International Forum for Macroeconomic Issues

Economic and Social Research Institute,

Cabinet Office, Japan

Prometeia Group
Bologna, Italy

Research Project:

The Consolidation of the General Budget in Italy:

Tools, Costs, and Benefits

Paper n. 2

Italian Budget Policy: a Long Run Overview

Paolo Bosi, Elena Giarda and Paolo Onofri

Tokyo, 17-19 February 2003

1
 Italian Budget Policy: a Long Run Overview

Paolo Bosi1, Elena Giarda,2 and Paolo Onofri3

1. Introduction4

The aim of this work is to present an overview on Italian Public Administration accounts from
the 1960s to the present days5. We will look at how public expenditure and receipts have
evolved over the years, responding to favourable or unfavourable economic circumstances
and to policy makers decisions. Analysis will start in detail from the beginning of the 1980s
(Section 3), with an eye to previous decades, in order to understand what determined the
present economic scenario (Section 2). Section 4 will look at the 1990s and the beginning of
the new century, splitting them into four sub-periods. Section 5 will conclude.

2. Overview of Italian budget policy from the 1960s to 2001.

Italian public finances have seen a deterioration starting from the second half of the 1960s:
the deficit to GDP ratio went from 1.1% in 1964 to 4.0% in 1965 and, after hitting double-
digit figures in the 1970s, 1980s and mid-1990s, it took an impressive budgetary readjustment
driven by the run-up to EMU in the second half of the 1990s to go back on track.

Between 1962-63 and 1973-74 public spending was given a primary role in the economic and
social development of the country. Expenditure growth was driven by the implementation of

1
University of Modena
2
Prometeia
3
University of Bologna
4
Data from 1990 to 2001 are ESA95 figures. Data from 1951 to 1989 are ESA79 figures, but they were linked-
up to the ESA95 series. In order to have consistent series, two major adjustments concerning “in-kind benefits”
and “interest payments” were required due to the fact that “in-kind benefits”, which until 1990 were part of
“social assistance”, are now an item of “intermediate consumption”, while “interest payments”, which were on a
cash basis until 1990, are now on an accruals basis.
5
Reference will be made to the overall general government accounts (the so-called Public Administration
accounts), which consolidate accounts of central government, local and regional governments and social security
institutions.

2
structural reforms, such as compulsory state secondary-level education and social security
coverage. Following the economic slowdown of 1964 and 1971 (GDP growth went from
5.4% in 1963 to 2.9% in 1964 and from 4.9% in 1970 to 1.6% in 1971), expansionary fiscal
policy -through public spending increases- was also used to sustain internal demand. In the
1960s primary expenditure grew by an average yearly rate of 7.1% in real terms (see Table 1)
and 12% in nominal terms. The rise in expenditure did not come together with an equally
increasing level of revenues. The average ratio of taxation6 to GDP remained stable around
29% over the decade. As a consequence of these diverging dynamics, a process of erosion of
public savings (the difference between current expenditure and current receipts) was set in
motion: the ratio of current balance to GDP turned from a surplus of 2.5% in 1962 into a
deficit of 3.7% in 1973. The deficit went from 1.2% in terms of national product in 1962 to
6.9% in 1973 (Fig. 1).

Table 1. Real average growth ratios and average ratios

Real average growth
1951-59 1960-69 1970-79 1980-89 1990-99 1990-96 1996-01
rates

Primary spending 8,0 7,1 5,3 4,0 0,9 0,3 2,1

GDP 5,5 5,7 3,7 2,2 1,4 1,2 2,0

Average ratios

Total expenditure/GDP 26,9 31,0 38,5 50,0 53,3 54,9 49,5

Total receipts/GDP 24,2 28,8 30,4 38,3 45,7 45,2 46,4

With the first oil crisis in 1973, Italy started facing problems of high inflation and
disequilibria in the balance of payments. In the years between 1974 and 1984 deficit
dynamics followed the economic cycle: deficit increased during recessions and decreased
during recoveries. In 1974 the tax reform proposed in the early sixties, which planned to
introduce a progressive taxation system, was eventually enacted and revenues increased
substantially. The average taxation to GDP ratio increased to 33.4% over the period 1974-
1984 (29% in 1974 and 38.5% in 1984), also helped by fiscal drag, which in turn was caused
by high inflation. A growing weight of the interest payments component (from 3.0% in 1974
to 8.8% in 1984), a rise in current expenditure (32.0% in 1974 and 45.9% in 1984) and the

6
In the whole analysis total public receipts (or revenues) are used as an approximation of tax pressure.

3
introduction of an open-to-all public health system (in 1978) made the deficit worsen and
reach 12.4% of GDP in 1984 (Fig. 1).

