## cr17238

## Source details

**Canonical URL:** [cr17238](https://www.imf.org/-/media/files/publications/cr/2017/cr17238.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/cr/2017/cr17238.pdf.md)
- [Structured JSON version](/-/media/files/publications/cr/2017/cr17238.pdf.json)

---

### Competitiveness, growth, and export performance
- Growth and productivity gaps:
  - Real GDP per capita, total factor productivity (TFP), and real export performance in Italy have lagged euro area peers over the past two decades.
  - Real incomes per capita and TFP in Italy are below levels from more than two decades ago; in Germany these increased by about 20 and 12 percent respectively over the same period.
- Real effective exchange rates and price gaps:
  - The euro depreciated since 2010 by about 15 percent against a basket of main trading partners and 25 percent against the Chinese yuan.
  - CPI- or PPI-based REERs returned close to levels at euro introduction.
  - Italy maintains a price-based REER gap in the range of about 5–15 percent against the euro area and Germany, depending on CPI, PPI, or GDP deflator.
- Unit labor costs and manufacturing competitiveness:
  - Measured at factor costs (ULCs), Italy maintains an REER gap of close to 10 percent vis-à-vis the euro area average and almost 20 percent vis-à-vis Germany.
  - About 45 percent of the ULC gap in manufacturing relative to Germany is due to the rising hourly wage rate (Manasse, 2013 decomposition).
  - Over 1995–2010, Italy lost about 40 percent of competitiveness against Germany; productivity gap accounted for roughly 60 percent and hourly wages added about 45 percent.
  - In the last five years, Italy regained about 4.4 percent of the competitiveness gap supported mostly by higher productivity and some fiscal devaluation.
- External adjustment:
  - Between 1995 Q1 and 2011 Q1, real imports grew by 75 percent compared to about 40 percent growth in real exports.
  - The exports-to-GDP ratio (real terms) increased by 4.7 percent of GDP over that period; imports-to-GDP increased by 9.5 percent of GDP (or 10.9 percent of final consumption).
  - Estimated required real depreciation to realign Italy’s current account with fundamentals: on the order of 10 percent.

### Pass-through of domestic costs to export prices (empirical evidence)
- Descriptive findings:
  - Italy has historically had very low domestic cost elasticity of the export price, unlike German and U.S. exporters.
  - Italian export prices have followed import prices in the euro area more closely than domestic ULCs; a negative correlation is observed between Italian export prices and ULCs in manufacturing.
  - Italian export prices are relatively sensitive to oil and energy prices.
- Full-sample quarterly regression (past 20 years) — key coefficients for Italy (Table 1):
  - Export prices (-1): 0.267*** (standard error (0.08))
  - Foreign prices: -0.138*** (standard error (0.04))
  - Domestic PPI: 0.225* (standard error (0.12))
  - PPI energy: 0.035* (standard error (0.02))
  - PPI oil: 0.037** (standard error (0.02))
  - Brent oil price: 0.001 (standard error (0.01))
  - R-squared: 0.69
  - Adj. R-squared: 0.67
  - Observations: 81
- Sub-period (pre- and post-crisis from beginning of 2008) — key coefficients for Italy (Table 2):
  - Export prices (-1): Pre-crisis -0.049 (0.13); Post-crisis -0.287 (0.18)
  - Foreign prices: Pre-crisis -0.051 (0.17); Post-crisis -0.142 (0.23)
  - Domestic PPI: Pre-crisis 0.653** (0.32); Post-crisis 0.751** (0.30)
  - PPI oil: Pre-crisis 0.146*** (0.03); Post-crisis 0.093* (0.05)
  - Brent oil price: Pre-crisis -0.068*** (0.01); Post-crisis -0.047* (0.03)
  - R-squared: Pre-crisis 0.60; Post-crisis 0.54
  - Observations: Pre-crisis 47; Post-crisis 35
- Interpretation:
  - Italy’s cost elasticity increased post-crisis but remains closer to France and about two times lower than Portugal or Spain, indicating limited pass-through and constrained ability to enhance export profitability via domestic cost pass-through.

### Adjustment margins: prices versus quantities and real-economy outcomes
- Pre-crisis: manufacturing firms absorbed wage increases via lower profit margins (pricing-to-market).
- Post-crisis: nominal wage rigidities led to adjustment through quantities — employment and investment fell.
  - Manufacturing employment declined for eight consecutive years and remains 16 percent below its pre-crisis level.
  - Real investment is 2 percent below the euro introduction level.
  - Business services: 10 percent reduction in real investment compared to 1999.
- Export volumes subdued amid compressed profit margins and limited pass-through of domestic costs.

### Export structure, productivity, and GVCs
- Export quality and market share:
  - Italy’s exports are among the most diversified and historically high-quality; export unit values historically grew faster than the export deflator.
  - Henn and others (2013): Italy placed at or just below the 90th percentile of 178 countries in a quality index, with steady deterioration since the late 1990s.
  - Increasing export unit values combined with declining relative market share: exports have not driven recovery.
- Productivity decomposition (2001–2012):
  - Shift across industries contributes −0.48 percent annually to productivity growth in both Italy and the euro area.
  - Within-industry productivity contribution: euro area 0.42 percent; Italy 0.17 percent.
  - Productivity in the top 10 percent of Italian manufacturing firms declined by almost 15 percent; OECD top five frontier firms increased by more than 30 percent.
  - Increasing productivity and size of Italian frontier firms to global frontier could expand the manufacturing sector by about one-fifth.
- GVCs and competition from China:
  - Italy’s participation in GVCs has been generally low.
  - Italy had the highest export similarity with China among comparable countries; in 1999, 67 percent of Italy’s exports faced high or medium competition from China; by 2015 about 59 percent (Germany 44 percent; France 36 percent).
- Economic Complexity Index:
  - Since 1991 Italy’s ECI has declined by 40 percent, indicating a move away from the technological frontier.

### Structural impediments to productivity
- Innovation and R&D: overall scale of innovative activity low by EU/OECD standards despite relatively high research productivity.
- Firm size: small size impedes economies of scale; about three-fourths of the productivity gap with global frontier attributable to small size of Italian frontier firms (Andrews and Cingano, 2014).
- Zombie firms and misallocation:
  - Zombie firms hold almost one-fifth of capital and account for almost one-quarter of the decline in business investment (Adalet McGowan and others, 2017).
  - Schivardi and others (2017): bank weaknesses contribute to misallocation; bank balance-sheet cleanup would boost profitability and support recovery.
- Competition and public administration: impediments remain; decisive public administration reforms crucial to unlock productivity gains.

---

### Wage-setting institutions, quantitative reform impacts, and model results
- Current institutional framework:
  - Wage setting via centralized sectoral bargaining extended nationwide; two-tier system from the 1993 social pact with limited firm-level scope.
  - Legal standing for firm-level agreements weak; favorability principle and framework agreements by social partners prevail.
  - Coverage of national wage contracts in practice exceeds 90 percent; portion of wages exceeding national minima around 10.5 percent — implying compressed wage distribution.
- Micro evidence:
  - Firms with second-level bargaining provided productivity-related wage increases and were more likely to adopt innovative practices.
  - Only 12 percent of companies used derogative principles of the 2011 law; interest declining (D’Amuri and Giorgiantonio, 2015).
- Search-and-match DSGE model (Mortensen-Pissarides, Jimeno and Thomas (2013) extension) — baseline calibration to Italy:
  - Steady-state quarterly real interest rate: 0.01
  - Long-term unemployment rate: 10 percent (Italy’s long-term average about 9½ percent)
  - Quarterly job finding rate: 0.075
  - Monthly job finding rate for Italy at 0.026 (Hobijn and Şahin (2007))
  - Probability of filling a vacancy: 0.7
  - Labor market tightness: 0.11
  - Separation rate implied: 0.8 percent
  - Share of exogenous separations: 0.7 (exogenous separation rate 0.6 percent)
  - Matching function elasticity of unemployment: 0.4
  - Idiosyncratic productivity shocks log-normal; σ = 0.2
- Key quantitative baseline finding:
  - Moving from sector- to firm-level bargaining reduces steady-state unemployment from 10 percent to 6.5 percent.
  - Corresponding employment increase: 3.5 percentage point (or 4 percent) increase in steady-state employment (labor force normalized to 1).
- Robustness scenarios:
  - “Medium tightness” (target tightness 0.2): implied job finding rate 14 percent; separation rate 1.6 percent; equilibrium unemployment under firm-level bargaining ≈ 6¼ percent.
  - “High tightness” (tightness 0.445, unemployment elasticity 0.23, vacancy fill rate 0.8): implied job finding rate 0.36; equilibrium unemployment under firm-level bargaining just below 5 percent.
  - Conclusion: baseline likely conservative; employment gains larger in more fluid labor markets.

### Policy recommendations on wage-bargaining reform
- Move toward firm-level bargaining rather than regional or national bargaining given firm heterogeneity and low coordination.
- Consider a “clean slate” legal approach: allow firm-level contracts to take prevalence over higher-level bargaining; allow recourse to higher-level bargaining only when firms do not engage in firm-level bargaining or opt out.
- Allow derogation from sectoral contracts on wages, hours, and non-wage benefits; firmly establish representativeness criteria in law.
- Consider instituting a statutory minimum wage as a floor:
  - Jobs Act foresees this option though not implemented; national contracts currently provide de facto wage floors.
  - Minimum wage should not dis-incentivize participation and ideally be differentiated by regions.
- Caveat: complement wage-bargaining reform with productivity-enhancing reforms (administrative, product market, fiscal, bank balance-sheet cleanup) and labor-market measures for full realization of gains.

---

### Mapping reforms into GIMF and simulated macro effects of wage-bargaining reform
- Mapping: to replicate DSGE employment gains (~4 percent), GIMF reduces wage markups by about 15 percentage points.
- Implementation in simulation:
  - 15 percentage point reduction in wage markups phased linearly over five years.
  - Reduction anticipated by households and firms and fully credible after year five.
- GIMF simulation near-term effects:
  - Little or no upfront output losses.
  - Real consumption and investment decline somewhat initially as wages and inflation decline and real interest rates rise.
  - Initial declines offset by expenditure switching toward imports as the REER depreciates.
- Medium-run (5–10 years):
  - Real output about 4–5 percentage points higher than baseline.
  - REER depreciates by about 2–3 percent.
- Long-run:
  - Some initial overshooting; as inflation recovers and real interest rate declines, output and REER improvements reduce slightly in steady state.
- Policy implication:
  - Decentralization of wage bargaining need not be recessionary in the near term, especially when part of a comprehensive reform package.
  - Complementary labor market measures (active labor market policies, childcare, tax incentives for second earners) enhance realization of full gains.

