## _cr13299 ## Source details **Canonical URL:** [_cr13299](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13299.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13299.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13299.pdf.json) --- ### Executive Summary — Italian Productivity, Innovation, and Competitiveness - Objective: provide a comprehensive assessment of Italian export competitiveness with focus on evolution of Italy’s export market share. - Key finding: competitiveness is a matter of concern but "perhaps not as critical as some assessments have claimed." - Strengths: - High-quality export mix and adaptability of small-scale specialized firms. - WTO/UNCTAD Trade Performance Index: Italy top-ranked exporter in textiles, clothing and leather goods; ranked second in non-electronic machinery and manufactures (basic and miscellaneous). - Structural challenge: small firm size increasingly less of an asset; structural barriers have depressed productivity broadly. - Policy implication: future competitiveness depends on successful implementation of the authorities’ full structural- and institutional-reform agenda. - Export industry classification (extended Pavitt taxonomy): Science-based; Specialized supplier; Traditional; Scale-intensive technology-based; Scale-intensive resource-based. - Sectoral observation: export mix has substantial weight of traditional products and large, stable share of specialized-suppliers comparable to Germany or the United States. ### Price Competitiveness — measures and interpretation - ULC-based indicators: "deteriorated by up to 5 percent since adoption of the euro." - Germany: "improvement in Germany of nearly 20 percent" (ULC-based). - PPI-based measures: Italy "not materially less competitive than it was in 1999." - Diagnostic: labor-cost (ULC) measures may be incomplete due to globalization and international supply chains reducing the domestic labor share of production costs. - Alternative IMF staff measures: - Value-added Real Effective Exchange Rate (VA-REER): adapts REER to competition in supply of value-added ("tasks"). - Supply-chain adjusted REER (Bayoumi, Saito, & Turunen, 2013): modifies price-based REER to include an outsourcing term offsetting domestic factor-price inflation. - Implication: supply-chain-aware price measures can better guide actual price competitiveness of gross exports than labor-focused ULC measures. ### Price-based competitiveness: tasks-based and price measures (Italy vs Germany) - Tasks-based VA-REER: roughly same assessment as standard CPI-based REER for cumulative Italian appreciation since euro adoption. - Modified price-based measure: suggests a substantially less-marked decline in competitiveness. - Interpretation: rising factor costs in Italy have not translated equivalently into higher relative export prices due partly to low-cost imports; Germany’s falling factor costs imply sharp competitiveness gains not fully matched by lower export prices because of higher-inflation input imports. - Implication: competitiveness challenge in Italy may not be as immediately dire as ULC measures alone imply. ### Non-price competitiveness — Quality indicators - Export unit values: averaging across sectors, unit values in Italy are around "1½ times higher than the global mean." - IMF staff quality indicator (Henn, Papageorgiou, & Spatafora (2013)): Italy remains at the top of global quality ladder across major exports, including traditional industries. ### Market-share dynamics — Shift-share analysis (methodology) - Method adjusts raw market-share changes for world trade growth, trading-partner mix, and product mix. - Uses mid-point growth rates, fixed-effects regression with exporter, importer, and product fixed effects. - Decomposes market-share growth into: Sectoral component (product mix); Geographical component; Adjusted market share (performance component). ### Market-share dynamics — Selected exact annualized figures (percentage points, 1995-2011, from Table 1) - All Export Industries — Italy - 1995-2007: Market Share -1.5; Adjusted Share -1.4; Geography 0.4; Product Mix -0.6 - 2007-2011: Market Share -4.1; Adjusted Share -2.6; Geography -1.2; Product Mix -0.3 - Science-Based Industries — Italy - 1995-2007: Market Share -1.2; Adjusted Share -4.7; Geography 0.2; Product Mix 3.4 - 2007-2011: Market Share 1.6; Adjusted Share -1.7; Geography -0.9; Product Mix 4.3 - Specialized Supplier Industries — Italy - 1995-2007: Market Share -1.5; Adjusted Share -2.7; Geography 0.7; Product Mix 0.5 - 2007-2011: Market Share -4.9; Adjusted Share -4.1; Geography -1.3; Product Mix 0.5 - Traditional Industries — Italy - 1995-2007: Market Share -2.2; Adjusted Share -2.5; Geography 0.5; Product Mix -0.3 - 2007-2011: Market