VoxEU Column Politics and economics

Three challenges for Silvio IV

Berlusconi’s new government faces tough economic challenges. Here one of Italy’s leading economists highlights three concerns the government must tackle in its first year: fiscal federalism, electoral reform, and curbing tax evasion.

The new Italian Cabinet, the 4th Berlusconi Government, is simultaneously strong and weak. It is strong because the Government has solid majorities in both the House and Senate and the supporting coalition is less fragmented than in previous Berlusconi cabinets. It is weak because the Government is starting off with relatively low popular support and no honeymoon with voters. Italians voted more against the Prodi Government than in favour of a new Berlusconi cabinet. They are rightly sick and tired with a political class that has been successful in increasing its own wages (+10% per year in the last 50 years compared with 2-3 per cent for average Italians) rather than addressing the structural impediments to growth in Italy. Fiscal federalism, the electoral law, and the fight against tax evasion are going to be the three most important challenges of the first year of the new Government.

The first challenge concerns fiscal federalism. The real winners in the elections were two local movements gathered in the Berlusconi coalition – the Northern League and the Movement for the Autonomy (of Sicily). The House and Senate majorities depend on them. The Northern League calls for fiscal federalism preventing public money from going south: in its plans, 90 percent of tax revenues must stay in the areas that generate them. On the other hand, the Movement for Autonomy wants revenues from oil refined on the island (no matter where it is sold!) to go to Sicily. Berlusconi’s party (PDL, Popolo delle Libertà) endorses a bill recently voted by the Lombardia Region that keeps 80 percent of the revenues from the value added tax in the region where it is generated, along with 15 percent of the income tax and the entire revenues from taxes on oil, tobacco and gambling. At the same time, the bill devolves a number of programmes currently funded by the State to local administrations, placing very low caps on redistribution across regions. If this law were to be adopted nationwide, there would be entire regions without sufficient resources to pay school teachers. Italy badly needs fiscal federalism, but it also has to cut public spending, which has been growing faster than GDP, notably at the local level. By making local governments fiscally responsible, one could possibly reconcile these two goals, as there would be a political sanction for those local administrations running large deficits. However, the first Cabinet meeting (planned for May 21st in Naples) will completely wipe out the property tax on housing, the only real local tax that exists. In this context, there is a high risk that the Italian path to fiscal federalism will continue to be based on a decentralisation of spending capacity and a centralisation of tax revenues. This is a recipe for losing control over local spending, as voters do not consider regional administrations liable for the taxes they pay.

The second challenge concerns the electoral law. Within a year, there will be a referendum on it. The current law is based on a complex combination of blocked lists decided by party leaders, proportional rules, and regional thresholds (eight percent of the votes in the case of the Senate) against fragmentation. The system is working very well for relatively small parties with a locally concentrated constituency, such as the Northern League. Indeed, the Northern League wants this system to be preserved and will fight hard to prevent the referendum. However, Italians want to decide who should sit in Parliament by choosing candidates in addition to parties. They don’t intend to sign any more blank checks over to party leaders. Polls conducted after the vote show that 2/3 of Italians want to change the electoral law. And large parties would gain by adopting a majoritarian system.

It would be suicide for the new government to trash the remarkable results obtained by the Prodi Government in reducing tax evasion. It is estimated that increasing the tax based raised as much as €20 billion. This is the third difficult challenge facing the new Government. It won’t be easy to give Italians a sign other than fiscal laxity with Giulio Tremonti, the champion of fiscal amnesties, in charge. The tradition of the Berlusconi cabinets has always been one of declining tax revenues even at unchanged tax rates. The first steps of the new Government are not encouraging in this respect. The fiscal measures, to be passed on May 21st, allow for a reduced tax rate for the variable components of wages (bonuses, performance related pay, overtime pay). It is a good idea to cut taxes on labour as the marginal tax rate for the average worker is about 60 percent. But when tax asymmetries are so large (the variable wage will be taxed at 10 percent), there are strong incentives for employers and their workers to collude in transforming fixed into variable pay. A more reasonable approach would be to increase tax deductions for all employees, independent of working hours and productivity-related pay.

Editors’ note: An edited version of this appeared in the Financial Times, 21 May 2008.