---

### Public finances, pensions, and revenue rebalancing
- Fiscal targets in 2017 DEF:
  - Headline deficit projections: 2017: 2.3 percent of GDP (before implementation of new measures of 0.2 percent of GDP); 2018: 1.2 percent of GDP; 2019: 0.2 percent of GDP; 2020: zero.
  - Structural deficit projections: 2017: about -1.5 percent of GDP; 2018: -0.7 percent of GDP; 2019: 0.1 percent of GDP.
  - Authorities plan consolidation measures over next three years amounting to a further 1½ percent of GDP (not fully specified).
- Public spending composition:
  - Total public expenditure about 2 percent of GDP above euro area average: 50.4 percent of GDP versus 48.5 percent.
  - Interest on debt: 4.2 percent of GDP in 2015.
  - Education spending: 4 percent of GDP.
  - Defense spending: 1.2 percent of GDP.
- Public spending trends:
  - From 1999 to 2007 nominal current primary expenditure grew faster than euro area average, driven by social benefits (primarily pensions), intermediate consumption, and wages.
  - From 2008 to 2016 nominal current primary expenditure grew at 1.8 percent per year on average (euro area average 2.6 percent).
  - Capital expenditure declined by about 28 percent in nominal terms between 2009 and 2016.
- Social benefits and pensions:
  - Social benefits rose about 43 percent cumulatively from 1999 to 2007 and a further 33 percent since then.
  - Social benefits constitute half of total primary spending, up from 40 percent at euro accession.
  - Pension spending about 16 percent of GDP — second highest in euro area after Greece.
- Pension system and reforms:
  - Transition from DB to NDC started in 1995; eligibility tightened in multiple reforms; statutory retirement age (SRA) gradually increasing to at least 67 years by 2021.
  - In 2017: SRA 66 years and 7 months for men and female public employees; 65 years and 7 months for female private-sector employees; 66 years and 1 month for female self-employed.
  - Early retirement allowed with minimum 42 years and 10 months for men and 41 years and 10 months for women; NDC allows retirement up to 3 years earlier with 20 years contributions and pension ≥ €1,200 per month.
  - Average contribution period for new pensions about 33 years (expected to increase to 35 years); life expectancy at 65 about 20 years.
  - Survivor pensions spending: around 2¾ percent of GDP; survivor pensions form about 28 percent of total pensions (EU average about 18 percent).
- Pension generosity and actuarial issues:
  - DB accrual rate: weighted average 2 percent (MEF, 2014); EU/euro area typical accrual rates about 1.5–1.7 percent.
  - Simple partial correction example: abolish thirteenth pension payment (Christmas bonus) = 7.7 percent cut in average pensions of the DB component.
  - NDC discount factors: notional IRR crediting notional capital = moving average of nominal GDP growth over past five years; discount rate used to derive annuity factor = 1.5 percent (based on expected long-run real growth) — this is likely above Italy’s current growth potential.
  - Recommendation: introduce an automatic sustainability adjustment linking current pension payments to long-term actuarial balance.
- Long-run projections and sensitivity:
  - MEF projection: pension spending just above 15 percent of GDP until 2045, declining to 13.7 percent of GDP by 2060.
  - Projections rely on optimistic assumptions: high immigration, large employment pickup, sustained higher real GDP growth.
  - Sensitivity: unemployment settling at 9 percent (instead of MEF’s lower unemployment) → pension spending increases by more than 2¼ percent of GDP by 2060.
  - A permanent negative labor productivity shock of about ½ percentage point per year → pension spending about 1 percent of GDP higher in both 2040 and 2060.
  - Lower steady state employment, higher old-age dependency, or permanent negative productivity shock raise debt-to-GDP by 20–60 percentage points above baseline.
- Recommended near- and medium-term pension measures:
  - Eliminate fourteenth pension payment and consider abolishing thirteenth for DB/mixed schemes; protect vulnerable via targeted anti-poverty scheme.
  - Introduce age limit for surviving spouse eligibility and limit survivor payments to close relatives other than spouse or orphan.
  - Recalibrate existing pensions on steady-state NDC formula or equivalent accrual rates to reduce short- to medium-term spending.
  - Harmonize contribution rates for self-employed toward at least 27 percent (self-employed contribution in 2014: 22.2 percent; set to increase to 24 percent by 2018).
  - Subject pension benefits to health contributions and realign tax-free thresholds with wage earners.
  - Adjust NDC discount factor to reflect realistic growth potential and introduce automatic adjustment mechanisms.

### Revenue rebalancing and tax-policy considerations
- Structural tax facts (2015 and other):
  - Total government revenues 43.5 percent of GDP vs EU average 37.0 percent.
  - Total tax revenues 29.7 percent of GDP in 2015.
  - Labor tax wedge for single person earning average income: 47.9 percent vs OECD average 35.9 percent.
  - Share of personal income tax (PIT) in total taxes: 41 percent.
  - CIT to GDP ratio about 2 percent vs EU average 2.7 percent.
  - Standard VAT rate 22 percent vs EU average ~21.5 percent.
  - VAT compliance gap: €36.9 billion (~27.5 percent of VAT liability; 2.28 percent of GDP).
  - Tax arrears stock in 2016: €614 billion; about €31 billion deemed recoverable.
  - Tax expenditures estimated at 5.5–6.5 percent of GDP.
- Growth-friendly revenue measures suggested:
  - Lower employers’ SSC rate closer to EU average; consider partially financing via higher employees’ SSC share if accompanied by PIT cuts.
  - Replace dependent-spouse tax credit with in-work tax credit; evidence suggests a 3 percentage point increase in married women participation (Colonna and Marcassa, 2015).
  - Re-introduce modern property tax on primary residences, reform cadastral values; property tax potential noted (recurrent immovable property taxes raised 1.6 percent of GDP in 2015).
  - Reduce VAT policy gaps by harmonizing reduced VAT rates and improving compliance; halving compliance gap could raise revenues by 1.14 percent of GDP.
  - Rationalize tax expenditures (e.g., mortgage interest tax credit) and streamline business tax incentives (make R&D credit permanent, reform ACE, consider abolishing IP box).
  - Strengthen tax administration, enforcement, and write-off arrangements.
- Short-term effects of cutting employers’ SSCs:
  - Can reduce labor costs and increase labor demand; trade balance effect may be temporary if nominal wages adjust.
  - Longer lasting output/employment effects if shift financed by less distortionary taxation (VAT/property).

---

### GIMF-based comprehensive reform package, scenarios, and quantitative outcomes
- Modeling approach and mapping:
  - Use GIMF to simulate growth-friendly fiscal consolidation of about 2 percent of GDP over four years plus structural reforms (wage markups, TFP, labor supply, ALMPs, childcare, NPL reduction).
  - Wage bargaining: firm-level change mapped to a 15 pp reduction in wage markups.
  - Product market reform: close one-half of distance-to-frontier in non-tradable PMR → 17 percent decline in ETCR / PMR.
  - Public administration: 1½ percent increase in steady-state real GDP via aggregate TFP shock.
  - ALMPs: 0.36 percent of GDP; childcare: 0.2 percent of GDP; universal anti-poverty: ½ percent of GDP (fiscally neutral reallocations).
  - NPL reduction: modeled as TFP shock delivering 2 percent increase in real GDP over 5 years (¾ non-tradables, ¼ tradables).
- Simulated package (main fiscal and structural elements and scales from Table 1):
  - Lower untargeted social transfers: 1¼ percent of GDP.
  - Lower government consumption (goods and services): 1¼ percent of GDP.
  - Higher government investment: ½ percent of GDP.
  - Lower tax wedge on labor (taxes on labor): 1½ percent of GDP.
  - Higher VAT revenue (taxes on consumption): 1 percent of GDP.
  - Higher property tax revenue (lump-sum tax): ½ percent of GDP.
  - Wage mark-up reduction: 15 pp.
- Key quantitative simulated results:
  - Full policy package:
    - Output increase of around 2 percent in a decade.
    - Debt-to-GDP ratio lower by around 13 percentage points in a decade.
    - Long run: output around 2½ percent higher than baseline.
    - Long run: debt-to-GDP ratio more than 35 percentage points lower than baseline.
  - Fiscal consolidation alone (2 percent of GDP over four years): real GDP about ½ percent below baseline at peak after three years.
  - Banking-sector NPL reduction to normal levels (around 5–6 percent) over five years:
    - About 2 percent higher real GDP in five years and around 3 percent in steady state.
    - Long-run mean-reverting NPL reduction yields about 3 percent higher real GDP.
  - Wage-bargaining reform (modeled as −15 p.p. wage markup):
    - Simulations indicate decentralized bargaining could increase steady-state employment by about 4 percent.
  - Aggregate simulated impact and competitiveness:
    - Cumulative output increase potential of 6–13 percent above baseline (figures aggregated across reforms).
    - About one-half of medium-term competitiveness gains stem from structural reforms (particularly wage bargaining) and the other half from fiscal devaluation, spending rebalancing, and bank cleanup.
    - REER depreciation notable under reform package (REER movements relative to baseline over transition and steady state).
- Short-term tradeoffs and credibility:
  - Short-term reductions in consumption and output from consolidation and transfer cuts are modest.
  - Credible and timely implementation increases near-term investment and reduces short-term costs.
- Policy sequencing and recommendations:
  - Combine growth-friendly fiscal consolidation (2 percent of GDP over four years) with revenue-neutral tax reform reducing labor wedge by 1½ percent of GDP (financed by 1 percent of GDP higher VAT collections and ½ percent of GDP property tax).
  - Rebalance spending: reduce current primary spending (1¼ percent of GDP) and increase public capital spending by ½ percent of GDP.
  - Implement wage-bargaining decentralization (−15 p.p. markups) alongside ALMPs (0.4 percent of GDP), childcare (0.2 percent of GDP), targeted anti-poverty (0.5 percent of GDP), product-market and public administration reforms, and NPL reduction to normal levels in five years.
  - Emphasize credible communication and sequencing to minimize near-term costs and maximize medium-term gains.

---

*cr17238 - References (cr17238 - References _______________________________________________________________________________ 29)*

### References _______________________________________________________________________________ 29

### References

### Figures, Tables, and Appendices (Inventory highlights)
- Figures listed include: Competitiveness Indicators; Competitiveness and Internal Adjustment; The Dynamics and Structure of Exports; Labor Market Indicators; GIMF Simulations of a 15pp Reduction in Wage Markups.
- Tables listed include: Italy and Euro Area: Export Price Regression for the Full Period; Italy and Euro Area: Export Price Regression for Sub-periods.
- Appendix sections listed: A. Public Spending Trends and Composition; B. The Italian Pension System: A Deeper Look; C. Revenue Rebalancing: Some Considerations; D. A Growth-Friendly Fiscal Policy Mix.