Share -5.1; Adjusted Share -4.4; Geography -0.6; Product Mix -0.2 - Scale-Intensive Technology-Based Industries — Italy - 1995-2007: Market Share -0.7; Adjusted Share -0.1; Geography -0.5; Product Mix 0.0 - 2007-2011: Market Share -5.7; Adjusted Share -4.3; Geography -1.4; Product Mix 0.0 - Scale-Intensive Resource-Based Industries — Italy - 1995-2007: Market Share 0.8; Adjusted Share -1.0; Geography 0.2; Product Mix 0.0 - 2007-2011: Market Share 3.3; Adjusted Share -0.9; Geography -1.7; Product Mix -0.6 ### Market-share dynamics — interpretation - Italy’s market share weighed down by unfavorable product mix; adjusted market share disappointing but compares favorably to France and the United Kingdom and broadly comparable to Germany. - Pre-crisis (1995-2007): exports oriented to markets with rapid import demand but biased to less dynamic products. - Post-crisis (2007-2011): sudden downturn in partner demand hit European countries; Italy additionally held back by poor product mix. - Sector observations: - Science-based: targeted better-prospect products, mostly maintained/increased market share, but adjusted measure shows underlying competitiveness weakness. - Specialized suppliers: good product choice but underlying competitiveness deficit erodes global share. - Causes of erosion: structural distortions, rigidities, administrative impediments; global scale advantages favor larger firms. ### Policy implications — competitiveness - Structural reforms to remove barriers to firm growth and encourage inward FDI. - Apply structural reforms to enlarge role of science-based sector. - Successful implementation of full structural- and institutional-reform agenda crucial. --- ### Judicial System Reform — key findings, diagnostics, and remedies - Finding: inefficient judicial system contributed to difficult business environment and lower investment. - Key reform areas: - Strengthen mediation system. - Enhance court management and accountability. - Reform the appeal system. - Performance indicators and magnitudes: - Average of 1,200 days to enforce a contract in Italy. - OECD average to complete a civil case up to Supreme Court level: 788 days; Italy: almost 8 years. - Italy ranks 112th in legal enforcement of contracts (Fraser Institute) and 139th in efficiency of the legal framework (World Economic Forum, 2013 Report). - Pending cases: 9.7 million pending cases (end 2012), including about 5 million pending civil cases (end 2012). - Pending tax-related cases: about 870,000 (end 2011). - Italy highest number of violations of "reasonable time" requirement in Article 6 of the ECHR. - Growth context: - Growth projected to average 0.7 percent during 2013–18. - Without deeper structural reforms, potential growth estimated around ½ percent. ### Channels linking judicial inefficiency to economic outcomes - Inward FDI over 2005-11: about 1/3 of the euro area average as percent of GDP. - Credit markets: weak enforcement reduces willingness to lend, raises borrowing costs, shortens maturities. - Firm size and labor market: - SMEs account for nearly 70 percent of value added in Italy. - Halving length of civil proceedings could increase average firm size by 8–12 percent (Giacomelli and Menon, 2012). - Enforcement and liquidity: late payments, liquidity problems, higher insolvency, increased unemployment. - Entrepreneurship and innovation: judicial efficiency correlates with entrepreneurship rates; high-technology products account for 7 percent of manufactured exports, 9 percentage points below OECD average. ### Diagnostic factors causing inefficiency - Court structure and fees: - Italy has 1,231 first instance courts of general jurisdiction (CEPEJ, 2012). - Historically low court fees; Italy ranked in bottom 6 countries of Council of Europe states in 2012 for share of court fees supporting court expenditure. - Large inflow and stock of pending cases: - Court of Cassation inflow rose from 3,000 per year in 1960s to nearly 30,000 in recent years. - Legal profession: number of practicing lawyers per 100,000 inhabitants very high. - Appeal system and predictability: - Law 83/2012 introduced appeal rationalization (Article 348 bis). - Italy reversal rate in appeal courts: 34.54; France: 11.74. - Procedural complexity: - Enforcement procedures lengthy; World Bank estimated average foreclosure duration in Italy as 90 months. - No obligation for debtor to provide full disclosure in enforcement of money claims. ### Measures taken and observed effects - Measures: increased court fees, appeal barriers, lawyer fee structure changes, promoting out-of-court settlements, mandatory mediation, reducing number of courts, strengthening court management. - Observed effect: 43 percent decline in inflow of small claims