Fig. 1: Deficit, interest payments and primary deficit ratios to GDP, 1951-
2001
15,0

10,0

5,0

0,0
1951

1953
1955
1957

1959
1961
1963

1965

1967
1969

1971
1973
1975

1977
1979

1981
1983
1985
1987
1989
1991
1993
1995
1997
1999

2001
-5,0

-10,0

Deficit Primary deficit Interest payments

Note: negative values indicate a surplus

During the second half of the 1980s, governments recognised the non sustainability of public
debt accumulation. Primary deficit became the crucial variable to be kept under control. As
far as tools of intervention were concerned, different stances were taken. Until 1987 the
government followed the principle that tax pressure should not change, current expenditure in
real terms should not increase and capital expenditure over GDP should remain constant.
After 1988 the government’s line of action changed and they decided that both expenditure
and receipts should be targeted, by curtailing expenditure and increasing taxes. The latter was
the distinguishing feature of fiscal policy in this period. On the expenditure side, limits were
put on the size of public employment and the wage level, and a social security system reform
was outlined.

Between 1984 and 1989 current expenditure net of interests remained stable around 37% of
GDP, but then it increased up to 40.3% in 1993 (Fig. 2). Nonetheless, primary balance turned
from a deficit of 3.6% in 1984 into a surplus of 0.2% in 1991 (see Fig. 1). Tax pressure
increased from 38.5% in 1984 to 41.9% in 1989 and 47.3% in 1993. The deficit/GDP ratio
started showing signs of improvement despite the increase of interest payments (8.8% in 1984

4
and 1985 to 13.0% in 1993): it went from the spike of 13.4% in 1985 to 10.6% in 1989, with a
slippage in 1990 and 1991 (11.8% and 11.7% respectively) and an improvement again from
1993 onwards. The second half of the 1980s marked the beginning of Italian public accounts
readjustment.

Fig. 2: Primary spending and total receipts (% of GDP), 1951-2001

60,0

55,0

50,0

45,0

40,0

35,0

30,0

25,0

20,0

15,0
1951
1953
1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
Primary spending Total receipts Primary current expenditure

The 1990s were the decade of fruitful budgetary adjustment. Between 1990 and 2001 fiscal
policy measures allowed Italy to reduce its deficit by 9.6 percentage points in terms of GDP
(from 11.8% to 2.2%). The economic policy of the second half of the decade was driven by
the strong will to enter EMU together with the first-wave countries, despite the not very
optimistic economic outlook. In fact, as already mentioned above, public finances were in
double-deep red. Besides, the country had to go through a financial crisis (September 1992)
with the consequent exit of the national currency from the ERM and a succession of political
reshuffles and elections. The required budgetary effort had to be exceptional, were Italy to
meet the Maastricht criteria. And so it was.

Structural reforms were enacted both on the expenditure and the receipts side. Governments
occasionally turned to temporary measures (and were heavily criticised by other European
countries) to gain time in terms of public accounts adjustment and bring in permanent
measures at a later stage to consolidate results. Year 1997 marked the turning point:

5
deficit/GDP dropped from 7.1% to 2.7%, due to a decrease in interest payments of 2.1
percentage points on the previous year and an increase in total revenues of 2.2 percentage
points, total expenditure (net of interests) being equal. Year 2001 concluded with an overall
deficit of 2.2% of GDP, a primary surplus of 4.1% and interest payments of 6.3% (see Fig. 1).

3. The 1980s and the beginning of fiscal readjustment in 1985

In the 1980s fiscal policy targets were very ambitious, but were not followed by equally
satisfying results. In 1986 the Minister of Treasury presented a plan (the “Goria plan”) to cut
expenditure by nine percentage points over the following four-year period. Instead total
expenditure grew from 52.0% of GDP in 1986 to 52.5% in 1989: what had been achieved was
only a slowdown of the growth rate in comparison to the previous five years. Primary
expenditure did not show signs of improvement either: it slightly increased from 42.7% in
1986 to 42.9% in 1989, following the trend of the first half of the decade (from 36.9% in 1980
to 43.4% in 1985) (Fig. 2). Capital account expenditure maintained an upward trend during
the first half of the decade, decreased from 5.9% in terms of GDP in 1985 to 5.1% in 1986
and then remained stable around 5.4% until 1990 (Table 2). In terms of expenditure
composition, expenditure net of interests went from 86.4% of the total in 1980 to 83.1% in
1985 and 81.7% in 1989, growing by an annual average rate of 4% over the decade.

