UPDATE 1-Italy PM Monti wins confidence votes on budget plan
* Government wins confidence votes on budget law
* Final approval set for Thursday, law then goes to Senate
* Last major piece of legislation before 2013 election
* Productivity deal signed without largest union
ROME, Nov 21 (Reuters) - Italy's government won three parliamentary confidence votes on its budget plans on Wednesday, paving the way for a sales tax hike to help mend public finances and taking a step towards clearing one of its last big hurdles before elections next year.
President Giorgio Napolitano, who will decide the date of the election and has indicated a March date, has directed that the law must be passed before the end of the government's term.
The budget, enshrined in a so-called Stability Law, is central to Prime Minister Mario Monti's efforts to lower Italy's public deficit to 1.8 percent of output next year from a targeted 2.6 percent in 2012.
Italy's economy has been the most sluggish in the European Union for more than a decade, fuelling investor concerns about its ability to bring down its public debt of 126 percent of GDP.
The government called the confidence votes to speed approval of the Stability Law, which is expected to be one of the final pieces of major legislation approved under Monti before Italy gears up for a national election.
Following Wednesday's three votes in the lower house of parliament on different articles in the law, deputies give their definitive approval on Thursday and the package will then go to the Senate for a final reading.
As part of the wider budget package, the government also signed a deal with employers and unions on Wednesday that will unblock 2.1 billion euros ($2.69 billion) set aside to allow tax breaks on productivity bonuses over the 2013-15 period.
The country's largest union, the leftwing CGIL, rejected the accord but Monti welcomed the deal, which is intended to address the chronic problem of Italy's lack of competitiveness, a major factor in its weak economic track record.
"This is an important step forward for economic recovery," he told a news conference.
The agreement would guarantee national collective contracts but would provide greater incentives for company-level wage agreements in a bid to boost flexibility.
It would attach productivity clauses to certain types of company contracts and would allow greater room for manoeuvre over conditions linked to productivity including working hours.
Monti agreed at the end of October to overhaul the first draft of the budget legislation by replacing a planned income tax cut with a reduction in payroll taxes paid by employers.
The package still includes a one percentage point rise in the highest value-added tax (VAT) rate, which will go into effect next July, bringing it to 22 percent. The lower 10 percent rate will not be increased as previously planned.
Ahead of the spring election, political parties have been pressing for some easing in the austerity medicine imposed by Monti since he took office a year ago to head off a financial crisis and restore order to public finances.
Tax hikes and spending cuts imposed to rein in the country's massive debt have exacerbated a recession in the euro zone's third-biggest economy, and increasingly been the focus of street protests and political attacks from the opposition.
With unemployment at almost 11 percent, the highest in records going back to 2004, Monti has been under growing pressure to do more to stimulate growth.
Italy's economy shrank a smaller-than-expected 0.2 percent in the third quarter of 2012 compared with the second, meaning the current recession has dragged on as long as one in 2008-09 at the height of the global financial crisis.