following increased fees. - Remaining challenges: high reversal rates and ease of access to higher courts continue to drive inflow and delays. ### Pinto Law (Law No. 89/2001) — effects and evaluation - Right to damages for excessively lengthy proceedings; did not incentivize judiciary to reform. - Consequences: - About 50,000 Pinto Law cases filed before Italian Courts of Appeal by 2011. - Compensation awarded under Pinto Law amounted to €200 million by 2011. - As of 2011, about 5,000 of the 14,500 pending ECtHR applications concerned Pinto proceedings; more than 300 such applications arrived each month. - Design shortcomings: compensation paid from special allocation did not cut courts' budgets; Court of Auditors’ right to impose contributions on judges hardly exercised. ### Mediation and out-of-court settlement — facts and recommendations - Decree-Law 28/2010 introduced mandatory mediation in 2010; scope extended in 2011. - Reported mediation procedures increased from 1,000 to 250,000 over 2009–10 (International Institute for Conflict Prevention & Resolution). - Constitutional Court declared mediation legislation unconstitutional in October 2012; compulsory mediation reinstated in 2013. - Challenges: logistical/institutional, weak incentives, compulsory lawyer presence may raise costs and hamper competition. - Recommendations: - Consider allowing mediation without compulsory lawyer presence. - Develop standards for mediator selection, responsibilities, training and qualification. - Improve public information about mediation procedures, time and costs. ### Pilot initiatives and recent measures - Pilot courts: streamlined first-instance proceedings, online civil case management, backlog-reduction teams. - Decreto del Fare (Law 98/2013, August 2013) measures include: - Law-clerk apprenticeships. - Task force of 400 magistrates to clear appellate backlog. - Compulsory mediation (reinstated). - New associate judges in Court of Cassation. - Concentration of foreign investor disputes in Naples, Milan, Rome Courts. - First hearing mandatory within 30 days; settlement expected at first hearing in most cases. ### Judicial reform recommendations (condensed) - Court fees: comprehensive assessment; explore increasing fees while upholding access to justice (e.g., legal aid). - Mandatory mediation: continue promotion, strengthen incentives, reconsider compulsory lawyer presence. - Court management: consolidation, professional management, digitalization, proactive case management, data warehouse, performance targets for judges. - Civil procedure and enforcement: pre-trial disclosure, stronger judge role, single judge processes, simplify lower court decision formats, review appeal system (filters/pre-selection), stronger IT-based processing. --- ### Capital Taxation — overview and key statistics - Comprehensive definition: taxes on (i) capital income; (ii) capital transfer; (iii) capital ownership. - Capital taxes yielded 10 percent of GDP — fourth highest revenue in EU-27 in 2011. - Implicit tax rate on capital: 33.6 percent. - Share of capital taxes in total taxes: 23.5 percent. - Taxes on household income, capital stock and corporate income rank 5th, 6th, and 9th in EU (2011, Eurostat). - Italy relies heavily on transaction taxes: taxes on financial and capital transactions about half of total taxes on wealth in 2011 (OECD average: one fourth). - Real estate tax reform increased immovable property revenues from 0.7 percent of GDP in 2011 to 1.5 percent in 2012. ### Recent fiscal measures and simulated 2012 revenue impacts (billions of Euros) - July-September Packages total: 5.5 (19% of total 2012 package) - Stamp duty on securities accounts: 1.3 - Higher IRAP on banks: 1.0 - Capital income taxation: 1.4 - IRAP deductibility: -1.5 - Allowance for corporate equity: -1.0 - December Package total: 9.9 (49% of total 2012 package) - First house property tax and base re-evaluation: 10.7 - Luxury good tax: 0.4 - Stamp duty (including on financial instruments): 1.2 - Tax on asset held abroad: 0.1 - Income surtax for energy sector: 1.8 - Financial transaction tax (FTT): introduced end-2012, expected yield slightly above €1 billion per year; effective from March 2013. - August 2013 announcement: as of 2014, property taxes (including non-primary residences) to be replaced with a local services tax; details yet to be designed. - Authorities prepared Delega fiscale (DF) framework law to set strategic directions for targeted tax reform. ### Enhancing neutrality of capital income taxation — DIT, ACE, and IRI considerations - Dual Income Tax (DIT): low single rate on capital income, progressive schedule on labor; textbook: set corporate profit tax equal to single capital rate with full imputation. - Italy’s