### Competitiveness and Wage Bargaining: Key findings
- Growth and export performance:
  - Over the past two decades, real GDP per capita, total factor productivity (TFP), and real export performance in Italy have lagged euro area peers.
  - Real incomes per capita and TFP in Italy are below levels from more than two decades ago; in Germany these increased by about 20 and 12 percent respectively over the same period.
- Real effective exchange rates (REERs) and prices:
  - CPI- or PPI-based REERs have returned close to levels at euro introduction, reflecting the euro depreciation since 2010 of about 15 percent against a basket of main trading partners and 25 percent against the Chinese yuan.
  - Despite that, Italy maintains a price-based REER gap in the range of about 5–15 percent against the euro area and Germany, depending on CPI, PPI, or GDP deflator.
- Unit labor costs (ULCs) and competitiveness:
  - Measured at factor costs (ULCs), Italy maintains an REER gap of close to 10 percent vis-à-vis the euro area average and almost 20 percent vis-à-vis Germany.
  - In manufacturing, ULCs in Germany and the rest of the euro area have followed each other closely; manufacturing in Italy has seen secularly increasing average wages compared to productivity that has stabilized but not reduced in recent years.
  - About 45 percent of the ULC gap in manufacturing relative to Germany is due to the rising hourly wage rate (Manasse, 2013 decomposition).
  - Over 1995–2010, Italy lost about 40 percent of competitiveness against Germany; productivity gap accounted for roughly 60 percent and hourly wages added about 45 percent. In the last five years, Italy regained about 4.4 percent of the competitiveness gap supported mostly by higher productivity and some fiscal devaluation.
- External adjustment and export elasticities:
  - ULC- and export unit value-based REERs are generally better indicators of competitiveness than PPI- or CPI-based measures in several studies; for Italy, ULC-based indicators are often more informative in explaining export flows.
  - Evidence on intra- vs. extra-euro-area elasticities is mixed: for Italy, ULC-based indicators have roughly two times higher (in absolute terms) long-term elasticity in explaining intra-EA compared to extra-EA exports in full sample regressions; other studies find within-EA elasticities can be substantially larger.
  - Rising relative ULC is associated with a declining trade balance; the relationship is stronger for euro area countries.
- External balance dynamics:
  - Between 1995 Q1 and 2011 Q1, real imports grew by 75 percent compared to about 40 percent growth in real exports.
  - The ratio of exports to GDP (real terms) increased by 4.7 percent of GDP over that period; the ratio of imports to GDP increased by 9.5 percent of GDP (or 10.9 percent of final consumption).
  - The double-dip recession swung the current account into a surplus mainly via import compression from declining investment and large commodity terms of trade gains; all else equal, the surplus is expected to diminish as the output gap closes and commodity gains reverse.
  - A real depreciation on the order of 10 percent is estimated to be needed to realign Italy’s current account with fundamentals.

### Internal adjustment: prices versus quantities
- Wage-productivity differentials:
  - A wide gap persists between nominal wages and productivity in manufacturing; nominal manufacturing wage growth in Italy exceeded own productivity, which has been largely stagnant.
  - In services, an even wider wage-productivity gap is evident, with a secular decline in productivity of services in Italy.
  - Resources have been gradually reallocated from higher productivity manufacturing to lower productivity services.
- Adjustment channels:
  - Adjustment to competitiveness pressures has occurred through lower pre-crisis profits and reduced quantities since the crisis, including employment and investment, as companies sought to retain labor productivity without increasing price differentials.

### Wage-setting institutions and reform impacts
- Current wage-setting features:
  - Wages are set at the sectoral level and extended nationally; they do not respond well to firm-specific productivity, regional disparities, or skill mismatches.
  - Nominal wage rigidity has implied adjustment through lower profits and employment.
- Quantified reform impacts:
  - In a search-and-match DSGE model of the Italian labor market, moving from sectoral- to firm-level wage setting yields substantial gains: at least 3.5 percentage points lower unemployment (or higher employment) rate and a notable improvement in Italy’s competitiveness over the medium term.
- Policy implications:
  - Ensuring wage growth in line with productivity requires labor market institutions that allow wages to reflect firm-level productivity and regional differences.
  - Internal devaluations are more likely to be maintained and effective when accompanied by productivity-enhancing reforms, including supportive administrative, labor market and product market reforms, fiscal reforms, and cleaning bank balance sheets.

### Research and methodological notes
- Empirical literature:
  - Bayoumi and others (2011), Christodoulopoulou and Tkačevs (2014), Giordano and Zollino (2016), Bobeica and others (2016), Bluedorn and Lin (2017), and others provide evidence on the performance of different REER measures and on export and external balance elasticities.
  - Studies indicate cost competitiveness indicators (ULCs, export unit values) are often more informative than price-based indicators for Italy.
- Model simulations and tools mentioned:
  - GIMF Simulations of a 15pp Reduction in Wage Markups are listed among figures.
  - A search-and-match DSGE model was used to quantify labor market reform gains.

*Italic source attribution: cr17238 - References (cr17238 - References _______________________________________________________________________________ 29)*

### 11.      The prices of Italian exports do not appear to respond strongly to domestic ULCs,

### 11.      The prices of Italian exports do not appear to respond strongly to domestic ULCs, albeit with varying patterns pre- and post-crisis.

### Pass-through of domestic costs to export prices: descriptive findings
- Historical literature (Mazier and others (1999); Bussière and Peltonen (2008)) finds:
  - Italy has historically had very low domestic cost elasticity of the export price, in contrast to German and U.S. exporters.
  - Export prices in Italy have followed import prices in the euro area more closely than domestic ULCs.
  - A negative correlation is observed between Italian export prices and ULCs in manufacturing.
- Overall characterization from staff analysis:
  - Italy has a very low pass-through of domestic costs to export prices.
  - Italian export prices are relatively sensitive to oil and energy prices.

### Empirical results (full sample, quarterly data, past 20 years) — key coefficients for Italy (Table 1)
- Export prices (-1): 0.267*** (standard error (0.08))
- Foreign prices: -0.138*** (standard error (0.04))
- Domestic PPI: 0.225* (standard error (0.12))
- PPI energy: 0.035* (standard error (0.02))
- PPI oil: 0.037** (standard error (0.02))
- Brent oil price: 0.001 (standard error (0.01))
- R-squared: 0.69
- Adj. R-squared: 0.67
- Observations: 81
- Note on methodology: regressions relate the total export deflator to domestic costs and foreign competitors’ prices; domestic costs measured by domestic PPI excluding construction and energy; foreign prices measured with HICP-based REER divided by domestic HICP; regressions in log-differences with a lagged dependent variable; PPI oil, non-oil energy, and Brent oil included to avoid multicollinearity.

### Sub-period (pre- and post-crisis from beginning of 2008) patterns — key coefficients for Italy (Table 2)
- Export prices (-1):
  - Pre-crisis: -0.049 (standard error (0.13))
  - Post-crisis: -0.287 (standard error (0.18))
- Foreign prices:
  - Pre-crisis: -0.051 (standard error (0.17))
  - Post-crisis: -0.142 (standard error (0.23))
- Domestic PPI:
  - Pre-crisis: 0.653** (standard error (0.32))
  - Post-crisis: 0.751** (standard error (0.30))
- PPI oil:
  - Pre-crisis: 0.146*** (standard error (0.03))
  - Post-crisis: 0.093* (standard error (0.05))
- Brent oil price:
  - Pre-crisis: -0.068*** (standard error (0.01))
  - Post-crisis: -0.047* (standard error (0.03))
- R-squared:
  - Pre-crisis: 0.60
  - Post-crisis: 0.54
- Observations:
  - Pre-crisis: 47
  - Post-crisis: 35
- Interpretation:
  - Across many peer countries, domestic cost elasticity increased in the post-crisis period.
  - Italy’s cost elasticity increased post-crisis but remains closer to France and about two times lower than Portugal or Spain, suggesting limited ability to enhance export profitability via pass-through.

### Adjustment margins and real-economy outcomes
- Pre-crisis adjustments:
  - Manufacturing companies absorbed wage increases via lower profit margins (pricing-to-market behavior).
  - ULCs increased over and above the output deflator, implying declining capital share and profit margins in manufacturing (contrast with Germany).
- Post-crisis adjustments:
  - Nominal wage rigidities led to adjustment through quantities (employment and investment).
  - Manufacturing employment declined for eight consecutive years and remains 16 percent below its pre-crisis level.
  - Real investment has been cut dramatically and is now 2 percent below the euro introduction level.
  - Business services: 10 percent reduction in real investment compared to 1999.
  - Export volumes have remained subdued amid compressed profit margins and some pass-through of domestic costs.

### Export competitiveness, productivity, and global value chains (GVCs)
- Diversification and perceived quality:
  - Italy’s exports are among the most diversified and historically high-quality; export unit values have historically grown faster than the export deflator.
  - Henn and others (2013): Italy placed at or just below the 90th percentile of 178 countries in a quality index, but with steady deterioration since the late 1990s.
  - Bugamelli and others (2017): “Export quality” has grown rapidly but cannot be fully disentangled from other demand shifters or production cost changes.
- Market share and unit values:
  - Italy has been gradually losing export market share; unlike many euro area peers, Italy has not reversed this trend despite a weaker euro in recent years.
  - Increasing export unit values combined with declining relative market share indicate exports have not led the recovery.
- Productivity performance:
  - OECD (2017): shift across industries contributes −0.48 percent annually to productivity growth in both Italy and the euro area.
  - Within-industry productivity growth contribution:
    - Euro area: 0.42 percent
    - Italy: 0.17 percent
  - Between 2001 and 2012, productivity in the top 10 percent of Italian manufacturing firms declined by almost 15 percent.
  - Over the same period, productivity of OECD top five frontier firms increased by more than 30 percent.
  - Increasing the productivity and size of Italian frontier firms to global frontier could expand the manufacturing sector by about one-fifth.
- Integration in GVCs and exposure to China:
  - Italy’s participation in GVCs has been generally low.
  - Italy has the highest export similarity with China among comparable countries; Italy’s exports have substantial overlap with China’s export structure.
  - Bugamelli and others (2017): in 1999, 67 percent of Italy’s exports faced high or medium competition from China; by 2015, about 59 percent (still well above Germany’s 44 percent and France’s 36 percent).
- Economic Complexity Index (ECI):
  - Since 1991 Italy’s ECI has declined by 40 percent, indicating a move away from the technological frontier and declining product complexity.

### Other structural factors affecting productivity and competitiveness
- Innovation and R&D:
  - Overall scale of innovative activity in Italy is low by EU or OECD standards (number of researchers and patents, R&D spending as a share of GDP, private investment in fixed and knowledge-based capital), though research productivity is relatively high.
- Firm size and scale effects:
  - Small size of Italian firms impedes economies of scale and technology spillovers; correlation between market size and productivity is very low relative to other advanced European countries.
  - Andrews and Cingano (2014): about three-fourths of the productivity gap with the global frontier attributable to the small size of Italian frontier firms.
- Zombie firms and resource misallocation:
  - Adalet McGowan and others (2017): zombie firms in Italy hold almost one-fifth of capital and account for almost one-quarter of the decline in business investment.
  - Schivardi and others (2017): do not find crowding out from zombies but highlight bank weaknesses that contribute to misallocation and allow zombies to persist. Cleanup of bank balance sheets would boost bank profitability and support recovery.
- Competition and public administration:
  - Impediments to competition remain prevalent.
  - Decisive reforms in public administration are crucial for improving firm productivity and unlocking gains from product market reforms.

