The Monetary Fund warns Italy: “No to the extra tax on banks”. Pressing on Pnrr and pensions. “And the taxman protects progressivity”

The International Monetary Fund half promotes Italy in its regular periodic report, Article IV. According to which the painting is chiaroscuro. On the one hand, GDP growth during 2022 was better than expected and will also be in positive territory for 2023. On the other hand, there are the uncertainties due to inflation and the consequences of interest rate hikes on the domestic banking system. There was not even a reference to the tragedy that hit Emilia-Romagna, where floods risk having significant implications also at an economic level.

The IMF report on Italy opens with a sentence that risks being relevant for the country’s future. “The mission wishes to express its deepest condolences for the tragic loss of human life due to the ongoing floods in Northern Italy”, analysts of the Washington institution explain. “Economic activity and employment grew strongly in 2022 thanks to the authorities’ skillful management of gas supplies and welfare support provided in response to the energy price shock,” it underlines. Italy’s GDP will grow by 1.1% in 2023 and 2024 and then accelerate further in 2025, also thanks to the support of the Pnrr, whose spending will peak that year. Provided that the Pnrr is implemented in the best way, though. Things are no better on the price front. Core inflation in Italy is destined to decrease “gradually” but the trend in the cost of living will return “to the 2% target only around 2026”. Other flare-ups are expected, therefore. As if that weren’t enough, while remaining high, it is remarked, “the public debt/GDP ratio has decreased and non-performing loans have remained low”. However, starting in 2023, growth is expected to “shift into a lower gear, while core inflation is expected to remain sticky and high interest rates will keep financial sector risks elevated.” And in this case it would be the financial sector, both banking and non-banking, that would be most exposed to fluctuations and volatility in the financial markets.

In a context of complete and continuing uncertainty, the IMF points out, there is a lever to be used. “Fiscal policy can help the economy deal with shocks while protecting the sustainability of public finances,” analysts say. Furthermore, given the still high public debt, “the more restrictive financing conditions and the need to support disinflation, it is advisable to opportunistically save most of the unexpected revenues deriving from inflationary surprises and tax credit accounting changes”. All in anticipation of a rationalization of the consolidation programs, which should be more targeted and effective. “A credible medium-term debt reduction plan, supported by specific measures, would further mitigate debt-related risks.” Not to mention that “maintaining a sizeable primary balance, while carving out space for public investment, could lead to a rapid reduction in the debt/GDP ratio and support potential growth”. Eyes focused not only on the Pnrr, which must be implemented in a “complete and timely” manner, but also on the energy transition, which must be “accelerated”.

There are other risk factors. “Continuing to closely monitor and address evolving risks in the financial sector would strengthen resilience to a more restrictive environment. It is recommended that adequate reserves be maintained on a forward-looking basis. The use of public sector support or non-standard public-private instruments should be limited”, underline the analysts of the Fund. Spending well instead of spending badly is the mantra. According to the IMF “there is room to further increase spending efficiency, even in the short term”. The government “implemented or approved several welcome measures to improve the destination of benefits, including reducing the degree of indexation for higher pensions and restoring some taxes and energy charges”. But “there is room to further refine the targeting of households and businesses, limiting the compensation to the temporary part of higher energy prices”.

The obstacles are important for the Italian government. Redistribution through balanced-budget spending was “suitably used in 2022 to respond to the temporary energy price shock, but it is not suited to permanently boosting structurally low incomes, which instead requires improved productivity in the jobs and a boost to potential growth”. Not only. A specific invitation also arrives from Washington. “To contain expenditure linked to ageing” of the population in Italy “the retirement age should be linked to life expectancy and benefits should be more aligned with contributions, while early retirement schemes should be abolished”. A challenge for the Meloni government. Hand in hand with the next one, recommended by the Fund, namely the adoption of a tax model that “encourages employment, abolishes ineffective tax expenditures, strengthens revenue collection and safeguards progressivity”.

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Given the so marked unknowns, one should not think of having simple solutions. Like, for example, hitting the extra profits of credit institutions, which are already having to deal with the normalization of the monetary policy of the European Central Bank (ECB). “The introduction of a new tax on bank profits could have unintended consequences,” it explains. An additional tax on bank profits, it underlines, “would tend to reduce interest rates on deposits, increase the cost of loans and reduce the amount of financial intermediation at a time when the volume of loans is already declining”. The design of such a tax, even if temporary, “should consider the impact on the availability of credit, the cost of credit, the ability of financial institutions to withstand shocks and the fact that banks generally have not passed on the previously negative official rate on deposit rates. Not exactly the best tool for an economy that has to deal with the new normal dictated by more persistent inflation than assumed in the summer of 2021.