Italy commits to cut deficit despite soaring cost of tax credits

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The Italian government has outlined plans to bring its budget deficit in line with EU limits by 2026, despite raising the estimated cost of tax credit schemes to €219bn and cutting its growth forecast.

The “devastating impact” on public finances of the so-called Superbonus scheme was the main reason Italy’s debt-to-GDP ratio was set to rise in the next three years instead of falling as previously planned, finance minister Giancarlo Giorgetti said on Tuesday.

Giorgetti predicted that the cost of tax credits and other home improvement incentives would reach €219bn, more than 10 per cent of gross domestic product. This marks a sharp increase compared with Prime Minister Giorgia Meloni’s €140bn estimate she announced last autumn.

Launched in 2020 with cross-party support in the depths of the Covid-19 pandemic, the Superbonus offered Italian homeowners tradable tax credits of 110 per cent for undertaking improvements to enhance the energy efficiency of their homes.

The programme sparked a construction boom that has supported growth, but it has also been blighted by fraud and ballooning costs, as homeowners had little incentive to economise in their projects.

“We did not expect or rather did not wish for the disaster of the Superbonus,” Giorgetti said.

Despite ballooning Superbonus costs that have previously caused the government to overshoot its deficit targets, Rome stuck to its prediction for the fiscal deficit to fall to 4.3 per cent of GDP this year before reaching 3 per cent in 2026 and 2.2 per cent the following year.

However, the government announced last month that the 2023 deficit reached 7.2 per cent of GDP, well above the official target of 5.3 per cent.

On Tuesday, Italy’s finance ministry also cut its growth forecast for this year to 1 per cent, down from its 1.2 per cent forecast in September, but still above the 0.6 per cent foreseen by the Bank of Italy and 0.7 per cent by the IMF.

The ministry estimated the country’s debt-to-GDP ratio would tick up from 137.8 per cent this year to 139.8 per cent in 2026. While that is down from its recent peak above 140 per cent, it is still the second-highest public debt level in the EU behind Greece.

Given Italy’s high budget deficit and relatively weak growth expected in the next few years, some economists are sceptical about the country’s ability to bring its public finances into line with new EU fiscal rules that come into force this year.

Italy is expected to be one of more than 10 EU countries that would breach the bloc’s new fiscal rules that aim to limit annual deficits to 3 per cent and total debt to 60 per cent of GDP, which could result in sanctions by the European Commission.

“Some of the biggest risks lie in countries where interest rates have been pulled up by global or regional factors without a corresponding increase in growth,” said Neil Shearing, chief economist at Capital Economics. “Italy continues to be a cause for concern in this regard.”

Investors have seemed relatively unperturbed about Rome’s debt issues, helped by the European Central Bank buying the bonds of Italy and other governments until the end of this year and its scheme to buy more if borrowing costs surge in an unjustified way.

The closely watched spread between Italy’s 10-year bond yield and that of Germany fell to a two-year low of under 1.2 percentage points last month. However, it has since increased above 1.3 points.

Shearing said Italy had so far “flown under the radar” thanks in part to the Meloni government’s “more conciliatory approach to the EU”. But given Italy’s “grim” long-term debt dynamics, he said “it would be remarkable if it managed to stay out of the firing line forever”.

Economists have raised similar concerns about France, which said last month its budget deficit would be 5.5 per cent of GDP last year, significantly wider than its forecast of 4.9 per cent, lifting its public debt to 111 per cent of GDP.

However, Italy has both a weaker growth outlook and higher borrowing costs than France, making it harder to cut its debt. Shearing forecast that Italy would grow 0.5 per cent this year, below French growth of 1.2 per cent, meaning “there is less room for things to go wrong in Italy”.