Table 2. Public spending: ratios to GDP

1980 1981 1985 1989 1990 1996 2001

Current account expenditure 38,4 42,1 46,3 47,4 48,9 49,1 43,9
- Intermediate consumption 16,5 18,0 19,2 19,3 20,2 18,1 18,5
- public employment 11,0 12,1 11,6 11,9 12,6 11,5 10,6
- social protection 12,7 14,1 14,8 15,2 15,5 16,9 16,7
- interest payments 5,8 6,8 8,8 9,6 10,5 11,5 6,3
- other expenditure 3,4 3,3 3,5 3,3 2,8 2,7 2,4

Capital account expenditure 4,3 4,8 5,9 5,1 5,4 3,8 4,1
- public investment 3,2 3,7 3,7 3,3 3,3 2,2 2,5
- other expenditure 1,1 1,1 2,2 1,8 2,2 1,6 1,5

Total expenditure net of

interests 36,9 40,1 43,4 42,9 43,8 41,4 41,6

TOTAL EXPENDITURE 42,7 46,9 52,2 52,5 54,4 52,9 48,0

6
The great achievement of the second half of the decade was the improvement of primary
balance via tax increases. It can be reasonably stated that the consolidation effort of Italian
public accounts started in 1985 and not just in the 1990s when the government was under the
urge of meeting the Maastricht criteria.

Tax pressure increased from 30.4% in the 1970s to 38.3% in the 1980s, a rise of eight
percentage points (Table 1). It was only in the second half of the eighties that higher revenues
were able to permanently affect primary balance, also due to the smaller dimension of
expenditure. In the first half of the 1980s primary deficit oscillated around an average GDP
ratio of 4%, then it dropped from 4.6% in 1985 to 1.0% in 1989 with a level of taxation in
terms of GDP of 38.8% and 41.9% respectively. Primary deficit eventually turned into a
surplus in 1991 (0.2%) with a taxation level of 43.8% of GDP.

Fig. 3: Inflation, nominal and real interest rates, 1971-2001

22,0

17,0

12,0

7,0

2,0
1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

-3,0

-8,0

Inflation 3-month gov. bonds, annual average Real interest rates

Nevertheless, the improvement of primary deficit was offset by growing interests payments,
especially at the beginning of the decade (Fig. 1): this was the legacy of the so-called
“divorce” of the Bank of Italy from the Treasury in 1981. Till then the Bank of Italy had been
under the obligation of buying Government bonds issued to finance the deficit. Since this
benchmark year the Bank, freed from that obligation, started buying Government bonds only
coherently with its monetary policy stance aimed at disinflating the economy while the

7
remaining were placed on the private market. In order to make them appealing to the public,
interest rates grew substantially following high inflation dynamics (deriving from the second
oil shock of 1979): the 3-month Government bond annual average yield went from 16.0% in
1980 to 19.6% in 1981 (see Fig. 3). Together with the increase in interest rates went the
descent of the monetary base created by the Treasury in order to finance the state sector
borrowing requirement (SSBR). Once Government bonds had been placed on the market,
SSBR financing was not done through monetary means as much as before: in fact after the
peak of 1980, as shown in Fig. 4, the ratio of monetary base created by the Treasury to the
SSBR started its descent, until it reached negative values in the 1990s. As one might have
expected, an increase in public debt also followed (Fig. 5).

Fig. 4: Monetary base created by the Treasury (% of the state sector

borrowing requirement), 1975-1998
150,0

100,0

50,0

0,0

-50,0

-100,0

-150,0

-200,0
1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Interests payments to GDP sharply increased from 5.8% in 1980 to 8.8% in 1985. In 1991
they amounted to 11.9% and in 1993 to 13.0%. Despite growing interests, the deficit to GDP
ratio decreased from 13.4% in 1985 to 10.6% in 1989. This ratio saw a deterioration at the
beginning of the nineties (around 11.7% in 1990 and 1991), but maintained a descending
trend ever since (see Fig. 1).

8
 Fig. 5: Ratios to GDP of public debt and deficit, 1984-2001
16,0
120,0
14,0

12,0 100,0

10,0 80,0

8,0
60,0
6,0
40,0
4,0
20,0
2,0

0,0 0,0
1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001
Debt/GDP Budget defici/GDP

Debt/GDP: right-hand scale

Real interest rates7 turned from negative in 1980 to positive in 1981: -5.3 and +1.8
respectively (Fig. 3). This implied a fall in the “inflation tax” -loss of value of public debt due
to inflation- and the consequent increase in value of the stock of debt. During the 1980s Italy
started facing the problem of debt sustainability. In fact the central government debt in real
terms increased by 5.7% between 1980 and 1981, by 9.0% between 1981 and 1982 and by
11.6% between 1984 and 1985. Ratios to GDP were 55.3%, 58% and 82.3% in 1980, 1981
and 1985 respectively, as shown in Fig. 5, following an upward trend until the peak of 1994
(124%). Fig. 6 shows the levels of primary balance necessary to stabilise the debt/GDP ratio:
in the 1980s the actual primary deficit/GDP was constantly higher in absolute terms than the
one required to stabilise the debt/GDP ratio of the previous year, which in fact maintained an
upward trend for the entire period.

7
Real interest rates are calculated as the difference between the 3-month Government bond yield (annual
average) and ex-post year-on-year inflation.

