THE ITALIAN government’s decision last week to cut income tax on low and middle earners is a shrewd move to demonstrate that budget consolidation leaves open options on how it is delivered.
Balanced by other tax measures such as an increase in VAT and by cuts in expenditure, it reflects the political pressures on the government led by Mario Monti. As an interim prime minister he does not face elections next year, but the parties supporting him do and are already adopting political positions to prepare for them. They are critical of many of these budget measures, decided after a marathon cabinet meeting.
In truth, the gesture made to maintaining demand in the Italian economy by cutting taxes – which were last year sharply increased – is not sufficient to stop it contracting by an estimated 2.4 per cent this year under the weight of overall austerity.
That may flatten out in the year to come, and the markets have so far read Mr Monti’s strategy favourably, after a recent bond sale proceeded smoothly at affordable rates. He allowed himself some credit by saying Italy is seeing the tangible effects of rigid budget discipline.
But as an economist he knows well the severe effects of enduring austerity on fragile economies. Too much of it kills activity, restricts demand and ends up making the recession deeper.
Mr Monti is not opposed to budgetary consolidation and debt reduction, part of his mandate when appointed to succeed Silvio Berlusconi 11 months ago. As a highly experienced European official, he knows deep structural changes are required at EU level to save the euro and stimulate European economies by making them more competitive and open. He favours mutualising debt through eurobonds and supports the European Central Bank’s recent plan to buy bank bonds.
This makes Mr Monti an ally of the Government in Dublin in its campaign to separate sovereign from bank debt and to see that applied to legacy debts in Ireland as was agreed last June, but which is now disputed by Germany, Finland and the Netherlands.
The issue will be discussed at this week’s EU summit meeting in Brussels where bruising arguments are expected between creditor and debtor states. Italy is a key player in this high stakes political game. Mr Monti deserves support for his readiness to think and act strategically as it intensifies. A great deal hangs on the outcome for all Europeans.