Restoring growth and tackling public debt in Italy

by Cyrille Schwellnus

Italy has weathered recent crises well, but growth is now slowing amid tightening financial conditions. Public debt remains among the highest in the OECD, limiting the space for continued fiscal policy support. The 2024 OECD Survey of Italy discusses fiscal and structural reforms to tackle high public debt and restore growth.

Under current tax and spending policies, public debt is on an upward trajectory (Figure 1). Over 2024-40, spending on pensions, health and long-term care is projected to increase by about 2½ percent of GDP and debt servicing costs could rise by 2% of GDP if interest rates remain high.

A sustained fiscal adjustment will be required over several years to put the debt ratio on a more prudent path, meet future costs and comply with proposed EU fiscal rules. Decisively tackling tax evasion, including of value added taxes, and limiting costly tax expenditures, for instance by limiting the coverage of the dependent spouse deduction, would help. The property tax base needs to be updated. Strengthening the ambition of spending reviews and reducing the generosity of pensions for higher-income households could address spending pressures, while maintaining adequate public services and social protection.

Figure 1: Reforms are required to ensure fiscal sustainability

Note: Ratio of public debt to GDP in percent of GDP. The scenario “Current tax and spending policies” assumes current tax and spending policies, accounting for announced changes in 2025. The scenario “Proposed EU fiscal rules” is based on a stylised simulation of new EU fiscal rules, which results in a primary budget surplus of around 3% of GDP in 2031. The scenario “Proposed EU fiscal rules + structural reforms” assumes the additional implementation of structural reforms in the areas of competition, civil justice, public administration and labour markets.
Source: OECD calculations based on OECD Economic Outlook database and OECD Long-Term Model.

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The revised National Recovery and Resilience Plan (NRRP), largely financed by Next Generation EU (NGEU) funds, is an ambitious package of structural reforms, as well as a major ramp-up in public investment. This will support demand in the near term and boost growth over the next years. But, potential output growth is estimated around 1% and will decline further due to rapid population ageing unless productivity growth is lifted and labour market participation is enhanced. The transition to an innovation-led high-productivity growth model has been hindered by inefficiencies in the justice system and the public administration, weak competition in services, sub-par workforce skills and a rigid labour market.

Strengthening competition, especially in professional services (Figure 2), would boost productivity and lower prices. New “fair compensation” rules risk being perceived as minimum tariffs and should be re-examined. Continuing to improve the effectiveness of the public administration, including by expanding the hiring of specialised personnel and strengthening training and performance incentives, would help to implement the public investment projects in the NRRP that are critical to raise long-term growth. Bringing more women into the labour force by promoting public early childcare education and strengthening incentives for paternity leave would support employment growth in the face of a shrinking working-age population.

Figure 2: Regulatory barriers to competition in professional services should be lifted

0-6 in ascending order of restrictiveness, 2018

Note: Product market regulation indicators, professional services, 0-6 in ascending order of restrictiveness, 2018. The preliminary 2023 Product Market Regulation data suggest that regulation of professional services in Italy remains among the most restrictive in the OECD.
Source: OECD 2018 PMR database.

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Significant progress in emissions reduction was made in the wake of the global economic crisis of 2008-09, but additional policy efforts are now needed to meet emissions reduction targets. Excise taxes could be better aligned with the carbon content of consumption, as foreseen by the ongoing tax reform. Authorisation procedures for renewable energy investments and the expansion of the electricity grid could be simplified. Continuing the strengthening of public transport and the regional train network, as well as updating the system of car purchase and scrapping incentives, would help reduce vehicle emissions. Further reforming the system of tax incentives for energy efficiency home improvements – which in the form of the so-called Superbonus generated large fiscal costs in the past – would improve value for money.

References

OECD (2024), OECD Economic Surveys: Italy 2024, OECD Publishing, Paris.