9
 Fig. 6: Primary balance and stabilising debt/GDP primary balance, 1970-
2001
10,0

8,0

6,0

4,0

2,0

0,0

-2,0

-4,0

-6,0

-8,0

-10,0
1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000
Primary balance Stabilising primary balance

The primary spending trend was influenced mainly by public employment wages and
pensions. Expenditure for wages remained on a positive growth trend during the whole
decade driven by the increase of both the number of civil servants and their salary level:
following the large number of dismissals in the private sector at the beginning of the decade,
the State acted as a shock-absorber, unlike the 1990s when the shut-down of big industries
went along the closure of “Cassa del Mezzogiorno” and a reduction of public employment.
Fig. 7 depicts public sector and total employment (excluding public employment) growth
rates: public employment grew faster than private employment. Between 1980 and 1985 the
number of civil servants rose by 1.5% and in 1985-1989 by 1.3%, against 0.3% and 0.6% of
private sector employees in the corresponding periods. The quota of public spending towards
wages sharply increased in 1981 due to the previous national wage bargaining (involving
railwaymen and general practitioners), which had an effect on the 1981 overall level (Fig. 8).

It is reasonable to say that primary spending was mainly driven by the rise of public
employment and pensions expenditure, which in 1981 made up around 65% of total spending
net of interests. In fact primary spending in real terms grew by 9.5% between 1980 and 1981,
whilst net of salaries and pensions “only” by 6.6%. The ratio of public employment wages to
GDP accounted for 11.0% in 1980 and for 12.1% in 1981, the year of the sharp increase in
public administration wage level (Table 2).

10
 Fig. 7: Annual growth rates: public sector and total employment, 1971-
2001

6,0

5,0

4,0

3,0

2,0

1,0

0,0
1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001
-1,0

-2,0

-3,0

-4,0

Public sector Total (excl. public sector)

Fig. 8: Public expenditure: wages component (% of GDP), 1980-2001

13,0

12,5

12,0

11,5

11,0

10,5

10,0

9,5
1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Opinions on government policies of the eighties are controversial. Criticism stems from the
consideration that economic growth was much higher in the 1980s than in the 1990s (3.0%
and 1.4% respectively) and that despite this the 1990s achieved much better results in terms of
public accounts consolidation. This is why some authors see the 1980s as the years of “missed
chances”. Nevertheless it cannot be denied that primary balance started improving

11
consistently after 1985 and for this reason other authors see the second half of the decade as
the beginning of the realignment of public accounts.

4. Budgetary consolidation of the 1990s

The nineties were the decade of budgetary consolidation. Italy carried out an impressive
public finances adjustment which secured Italy’s entry in the third phase of EMU in 1999.

At the beginning of the decade prospects were rather bleak. Despite some positive signals of
readjustment coming from the second half of the eighties, the country was still way up from
meeting the targets set by the Maastricht Treaty8. In 1990 the deficit/GDP was 11.8% and the
public debt to GDP ratio 97.1%.

The economic policies being put in place during these ten years resulted in two conflicting
outcomes in terms of economic performance. On the one hand Italy managed to re-establish
sound macroeconomic conditions, on the other it experienced a poor growth performance
compared to its European counterparts. It seems reasonable to say that slow GDP growth was
the price Italy had to pay to enter the Monetary Union. The question is: what would have
happened should Italy not have pursued budgetary consolidation with strong determination?
The country would probably have faced rising inflation and high interest rates, which mixed
with fiscal imbalances, might have led to a financial crisis.

The nineties will probably be remembered as the years of ambitious structural reforms. Three
pensions reforms were carried out in 1992, 1995 and 1997, directed towards a reduction of
benefits, a rise of retirement age, more restrictive conditions of access to seniority pensions, a
lower degree of indexation and a more harmonised system of different pensions funds. A
reform of public employment was enacted to control careers of public employees, to introduce
incentive-related pay-schemes and to privatise wage negotiations. Privatisation of publicly-
owned corporations was implemented. Steps were taken towards labour market liberalisation.

8
According to the treaty, countries are required to comply with four convergence criteria: 1. Deficit must not
exceed 3% of GDP; 2. The public debt to GDP ratio must not exceed 60% (some flexibility is allowed for
countries showing progress in reducing public debt); 3. The inflation rate must not be more than 1.5 percentage
points above that of, at most, the three best performing member states; 4. The long-term interest rate must not be

12
Starting from 1999 regional and local governments were requested to reduce their current
deficits, implying an “active” participation of non-national governments in the consolidation
of the overall budgetary situation. In 1992 relevant innovations were introduced in the
national health system: the aim was to give it a managerial structure in order to improve
efficiency and effectiveness, and this was done by giving the new managers more power
together with a higher degree of responsibility.

