Tax Evasion At 50%?

``There are certain provinces and certain sectors where fiscal irregularities are higher than 50 percent and the level of tax evasion is higher even than the income being declared''

This according to Italian Deputy Finance Minister Vincenzo Visco is a reasonable estimate of the efficacy of the fiscal authorities in collecting revenue in some parts of Italy. One example given by Bloomberg: a recent study by the Italian fiscal agency (using 2004 data) found that the median salary declared to tax authorities for 50 professions, ranging from seamstresses to dentists, was 26,095 euros, a figure more or less equivalent to the salary of a public high-school teacher. In 2003 ISTAT estimated the informal economy in Italy as being worth some 16.7 percent of gross domestic product, a figure which is surely a substantial underestimate.

Now one point needs to be made very clear here. The high level of informal economic activity is often cited as evidence for the fact that Italy is a much richer country than appears to be the case, and that is almost certainly true. However this argument is often brought out when discussing the fundability of the Italian government debt moving forward and the possibility of default. Unfortunately this argument is entirely irrelevant here, as Standard and Poor's recently pointed out in the context of Greece's surprising upward revision of of its GDP: informal activity does not in and of itself influence the fundability of the deficit since it is, by definition, not taxed.

However, clearly the existence of such activity does mean there is a potential for revenue raising by incorporating it into the formal economy. One such move has been the regularisation of 'irregular' migrants (and one wonders how much of the industrial output increase this year has been a result of the 'officialisation' of such previously unofficial activity). Other such measures are contained in the 2007 budget proposals, and obviously one way of measuring just how much progress Italy makes next year towards sustainability will be in just how much extra revenue the Italian exchequer is able to generate in this way.

Italian Industrial Production

Paris asks me in comments if I could say something about Italian industrial production. Basically production in August was up significantly (month on month 1.2 percent), but this followed a 0.3% month on month fall in July, so the actual increase is not as large as it seems at first sight. The August reading is undoubtedly in line with the September confidence index reading, but again the big question is, where is all this leading?

The EU commission only today has revised down its first quarter 2007 growth estimate:

The European Commission said the economy of the dozen euro nations may not grow at all in the first quarter of next year amid higher interest rates and a slowdown in the U.S.

The forecast of stagnation is the bottom end of the commission's range of between zero and 0.5 percent growth for the first three months of 2007, which is down from an August estimate of between 0.2 percent and 0.8 percent. The European Union's executive arm also lowered its prediction for growth in the current quarter to about 0.5 percent.

and please note this:

``The data is further suggestion that after reasonable growth in the second half of this year there may be a more meaningful slump at the start of next year,'' said Ed Teather, an economist at UBS AG in London.

Part of the reason for the mid-summer surge in activity in the eurozone was an increase in construction activity in Germany which was brought forward to avoid the forthcoming 3% increase in VAT.

The August data is now somewhat old, and all the signs are that the Eurozone has peaked. This situation will only be made worse by the ECB's obsession with raising interest rates, counter cyclically. The future is additionally complicated by the fact that during the good years (2001- 2006) several major European economies used pro-cyclical fiscal policy, and they will now have to move in the direction of tightening at just the time when an expansionary fiscal policy is just what is called for. As you make your bed, so shall you lie, as they say.

Also it is important to take into account what is happening in the services sector, where again a slowdown is also making its presence felt:

Euro zone services growth slipped to a 10-month low in September, a survey showed on Wednesday, but analysts said this won't stop the European Central Bank raising interest rates this week and again later this year.

The RBS/NTC Research survey of 2,000 companies, ranging from financial services to hotels, showed business in the euro zone's dominant services sector remained robust, but eased for the third consecutive month.

The euro zone services activity index fell to 56.7 in September from an upwardly-revised 57.4, still well above the 50 mark that separates growth from contraction. Economists had expected a stable reading of 57.0.

That left the index at its lowest level since November 2005 and puts it sharply lower than a World Cup-related high of 60.7 in June, with a slowing in input cost rises and the rate of growth in new business.

It is important here to remember that in a developed economy services make up around 70% of total economic activity (with industry accounting for around 25% and agriculture around 5%). So services are really a much more important indicator than industrial activity. Clearly services activity is still growing, but the rate of expansion is slowing.

All in all it is important to remember that one swallow doesn't make a summer, and above all that Rome certainly wasn't built in a day.

2007 Budget To Be Changed (Already!!)

Well the FT this morning reprorts that Prodi is now 'vowing' to change the budget:

Italy’s centre-left government promised to make changes to its 2007 budget after coming under intense criticism from business leaders at the weekend for raising taxes and failing to introduce economic reforms.

“It’s clear that we will make technical corrections and adjustments, but we absolutely won’t renounce the three objectives of fairness, restoring the health of the public finances and development,” said Romano Prodi, prime minister.

Much of the 'intense criticism' has centred around the proposal which would have compelled companies to transfer about €5bn in funds, held in reserve for employees’ severance pay, to the state pension system which was covered in my post yesterday. As the FT notes:

This has caused uproar among the several million Italians who run small companies with fewer than 10 employees. They fear it would prevent them from meeting their obligations on severance pay and that banks might refuse to help them out with loans.

While denying that the pension funds transfer was a major issue, Mr Padoa-Schioppa acknowledged the objections of small companies and said: “I recognise that for them it’s a problem and something will have to be done.”

The government might in any case have needed to redesign this proposal, because the European Union’s accounting rules would not necessarily let Italy count such transferred pension contributions as extra government revenues.

Well, now we may well get a more serious and realistic version of the budget up and on the table, since in this case at least, all may be well that ends well, always assuming the Padoa-Scioppa is a man of his word, and not like that other European leader who was lying in the morning, in the afternoon and in the evening.

Mr Padoa-Schioppa was adamant any adjustments to the budget, which MPs must approve, would not affect its goal of cutting Italy’s budget deficit to 2.8 per cent.