movement toward DIT features: - Rental income: 21 percent; interest income other than government debt: 20 percent; dividends (non-qualified): 20 percent or more; capital gains on most financial instruments: 20 percent. - Unification of withholding rates on interest income key measure of August 2011 package. - Allowance for Corporate Equity (ACE): introduced December 2011; notional interest rate 3 percent for 2011-13; thereafter based on Italian public debt securities' average return (adjusted for risk). - Remaining deviations from textbook DIT: - Half of dividends for qualified shareholdings taxed under progressive IRPEF rates. - Potential taxation of capital gains on real estate at IRPEF rate (no tax if held at least 5 years or used as primary residence). - IRES rate: 27.5 percent (above interest income rate). - Distortions across organizational forms: corporations (IRES 27.5 percent) vs partnerships/sole proprietorships (IRPEF range 23-43 percent). - Policy proposal: Imposta sul Reddito Imprenditoriale (IRI) — new business tax irrespective of legal form; retained earnings taxed at same rate as IRES; optionality and mandatory thresholds pose design and budgetary considerations. ### Implementing a fairer and more effective property tax (IMU and valuation) - Rationale: recurrent property taxes efficient; stable revenue; finance local services; less internationally mobile. - IMU introduced 2012 replaced ICI; primary residences brought back into tax base; cadastral values adjusted with ad hoc factors. - Property tax revenue more than doubled in 2012 to 1.5 percent of GDP. ### Cadastral revaluation (IMU implementation and options) - Cadastral system based on 1988–89 market rental estimates. - Revaluation coefficients applied: houses: 1.6; other property types: revaluation ranged from 1.2 to 1.6 percent (as multiplicative factors). - Result: taxable value increased by about 50 percent overall. - National average market-to-taxable ratios remain: - Primary residences: 2.2 - Other dwellings: 2.4 - Shortcomings: common-factor approach fails to capture property characteristics and spatially variable price changes (some regions increased up to five-fold since 1988-89). - Valuation options: - Market-driven comparable sales approach where feasible. - Cost-based approach for unique owner-occupied properties. - Income approach for income-producing properties. - Revenue implication: taxable base still less than half average market value nationally; comprehensive revaluation could raise comparable revenue with less than half current tax rate; some revenue could finance IMU rate cuts and transaction tax cuts. - Administrative requirements: over 83 million parcels; individualized appraisals for over one million specialized cadastral properties; suggested periodic updates (example: every three years); possibility of taxpayer self-declaration with audit and penalties. ### Transaction taxes — scale, structure, distortions (figures and features) - Transaction taxes: estimated 1.0 percent of GDP in 2011 (twice OECD average 0.5 percent). - 2012 transaction tax composition: - Registration taxes: 30% - Duty in lieu of registration taxes and stamp duties: 20% - Mortgage tax and land registry duties: 12% - Stamp duties: 32% - Surcharges on cadastral acts: 6% - Rates range from 0.5 to 15 percent depending on asset type. - Buyers pay three taxes on real estate purchases: registration tax (3–15 percent depending on property type; flat amount for business assets), land registry tax 1 percent, mortgage tax 2–3 percent. - VAT on new housing: 4–21 percent depending on property; if sale subject to VAT, registration and land registry taxes reduced to small flat amounts (except for business assets). - Transaction costs in housing market: about 25 percent above OECD average. - Adverse effects: impede transactions, reduce liquidity, inflate housing prices, create lock-in effects, reduce residential mobility (average cited: 12.5 percent of households changed residence within last two years — Italy’s mobility significantly below OECD average). ### Recommendation on transaction taxes - Strong case for reducing transaction taxes on real property; use part of revenue gains from improved IMU. - Legislative Decree 23/2011 planned substitution (from 2014) of single rate: 2 percent for primary residences; 9 percent for other properties (current rates range 3–18 percent). - Continue streamlining transaction taxes; rate cuts of this magnitude seen as reasonable though possibly still low for non-primary residences. ### Financial Transactions Tax (FTT) — facts and risks - FTT effective March 2013 targets transfers of equity instruments, equity derivative trades, high-frequency trading. - Expected yield: slightly above €1 billion