As a result of a sequence of budget laws from 1992 to 1999, the budget deficit to GPD ratio
was reduced from 11.7% in 1991 to 1.7% in 2000 and interest payments on public debt were
reduced from 11.9% in 1991 to 6.5% in 2000 (see Fig. 1).

Italian budgetary consolidation of the nineties can be better viewed and understood by
splitting the decade into three sub-periods:
1. End of 1992 – beginning of 1996;
2. 1996 – beginning of 1998;
3. 1998 - 2000
A final paragraph will be devoted to the most recent years.

4.1. 1992 - beginning of 1996

The first period is characterised by the ERM financial crisis of September 1992, which
arrived less than two years after Italy had joined the narrow band of the ERM. It led to a
period of great instability of European financial markets and to the sharp depreciation of the
lira, which caused the exit of Italy from the Monetary System. The “great illusion” of
pursuing monetary stabilisation policy via fixed monetary exchange rates had vanished.

The beginning of the nineties was characterised by the Government attempt in early summer
1992 to avoid the crisis. Interest rates were kept high and taxes were increased. Before and
after the September 1992 exchange rate crisis, the Government led by Mr. Amato proposed
and put into effect permanent tax increases and public spending cuts. The objective was to
accelerate the improvement of the primary budget surplus.

more than 2 percentage points above that of, at most, the three best performing member states in terms of price
stability.

13
Receipts were increased via the introduction of various measures, such as a generalised
increase in income tax rates, an extraordinary real estate tax and a one-shot special tax on
bank deposits. Public health sources were reformed to improve efficiency and reduce
spending through regional and local devolution, even though the effects were to be seen only
in 1994-95. The first pension reform was launched, so that the 6.9% growth rate of social
expenditure in 1992 was turned into 4.0% in 1993 until it decreased in 1995, when the
restrictive measures of the second reform were brought in.

Total revenues maintained the upward trend of the late eighties until 1993 (Fig. 2). The GDP
ratio went from 42.6% in 1990 to 47.3% in 1993.

Despite an improvement in the primary balance, which became a surplus in 1991 (0.2% of
GDP), reaching 2.0% in 1992 and 2.8% in 1993, the deficit/GDP did not show signs of great
improvement (11.8% in 1990, 11.7% in 1991) due to high interest rates; in 1992 the ratio
dropped by one percentage point (10.7%) despite an increase of primary surplus of more than
two and a half percentage points, again due to rising interests. Interests on public debt stayed
on an upward trend until 1993 (13.0% of GDP). In 1994 there was a change of direction:
interests dropped by 1.5 percentage points, which counterbalanced the worsening of primary
surplus. It followed that the deficit/GDP ratio was reduced to a one-digit figure (9.3%) for the
first time since 1980 (Fig. 1).

A subsequent increase in interest expenditure in 1995 can be explained by political instability

of the previous year, when a political reshuffle was carried out, and by the effects of the
Mexican crisis. This year was characterised by uncertainties in the orientation of fiscal policy.
The new 1994 Government led by Mr. Berlusconi was more oriented towards an
improvement of growth performance rather than budgetary consolidation. He was inspired by
the Reagan-Thatcher paradigm: immediate reduction of tax pressure, expenditure being equal.
Larger deficits would sustain the economy and give the economic system resources to carry
out structural reforms, which would allow expenditure cuts, and eventually reduce the deficit.
Unfortunately he did not take into account the level of the stock of debt inherited: 118% of
GDP in 1993 (Fig. 5). They started with cutting corporate taxation in June-July and in the
September financial law they planned retrenchment via pensions cuts and control on public

14
employment. When the times came to put into effects the planned reforms, the government
was overthrown and a new majority was established.

Before moving to the new political scenario, let us have a look at some figures. In 1994 total
receipts increased by 0.7 %, but in real terms they dropped by 4.4%. Primary spending in
nominal terms increased less in 1994 than in 1993 (1.8% against 4.4%), but in real terms it
decreased by 3.3% due to unexpected rising inflation. Social protection expenditure
decreased, but this was imputable to the effects of the 1992 pensions reform. From May 1994
interest rates started rising because of financial markets negative expectations on Italian
economic policy (see Fig. 9). The result was an inversion in the trend of interests on public
debt: 11.5% of GDP in 1995.

Fig. 9: Ten-year government bonds, monthly values, 1993-2001

14,0

12,0

10,0
1994M05
8,0 1997M04

6,0

4,0

2,0
1993M01
1993M05
1993M09
1994M01
1994M05
1994M09
1995M01
1995M05
1995M09
1996M01
1996M05
1996M09
1997M01
1997M05
1997M09
1998M01
1998M05
1998M09
1999M01
1999M05
1999M09
2000M01
2000M05
2000M09
2001M01
2001M05
2001M09

Italy Germany

In March 1995 the new political majority with Mr. Dini as Prime Minister started pursuing a
restrictive fiscal policy, which despite all led to a substantial reduction of the deficit/GDP
ratio during the same year: 1.7 percentage points less than the previous year (7.6% in 1995 vs.
9.3% in 1994). As already mentioned, the second pensions reform was implemented and
social protection expenditure decreased by 0.4% in 1995 (probably this was still an effect of
the 1992 reform) against an increase of 1.8% the previous year.

