The cabinet of PM Giorgia Meloni stepped into office on Oct 27 amidst a protracted energy crisis and into a slowing economy, promising to cut taxes, improve business conditions, overhaul the safety net system and avoid a sharp increase in the retirement age. While Budget 2023 touches upon most of the pledges made by the centre-right coalition ahead of the elections, it does so sparingly, acknowledging the narrow fiscal space within which the government has to operate. As a result, most of the deviation from earlier announced fiscal targets is due to reactionary spending related to the energy crisis rather than structural policy efforts.
Straightforward comparisons between the Draft Budgetary Plan (DBP) submitted by the cabinet of PM Mario Draghi in early October and the budget law presented by Meloni's government are ill-advised, in our view. The original DBP was based on a "no-policy-change" scenario which even excluded the provision of energy aid as of mid-November (while leaving the incoming cabinet some room within which to operate). It also contained more favourable forecasts as far as the general macroeconomic environment, inflation and the government's financing conditions are concerned. Furthermore, it was only natural to expect that a new government will want to push some of its policy ideas through the first budget approved under its watch, despite the limited time and resources at its disposal.
Following a stronger-than-expected expansion in the first three quarters of 2022, the government forecasts a slight q/q decline of GDP in Q4 2022 and Q1 2023, characterised by lower GVA in the industrial sector and a further slowdown of service sector activity growth. Net exports should remain a drag on growth over the next few quarters. Even though the external goods trade deficit is likely to have peaked in Q3, the current account balance is not projected to return to a surplus before 2025.
The government still expects positive GDP growth of 0.6% in 2023, with household consumption growth and investment remaining the main factors keeping the economy above water. The updated no-policy-change scenario foresees softer real GDP growth of 0.3%, which means that the cabinet believes that the measures included in the budget will double the rate of economic growth. GDP growth will then pick up to 1.9% in 2024, before easing to 1.3% in 2025.
The continuation of energy aid measures and the shift of the annual headline CPI comparison to higher base values in early 2023 should mean that consumer price growth is close to peaking. The government expects core inflation to continue heading higher for a little while longer due to the delay in the transmission of energy and wage cost pressures into the broader basket of goods and services. Both indices are projected to assume a more steady downward trend later on in 2023.
The timely implementation of the National Recovery and Resilience Plan (NRRP) remains a key prerequisite for safeguarding not only short-term GDP growth but also the medium-long-term prospects of improving productivity. The centre-right coalition threatened to rewrite the NRRP on several occasions prior to the elections but has now dialled back its criticism of Draghi's agenda and only intends to potentially seek EC approval for small modifications that reflect the impact of the energy crisis and inflation on the economy's needs. We do not expect the NRRP to be a point of contention between Brussels and Rome, as the Italian government cannot afford to miss milestones and deadlines if it wants to ensure the much-needed timely flow of NGEU funds into the economy. The marked deterioration of the financing conditions of EU governments has already prompted even countries such as Spain which initially did not apply for their allotted low-interest loans package to reconsider its importance.
The continued (if moderate) decline in unemployment to 7.9% in 2023 is one of the more favourable assumptions of the government's macroeconomic forecast. Seeing as the labour market already entered a soft patch in Q3, we would argue that the latest 2023 forecasts of the Bank of Italy (8.3%), the EC (8.7%) and the OECD (8.3%) are much more grounded, even if we assume that the latest round of energy measures is sufficient to guarantee only a mild and short technical recession in Q4 2022-Q1 2023.
Softening the adverse impact of high energy prices on household consumption patterns may very well be achieved through the measures adopted but the government's projections evidently do not account for the fiscal impact of a feasible 0.3-0.5pps increase in annual average unemployment. The lack of an adverse macroeconomic scenario forecast (as the one developed by the cabinet of PM Mario Draghi) deserves to be noted in the present highly uncertain environment. Finally, we believe that discretionary spending pressures will likely remain elevated throughout 2023 as a number of sectors line up for help from the government and also as a consequence of the foreseeable efforts of the new Minister of Infrastructure Matteo Salvini to reclaim some of his lost personal popularity in recent years.