*International Monetary Fund — Chapter: The prices of Italian exports do not appear to respond strongly to domestic ULCs (cr17238).*

### 19.      Wage setting in Italy is conducted through centralized wage bargaining at the sectoral

### Wage setting in Italy is conducted through centralized wage bargaining at the sectoral level

### Institutional framework and recent reforms
- Wage setting is conducted through centralized wage bargaining at the sectoral level; sectoral wage agreements are extended to the whole country.
- Framework defined by the 1993 social pact: two-tier wage bargaining with firm-level bargaining subordinated to national sectoral contracts and applicable in “non-repeatable” areas to provide productivity-related wage increases.
- Since 2009, several limited attempts to facilitate firm- or second-level bargaining; most notably, the 2011 decree law (138) set conditions for firm-level and local wage agreements to prevail over the industry-wide national collective agreement.
- Legal standing of conditions for firm-level agreements remains weak and restrictive (e.g., requiring a majority representation of trade unions for contract discussions at the firm level with restrictive or unclear criteria such as the aim to foster employment, increase in salary and competitiveness).
- Rules on wage bargaining and contract structure are set by social partners in framework agreements (rather than by law); the favorability principle remains deeply rooted.
- Empirical evidence: only 12 percent of companies resorted to the derogative principles of the 2011 law and interest by companies is declining (D’Amuri and Giorgiantonio, 2015).

### Institutional rigidities, coordination, and wage outcomes
- Wage-setting institutions impose strong wage rigidities.
- According to WEF (2016) indicators, flexibility of wage determination and degree of cooperation between social partners are among the lowest in the euro area.
- Bargaining governability (ability of employer associations and trade unions to control constituencies) is also low (OECD, 2004).
- Coverage of national wage contracts in practice exceeds 90 percent due to constitutionally-provided administrative extension to the entire workforce.
- Portion of wages exceeding national collective agreement minimums is around 10.5 percent, implying highly compressed wage distribution despite pervasive regional firm-level productivity differentials and a large supply–demand skills mismatch.
- Industry agreements typically last three years and link contractual wages to CPI forecasts excluding energy; adjustments can be made only at the next negotiation round, contributing to high persistence and sluggish adjustment.
- These institutional features point to potentially large employment gains from decompressing the wage distribution to reflect productivity differentials.

### Business attitudes and micro evidence
- Firms with second-level bargaining tended to provide wage increases related to productivity and were more likely to adopt innovative practices (D’Amuri and Giorgiantonio, 2015).
- Roughly one-third of surveyed businesses and 44 percent of those with supplementary firm-level agreements declared dissatisfaction with national agreements.
- Almost two-thirds of firms expressed interest in more flexible working hours in exchange for employment guarantees or wage increments.
- Need to keep wages down in exchange for concessions was especially strong for internationally oriented companies (exports > one-third of turnover).

### Cross-country and theoretical evidence on two-tier bargaining
- Two-tier bargaining schemes have not delivered enhanced wage flexibility elsewhere in Europe (Boeri, 2014, 2015).
- Empirical findings:
  - Firms under two-tier bargaining adjust mainly employment in response to adverse shocks, whereas firms with decentralized firm/plant-level bargaining adjust mainly wages.
  - Firms’ wage share linked to individual performance is about the same as in firms applying only higher-level agreements; it is higher in firms applying firm-level agreements.
  - Compression of nominal wages does not necessarily reduce real wage inequality in countries with large productivity dispersions across firms and regions (e.g., Italy).

### Quantitative assessment: model setup and baseline calibration
- Model: search-and-match Mortensen-Pissarides framework extended per Jimeno and Thomas (2013) to allow relative wages to respond to firm- and sector-specific productivity shocks.
- Baseline parameterization to the Italian labor market:
  - Steady-state quarterly real interest rate: 0.01
  - Long-term unemployment rate: 10 percent (Italy’s average unemployment rate over the long term is about 9½ percent)
  - Quarterly job finding rate: 0.075 (monthly job finding rate for Italy at 0.026 per Hobijn and Şahin (2007))
  - Probability of filling a vacancy: 0.7
  - Labor market tightness: 0.11
  - Separation rate implied by job finding rate and unemployment rate: 0.8 percent
  - Share of exogenous separations: 0.7 (implying an exogenous separation rate of 0.6 percent)
  - Matching function: Cobb-Douglas with elasticity of unemployment: 0.4
  - Idiosyncratic productivity shocks: log-normal; mean log-productivity μ normalized to σ^2/2 so E(z)=1
  - Standard deviation of productivity σ: 0.2

### Key quantitative findings (baseline)
- Moving from sector- to firm-level bargaining reduces steady-state unemployment:
  - Equilibrium unemployment rate falls from 10 percent to 6.5 percent under firm-level bargaining.
  - Corresponding employment increase: 3.5 percentage point (or 4 percent) increase in the steady-state employment (size of labor force normalized to 1).
- Unemployment is lower under firm-level bargaining compared to sector-level bargaining and an alternative “right-to-manage” bargaining regime.
- Mechanism: firm-level bargaining allows wages to respond to firm-specific productivity, saving jobs through lower separation rates and creating new jobs through higher job finding rates.

### Robustness scenarios and sensitivity
- Three limitations to the baseline calibration identified: (i) data concern firms with 10+ employees (industry and services); (ii) many vacancies may be filled via short-term arrangements not advertised; (iii) data dominated by crisis and prolonged adjustment.
- Two alternative scenarios tested:
  - “Medium tightness” scenario:
    - Target labor market tightness: 0.2 (higher end of Italy’s pre-crisis period)
    - With unchanged probability of finding work (0.7) and long-run unemployment rate (0.1), implied job finding rate: 14 percent; separation rate: 1.6 percent.
    - Equilibrium unemployment under firm-level bargaining falls to about 6¼ percent.
  - “High tightness” scenario:
    - Target labor market tightness: 0.445
    - Unemployment elasticity of matching function reduced to 0.23 (Peracchi and Viviano (2004) point estimates)
    - Vacancy filling rate increased to 0.8
    - Implied job finding rate: 0.36
    - Equilibrium unemployment under firm-level bargaining falls to just below 5 percent.
- Conclusion: employment gains are larger in more fluid labor market parameterizations; baseline is likely a conservative lower-bound.

### Policy considerations and recommendations
- Institutional diagnosis:
  - Given Italy’s low degree of coordination/corporatism, fully centralized or regional bargaining is unlikely to internalize negative wage externalities effectively; firm-level bargaining is a more feasible option given large firm heterogeneity.
- Recommended reforms:
  - Move toward firm-level bargaining rather than regional or national bargaining.
  - Consider starting from a “clean slate” to address legal uncertainty: allow firm-level contracts to take prevalence over higher bargaining levels, with firms able to resort to higher-level bargaining only when they do not engage in firm-level bargaining or opt out of firm-level bargaining.
  - Allow derogation from sectoral contracts for a wide range of issues (wages, hours worked, other non-wage benefits); firmly establish representativeness criteria in law.
  - Consider instituting a statutory minimum wage as a floor:
    - Jobs Act foresees this option though not implemented; national contracts currently provide de facto wage floors.
    - Minimum wage level should be set so as not to dis-incentivize participation and ideally differentiated by regions to reflect productivity and living standard differences.
- Caveat: a comprehensive complementary reform package to tackle other structural rigidities is necessary for the full realization of gains from wage-bargaining reform.

*Source: cr17238 — excerpt from IMF country report text.*

### 32.      Implementing other labor reforms could allow the gains from firm-level bargaining to

### 32.      Implementing other labor reforms could allow the gains from firm-level bargaining to 

### Labor market complementarities and recommended measures
- Other rigidities can contribute to structural unemployment and dampen the efficiency gains from firm-level wage setting.
- Wage bargaining reform can be supported by other labor market measures to reduce supply constraints, including:
  - active labor market policies to facilitate search-and-match and reduce skill mismatches;
  - scaling up child-care;
  - lowering the labor tax wedge for second earners to incentivize employment (Topalova, 2016).

### Mapping reforms into the GIMF framework (assumptions used)
- The IMF’s Global Integrated Monetary and Fiscal Model (GIMF) is used to simulate the effect of firm-level wage bargaining on growth and competitiveness.
- Key mapping: to replicate the search-and-match DSGE model baseline scenario (which pointed to an increase in employment of about 4 percent), GIMF reduces wage markups by about 15 percentage points.
- Implementation features in the simulation:
  - The 15 percentage point reduction in wage markups is phased in linearly over five years.
  - The reduction is anticipated by households and firms and is fully credible after the fifth year.
- Note on labor market representation: GIMF contains only the intensive margin (hours worked), so the markup reduction is used to replicate steady-state employment outcomes from the prior DSGE model.

### GIMF simulation results — medium-term macroeconomic effects
- Near-term impact:
  - The reform is associated with little or no upfront output losses.
  - Real consumption and investment decline somewhat initially as wages and inflation decline, pushing up real interest rates.
  - These initial declines are offset by expenditure switching toward imports as the real exchange rate depreciates.
- Medium-run gains (over a 5–10 year horizon):
  - Real output is about 4–5 percentage points higher than in the baseline.
  - The REER (real effective exchange rate) depreciates by about 2–3 percent.
- Long-run dynamics:
  - There is some initial overshooting; as inflation recovers and the real interest rate declines, the improvement in output and the REER reduces slightly in the long-run steady state.

### Additional simulation outputs shown in Figure 5 (panels described)
- Panels illustrate percent deviations from baseline for:
  - Real GDP, Consumption, Investment (percent deviation from baseline).
  - Current Account/GDP (difference from baseline).
  - Real Effective Exchange Rate (Percent deviation from baseline; "+"=appreciation).
  - Primary Surplus/GDP (Difference from baseline).
  - Debt/GDP (Difference from baseline).
  - Interest Expenditure/GDP (Difference from baseline).
- Figure 5 horizontal axis spans years 0 through 10 and SS (steady state).

### Policy implications and interpretation
- Concerns that wage-bargaining decentralization is recessionary in the near term need not materialize, particularly when reforms are part of a comprehensive package (see Part 3).
- Complementary labor market reforms (active labor market policies, childcare expansion, tax incentives for second earners) can help realize the full employment and efficiency gains from firm-level bargaining.
- The simulated package—modeled as a 15 percentage point reduction in wage markups phased over five years and anticipated—yields notable medium-term improvements in output and competitiveness with limited near-term output costs.

*Source: IMF staff estimates and text from the chapter on firm-level bargaining and labor market reform in the IMF country report.*

### 1.      In the 2017 Economic and Financial Document (DEF), the authorities committed to

### 1.      In the 2017 Economic and Financial Document (DEF), the authorities committed to

### Fiscal targets and policy commitment
- The authorities committed to achieving a structurally balanced budget by 2019, corresponding with Italy’s medium-term objective of a balanced budget under the European fiscal framework.  
- DEF headline deficit projections:
  - 2017: 2.3 percent of GDP (before implementation of new measures of 0.2 percent of GDP)
  - 2018: 1.2 percent of GDP
  - 2019: 0.2 percent of GDP
  - 2020: zero
- DEF related structural deficit projections (deficit adjusting for the economic cycle):
  - 2017: about -1.5 percent of GDP
  - 2018: -0.7 percent of GDP
  - 2019: 0.1 percent of GDP
- The authorities plan consolidation measures over the next three years amounting to a further 1½ percent of GDP, but have not specified concrete measures beyond broad areas (cuts following spending reviews, fight against tax evasion, rationalizing tax expenditures).

### Objective of the paper
- Identify growth-friendly options to achieve fiscal consolidation and put debt on a firm downward path.
- The paper is divided into four parts: Public spending trend and composition; Pension system; Revenue rebalancing; Toward a growth-friendly policy mix (model simulations).

