Analysis-Italy reaps tax windfall thanks to inflation, job growth

By Giuseppe Fonte

ROME (Reuters) -Italy's tax take is rising faster than expected thanks to job growth and inflation, putting the budget deficit on track to dip below the European Union ceiling of 3% of gross domestic product in 2025, a year ahead of schedule.

Tax revenues rose by more than 16 billion euros ($18.76 billion) between January and July, 5% higher than in the same period last year and outpacing the expectations of the Italian Treasury, which in April forecast a 0.8% increase for the full year.

The government had estimated a deficit of 3.3% of GDP in 2025, but the extra taxes mean the fiscal gap will probably be significantly lower.

Prime Minister Giorgia Meloni and her right-wing allies are claiming credit for the stronger numbers, yet economists say the upswing has been caused by phenomena not necessarily tied to the government, which took office in late 2022.

ARITHMETIC OF ITALY'S TAX TAKE

Tax evasion reforms introduced over the years are bearing fruit, analysts say, although much of the heavy lifting is down to inflation-driven fiscal drag and the creation of some 2 million new jobs over the past four years that have boosted tax receipts.

"Job growth boosts both tax revenue and GDP, but tax revenues grow faster than GDP since employment is taxed much more heavily than other kinds of income," said Marco Leonardi, economics professor at Milan's Statale University.

Meloni frequently points to the job growth as an achievement of her government, but never mentions the fiscal drag - a simple economic phenomenon where inflation and nominal pay growth raise the proportion of taxes paid on income.

Leonardi estimated that the state had collected an extra 25 billion euros from 2021 to 2024 thanks to this effect, with more cash piling up this year, outpacing limited tax cuts introduced by Meloni so far.

Consumer prices in Italy rose by 19% between 2020 and this year. Wages have risen in nominal terms in recent years too but by less than inflation, leaving ordinary Italians feeling worse off. Italian salaries adjusted for inflation are below the level of 1990, data by the OECD and Italy's national statistics bureau ISTAT show.

"The government says it has passed billions of euros of tax cuts, but the impact on our pay packet seems minimal or inexistent. Meanwhile, prices remain high," said Veronica D'Amato, an office worker from Rome.

In Germany, by contrast, the government shifts income‑tax brackets each year to offset fully the impact of inflation.

France has seen no tax windfall this year, partly as a result of more modest employment and consumer price growth than Italy, and faces a 2025 budget deficit of at least 5.4% of GDP.

RISING TAX COMPLIANCE

Italy's sturdier accounts are also a reflection of new rules introduced progressively since 2011 that have narrowed the scope to evade taxes, with successive governments pushing traceable digital payments and tightening controls. 

Tools now in place include expanded e‑invoicing, real‑time VAT reporting, penalties for retailers that refuse card payments, and heavy use of data matching across state systems.

"In my field, the level of evasion has definitely declined in the last 20 years," said Martina Di Egidio, a Rome architect.

She cited a national digital platform introduced around a decade ago where all applications for building work must be uploaded as one measure that curbed evasion.

Giacomo Ricotti, head of the Bank of Italy's tax department, told parliament last week that tax evasion fell from 97 billion euros in 2017 to around 72 billion in 2021, the most recent data available.

Fitch ratings cited "rising tax compliance" among the factors behind its decision on September 19 to upgrade Italy's credit rating.

MELONI FIGHTING OR ENABLING TAX EVASION?

Yet Italy's long-running fight against tax fraud is still far from won, with critics pointing the finger at Meloni for some setbacks.

Soon after taking office, she partially softened past crack-downs on evasion by raising a limit on cash payments to 5,000 euros from 1,000 and offering numerous tax amnesties allowing people to settle their disputes.

The European Commission says that in Italy the VAT compliance gap, which measures estimated losses from fraud and evasion, widened by roughly four percentage points in 2023 from 2022, reversing a tightening between 2020 and 2022.

Brussels linked the higher compliance observed during the pandemic to home renovation incentives that taxpayers could access by declaring work. Meloni has almost entirely phased out these programmes, given their massive costs for state coffers.

The government says its strategy is focused on targeted tax audits to avoid hitting honest taxpayers and on pre-emptive agreements with companies on their future tax bills. Meanwhile, the co-ruling League party is piling pressure on Meloni to adopt a further, large-scale tax amnesty.

Italy's tax burden remains stuck above 42% of GDP, higher than the EU average of 40% -- a statistic that opposition parties say belies repeated claims by the coalition that it is slashing taxes.

With national elections due in 2027, Meloni is looking to cut income taxes for those earning between 28,000 and 60,000 euros a year, politicians said.

"It's time to give an important signal for a reduction of the tax burden on the middle class," said junior Treasury Minister Federico Freni.

($1 = 0.8530 euros)

(Additional reporting by Gavin Jones and Alvise Armellini in Rome, Maria Martinez in Berlin and Leigh Thomas in Paris, graphic by Stefano Bernabei; Editing by Crispian Balmer and Susan Fenton)