Italy seeking spending cuts in 2014 budget

By Gavin Jones and Giuseppe Fonte

ROME (Reuters) - The Italian cabinet will try to agree on Tuesday on a 2014 budget geared to reviving a chronically stagnant economy by cutting taxes and spending, while keeping the budget deficit inside the EU ceiling.

Enrico Letta's left-right coalition has an easier task than its predecessors because, after the austerity of recent years, there is no longer a need for net fiscal tightening.

The cabinet will meet at 1600 BST to discuss the package, which aims to cut the deficit to 2.5 percent of gross domestic product from this year's 3 percent.

Most analysts doubt the 2014 target will be met, partly because they expect weaker growth than the government's 1 percent forecast, but the European Commission is expected to turn a blind eye so long as the deficit stays below its 3 percent ceiling.

A return to modest growth after two years of recession and lower debt servicing costs mean the budget can concentrate on enabling economic growth rather than cutting the budget deficit.

To do this, Letta wants to reduce taxes on companies and workers and cut public spending to pay for it. The problem is that while there is political and public backing for lower taxes there is great resistance to the spending cuts.

"We will only know how much is available for tax cuts when the ministries have made clear how much can be cut from their budgets," a Treasury source told Reuters. "Every euro of tax cuts must be paid for by lower spending."

Yet Silvio Berlusconi's People of Freedom party has flatly refused so far to accept any cuts to the health budget, backed up for once by Letta's centre-left Democratic Party.

The austerity drive of recent years has been based on tax hikes, while public spending has continued to climb.

The tax cuts are likely to be financed not only from spending reductions, but also from the sale of public buildings which has already contributed 50 million euros to emergency measures approved last week to rein in this year's deficit.

Government sources say the budget will cut the "tax wedge" - the difference between labour costs and take-home pay - by 4-5 billion euros next year, with the benefits divided roughly equally between employers and workers.

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The cut is likely to be split between lower contributions for insurance against injury, a cut in a regional tax on production and fiscal incentives for firms that hire workers on permanent contracts.

The budget will also reduce municipal taxes by 1-2 billion thanks to the merging of the former housing tax IMU with a tax on refuse disposal, under a new overarching "Service Tax."

Yet analysts say the cut in the tax wedge in particular is far too modest to stimulate an economy which has shrunk by 9 percent since 2007 and which, after 10 years of recession and stagnation, is smaller now than it was in 2001.

Tito Boeri, economics professor at Milan's Bocconi University, said a cut of 4 billion euros would mean an average increase of 50 euros per year for workers and 100 for companies.

"That is just symbolic and of no use at all," he said, calling on Letta to cut taxes by 1 percent of output, or 16 billion euros.

He said this could be funded with cuts to a myriad of badly organised tax breaks for firms, cuts to government funded training courses organised by trade unions, cuts to the highest state pensions and by hiking medical fees for high earners.

However, Boeri held out little hope that the government would take his advice.

Francesco Giavazzi, another Bocconi economics professor and former Treasury director-general, said Letta should immediately cut taxes by a whopping 50 billion euros, spreading a corresponding spending cut over the next three years.

(Reporting by Gavin Jones; Editing by Ruth Pitchford)