Shortly after assuming power, the cabinet of Giorgia Meloni reinstated the original annual general government deficit target of 5.6% of GDP for 2022. It also raised next year's target to 4.5% from the 3.4% forecasted in the no-policy-change scenario drafted by the previous government. In both cases, the main driver behind the increase in expenditures is the government's effort to mitigate the impact of high energy prices on businesses and households. The new deficit consolidation path maintains a moderate downward trend to 3.7% in 2024 and 3.0% in 2025. If the nominal growth forecasts of the administration come to pass, the tax burden is expected to decline from 43.8% of GDP in 2022 to 42.5% of GDP in 2025, which could allow it more room for manoeuvre towards the end of the period.
According to the latest macroeconomic forecast and the programmatic scenario of the Update to the Economic and Financial Document (NADEF), the general government debt/GDP ratio will remain on a moderate downward trend, shrinking to 142.3% at end-2024 (from a previous projection of 140.9%). The primary balance will remain negative in 2023, before turning to a marginal surplus of 0.2% of GDP in 2024.
The improvement in most metrics remains subject to cyclical factors, which is why there are some concerns regarding the feasibility of the government's forecasts. In the context of a slowing economy, revenue growth may not be able to keep up with spending pressures, especially in the case of a more pronounced labour market downturn. This is why we view medium-term risks as tilted to the downside, as far as both the achievement of the fiscal targets and the forecasted rate of decline of the debt/GDP ratio. A scenario in which interest rates stay higher for longer will further narrow the government's fiscal space as debt service costs will continue mounting, stabilizing above 4% of GDP and hurting prospects for the implementation of wider-reaching tax reforms.
The 2023 Budget foresees a higher interest expense forecast than the DBP submitted by the cabinet of Mario Draghi to the EC in September, reflective of the more hawkish stance of the European Central Bank (ECB) and the expectation that rates may have to remain higher for a longer period. Recent signals from the central bank suggest that rate hikes may be softened at some point in the near future, especially if the EU economy shows signs of entering a deeper-than-anticipated recession. In the absence of a clear shift, the centre-right cabinet headed by Meloni expects interest spending to rise by about EUR 3.6bn in 2023, EUR 2.6bn in 2024 and EUR 4.7bn in 2025.
The measures included in the budget constitute a fiscal adjustment of EUR 35bn, mostly targeted at cushioning the impact of high energy prices (about EUR 21bn). Some 60% of this will be covered by additional deficit spending, bringing the 2023 general govt deficit/GDP ratio to 4.5% rather than the 3.4% indicated by the no-policy-change scenario submitted by the former cabinet to the EC. The remaining EUR 14bn will come from higher tax revenues (including the amended tax on energy companies) and savings from the citizenship income scheme and the building renovation schemes.
About two-thirds of the EUR 35bn fiscal adjustment carried out with the budget accounts for the continuation of energy support measures over Q1 2023, in a bid to shore up consumption and protect the international competitiveness of domestic businesses in the face of similar measures adopted throughout the EU. This includes extending and increasing the tax credits for energy-intensive companies and maintaining the 5% VAT on gas bills introduced a month ago. The gasoline and diesel fuel discount is cut to 18 euro cents per litre for private persons, allowing transport professionals to continue using the full amount of 30 euro cents. Finally, the direct aid package for households (focuses on the more vulnerable part of the population) is the most expensive one, accounting for about EUR 9bn of the intervention. These measures are in addition to the EUR 9bn package approved by the cabinet on Nov 10.
Despite the ambitious tax reform agenda promoted by the centre-right coalition, the 2023 Budget pencils in only mild tax cuts, respecting the narrow fiscal space remaining after accounting for the extension of energy aid measures. The ceiling of the 15% flat income tax rate for the self-employed rises from EUR 65k to EUR 85k and the tax wedge on labour for low-medium income earners [those earning below EUR 1,540 per month] is cut by 2pps, which should leave an additional EUR 4.2bn in the hands of Italian workers. The cut will rise to 3pps in 2024. Business lobbies have been pushing for a reduction in the tax wedge on labour that also benefits firms but it does not seem like the cabinet is ready to agree to this as part of the current budget procedure. However, some cabinet members have called for further discussions with regard to the actual income tax brackets in Parliament.
