Italy’s government recently cut income taxes in order to boost the economy. The intended purpose of these tax cuts are to get more of the middle- and lower- income households spending. The cuts will go into effect next month and are expected to give up to €80 a month in extra income to three-quarters of the workforce. As foreign demand in Italy has been slowing, these tax cuts are meant to boost domestic demand and shift less dependence growth from exports.
Prime Minister Matteo Renzi intends for these tax cuts to be structural tax cuts, not just a one-time basis tax cuts. These tax cuts are much needed, as Italy’s economic output (measured in GDP per capita) has contracted even more than the output in Greece. Specifically, “Italy’s economy was growing at a 3.7% annual rate, the budget deficit was 0.9% of gross domestic product, and the public debt was 109% of GDP. Today, Italy’s economy has just begun a modest recovery after a five-year crisis that has eroded economic output by 9% and pushed the debt level up to 133% of GDP.” As debt levels are rising and Italian exports are becoming less attractive, Mr. Renzi believes that these cuts will shift resources to people most likely to spend it. Thus, maximizing economic impact.
However, some economists believe that an even more effective intervention was overlooked. This group of economists recommended that cutting business taxes levied on payrolls would have been more effective (Italian employees face pretty steep tax rates- about 50% and higher when payroll contributions are included). These economists feel that lowering the business tax on payrolls will lower Italy’s labor costs and increase job creation in the medium-run. To the contrary, Prime Minister Renzi feels that at the marginal level, targeting tax cuts at the medium and lower end of the income distribution will have a larger positive effect on consumption. Additionally, he is not opposed to the view of the other economists as well. He plans to focus on lowering business taxes by a small margin this year and then later focus more heavily on this issue in 2015.
I think that Mr. Renzi’s current proposal of tax cuts will have a positive effect in that they are structural tax cuts. Although some economists doubt the effect of the proposal at the moment, I think that strengthening the domestic reliance of Italy’s economy will prove beneficial in the long-run– maybe 15 or 20 years from now. I also think it was smart of the prime minister to address the opposite side of the argument. The main counterargument of cutting taxes is that it favors the rich because cuts can lead to reductions in government services that lower-income households generally rely on. Since the cuts only apply to workers with salaries of up to €28,000 a year, I believe that Mr. Renzi is efficiently targeting the correct demographic.