### Key quantitative context on public finances
- Total public expenditure in Italy is about 2 percent of GDP above the euro area average (50.4 percent of GDP versus 48.5 percent).
- Interest on debt: 4.2 percent of GDP in 2015.
- Education spending: 4 percent of GDP.
- Defense spending: 1.2 percent of GDP.

### Final recommendation headline
- A revenue-neutral, less distortionary tax reform combined with current spending cuts and increases in capital spending can generate sizable output gains and a sustainably lower public debt ratio over the medium to long term; short-term output costs are limited if the package is implemented credibly.

---

### A. Public spending trends and composition
- Long-run pattern:
  - Over the past two decades, primary spending in Italy grew faster than potential output, notably in the decade after euro accession.
  - From 1999 to 2007: nominal current primary expenditure grew faster than the euro area average and well above Italy’s average nominal potential growth—driven mainly by social benefit spending (primarily pensions), intermediate consumption, and wages.
  - From 2008 to 2016: nominal current primary expenditure grew at 1.8 percent per year on average, below the euro area average of 2.6 percent.
- Drivers of post-crisis deceleration:
  - Freezing of nominal wages from 2010 to 2015.
  - Reduction in public sector employees from 3.6 million in 2007 to around 3.3 million in 2015.
  - Severe cut in capital expenditure: declined by about 28 percent in nominal terms between 2009 and 2016.
- Despite post-crisis measures, total primary spending still grew above the country’s average nominal potential GDP growth over the period; pre-crisis overspending has not been reversed.

Key spending patterns and imbalances
- Social benefits dominate spending:
  - Social benefits rose by about 43 percent cumulatively from 1999 to 2007 and by a further 33 percent since then.
  - Social benefits constitute half of total primary spending, up from 40 percent at euro accession.
  - The bulk of social benefits spending is pensions.
- Non-pension social benefits:
  - Non-pension social benefit spending is low, fragmented, and poorly targeted compared to other EU countries.
  - Disproportionately low share of social transfers accruing to the low-income working age population; higher reliance on intra-family transfers; underspending on social inclusion, family/child benefits, and housing relative to the euro area average.
- Other areas of overspending relative to the euro area average:
  - Interest payments exceed the euro area average by 1.6 percent of GDP.
  - Intermediate consumption spending (primarily on goods and services) in the health sector.
  - Compensation of employees in defense, public order and safety, and health.
  - Subsidies in the economic affairs sector.
  - Capital transfers in general services and economic affairs.
- Health spending composition:
  - Overall public health spending is in line with the euro area average, but the bulk is for compensation of employees and intermediate consumption—pointing to potential efficiency savings at the local-government level.
- Underspending:
  - Education (provision of goods and services and total compensation), especially concentrated at the tertiary level.
  - Gross capital formation.
- Policy implications for spending mix:
  - Cuts to total social benefit spending will likely be required to meet medium-term objectives.
  - Improve targeting of non-pension social benefits to those most in need.
  - Improve efficiency of health spending at the local level.
  - Reallocate spending toward capital spending and education while improving outcome efficiency.
  - Complementary measures: more intense use of active labor market policies and a modern social safety net.

Spending review background
- Recent spending reviews:
  - 2012 “Giarda” spending review: address territorial differences in production costs and variability of unit costs; proposed privatization and targeted efficiency actions.
  - 2015 “Cottarelli” spending review: proposed savings up to 0.4 percent of GDP in 2014, 1 percent of GDP in 2015, and 2 percent of GDP in 2016 relative to trend; priority actions included centralized procurement, digitalization, cuts in state-owned enterprises, reduction of firm support, rationalization of services, and interventions on pension entitlements (including de-indexation).
  - 2016 reform of the accounting law envisaged integrating the spending review into the economic-financial planning cycle.

Constraints on further adjustment
- Recent strategy focused on cutting capital spending and curtailing the wage bill; wage bill at 9.8 percent of GDP is at its lowest level in several years.
- Limited room for further cuts in wage bill or capital spending; need for public investment to support stronger, sustained growth.
- Public sector employment as a share of total employment is below the euro area average; age structure tilted toward older workers.
- Years of wage freezes—planned wage increases are anticipated; keeping freezes in stronger nominal growth may be difficult.

---

### B. The Italian pension system: past reforms and current structure
- Reforms since 1992:
  - Pro-rata replacement of old Defined Benefit (DB) scheme with a Notional Defined Contribution (NDC) scheme (1995).
  - Periodic updates based on mortality rates (2007).
  - Tightening of eligibility requirements (1992, 1995, 1997, 2004, 2007, 2011).
  - Alignment of statutory retirement age of women with men (2010, 2011).
  - Indexation of retirement age to life expectancy.
- Transition rules dividing beneficiaries:
  - Insured with at least 18 years of contributions accumulated by end-1995:
    - Largely maintain the DB formula. Old rules grandfathered for contributions accumulated until 2011; contributions after 2011 subject to NDC.
  - Insured with less than 18 years of contributions by end-1995:
    - Subject to a pro-rated scheme: contributions up to 1995 under DB formula; contributions after 1995 under NDC.
- Pension spending scale and concerns:
  - At around 16 percent of GDP, pension spending in Italy is the second highest in the euro area after Greece.
  - Over half of current primary spending is social benefit spending, dominated by pensions.
  - Despite legislated reforms, fiscal pressures are likely to persist until the full effect of reforms emerges over the very long run.
- Projections caveats:
  - Pension projections rest on optimistic assumptions:
    - High immigration and employment: assumption that Italy will benefit from more immigration than any other country in Europe for decades and move from among the highest to very low unemployment rates.
    - Sustained higher real GDP growth rates for decades than past experience and policy settings suggest.
  - Relaxing these assumptions implies a notable rise in projected spending over coming decades until full benefits of past reforms materialize.
- Demographic and contribution statistics:
  - Average contribution period for new pensions: about 33 years (expected to increase to 35 years).
  - Life expectancy at 65: about 20 years.
  - By about 2030, all new retirees will be fully subject to the NDC formula.
  - By about 2050, the old DB should be fully phased out from the stock of existing retirees.

---

### C. Revenue rebalancing (summary of scope)
- Tax system characteristics:
  - High tax wedge.
  - Relatively narrow tax base.
  - Significant tax arrears.
- Fiscal devaluation (shift from taxing productive factors to taxing consumption and property) options identified:
  - Decrease the tax wedge significantly.
  - Reduce value-added tax gaps (both compliance and policy) by harmonizing reduced VAT rates and improving tax collection.
  - Rationalize tax expenditures.
  - Raise revenues by re-introducing the property tax on primary residences.

---

### D. Toward a growth-friendly policy mix and model simulations
- Approach:
  - Use IMF’s GIMF model to simulate a growth-friendly mix of spending and revenue measures along a gradual fiscal consolidation path that puts debt-to-GDP on a firm downward trajectory.
- Main simulation findings:
  - A revenue-neutral, less distortionary tax reform, alongside current spending cuts and capital spending increases:
    - Can generate sizable output gains.
    - Can produce a sustainably lower public debt ratio over the medium to long term.
  - Short-term output costs of this fiscal package, if implemented credibly, are limited.

---

*Prepared by Michal Andrle (RES), Shafik Hebous (FAD), Alvar Kangur, and Mehdi Raissi (both EUR).*

### 10.      Eligibility requirements have been tightened considerably in a series of reforms,

### 10.      Eligibility requirements have been tightened considerably in a series of reforms,

### Eligibility reforms and retirement ages
- Statutory Retirement Age (SRA) is gradually increasing to at least 67 years by 2021.
- In 2017:
  - SRA is 66 years and 7 months for men and for female employees in the public sector.
  - SRA is 65 years and 7 months for female employees in the private sector.
  - SRA is 66 years and 1 month for female self-employed.
  - Female employees in the private sector and female self-employed are set to catch up with the SRA of other workers by January 1, 2018.
- Early Retirement:
  - Allowed regardless of age based on minimum years of service of 42 years and 10 months for men and 41 years and 10 months for women.
  - Under NDC, workers may retire up to 3 years earlier than the SRA with minimum 20 years of contributions and a pension of at least €1,200 per month.
- Indexation:
  - From 2013 onwards, eligibility requirements are linked to changes in life expectancy at 65 (every three years up to 2019 and two years starting from 2021).
- Policy note:
  - “Pathways to early retirement.” Eligibility tightened over time, but pathways to early retirement were occasionally eased or implementation postponed (see ¶15 for measures in the 2017 budget). Special treatments and incentives for early withdrawal from the labor market should be avoided in both DB and NDC schemes.

### Minimum and targeted pensions
- Minimum contributory pension level in 2016: €6,524.57 annually.
  - Any contributory pension would be topped up to reach this level.
  - This forms about 70 percent of the relative 60 percent poverty level that in 2015 reached €9,508 for a single person.
- Social pension in 2016: €5,824.91 annually provided at an age of 65 years and 7 months that increases with life expectancy.
- Retirees above 70 years of age receive an additional monthly pension (or social purchase card), increasing the annual social pension to €8,298.29.
- Comparative context:
  - Minimum income guarantee for working age people in the EU generally falls into a range of 50–80 percent of the poverty level.

### Box 3 — Mechanics of DB and NDC pension schemes (quantitative primer)
- DB benefit defined by four parameters:
  - (i) accrual rate (a);
  - (ii) measure of earnings (w);
  - (iii) valorization factor (u);
  - (iv) retirement age (T).
- DB benefit formula (as given): DB = Σ_{t=0}^T a w_t (1+u)^{T−t}.
- NDC notional capital accumulation:
  - K_{t,T} = Σ_{t=0}^T c w_t (1+ρ)^{T−t}, where ρ is the notional interest rate (IRR).
- Annuity at retirement:
  - NA = K / G[LE,ρ(LE)], where G is annuity factor function of life expectancy (LE) and IRR.
- IRR in pure NDC derived from PV(L) = PV(A).
- Natural choice for notional IRR in PAYG-financed NDC: ρ = n + g (where n = growth rate of labor force (population) and g = productivity growth).
- Steady-state equivalence:
  - When u = n and a = c/G, DB and NDC can be identical in steady state.
- Policy instruments differ:
  - NDC: IRR computation rules, minimum retirement age, life expectancy tables, methods to calculate annuity.
  - DB: fewer controllable/discretionary parameters.

### Short- to medium-run issues — generosity and actuarial fairness
- The DB scheme is overly generous on many accounts:
  - Accrual rates:
    - DB uses a weighted average accrual rate of 2 percent (MEF, 2014).
    - International comparison: about 1.5–1.7 percent in the EU/euro area.
  - Reference wage / pensionable earnings:
    - For insurance years before 1992: reference wage is last monthly wage for civil servants or average of last 5 to 10 years in private sector.
    - For contribution years after 1992: number of annual wages involved increases until covering last 10 years for employees and last 15 years for self-employed.
    - Periods are still too short and tend to inflate DB pension benefits; NDC covers total lifetime contributions.
  - Early retirement penalties (actuarial corrections):
    - Under DB: penalty is 1 percent at age 61, 2 percent at age 60, and a further 2 p.p. for each year below 60.
    - Queisser and Whitehouse (2006) estimate actuarially neutral reduction for Italy ~ 7.5 percent per year of early retirement.
- Replacement rates:
  - DB/mixed schemes provide high replacement rates that place adjustment burden on future retirees.
  - Difference from euro area average (EC, 2015): around 10 percentage points higher.
  - Simple partial correction: reduce spending in DB/mixed schemes equivalent to the thirteenth pension payment (Christmas bonus) = 7.7 percent cut in average pensions of the DB component.
  - Recalibration suggestion: rebase existing pensions on steady-state NDC formula or equivalent accrual rates.

