The interaction between the labour tax wedge and structural reforms in Italy

Abstract

We present a quantitative analysis of Italian fiscal and structural reforms using the Prometeia Dynamic Stochastic General Equilibrium (DSGE) model to identify the optimal reform mix to boost growth and employment. We find that structural reforms via a reduction in price and wage markups and a labour tax wedge cut can provide a strong stimulus to the economy by increasing GDP and employment levels. The balanced budget constraint shows that to offset the decreased revenue due to the labour wedge cut, a reduction in public lump-sum transfers or a tax shift from labour to consumption or property is preferred over a cut in public spending on goods and services. Conversely, under simultaneous fiscal and structural reforms, the best payoff would be obtained from an expansion to public spending. Finally, we find that public investment works to magnify this effect in the long run.