Fisher Investments Editorial Staff
Deficits, Developed Markets

Technoplans From Italy’s Technocrats

By, 12/06/2011

Italy took a step forward on Sunday when Prime Minister Mario Monti unveiled his “decree to save Italy”: A new three-year, €30 billion austerity package. Italy already runs a primary budget surplus (tax revenue exceeds all expenses except debt interest payments), and Monti’s cabinet believes these measures put Italy on track for a fully balanced budget by 2013.

Among the planned €17 billion in revenue enhancements are higher property taxes. The controversial wealth tax was absent, but wealthy folks will get hit with new surtaxes on owning or storing yachts, private aircraft and luxury/sports cars. There’s also a one-time, retroactive 1.5% tax on all funds repatriated under Silvio Berlusconi’s tax amnesty, when assets off-shored to avoid income tax moved home with a 5% fee, but no back taxes due. Monti’s plan also combats tax evasion through several measures. First, the limit on cash transactions will fall from €2,500 to €1,000, with the goal of reducing unreported (and untaxed) payments, and businesses whose revenues are documented through full paper trails will receive tax incentives. And if long-delayed, much-debated welfare reforms don’t come to fruition, the value-added tax will increase by two percentage points in 2012 and another 50 basis points in 2014.

Much of the €13 billion in spending cuts was pension reforms. The retirement age for full pension collection will rise to 66 by 2018. And anyone whose monthly pension income is more than twice the current minimum—around €950 in today’s euro—will no longer get inflation-adjusted increases over time. Instead, their incomes will be frozen at current levels. As a goodwill gesture, Monti is also waiving his personal salary. (We don’t think he’s evading Italian taxes, just trying to score some political points.)

The package also includes pro-growth measures. €2 billion in tax breaks are earmarked for companies that hire more women and young workers (youth unemployment is 29%). Additional funds are slated for infrastructure development, fuel distribution improvements, liberalizing domestic commerce and increased lending to small-to-medium businesses. The effects of these likely won’t be felt in the near term, given Italy’s GDP is expected to contract a bit in 2012 and be flat in 2013, but over time, they could help improve Italy’s competitiveness. As could labor market reforms due in a few weeks.

Parliament expects to vote on these before Christmas, and the package appears to have support. The leader of former Prime Minister Silvio Berlusconi’s People of Freedom Party, which still has a plurality, indicated a “harsh plan today” was likely preferable to “the risk of bankruptcy” tomorrow. Though, given some popular opposition to some measures—particularly the pension reforms—we wouldn’t be surprised if there’s some grandstanding by politicians trying to curry favor ahead of the next election.

Perhaps partly in response to Monti’s package, Italian 10-year debt yields continued falling Monday—and are now below 6% on the secondary market. When yields were near 8%, many feared Italy’s debt costs would skyrocket when a sizeable chunk rolls over in early 2012. Though, in our view, this risk was somewhat overstated, lower costs today decrease the likelihood Italy’s debt service burden becomes unmanageable. Of course, yields could easily reverse course, so just as one shouldn’t have extrapolated higher rates forward and sounded the alarm, one shouldn’t assume rates keep falling and sound the all-clear.

But recently falling rates do seemingly allude to market confidence in Monti’s ability to pass and enact tough reforms. That’s not to say these measures are all Italy will need or are all good ideas. However, they are serious reforms, signaling the government understands austerity is imperative and will make every effort to see it through. 

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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