### Annuity factor, IRR, and automatic adjustments
- Long-run NDC design screens out past excesses but:
  - Annuity factor is based on a too high internal rate of return (IRR).
  - In pure NDC, IRR should ensure actuarial balance; in steady state IRR converges to economic growth rate.
  - Italian NDC:
    - IRR that credits notional capital = moving average of nominal GDP growth over past five years.
    - Discount rate used to derive annuity factor = 1.5 percent, based on an expected long-run real growth rate.
    - Absent comprehensive structural reforms, this real rate of return is considerably above Italy’s current growth potential.
  - Adjustment to macro-demographic conditions (periodic revisions in transformation coefficient) affect future generations only, leaving current retirees unaffected.
  - Recommendation:
    - Introduce an automatic adjustment (sustainability) factor linking current pension payments to a measure of long-term actuarial balance to shield against shocks and improve intergenerational equity.

### 2017 budget measures and their effects
- The 2017 budget includes:
  - Annual fourteenth pension payment to low-income persons.
  - Temporary cash benefits to elderly workers until retirement.
  - Raises the tax-free threshold for pensioners.
  - Facilitates portability for public mandatory pensions.
  - Temporarily extends voluntary early retirement loan program.
  - Facilitates early retirement of certain categories (arduous and hazardous workers, young workers with contribution histories before 19 years of age).
  - Abolishes a limited set of early retirement penalties introduced with the 2011 reform.
- Assessment:
  - Some measures (e.g., enhanced pension portability) are structurally welcome.
  - Fourteenth payment and higher tax-free thresholds are costly and depart from actuarial fairness.
  - Frequent deviations from general rules can undermine past reforms.

### Separation of insurance and social protection functions
- Recommendation:
  - Separate insurance and social protection/welfare functions.
  - Provide welfare benefits through a national and universal anti-poverty scheme for better targeting (retirees have lower incidence of poverty than working age youth or unemployed).
  - Child-related pension credits (higher transformation coefficient for women with children) are not transparent insurance and overlap with pensionable time; better delivered via direct family benefits or childcare support.

### Survivor pensions
- Spending on survivor pensions: around 2¾ percent of GDP — the highest in Europe.
- Average monthly survivors benefit per inhabitant (constant prices) in Italy: €608 (compared to about €500 in the euro area).
- Survivor pensions share:
  - Number of survivor pensions forms about 28 percent of total pensions in Italy (EU average about 18 percent).
- Eligibility concerns:
  - Eligibility for a surviving spouse does not appear constrained by an age limit; absence of age limit can disincentivize labor market return, especially for women.
  - Recommendation: Strictly limit survivor pension payments to family members other than surviving spouse or orphans.

### Self-employed contribution revenue and harmonization
- Pension contribution rates on wage earners: 33 percent (about one-third borne by employee and two-thirds by employer).
- Contribution rate for self-employed and farmers in 2014: 22.2 percent, set to increase to 24 percent by 2018.
- “Neutral” contribution rate for self-employed should be at least 27 percent.
- Revenue productivity of the self-employed is below euro-area peers, indicating need to:
  - Harmonize contribution rates.
  - Strengthen collection and payment compliance.

### Tax treatment of pensions
- Tax burden on pensions is favorable to retirees:
  - OECD (2015): gross and net replacement rates in Italy are on average about 17 percentage points higher than for the OECD average retiree.
  - Extension of the non-taxable area for retirees in the 2017 budget will widen the gap with the OECD.
  - Retirees benefit from higher tax-free allowance and full exemption on health contributions on pensions.
  - Italy offers tax relief on pension income from private schemes compared to other OECD countries.

### Long-run projections and sustainability
- NDC expected to reduce pension spending in the very long run but is not, by itself, sufficient to address Italy’s fiscal problems.
- OECD (2015) projection: future gross replacement rates in Italy would remain one of the highest in the OECD.
  - Both gross and net replacement rates about 15–20 percentage points above the OECD average depending on the average pensionable wage.
- EC (2015) projects Italy’s pension spending to remain more than 3 percent of GDP above the average of other European countries.
- Additional pressures:
  - Rapid aging will increase spending on health and long-term care by about 1½ percent of GDP by 2060 (net of lower spending on education).

*Source: IMF staff analysis in the provided chapter content.*

### 21.      The authorities project long-term pension spending to remain relatively subdued,

### 21.      The authorities project long-term pension spending to remain relatively subdued,

### Projections and main drivers
- MEF projection: pension spending expected to remain relatively flat at just above 15 percent of GDP until 2045 and decline afterwards, reaching 13.7 percent of GDP by 2060.
- MEF conclusion: based on these findings, the pension system and overall public debt are understood to be sustainable over the long term.
- Main offsetting factors keeping spending broadly flat until 2045 and declining thereafter:
  - Adverse demographic trends (rising old-age dependency) are the main drivers of future pension increases, adding more than 9 percent of GDP to pension spending by 2050.
  - Benefit rate (ratio of average pensions to GDP per worker) expected to continue to increase over the next decade, until 2025, due to the generosity of the old though declining DB component compared to low productivity growth.
  - Thereafter, the share of retirees under the NDC scheme is projected to become sufficiently large to dominate the more generous older DB scheme, settling the benefit rate on a modest downward trend.
  - Largest projected savings stem from:
    - A sizeable pick-up in the employment rate;
    - Notable immigration ensuring steady labor force and population over the long term;
    - Reforms to restrict early retirement and extend retirement ages (eligibility rate).
  - Each of the latter two reforms (immigration/steady labor force and eligibility rate changes) is estimated to reduce pension spending by about 4½ percent of GDP.
- Unemployment projection: unemployment rate reaching as low as 5.5 percent of GDP by 2060, implying Italy is expected to move from one of the worst to among the best performers in the labor market.

### Sensitivity analysis and alternative scenarios
- General finding: relaxing optimistic demographic and macroeconomic projections suggests spending would be notably higher.
- NDC implication: for the authorities’ projections to materialize, the NDC system must cut average pensions of future retirees further by more than 4 percent of GDP (or by more than by 30 percent).
- Employment rate scenario:
  - Current steady state unemployment around 10 percent; Italy’s long-term average unemployment about 9½ percent.
  - If unemployment settles at 9 percent (an increase in the employment rate only half of the MEF’s), total pension spending increases by more than 2¼ percent of GDP by 2060.
  - Note: employment rates in Figure 4 defined as employed aged 15–74 relative to working age population aged 20–64; scales not directly comparable with published statistics across countries.
- Old-age dependency scenario:
  - MEF and 2015 EC Aging Report assume strong immigration into Italy larger than into other euro area countries.
  - UN Population Division projections point to more rapid population aging in Italy, increasing long-run pension spending by more than ¾ percent of GDP by 2060.
- Total factor productivity (TFP) scenario:
  - Authorities expect per capita real GDP growth and real labor productivity growth around 1¾ percent.
  - MEF sensitivity:
    - 0.25 percentage points lower labor productivity growth → about 0.5 percent of GDP higher pension spending in both 2040 and 2060.
    - 0.2 percentage points lower TFP alone → pension spending to GDP ratio increases by 0.6–0.7 percent of GDP in 2040 and 2060.
  - IMF staff simulation:
    - Permanent negative labor productivity shock of about ½ percentage points per year → pension spending about 1 percent of GDP higher in both 2040 and 2060.
  - Temporary negative labor productivity shock of the same size over 2016–2025 → 0.4 percent of GDP higher pension spending between 2025–2040 before fading.

### Impact on public debt
- All else equal, lower steady state employment, higher old-age dependency rate, or a permanent negative labor productivity shock would raise the debt-to-GDP ratio by 20–60 percentage points above the baseline, demonstrating high sensitivity of public debt to pension expenditures.

### Reform options to yield near-term and medium-term savings
- Objectives: generate near-term savings by addressing excessive generosity and lack of actuarial fairness in DB and mixed schemes; secure medium- and long-term savings using realistic parameters and actuarial balance.
- Near-term and medium-term options:
  - Eliminate the newly introduced fourteenth pension payment fully and the thirteenth payment for all retirees in the DB and mixed schemes; support for the most vulnerable could be achieved through a modern well-targeted social safety net, in particular a national and universal anti-poverty scheme.
  - Introduce an age limit for a surviving spouse and limit any payments to relatives other than surviving spouse or orphan to restrict survivor pension eligibility and incentivize labor force participation.
  - Recalibrate existing pensions based on the steady-state NDC formula or equivalent parameters for accrual rates and/or pensionable earnings to reduce short- to medium-run pension spending for those who benefited from the generous DB scheme (won’t affect long-run steady-state spending given by the NDC).
  - Harmonize (effective) contribution rates of self-employed with those of wage earners to remove preferential treatment and improve fairness and financing in the PAYG system.
  - As a second-best, part of the reduction in the high labor tax wedge can rest on lowering employers’ contributions (fiscal devaluation) — this reduces current labor tax wedge and translates into lower future pension spending via the NDC, but is not first-best when NDC enforces tight actuarial link between contributions and benefits.
  - Subject pension benefits to health contributions and realign the tax-free threshold with wage earners; retirees should pay health contributions given relatively higher health service use and consider reversing the higher tax-free threshold for retirees introduced in the 2017 budget.
  - Adjust the NDC discount factor to reflect realistic growth potential and introduce an automatic adjustment mechanism linking pension spending to the long-term actuarial balance (examples: Sweden, Canada, Germany). The discount factor currently fixed at 1.5 percent annually is well above Italy’s long-term growth potential based on current policy settings.

### Policy implications and recommended stance
- Italy needs to pursue comprehensive growth-enhancing reforms urgently to reduce nominal wage rigidities and increase productivity and long-run employment rates.
- Absent such reforms, even a self-adjusting NDC cannot ensure sustainability of the pension system and public debt.
- Prudence principle: set safeguards and system-wide parameters in line with the economy’s potential under current policies rather than the stronger growth rates assumed in MEF projections to reduce the risk of large, sudden adjustments and reduce policy uncertainty.

