Italy PM Letta says his budget is crucial for stability
* "No magic wand" to balance fiscal discipline and growth
* Employers lobby says budget does not meet expectations
* Government expected to win confidence votes
ROME, Dec 20 (Reuters) - Italian Prime Minister Enrico Letta said on Friday his government's 2014 budget was crucial for Italy's stability despite it pleasing neither unions nor business.
The lower house of Italy's parliament is due to vote on a confidence motion in the early afternoon with the Senate following on Monday. The government is expected to win both easily. Confidence motions are regularly used to speed up legislation.
The budget, which keeps Italy's public deficit just within the European Union's ceiling of 3 percent of gross domestic product this year, trims some taxes and replaces the hated IMU housing levy. It has been criticised for not doing enough to cut spending and help growth.
"I have to keep the ship afloat, I want there to be instruments for growth without wrecking public finances," Letta told reporters in Brussels where he was attending a summit of European Union leaders. "Nobody has a magic wand, we can't print money."
Letta's coalition, based around the centre-left Democratic Party and a smaller centre-right group led by Interior Minister Angelino Alfano, is more confident of being able to pass reforms since a break with former Prime Minister Silvio Berlusconi, who quit the government last month.
But it faces a huge challenge in turning around an economy which has shrunk by more than 9 percent since 2007, with youth unemployment running at over 40 percent and an industrial infrastructure which has crumbled during the crisis.
The mildly expansionary budget makes only minor adjustments to current spending and revenue trends, but with the government determined to banish any doubts about the solidity of public finances, its room for manoeuvre has been severely limited.
Confindustria, Italy's main business lobby, has been particularly critical of the government's failure to act more decisively to cut the so-called "tax wedge" - the difference between employers' labour costs and a worker's take home pay.
"It's not what we were expecting and it's not enough to get the country going again," Confindustria President Giorgio Squinzi said this week.
The budget foresees a reduction in the tax wedge of just over 2.5 billion euros ($3.42 billion) in 2014 and 3 billion in 2015, which it intends to fund partly out of spending cuts, well short of Confindustria's call for 10 billion euros in tax cuts.
However there has already been growing concern that resources originally earmarked to balance tax cuts may be diverted to fund urgent spending priorities such as unemployment benefit funds.
"I think there have probably been excessive expectations about our ability to concentrate resources, which are not enormous, on strategic objectives such as the reduction of the tax wedge," Economy Minister Fabrizio Saccomanni told RAI state radio on Friday.
The government expects Italy's budget deficit to fall to 2.5 percent of output in 2014 from a targeted 3.0 percent this year, on the assumption that the economy grows by 1.1 percent.
That growth forecast is widely considered optimistic and the public debt is seen rising to almost 133 percent of output this year and next, second only to Greece's in the euro zone.
The European Commission said the failure to ensure satisfactory debt reduction meant Italy was not eligible for budget leeway to increase investments, something Rome had hoped for.
The budget envisages some 4 billion euros in spending cuts and 7.3 billion euros in additional revenues this year, set against 13.9 billion euros in new spending commitments, leaving a fiscal gap of some 2.6 billion euros.
In addition to the tax wedge cut, the IMU tax on primary residences will be replaced by a new tax on municipal services which will go towards funding cash-strapped local authorities, which will also be given more room to finance investment.
Sales of publicly owned buildings are expected to raise 1.5 billion euros over three years, while top pensions will be held back and a series of tax breaks will be reorganized. But a comprehensive spending review under former International Monetary Fund official Carlo Cottarelli, expected to bring 11.3 billion euros of cuts by 2017, will not begin to produce results until 2015.
One source of extra income that has been contested in Italy and abroad is a tax aimed at raising revenue from online multinationals which currently pay their levies in low-tax countries like Luxembourg, Ireland or outside the EU.
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