This article originally appeared in
2 November, 2006
  Prodi retreats to familiar Italian habits

Italian Prime Minister Romano Prodi started out with serious plans to
reform the economy, but those plans have gone by the wayside and old
habits have returned.

Commentary by Eric J. Lyman in Rome for ISN Security Watch (02/11/06)

It took only four months for Romano Prodi to abandon plans to construct Italy's first real
post-war reformist government and to retreat instead to the familiar Italian habits of
raising taxes, pushing up protectionist trade barriers and blindly attacking the political

Prodi started out with serious plans to reform: battling to deregulate parts of the
transportation and pharmaceutical sectors, unveiling plans for serious belt-tightening
among government ministries and agencies and basing the government's strategy for
increasing tax revenue on tracking down corporate and individual tax cheats and
making them pay rather than increasing the burden on the shrinking percentage of
Italians who actually pay their taxes.

By September, though, that strategy had gone by the wayside.

Prodi's government drafted a budget that substantially raises taxes in several key
areas. And now the government is circling the wagons to push through a budget that
raises taxes on what it says are the wealthy, which is really anyone in the upper half
of the middle class or above, given the cut off salary of €40,000 in income per year. It
is also pushing a return of the estate tax and a change to the levy on corporate profits
that most economists say will result in more taxes being paid by the small- and medium-
sized companies that are the backbone of the Italian economy. Even tourists will feel
the bite: towns can elect to charge a tax that would add €5 per night to every hotel

The government has also shown that it is unwilling to abandon the policies of most
previous governments, making no qualms about protecting domestic companies from
outside competition rather than to help them grow stronger. A proposed merger
between Spanish and Italian road operators was blocked on technical grounds even
though both companies' boards overwhelmingly supported it, for example. And the
government has taken some questionable steps in regard to beleaguered flagship
national airline Alitalia. It has also been accused of meddling in the affairs of
telecommunications giant Telecom Italia.

And while the new Prodi government has not sunk to the depths of some previous
governments in regards to using political attacks to distract from economic issues, it is
not without guilt in that arena.

Government advocates would argue that their goals remain noble. They would like to
stay in power long enough to right Italy's accounts and reduce the budget deficit,
which is on the wrong side of the EU's limit of 3 percent of gross domestic product
(GDP). Doing so would shrink the country's debt-to-GDP ratio - an EU-high 107.4
percent and rising - and it might convince rating agencies Fitch and Standard & Poor's
to reverse recent bond rating downgrades that make paying off debt more expensive.

But is the cost of making these improvements too high?

Italians and Italy-based companies are already among the most highly taxed in the EU,
but per capita government tax revenue remains in the middle of the EU pack mostly
because of the country's high degree of tax avoidance. But economists say that higher
taxes only punish those who do pay and it creates an incentive for at least some to join
the ranks of the tax evaders.

More importantly, the move fails to address Italy's most basic problems of economic
inefficiency, anemic growth, corruption and a lack of accountability. What is the point
of improving the baseline economic situation if the foundational problems that
contributed to them remain?

There is hope. Italy's public pension system remains a particularly bloated and
inefficient bureaucracy - the most expensive pension system in Europe in per capita
terms and the government's single largest expenditure.

It is also headed in the wrong direction: Tight immigration policies and a low birth rate
contribute to a shrinking work force, and early retirement options and improving life
expectancy result in a growing pool of retirees.

The growth prospects of any economy with those two trajectories heading toward
each other is sorely limited.

The trouble is, reforming that bureaucracy has meant locking horns with Italy's
powerful trade unions, which aggressively oppose any significant changes in that
arena. That clash brought down one Italian government in the 1990s, and it made most
of the others - including Prodi's previous late-1990s government - trigger shy.

But the prime minister has nonetheless promised the EU that he would make the
necessary changes to the pension system a priority in 2007. If he does, he may yet
regain the reformer label he appeared to abandon earlier this year.

Eric J. Lyman is ISN Security Watch's senior correspondent in Rome.

The views and opinions expressed herein are those of the author only, not the
International Relations and Security Network (ISN).