per year. - Risks: reduce trading volume and liquidity, lower asset prices, unclear effect on leverage, displacement of trading activities, potential distortion if taxing transactions between businesses. - IMF (2010) preference: Financial Activities Tax on sum of profits and remuneration of financial institutions. ### Inheritance and gift taxation — features and yield - Italy taxes lifetime gifts and inheritances; allowances are lifetime amounts from a specific donor. - Inheritance and gift tax yield in 2012: €520 million, equivalent to 0.03 percent of GDP or 0.1 percent of total tax revenue. - Reasons for low yield: generous rates and allowances; for real property gifts/bequests, assessment base is cadastral not market value. - Weaknesses: donee-based allowance design allows cumulation of allowances from different donors; thresholds not automatically updated. - Policy options: apply allowances to sum of all prior gifts/inheritances from different donors; introduce automatic adjustment of allowance thresholds for inflation. ### Interest in a comprehensive Net Wealth Tax (NWT) — context and statistics - Motivations: political resistance to spending-only austerity; need to spread fiscal adjustment; difficulty distinguishing capital and labor income; concentrated wealth. - Key statistics: - Net household wealth: €8.6 trillion at end-2011. - Net household wealth about 4.5 times public debt. - Wealth-to-income ratio: about 770 percent of household disposable income in 2011. - Richest 10 percent households hold about half of total net wealth. - Current redistributive impact: excluding property tax, wealth taxes raise only 0.1 percent of GDP in 2012. - Composition of household wealth (top decile shares from Survey on Household Income and Wealth, 2010): - Real Estate: 78 - Business Equity: 10 - Valuables: 1 - Deposits: 4 - Government Securities: 1 - Other Securities: 5 - Trade Credit: 1 ### Efficiency and behavioral considerations for NWT - Concerns: layering NWT on existing capital income taxes raises effective marginal tax rates, especially in presence of inflation. - Illustration: investor earning 5 percent real return; a 1 percent NWT effectively doubles current 20 percent capital income tax to 40 percent; with 2 percent inflation the tax on real return could rise to 67 percent short-term and 48 percent medium-term (subject text). - Administrative issues: Italy already taxes many assets, moderating transition costs; needs information on financial liabilities; unit of taxation and joint filing choices critical. - Policy trade-off: piecemeal approach (asset-differentiated rates by mobility) vs comprehensive NWT (equity but higher administration and cross-asset distortions). ### Capital taxation — recommended directions (condensed) - Align cadastral values closer to market values; permit IMU rate cuts and offset transaction tax reductions. - Reduce significantly taxes on asset transactions. - Reform inheritance tax design: consider progressive banding to increase redistributive effect. - Consider medium-term move toward comprehensive wealth taxation while weighing administrative and economic effects. --- ### Tax Expenditures — identification, evaluation, and reform - Definition: government revenues foregone due to differential treatment (allowances, exemptions, rate relief, credits, deferrals). - MEF report: identifies and costs 720 tax expenditures amounting to about 16 percent of GDP. - Annual State Budget documents include list of tax expenditures at central government level measured against current legislation. - Evaluative framework questions for each tax expenditure: 1. Effect on economic efficiency. 2. Fairness. 3. Simplicity and administration. 4. Vulnerability to lobbying. - Italy: some tax expenditures are integral to normal tax system (e.g., tax credit substituting for lower PIT threshold). ### Selected largest tax expenditure values (billions; percent of GDP) - Personal Income Tax (largest items) - Tax credit for wage income, pensions, self-employment: 37.73; 2.41 percent of GDP - Various financial substitute taxes (interests, dividends, capital gains): 13.17; 0.84 percent of GDP - Tax credit for dependent relatives: 10.50; 0.67 percent of GDP - Exemption for contributions to welfare and pension schemes (employees): 10.10; 0.64 percent of GDP - Sum of largest PIT tax expenditures: 83.26; 5.32 percent of GDP - Corporate Income Tax (largest items) - 95% exemption for foreign-source dividends received by resident corporates: 8.38; 0.54 percent of GDP - Substitute tax (16 percent) for capital gains from intangible assets in extraordinary operations: 7.43; 0.47 percent of GDP - Full deduction from IRAP base of SSC costs and related measures: 6.69; 0.43 percent of GDP - Sum of