May 29, 2013 / 3:41 PM / 4 years ago

Italy gets some EU respite, but may need more to meet tax pledges

4 Min Read

* PM Letta to face more pressure to cut taxes, spend more

* Hopes to exclude some spending from deficit count

* Deficit risks exceeding 3 pct this year as economy shrinks

By Gavin Jones

ROME, May 29 (Reuters) - Italy got some help from Brussels on Wednesday when the European Commission ruled Rome could go off its excess deficit blacklist but the new government will need much more leeway in order to pass the tax cuts it has promised.

Prime Minister Enrico Letta has already suspended the next installment of a hated housing tax, due in June, and is also under pressure to cut labour taxes and scrap a planned increase in sales tax due to take effect in July.

How all this will be paid for without the deficit exceeding 3 percent this year is unclear. Letta is expected to lobby for the EU to grant Italy more fiscal leeway, such as excluding some spending from its deficit calculations.

Letta, who took office last month at the head of a fragile coalition government that has little popular support, welcomed the Commission's move to take Rome out of its excessive deficit procedure, which imposes corrective action on countries whose fiscal gap is deemed too high.

"The merit goes to the efforts of all Italians, who should be proud of this result," he said.

It is far from clear, whoever, whether the decision will let Italy spend more and cut taxes to fight its longest post-war recession which has already lasted for seven quarters.

The Commission forecasts the deficit at 2.9 percent of output this year, just a fraction below the 3 percent ceiling, offering no room for manoeuvre unless rules are changed to allow Rome to exclude some new spending from its deficit calculations.

"Italy has very little margin to keep the deficit below 3 percent," EU Monetary Affairs Commissioner Olli Rehn said.

The government forecasts the economy will shrink by 1.3 percent this year, but many analysts are more pessimistic. The Organisation for Economic Cooperation and Development on Wednesday forecast a contraction of 1.8 percent.

Anti-Austerity

The political stakes are high for the future of Letta's government whose majority in parliament is strongly anti-austerity. The pressure for more expansionary policies is likely to increase even more now Italy has come off the deficit list.

The Commission said Italy's forecast of economic recovery of 1.3 percent for next year was too optimistic and also forecast that the huge public debt will continue to rise to a peak of 132.2 percent of output next year.

European Commission President Jose Manuel Barroso said the size of the debt-to-GDP ratio, the second largest in the euro zone after Greece, was "the reason why we cannot say that Italy should relax its measures".

Moreover, the Commission saddled Italy with a series of policy recommendations which Letta will struggle to pass with such a diverse and divided majority.

For example it called on Italy to cut taxes on labour but to raise them on consumption and property, whereas the main demand of the centre-right half of Letta's majority is to eliminate the housing tax on primary residences definitively.

The Commission also urged Italy to strengthen anti-corruption legislation, be tougher on tax evasion and shorten legal proceedings.

These kinds of measures are also unlikely to get the backing of the centre-right whose leader Silvio Berlusconi this month lost an appeal against tax fraud but whose case may expire if it lasts long enough for the statute of limitations to kick in.

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