15
In 1995 the stock of debt in terms of GDP started decreasing for the first time after fifteen
years of continuous growth (123.7% vs. 124.0% in 1994, see Fig. 5). Since then the primary
surplus always remained above the levels required to stabilise the debt (Fig. 6) and in fact
public debt was reduced year after year.

Capital account expenditure increased from 3.7% of GDP in 1993 to 4.6% in 1995, despite
the decreasing overall trend of the nineties (5.4% in 1990): being a discretionary variable, it
was used to help control total spending.

4.2. 1996 - beginning of 1998

Following the 1996 general election, a new centre-left coalition led by Mr. Prodi came into
office. At that time the world economy was going through a slowdown phase. Prospects did
not look bright: by the end of the year Italian GDP growth was 1.1% and the deficit to GDP
ratio 7.1%. It became more and more compelling to act promptly, were Italy to enter the third
stage of EMU. The country needed to re-establish its credibility on the international scenario,
so it was essential that the new Government showed a strong determination in meeting the
Maastricht criteria. Credibility and speed of adjustment were the keys to success.

A very ambitious target was set in September 1996: meeting the 3% criteria of the
deficit/GDP ratio in 1997, despite the target of 4.4% which had already been announced in the
1997-99 fiscal strategy. Again the country’s budgetary situation was not looking good: the
1996 targeted deficit/GDP ratio of 5.5% turned out to be 7.1% by the end of the year. Very
restrictive fiscal policy measures had to be enacted.

The financial law approved at the end of 1996 introduced both temporary and permanent
measures. Temporary measures were meant to have immediate effects on 1997 public
finances and so they had (for instance the so-called “Euro tax”). In fact total receipts
increased from 45.8% of GDP in 1996 to 48.0% in 1997 (Fig. 2). A big reform on personal
and corporate incomes (the “Visco reform”) was approved with effect from 1998: it
introduced a new tax on businesses (IRAP) which replaced eight others, introduced a new
form of corporate income taxation (DIT, Dual Income Tax) and modified personal income tax
(IRPEF) by means of reduction and revision of tax rates and redefinition of tax allowances.

16
Immediately after the approval of the financial law, the government introduced new
legislation directed at controlling the state sector borrowing requirement, by imposing limits
on the cash outlay of central government departments, regional and local governments,
universities and state-owned companies. The actual reduction of the borrowing requirement at
the beginning of 1997 was instrumental in convincing the markets that the country was
serious about deficit reduction. Following financial markets newly-gained confidence in the
government’s line of action and in the possibility of meeting the targets, the long-term interest
rate spread with the DM began to decrease in April (see Fig. 9).

Interest payments to GDP decreased from 11.5% in 1996 to 9.4% in 1997, primary surplus
went from 4.4% of GDP in 1996 to 6.7% in 1997 and the stock of debt from 122.7% to
120.2% (Fig. 1 and Fig. 5).

The deficit/GDP ratio dropped substantially by more than 4 percentage points between 1996
and 1997 (7.1% and 2.7% respectively): the 3% target was met. More importantly Italy was
able to prove that the fiscal measures of 1996 and 1997 had a permanent effect also on
following years. In fact, the deficit/GDP ratio stayed on track in 1998 (2.8%) and reached
1.8% in 1999.

We have to remember that convergence also required targeting inflation and re-entering the
ERM. From here the necessity for the economic system to gain efficiency and flexibility in
order to avoid loss of competitiveness. Inflation dropped from 4.0% in 1996 to 2.0% in 1997
and Italy managed to re-enter the exchange rate agreement in November 1996. Among
reforms targeting more generally macroeconomic stability was the public administration
reform, which attempted to split political and managerial responsibilities. The Government
also started a process of privatisation of publicly-owned banks and public corporations
supplying services such as gas, electricity etc., and liberalisation of commercial activities and
house rents. Social consensus played a crucial role in producing the labour market reform
proposed in September 1996 and enforced in July 1997 (the “Treu Law”), which aimed at
making the labour market more flexible. In addition, government and trade unions started a
negotiation which led to the third pensions reform. They agreed on levelling private and
public pensions and on conditions of access to seniority pensions.

17
In 1997 fiscal readjustment went together a good overall macroeconomic performance: the
economy grew by 2.0% against 1.1% in 1996. This was an exceptionally good year which
opened the doors to Europe.

4.3. 1998-2000

Year 1998 saw some slippage in public accounts. The Visco reform started having its effects
but some of the one-shot measures explicitly brought in to meet the deficit/GDP target of
1997 had expired (total receipts went down from 48.0% of GDP in 1997 to 46.5% in 1998,
Fig. 2).