### Revenue rebalancing and tax-policy considerations (summary of considerations)
- Italy’s tax system features aspects of a Dual Income Tax (DIT): flat 26 percent on capital income (dividends, interest income, capital gains on securities), 21 percent on rental income; labor income taxed progressively from 23 percent up to 43 percent for income exceeding €75,000 (IRPEF); corporate income tax (IRES) rate 24 percent with a 3.5 percent surcharge on financial and insurance companies; regional production tax IRAP at a fixed rate of 3.9 percent on net value of production.
- 2015 fiscal facts:
  - Total government revenues 43.5 percent of GDP vs EU average 37 percent.
  - Total tax revenues 29.7 percent of GDP in 2015.
  - Labor tax wedge for a single person earning average income: 47.9 percent vs OECD average 35.9 percent.
  - Ratio of social security contributions (SSC) to GDP: 13.4 percent (2 percentage points higher than EU average).
  - Share of personal income tax (PIT) in total taxes: 41 percent.
  - CIT to GDP ratio about 2 percent vs EU average 2.7 percent.
  - Standard VAT rate 22 percent vs EU average standard VAT around 21.5 percent.
- Structural weaknesses:
  - Large tax expenditures estimated at 6.5 percent of GDP (Tyson, 2014) and 5.5 percent of GDP (Commissione Marè); MEF identifies 600 measures on legal basis.
  - VAT C-efficiency about 40 percent, well below EU average; combined with MEF-estimated compliance gap about 30 percent implies a policy gap about 40 percent.
  - CIT revenue productivity 7.4 percent vs EU average 13.4 percent.
  - Implicit Tax Rate on Corporate Income in Italy was 25.9 percent in 2012.
  - Revenues forgone per year (2012–2014 average) estimated by MEF at around €110 billion; stock of unpaid tax and SSC debt in 2016 was €614 billion.
- Growth-friendly tax-mix proposals and fiscal devaluation elements:
  - Lower employers’ SSC rate closer to the EU average.
  - Replace family (“dependent spouse”) tax credit with an in-work tax credit.
  - Introduce a modern property tax on primary residences and update cadastral values.
  - Lower VAT policy and compliance gaps by harmonizing reduced VAT rates, reducing range of items subject to reduced rates or exemptions, and consider moderate increase in the standard VAT rate.
  - Eliminate inefficient tax expenditures (e.g., abolish mortgage interest tax credit).
  - Make newly introduced self-employment regime compulsory.
  - Strengthen capital gains taxation (ensure Italy’s right in domestic law to tax capital gains from offshore indirect transfers).
  - Encourage investment via streamlined targeted tax incentives for innovation and R&D, improve design of ACE (higher ACE rate for start-ups), abolish IP box regime, make R&D tax credit permanent, credibly announce non-extension of enhanced depreciation.
  - Reform tax administration: restore autonomy to fiscal agencies, strengthen enforcement, relax legal constraints to tackle tax debt, align instalment arrangements with international best practice.
- Caution: fiscal devaluation can have positive employment/output effects but could present risks for pension financing.

*Source: IMF staff compilation from the provided chapter content.*

### 29.      Reducing employers’ SSCs can stimulate labor demand in the short term. Given wage

### 29.      Reducing employers’ SSCs can stimulate labor demand in the short term. Given wage

### Short-term macro effects of cutting employers’ SSCs
- Cutting employers’ SSCs can reduce labor costs (and producer prices, including those of exports) and increase labor demand in the short term.
- The favorable effect on the trade balance could be temporary if nominal wages eventually adjust to fully offset the cut.
- Employment and output effects may be longer lasting if the tax burden shifts toward non-labor income (VAT and property taxes) that is also less distortionary.

### General government revenue structure — selected statistics (percent of GDP)
- Italy row (as reported in table):
  - 43.5
  - 29.7
  - 14.4
  - 12.1
  - 2.1
  - 0.3
  - 15.3
  - 6.2
  - 0.1
  - 8.9
  - 0.1
  - 13.4
- EU 28 average including:
  - 37.0
  - 25.0
  - 10.7
  - 7.8
  - 2.7
  - 0.2
  - 14.1
  - 7.9
  - 0.5
  - 5.7
  - 0.2
  - 11.5
- EU 28 average excluding:
  - 36.8
  - 24.8
  - 10.6
  - 7.6
  - 2.7
  - 0.2
  - 14.1
  - 7.9
  - 0.5
  - 5.6
  - 0.2
  - 11.4

### Adjusting the composition of SSCs and labor supply measures
- Moderately increasing the share of employees’ SSCs in total could, under certain conditions, partially finance a cut in employers’ SSCs and ensure a stable stream of funding.
  - Changing the composition of SSCs by adjusting the employees’ SSC share would address the risk of using general revenues to finance pension and social security obligations.
  - There could be a negative effect on wages and labor supply; best introduced if the government decides to reduce personal income taxes and complements the change with other targeted measures.
- Targeted measures to increase labor supply, especially of low income earners, are recommended.
  - Italy has the lowest labor supply of married women among EU countries, partly driven by a tax credit for non-working spouses that discourages their labor supply.
  - Replacing the dependent-spouse tax credit with an in-work tax credit (working family tax credit), increasing with number of children, is recommended.
  - Evidence: Colonna and Marcassa (2015) find that replacing the dependent-spouse tax credit with an in-work tax credit increases married women participation rate by 3 percentage points.
  - In-work tax credits can increase distortion at the intensive margin of labor supply; appropriate design can mitigate this risk.

### Property tax and local finance
- Re-introduction of a property tax on primary residences is recommended to modernize Italy’s tax system.
  - In 2015, recurrent taxes on immovable property raised 1.6 percent of GDP in Italy.
  - The IMU on luxury houses remains enacted; the basic rate for the IMU for the primary residence was equal to 0.76 percent, but it varies depending on the location of the house by a maximum of +0.3 percent.
  - Reforming the cadastral system and updating cadastral declared values is essential to fully exploit property tax potential.
  - Using municipal property taxes to finance local governments would allow the central government to reduce transfers to local governments and free up resources to fund lowering employers’ SSCs.

### VAT policy gap and revenue potential
- VAT compliance and policy gaps:
  - VAT compliance gap: €36.9 billion, about 27.5 percent of total VAT liability (2.28 percent of GDP).
  - EU-27 average policy gap: 14 percent.
  - Halving the VAT compliance gap, while maintaining all tax rates unchanged, would increase revenues by 1.14 percent of GDP.
  - Fully closing the policy gap (no VAT reduced rates and exemptions) would enable Italy to increase its VAT revenue by an additional 15 percent (based on EU (2016) and under a full compliance scenario).
  - Reducing the range of items subject to reduced rates or exemptions is an intermediate step to lower the policy gap.

### Tax arrears and administration
- Tax arrears and recoverability:
  - Tax arrears reach €614 billion (as of 2016).
  - A significant amount of arrears is not collectable: 31 percent of debtors are out of business or bankrupt, and 36 percent relate to cases where enforcement actions were taken but did not result in actual collection.
  - About €31 billion of tax arrears is deemed recoverable.
  - Recommendations: effective write-off arrangements, avoid recurrent tax concessions, strengthen voluntary compliance, timely filing, modern payment arrangements, and relax legal constraints where appropriate.

### Tax expenditures and specific tax credits
- Italy uses many tax credits for redistribution within personal income tax (dependent spouses, children, retirees, education, medical expenses).
- Employment income tax credit is the largest tax expenditure because the first PIT bracket (from zero to 15,000 euro) is taxed at 23 percent (no zero-tax bracket).
- Suggested revisions:
  - Mortgage interest tax credit: equal to 19 percent of mortgage interest payments, upper limit €4,000; suggested to be phased out or reduced in generosity.
  - Tax credit for medical expenses: equal to 19 percent of medical expenses exceeding €129.11; beneficiaries mostly with incomes below €55,000, number of beneficiaries 17.3 million for a total amount of €16.2 billion of expenses.
  - Other direct income tax expenditures should be revisited and could be gradually eliminated.

### Business taxation, ACE, and investment incentives
- Strategy: simple and certain business taxation with (i) innovation and allowance for corporate equity (ACE), and (ii) removal of inefficient incentives.
- On ACE and CIT:
  - The recent CIT rate cut from 27.5 to 24 percent: the revenue cost may be compensated by increased investment and growth depending on profit shifting and location choice.
  - ACE can contribute to very low or negative METRs; in theory the METR is zero in Italy because the ACE does not tax normal return.
  - Suggested ACE enhancements:
    - Provide a higher ACE rate for small businesses (perhaps contingent on an age requirement).
    - Re-link the ACE rate to government bond yields and a premium to reflect risks.
    - Introduce a minimum rate of 2 to 3 percent in line with the EU CCCTB proposal.
  - Note: Within the 2017 supplementary budget, the base of the ACE tax deduction was changed from “the increase in equity since 2011” to “the increase in equity in the last five years before the tax year considered”.

### R&D incentives and IP box concerns
- R&D tax incentives:
  - Well-designed R&D tax incentives can have a sizable impact on productivity.
  - Empirical evidence: one euro spent by the government on R&D tax incentives, on average, increases domestic private R&D by one euro; one euro spent on an IP box increases R&D by less than one euro (IMF, 2016b; Dumont, 2015).
  - Bloom and others (2002): a 10 percent reduction in the cost of R&D increases the level of R&D by about 1 percent in the short run and 10 percent in the long run.
- IP box in Italy:
  - Italy exempts 50 percent of qualified IP income from taxation and taxes the remaining 50 percent at the statutory CIT rate of 24 percent, implying an effective tax rate of about 12 percent.
- Conceptual concerns with IP boxes:
  - Rewards only success and may favor large enterprises.
  - Benefit is proportional to qualifying IP income, not linked to R&D expenditure.
  - Can encourage relocation of legal ownership of IP without domestic R&D gains.
- Options to streamline incentives:
  - Abolish the IP box regime (CCCTB proposal envisages a super deduction for R&D expenditures).
  - Make the tax credit for R&D expenses permanent.
  - Credibly announce that temporary super depreciation rules will not be renewed (starting from a given date).
  - Periodically assess effectiveness of allowances for investment in innovative startups (potentially not size-based and apply only to startups).

### Tax policy stability and temporary measures
- Frequent tax changes and excessive use of temporary provisions generate uncertainty.
  - Temporary measures with unclear or not credible expiry dates create a hold-up problem and can lead firms to defer investment.
  - Italy’s frequency of tax changes is high compared to other G20 countries.

### Modelled fiscal consolidation scenario and growth-friendly mix (GIMF)
- Scenario assumptions:
  - Permanent fiscal consolidation of about 2 percent of GDP (in the structural primary balance) over four years to achieve a small structural surplus.
  - Compared to a trend or no-policy-change baseline.
  - Two growth-friendly reform types considered: shifting taxation from direct to indirect taxes and lowering expenditure while shifting composition from transfers to investment.
- Revenue-side measures in the scenario:
  - Lower labor tax wedge: 1.5 percent of GDP (reduction).
  - Higher VAT collections: 1 percent of GDP (increase).
  - Introducing a modern property tax: 0.5 percent of GDP (increase).
- Expenditure-side measures in the scenario:
  - Public consumption lowered by 1.25 percent of GDP.
  - Productive public investment increased by 0.5 percent of GDP.
  - Remaining portion of consolidation, 1.25 percent of GDP, implemented via reduced social transfers.
  - Assumption: higher public investment spending and associated higher government capital exert positive spillovers on private sector productivity.

*Source: IMF staff, Eurostat, and OECD (as presented in the provided content).*

### 42.      The policy package would result in an output increase of around 2 percent and a lower

### 42.      The policy package would result in an output increase of around 2 percent and a lower

### Summary of reform package and modeling approach
- Framework: Simulations use the IMF’s Global Integrated Monetary and Fiscal Model (GIMF), with structural reforms mapped to changes in model parameters (wage and price markups, labor supply, total factor productivity).
- Phasing: Structural policies are phased in over a 5–10-year horizon, becoming fully implemented and credible at the fifth year. The fiscal consolidation/composition shift scenario phases measures in gradually over four years.
- Distance-to-frontier approach: The gap between Italy and the euro area frontier is narrowed over the medium term; specific reforms are mapped using literature guidance and empirical estimates.