Arguably the main item on the centre-right cabinet's agenda, the introduction of an incremental flat income tax, is left out of this year's tax adjustments as far as the employed are concerned. However, self-employed persons who invoice more than EUR 100k per year will benefit from a similar system in a de-facto test of the broader incremental flat tax income reform championed by FdI. In addition, annual productivity bonuses of up to EUR 3,000 will be taxed at 5%.
Looking at indirect taxes, the budget cuts the applicable VAT on baby-care products, car seats for children and female intimate hygiene products from 10% to 5% but stops short of adding basic foods to the list. Among the less impactful tax changes are the introduction of a flat 5% levy on taxable income from tips and a gradual increase in excise duties on cigarettes spanning over the period 2023-2025 and starting from next year. The budget law also offers amnesties on obligations up to EUR 1,000 incurred in the period 2000-2015.
On the revenue side, the government initially intended to raise the windfall tax on energy companies to 35% (from 25% currently) and to calculate it on profits, rather than revenues, in an effort to increase compliance and collections. A later draft showed a one-off 50% tax on excess profits, which according to a statement made by PM Giorgia Meloni, will raise about EUR 2.6bn in 2023. The budget law also introduces a 14% novelty tax on capital gains from trading cryptocurrencies that exceed EUR 2,000 per year.
Finally, the entry into force of the taxes on disposable plastic products and sugary drinks is postponed until 2024. Both taxes were originally conceived by the M5S-PD cabinet as part of the 2020 Budget but are yet to be implemented. The two taxes were expected to bring in about EUR 1.5bn per annum in their original form which was later watered down by exceptions and amendments to about EUR 500mn. As things stand, we believe that both taxes will go through one more overhaul before they are potentially implemented in 2024, as all of the centre-right parties opposed them on previous occasions.
The inflation-indexation mechanism of the pension system has been and will continue to be one of the main obstacles to the consolidation efforts of Italian governments going forward. Due to high inflation, the annual pension payments bill is projected to rise by a total of EUR 47bn in 2023-2025 with the sharpest increase of EUR 21bn expected in 2023. In comparison, MinFin Giancarlo Giorgetti recently told parliament that the projected growth of annual general government revenues over the same period is below EUR 20bn.
As regards the 2023 Budget, the cabinet ultimately settled on the quota 103 proposal, which allows workers to retire aged 62, as long as they have 41 years of paid contributions. Last year's early retirement scheme (quota 102) required a minimum age of 64 with 38 years of paid contributions. Citizens who continue working after fulfilling the terms of the early retirement scheme will benefit from a 10% cut in contributions. It is estimated that about 50k Italians will be able to retire under these conditions in 2023 for a total cost of EUR 750mn.
The proposed formula is yet another "bridge" solution looking ahead to a more comprehensive pension reform, potentially in 2023. Seeing as the inflation-adjustment of pensions is not something which the centre-right cabinet (or any other cabinet for that matter) has shown interest in suspending, increasing the effective retirement age is the main tool that the government has at its disposal to better balance the system. However, one of the key issues to be debated in Parliament with regard to the adjustment of pensions is the proposed gradual cut in the reevaluation coefficient for the highest pensions (those over EUR 2.1k).
Overhauling the citizenship income scheme was one of the clearly stated goals of the centre-right coalition heading into the elections. To begin with, the government will try to free up funds in 2023 (of about EUR 700mn and up to EUR 1bn by some estimates) by tightening conditions for the receipt of citizenship income for able-bodied workers who will lose access after 8 months. By all accounts, 2023 will be a transitional year for the basic income scheme, which will likely be abolished altogether in 2024.
The Five Star Movement (M5S) has already announced "permanent protests" against the decision and will seek to capitalize on popular support for the scheme, stemming mainly from the families of its beneficiaries. While the centre-right coalition has a sufficient majority to repeal the basic income scheme, there does not seem to be a full agreement between the parties on the best way to proceed. Thus, the texts contained in the budget law may yet be altered in Parliament.
