. According to the authors, there is now a need to shift the focus of fiscal policy from the arithmetic to the microeconomics of fiscal sustainability. Sustaining high taxes and low investment may become difficult as the integration of the Single European Market goes further. Allowing for a lower tax burden, while complying with EMU fiscal rules, calls for expenditure control, a task made more difficult by the upward pressure on outlays exerted by the ageing process. Balassone et al. note that the current trend towards greater autonomy for local governments may require significant institutional engineering to ensure consistency with EMU fiscal rules. More generally, existing budgetary procedures and institutions will have to be reconsidered. Finally, with EMU macroeconomic stabilisation regains importance, while during the Nineties it was not the main focus of fiscal policy. Budgetary targets should allow sufficient room for manoeuvre. Size and quality of automatic stabilisers will have to be reconsidered.