### Key quantitative results (simulated)
- Short-run and long-run output and debt effects of the full policy package:
  - Output increase of around 2 percent in a decade.
  - Debt-to-GDP ratio lower by around 13 percentage points in a decade.
  - Long run: output around 2½ percent higher than the baseline.
  - Long run: debt-to-GDP ratio more than 35 percentage points lower than the baseline.
- Fiscal consolidation alone:
  - Modeled as a fiscal consolidation of 2 percent of GDP over four years to achieve a small structural surplus.
  - Fiscal consolidation by itself results in lower real GDP that, at its peak, is about ½ percent below baseline after three years.
- Banking-sector reform (NPL reduction):
  - Mean-reverting the NPL ratio to normal levels (around 5–6 percent) would lead to a 3 percent higher real GDP in the long run.
  - Reducing the NPL ratio to normal levels in five years and sustaining them implies about 2 percent higher real GDP in five years and around 3 percent in steady state.
  - Empirical linkage: a 5 percent persistent increase in the NPL ratio per year is associated with 0.4 percentage points lower annual GDP growth in the long run on average; estimated coefficients are about –0.08 and statistically significant at the 1 percent level.
- Labor market and wage bargaining:
  - Firm-level wage bargaining modeled as a reduction in the wage markup by about 15 p.p.
  - Simulations (SIP Part 1) indicate decentralized bargaining could increase steady-state employment by about 4 percent.
- Product market and public administration reforms:
  - Product market reform: close one-half of the distance-to-frontier in non-tradable PMR, equivalent to about a 17 percent improvement in the PMR score, phased over 5–10 years.
  - Public administration: assume closing about one-half of distance to frontier via an economy-wide TFP shock; raising public-sector efficiency to frontier would expand output for an average firm by 3 percent (Giordano et al.); half of that distance closed via TFP shock in simulations.
- Labor market participation and targeted social spending:
  - Active labor market policies scaled up by 0.4 percent of GDP.
  - Increased spending on childcare of 0.2 percent of GDP.
  - Broaden social safety net coverage to all those below the poverty line, 0.5 percent of GDP.
  - Modeled as neutral reallocation from general transfers to targeted transfers phased in over five years.

### Mechanisms driving results
- Less distortionary tax structure and revenue-neutral tax reform:
  - Reduce labor tax wedges and finance via lower VAT gaps (1 percent of GDP) and a property tax on primary residences (½ percent of GDP).
  - Reduce labor income taxes by 1½ percent of GDP, financed by other measures, raising private consumption and output in the long term.
- Composition of public spending:
  - Increase public capital spending by ½ percent of GDP.
  - Reduce current primary spending by reducing large social benefits and spending on goods and services by 1¼ percent of GDP.
  - Productive public investment stimulates private capital accumulation and reduces debt-service costs.
- Lower taxes on capital and labor:
  - Lower capital taxes induce firms to increase investment and desired private capital stock.
  - Lower labor income taxes encourage households to supply more labor.
- Bank balance-sheet clean-up:
  - Reducing NPLs frees lending capacity and supports higher credit growth, investment, and labor market outcomes; modeled via TFP shocks split ¾ non-tradable and ¼ tradable.

### Short-term tradeoffs and credibility effects
- Short-term: Reduced social transfers and public consumption dampen private consumption and output initially; short-term costs are modest.
- Credibility: If firms and households fully believe the announced reform path, short-term costs are even smaller because firms and households invest more from the outset and reap long-term benefits sooner. If the public only believes currently implemented measures, near-term impacts are larger.

### Aggregate simulated impact and competitiveness
- Cumulative impact:
  - The reform package potentially increases output by 6–13 percent above the baseline (Figures 1–4 and cumulative Figure 5).
  - About one-half of medium-term competitiveness gains stem from structural reforms—particularly wage bargaining—and the other half from growth-enhancing fiscal devaluation, spending rebalancing, and bank balance-sheet cleanup.
- Real effective exchange rate:
  - The reform package delivers a notable REER depreciation (simulations show REER movements relative to baseline over the transition and steady state).

### Policy implications and recommended components
- Implement a comprehensive package combining:
  - Growth-friendly fiscal consolidation of 2 percent of GDP over four years, centered on a revenue-neutral, less distortionary tax reform that reduces the labor tax wedge by 1½ percent of GDP and finances via lower VAT gaps (1 percent of GDP) and a property tax on primary residences (½ percent of GDP).
  - Rebalance spending: cut current primary spending (reduce large social benefits and goods and services by 1¼ percent of GDP) while increasing public capital spending by ½ percent of GDP.
  - Wage-bargaining reform: move toward firm-level bargaining to reduce wage markups (modeled as –15 p.p.) and boost employment.
  - Labor market and social policy: scale up ALMPs (0.4 percent of GDP), increase childcare spending (0.2 percent of GDP), and broaden targeted social safety net coverage (0.5 percent of GDP).
  - Product market and public administration reforms to raise non-tradable TFP and public-sector efficiency (close about half the distance to frontier).
  - Banking-sector measures to reduce NPL ratios to normal levels (around 5–6 percent) over five years to support credit, investment, and output.
- Sequencing and communication:
  - Credible and timely implementation increases near-term investment and reduces short-term output costs.
  - Upfront structural reforms help offset short-term contractionary effects of fiscal consolidation.

*International Monetary Fund, “Quantifying the Benefits of a Comprehensive Reform Package” (extract: paragraphs 42–C; simulations using GIMF).*

### 9.      In practice, the yields from the

### 9.      In practice, the yields from the

### Summary conclusion on reform yields
- Model uncertainty, measurement error, interim economic shocks, implementation challenges, and similar factors may reduce the yields of the comprehensive policy package outlined.
- It may be more prudent to conclude that growth over the medium term would increase at best by the amounts estimated above.

### Box 1. The Global Integrated Monetary and Fiscal Model (GIMF) — model description
- GIMF is a multi-country structural dynamic general equilibrium model featuring Italy, the rest of the euro area, and the rest of the world.
- Links behavior of households, firms, and government sector within and among countries; consistent system of national accounting and stock-flow budget constraints for all sectors, including the government.
- Model type: exogenous-growth — long-term growth of output is exogenous; fiscal or structural measures can increase the level of real output per capita permanently but never long-term growth.
- Household sector:
  - Forward-looking optimizing households modeled as overlapping generations (OLG) with finite lives, following the Blanchard-Weil-Yaari framework.
  - Liquidity-constrained households who spend all their available income every period.
  - Households gain utility from consumption and disutility from labor effort; consume traded and non-traded services and goods; receive labor income, transfers from the government, dividends from corporations; pay income, consumption, and lump-sum taxes.
  - Presence of OLG households breaks Ricardian equivalence and is important for realistic fiscal policy results in both short and long run.
- Firms:
  - Produce intermediate and final goods using labor and capital inputs, accumulate capital, and import or export production.
  - Firms pay taxes from corporate income.
- Monetary policy:
  - In the euro area and rest of the world regions follows an inflation-forecast targeting rule to set policy interest rates.
  - Italy is a member of the euro area.
- Government:
  - Collects tax revenues (consumption, labor income, capital income, and lump-sum taxes) and spends on government consumption, investment, and transfers to households.
  - Targets specific debt-to-GDP (and thus deficit-to-GDP) ratios and uses a mix of instruments to achieve them.
  - Government’s commitment to sustainable public finance is credible for firms and households, who hold the stock of government bonds.

### Key simulation figures (aggregate impacts shown in figures)
- Figures present percent deviations from baseline (Real GDP, Consumption, Investment) and differences from baseline (Current Account/GDP, Primary Surplus/GDP, Debt/GDP, Interest Expenditure/GDP), with horizontal axis = years and SS = steady state.
- Figure captions and notes:
  - Figure 1. Italy: Fiscal Reform — Red: revenue rebalancing. Blue: total impact.
  - Figure 2. Italy: Wage Bargaining — Blue: total impact.
  - Figure 3. Italy: Other Structural Reforms: Product Markets, Public Sector Efficiency, Guaranteed Minimum Income, ALMPs, and Child Care — Blue: total impact.
  - Figure 4. Italy: NPL Reduction — Blue: total impact.
  - Figure 5. Italy: Total Reform Package — Blue: total impact.
- Charts show multi-year dynamics up to SS (steady state) for each reform component and for the total reform package; axes and tick marks denote percent deviations and differences as labeled in the figures.

### Table 1. Italy: GIMF Simulation Strategy — measures, instruments, scales, and mapping
- Fiscal Adjustment and Rebalancing
  - Lower untargeted social transfers
    - GIMF instrument / shock: General untargeted transfers
    - Scale: 1¼ percent of GDP
  - Lower spending on goods and services
    - GIMF instrument / shock: Government consumption
    - Scale: 1¼ percent of GDP
  - Higher spending on public investment
    - GIMF instrument / shock: Government investment
    - Scale: ½ percent of GDP
  - Lower tax wedge on labor
    - GIMF instrument / shock: Taxes on labor
    - Scale: 1½ percent of GDP
  - Higher VAT revenue
    - GIMF instrument / shock: Taxes on consumption
    - Scale: 1 percent of GDP
  - Higher revenue from property tax
    - GIMF instrument / shock: Lump-sum tax
    - Scale: ½ percent of GDP
- Wage Bargaining
  - Move to firm-level wage bargaining
    - GIMF instrument / shock: Wage mark-ups
    - Scale: 15 pp reduction
    - Mapping note: Kangur (2017)
- Other Structural Reforms
  - Higher spending on ALMPs (fiscally neutral)
    - GIMF instrument / shock: Higher targeted and lower untargeted social transfers
    - Scale: 0.36 percent of GDP
    - Mapping note: Barnes (2014)
  - Higher spending on child care (fiscally neutral)
    - GIMF instrument / shock: Higher targeted and lower untargeted social transfers
    - Scale: 0.2 percent of GDP
    - Mapping note: Barnes (2014)
  - Universal anti-poverty program (fiscally neutral)
    - GIMF instrument / shock: Higher targeted and lower untargeted social transfers
    - Scale: ½ percent of GDP
    - Mapping note: Anderson and others (2013)
  - Product market reforms
    - GIMF instrument / shock: Non-tradables TFP (equivalently price mark-ups)
    - Scale: 17 percent decline in ETCR / PMR
    - Mapping note: Barnes (2014)
  - Public administration reforms
    - GIMF instrument / shock: Aggregate TFP
    - Scale: 1½ percent increase in steady-state real GDP
    - Mapping note: Giordano and others (2015)
- Banking Sector Clean-up
  - Reduction in NPLs
    - GIMF instrument / shock: TFP shock: ¾ non-tradables and ¼ to tradables
    - Scale: 2 percent increase in real GDP over 5 years
    - Mapping note: Mohaddes and others (2017); Anderson and others (2013), Kumhof and others (2010)

*Source: IMF staff estimates.*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17238.pdf_