The reform of the building renovation scheme known as the "Superbonus" is the main means by which the government will seek to limit its expenditure. The reduction of the bonus rate from 110% to 90% is expected to save some EUR 4.5bn in 2023, assuming a 20% decline in applications. During the presentation of the budget, Economy Minister Giancarlo Giorgetti said that due to the higher cost of building materials expenditures would have ballooned by an additional EUR 8bn per year if the scheme was left to run unchecked. The government's decision to cut the financing of the Superbonus scheme will have an adverse impact on construction sector activity growth. However, the cabinet's intentions were signalled well in advance, which is why the shock for the sector should not be too sudden and sentiment indicators suggest that companies may have already planned for such a scenario.
The cash payment ceiling is increased to EUR 5,000. It was supposed to decline to EUR 1,000 as a means of encouraging digital transactions in an effort to combat the shadow economy. Critics of the proposal argue that illicit payments will increase, potentially hurting government revenues and allowing the spread of competition malpractices. In addition, businesses will no longer be obliged to have POS terminals if they only deal with small transactions, with the new ceiling after which a terminal is required rising to EUR 60.
The budget allocates an additional EUR 2bn to the healthcare system, mainly for covering higher energy bills but also for the purchase of COVID-19 vaccines and drugs (for a total of EUR 650mn).
The 2023 Budget introduces bonuses for hiring workers on a permanent contract with an emphasis on women aged under 36 and citizenship income recipients. It also extends the home purchase incentives introduced by the government of PM Mario Draghi, strengthening the guarantee fund for first homes by EUR 430mn.
Family-related policies are worth a total of EUR 1.5bn (including the VAT cuts for children's products) and include a 50% increase in the universal childcare allowance for the first year of the life of the child, while for families with 3 or more children the monthly allowance will be doubled to EUR 200 per child.
The Stretto di Messina company (currently in liquidation) will be relaunched with the aim of restarting the project for the construction of the bridge over the Strait of Messina. Infrastructure Minister Matteo Salvini has already indicated that the government will seek EU funding, which is why we do not expect that any tangible progress will be made in the short term, if at all. Salvini estimated the total cost of the project at about EUR 10bn, stating that it will create some 50k-100k jobs and that it will pay for itself in about 18 months.
Finally, the SME guarantee fund has been refinanced with EUR 1bn and a total of EUR 400mn have been allocated for works related to the 2026 Winter Olympic games in Milan-Cortina.
Overall, Budget 2023 seeks to primarily alleviate the impact of high inflation on households and to safeguard the competitiveness of Italian businesses in an environment in which a number of EU governments have deployed fiscal tools to shield their own economies against high energy prices. Had the government held back on energy aid in both Q4 2022 and 2023 (which was Meloni's clearly stated preference heading into the elections), Italian businesses would have been disproportionately affected by the energy crisis.
The medium-term loosening of the fiscal stance by the centre-right government is not a foregone conclusion, in our opinion. Even if a deterioration in the headline fiscal indicators does occur over the next two years, long-term debt sustainability should not be adversely impacted in comparison to the foreseeable results that the policies led by the last few governments would have yielded. Most IFIs agree that a reduction of the general government debt/GDP ratio to about 142-143% and the general government deficit/GDP ratio to about 3% in 2024-25 are still feasible if unspectacular targets.
Budget 2023 is by no means a game-changer as far as Italian public finances are concerned but it may serve as a launching pad for more ambitious reforms in the next few years, provided the majority stays compact and a full-blown recession is averted. At the same time, fiscal risks remain tilted firmly to the downside in the short term, as we can easily imagine the need for the implementation of further energy-aid packages, as well as a potential underperformance in the revenue side of the 2023 budget. A more pronounced labour market slowdown remains a very real possibility that may have a longer-lasting impact on revenue growth and may derail a few of the government's key reform initiatives such as the dismantling of citizenship income and its replacement with more training-based schemes promoting employment.