Prodi and Padoa Schioppa are divided on tax cuts

In response to demands from the radical
left, prime minister Romano Prodi has now promised income tax cuts for
low-income families. However, his economy minister Tommaso Padoa Schioppa has
immediately put the brakes on Prodi’s plans and declared that the government
does not have the resources to cut taxes at the moment. The Italian tax burden
increased dramatically in 2006/2007 but no truly decisive push in national debt
reduction has occurred.

Prodi told the party leaders of his
coalition that 2008 will be a year of tax cuts for those with low incomes and
that by March details would be announced. In response to Prodi’s announcement,
Padoa Schioppa made clear that currently the government cannot afford to loosen
fiscal policy and that it will only be able to examine the possibility of tax
cuts after June. This would mean that concrete measures could only be announced
in the second half of the year and take effect in 2009 or possibly 2010.

The cause for the disagreement between
Prodi and Padoa Schioppa seems to be that the latter regards the reduction of
the budget deficit as the highest priority of the government whereas Prodi
tries primarily to keep his coalition together by satisfying the wishes of the
communists. He also believes that the tax cuts can be paid for by so far
unspecified cuts in public spending and a continued battle against tax evasion.

However, it is uncertain whether the fight
against tax evasion will produce any further gains in government revenue. The
tax burden has already risen to ca. 43 per cent of GDP partly due to the
government’s policy of tightening the supervision of money flows. But the
additional revenue has mainly been used to increase public spending with a
minor portion going to the reduction of the budget deficit. The focus on
fighting tax evasion combined with the lack of tax cuts elsewhere in the budget
and the sluggish growth in wages has substantially damaged the purchasing power
of most Italians in 2007. If Prodi really does manage to extract still more
money from the fight against tax evasion, this will further squeeze the
economy.

It is here that the government’s plans do
not add up. In principle, the idea to fight tax evasion and in turn decrease
tax rates can of course be welcomed. However, the government does not intend to
leave more money in the pockets of the people as such. It concentrates on
low-income families because this is the demand of the far left. Such a policy
ignores a great number of income earners whose puchasing power also needs a
push to strengthen domestic consumption and, crucially, fails to address the
level of business taxation which is among the highest in Europe crippling
investment. In fact, the communists’ notion that Italy’s main challenge is to
distribute wealth and not to create growth has led to a proposal of increasing
taxes on financial earnings at a tme when the stock market is experiencing
great uncertainty.

Prodi’s announcement should therefore not
be seen as a long-term strategy to relaunch the economy through a policy of
alleviating fiscal pressure. It is a concession to those parts of the coalition
who have no interest in boosting growth, productivity and investment and who
narrowly focus on the concept of redistribution as the answer to all Italian
problems. If Prodi and Padoa Schioppa eventually settle their disagreement and
the proposed tax cuts take effect they will lead either to another increase in
taxation for those not on low incomes or further undermine the ambition to reduce
national debt.