The deficit/GDP ratio slightly increased from 2.7% in 1997 to 2.8% in 1998, despite interest
payments being on the descent (9.4% and 8.0% of GDP respectively). This was imputable to a
worsening of the primary surplus which went from 6.7% of GDP in 1997 to 5.2% in 1998
(Fig. 1). Primary spending mainly increased because of a bigger capital account expenditure
(3.5% of GDP in 1997 and 3.9% in 1998). Current expenditure decreased from 47.2% in 1997
to 45.4% in 1998 with a reduction of social expenditure of 0.3 percentage points (17.3% of
GDP and 17.0% in the two years).

The decreasing trend of the stock of debt on GDP reinforced (Fig. 5): it fell by 3.8 percentage
points (from 120.2 percent in 1997 to 116.4 percent in 1998) against a decrease of 2.5
percentage points between 1996 and 1997. Its level was more than 7.5 percentage points
below the peak of 1994 (124%). Revenues from privatisation and a more controlled issue of
government bonds contributed to this reduction.

Another political crisis hit the country in July 1998: Mr. Prodi had to leave office and was
replaced by Mr. D’Alema in October 1998, who in turn resigned at the end of 1999. Mr.
Amato took the leadership until the new electoral round in May 2001 gave the country a
centre-right majority led by Mr. Berlusconi.

In 1999 and 2000 fiscal policy remained on track with the government targets. The 1998 and
1999 financial laws setting the targets and measures for 1999 and 2000 differed substantially
in the mix of measures. The 1999 financial law was targeted towards “development and

18
employment”: expenditure cuts went along with the reduction of fiscal pressure and the
requalification of social expenditure. The Prime Minister committed himself, together with
trade unions and industry confederations, to reducing the cost of labour (this reduction of
revenues would be partially offset by the introduction of the carbon tax, aimed at reducing
carbon-dioxide emissions according to the Kyoto agreement); to giving incentives to increase
employment; and to giving businesses incentives to invest.

The deficit to GDP ratio dropped by one percentage point, well beyond what expected
(Fig. 1): from 2.8% in 1998 to 1.8% in 1999, imputable to a decrease of the interest payments
component (8.0% of GDP in 1998 vs. 6.8% in 1999) driven by the descent of interest rates
started in the middle of the year. Primary surplus to GDP worsened in 1999 compared to
1998: 5.0% vs. 5.2% due to an increase of primary spending of 0.4 percentage points (41.3%
in 1998 and 41.7% in 1999) and an increase of revenues of only 0.2 percentage points (46.5%
in 1998 and 46.7% in 1999), still driven by the reforms of the previous year.

The stock of debt in terms of GDP reached 114.5%, a lower level than expected, due to higher
privatisation revenues which more than compensated the slower GDP growth of 1999
(Fig. 5).

In 2000, excluding the UMTS9 licensing revenues, the deficit to GDP ratio slightly decreased
to 1.7%. Interests payments decreased by 0.3 percentage points (6.5% of GDP) and primary
surplus decreased by 0.2 percentage points (4.8% of GDP). Primary spending, now at 41.2%
of GDP (0.5 percentage points less than previous year), reflected the postponement of wage-
level renewal and the smaller number of pensions due to the one-year age increase of seniority
pensions. On the receipts side, total revenues in terms of GDP decreased by 0.7 percentage
points (45.9% in 2000) because of tax relieves put in place in 1999 and at the end of 2000.

Public debt in terms of GDP dropped by four percentage points, reaching 110.5% in 2000
(Fig. 5). This reduction could be explained by GDP growth in nominal terms, which was
above the previous year’s by almost two percentage points (3.3% in 1999 and 5.1% in 2000)
and above government forecasts by one percentage point. Between 1998 and 2000 average
yearly GDP growth was 4.2% in nominal terms and 2.2% in real terms.

9
UMTS stands for “Universal Mobile Telecommunications System”.

19
4.4. Beyond the adjustment years

The beginning years of the new decade are years of relaxation of the budget policy. A role is
played by the negative output gap, but the more relevant reason is the new approach to budget
policy of the new centre-right government. In 2001, an electoral year, the deficit/GDP ratio
instead of maintaining the downward trend started in 1994, grew to 2.2% (Fig. 1). Interests
payments decreased by 0.2 percentage points (the ratio to GDP was 6.3%), but they were
offset by a worsening in the primary surplus which dropped to 4.1% of GDP (-0.7 percentage
points of GDP). Primary expenditure increased to 41.6% of GDP and total revenues slightly
decreased (-0.1 percentage points of national product). The 2001 tax relieves (enacted with
the budget law at the end of 2000 by the incumbent government) were questioned as
motivated by electoral considerations. Nonetheless, the new government added other tax cuts,
consistently with the electoral campaign intensively based on promises of fiscal pressure
reduction.

The stock of debt stayed on the downward path of previous years, reaching 109.8% of GDP.
Real GDP growth was 1.8% against 2.9% in 2000.

At the end of 2001, the new government presented the Parliament with proposals to reform
the social security, and the tax systems. It is worth pointing out that expenditure cuts were not
among the objectives of the proposals. The aims of the social security system reform were the
development of a second pillar of the pension system, and the reorganisation of the existing
social security systems. The taxation bill aims at reforming personal and corporate income
taxation, VAT and other minor taxes. Income tax brackets allegedly will be reduced from the
current five to two and most tax allowances will be transformed into deductions from the tax
base. Businesses would see a reduction of their tax rate from 36% to 33%, the abolition of
DIT and gradually of IRAP. A first step of the reform was implemented starting from 2003:
the first tax rate changed from 18% to 23% and at the same time the first income band
increased from 10329 to 15000 euro. Deductions will play a fundamental role in defining a
No Tax Area -a minimum level of non-taxable income- and at the same time in guaranteeing
progressiveness by means of decreasing amounts. Businesses will see a first step of the
reduction of their tax rate to 34% in 2003.

20
The new budget strategy is aiming mainly to tax reduction with the expectation to be able to
avoid expenditure cuts. The government is confident that a recovery in the rate of growth of
the economy will allow to square the circle: reduce tax, and deficit without dramatic change
in the expenditure dynamics. In the meantime, huge programs of sales of public real estate
have been enacted to limit the impact of tax reduction on the deficit, at least temporarily.

5. Conclusions

Italian budgetary policy went through different phases. From the beginning of the sixties to
the first half of the seventies it was expansionary via expenditure growth. From the second
half of the seventies the orientation was towards tax increases (of 1974 the first tax reform).
The beginning of the eighties saw a deterioration of public accounts mainly due to the sharp
increase of interests rates and consequently of the interests payments component of public
expenditure. The second half of the eighties experienced a big improvement in the primary
balance (via high growth rates of public receipts), which set in motion public accounts
adjustment. In the years between 1993 and 1997 fiscal policy was fine-tuned on budgetary
consolidation with the aim of entering EMU, while in the following was focused on
maintaining budgetary stability.

21
 References

Ambrosanio M.F. (1993), “Disavanzo e debito pubblico: fatti stilizzati”, Persone & Imprese,
n. 2, Liguori Editori, Napoli.

Banca d’Italia (1999), Bollettino Economico. Febbraio 1999, n. 32, Banca d’Italia, Roma.

-- (2000), Bollettino Economico. Marzo 2000, n. 34, Banca d’Italia, Roma.

-- (2001), Bollettino Economico. Marzo 2001, n. 36, Banca d’Italia, Roma.

-- (2002), Bollettino Economico. Marzo 2002, n. 38, Banca d’Italia, Roma.

Degni M., et al. (2002), “Il riequilibrio della finanza pubblica negli anni novanta”, Studi e
Note di Economia, Quaderni 7, Monte dei Paschi di Siena Banca Toscana.

European Commission (1999), “Italy’s slow growth in the 1990s. Facts, explanations and
prospects”, European Economy, n. 5, European Commission, Directorate-General for
Economic and Financial Affairs.

Franco D., et al. (1998), “Lo scenario, i piani e le realizzazioni”, in Sartor N. (ed.), Il
risanamento mancato. La politica di bilancio italiana: 1986-90, Carocci Editore, Roma.

Giarda P. (1986), “L’evoluzione della spesa pubblica in Italia: alcuni fatti e qualche
proposta”, in Ente Luigi Einaudi (ed.), Oltre la crisi. Le prospettive dell’economia
italiana e il contributo del sistema finanziario, Il Mulino, Bologna.

-- (2000), “Entry in the Monetary Union: comments on the Italian case”, Seminar on
“Maitriser la dèpense publique”, Paris, March 23rd, mimeo.

Onofri P. (2001), “La lunga fase di risanamento dell’economia italiana: 1992-2000. Un po’ di
cronaca e qualche considerazione”, in D’Adda C. (ed.), Per l’economia italiana. Scritti
in onore di Nino Andreatta, Il Mulino, Bologna.

-- (2001), Un’economia sbloccata, Il Mulino, Bologna.

Stagni A. (2001), “La politica economica negli anni delle contraddizioni:1980-1992”, in

D’Adda C. (ed.), Per l’economia italiana. Scritti in onore di Nino Andreatta, Il Mulino,
Bologna.

Zanardi A. (2001), “Dopo le elezioni: quali spazi per le politiche della crescita?”, in Bernardi
L., Zanardi A. (eds.), La finanza pubblica italiana. Rapporto 2001, Il Mulino, Bologna.

22