largest CIT tax expenditures: 33.08; 2.11 percent of GDP - VAT (largest items) - VAT reduced rate (10 percent): 24.60; 1.57 percent of GDP - VAT reduced rate (4 percent): 14.60; 0.93 percent of GDP - Sum of largest VAT tax expenditures: 40.02; 2.56 percent of GDP ### VAT policy gap and compliance implications (illustrative figures) - C-efficiency estimated around 41 percent in 2010. - Combining with compliance gap ~30 percent implies policy gap ~41 percent (illustrative). - Halving compliance gap at unchanged rates could raise about 1.3 percent of GDP. - Halving policy gap at unchanged standard rate could raise about 2.7 percent of GDP. - Decomposition (MEF/De Mooij & Keen framework): lost revenue (2010, percent of GDP): 2.5 due to exemptions, 2.9 due to lower rates, 2.6 due to non-compliance; actual VAT revenue just over 6 percent of GDP; potential revenue at unchanged standard rate: 15 percent of GDP. ### Reform governance and priority review recommendations - Regular, systematic review of tax expenditures integrated with spending reviews. - Consider legislating expiry clauses for tax expenditures. - Any extension or new tax expenditure only via annual budget process. - Prioritize reviews for: - Unquantified items (e.g., VAT exempt regimes). - Poorly targeted items (e.g., VAT reduced rates). - Items better achieved by direct spending (e.g., medical services). - Distortionary provisions (e.g., preferential treatment for government bonds). ### Illustrative priority review figures (billions; percent of GDP) - VAT Reduced Rates: 39.20; 2.50 percent of GDP - Fuel excise exemptions and reduced rates: 3.17; 0.20 percent of GDP - Income tax credit for medical expenses: 2.36; 0.15 percent of GDP - Income tax credit for mortgage interest on principal residence: 1.34; 0.09 percent of GDP - CIT substitute taxes to encourage restructuring: 13.83; 0.88 percent of GDP - Total (illustrative): 61.28; 6.44 percent of GDP --- ### Nonperforming Loans (NPLs) and Market for Distressed Debt — scale and strategy - NPL definition: bad debt, substandard, past due (beyond 90 days), and restructured loans. - Since 2007, ratio of nonperforming loans nearly tripled to 14 percent. - Loan loss provisioning coverage fell from 45 percent to 39 percent. - Collateral (real estate and guarantees) covers nearly two-thirds of all loans. - Pace of write-offs increased to over 6 years (from just under 4 years pre-crisis). - Simulations: at current write-off rates, bad debt ratio would peak in 2015 and decline only gradually; absent stronger recovery, a near tripling of write-offs vs historical average needed to return to pre-crisis levels within ten years. - NPL write-off pricing gap with market: about 10-25 percent. - 2012: rising loan losses absorbed nearly all operating profits of large banks. ### How high NPLs affect banks - Negative carry: NPLs not generating interest but funded at positive market rates — reduced net interest margins. - For standardized methods: higher risk weight up to 150 percent for unprovisioned/uncollateralized NPL portion. - For IRB banks: expected losses not covered by provisions deducted from core capital ("expected IRB shortfall"). - Large NPL portfolios tie up human/operational resources, reduce capacity for profitable lending. - Worsening asset quality associated with higher CDS spreads, lower valuations, sensitivity to sovereign distress. ### Reasons for slow write-offs — push and pull factors - Push factors: - Lower provisioning reduces incentive to write-off; writing off requires booking losses net of provisions. - Heavy reliance on collateral (covering some 48 percent of total loans) encourages waiting for foreclosure. - Tax regime: write-offs not tax deductible without court declaration of insolvency; provisioning deductible only up to 0.3 percent of outstanding loans; remaining provisions treated as DTA deductible over 18 years, lowering tax benefits of provisioning. - Pull factors: - Lengthy judicial processes: average 3 years to foreclose and collect real estate collateral; bankruptcy >7 years on average. - World Bank Doing Business rankings: resolving insolvency (#20 of 31 OECD); enforcing contracts (#30 of 31). ### Market for distressed debt — current size and benefits - NPL sales: around €2 billion annually vs €122 billion stock of bad loans. - Market small; few domestic investors specializing in collection. - Benefits of developing market: - Banks: relieve collection burden, free resources, potentially higher recovery values, manage portfolio risk. - Financial markets: improve secondary loan liquidity, support NPL securitization, attract investors. - Economy: diversify financing sources, support earlier resolution, enhance corporate productivity via restructuring. ### Strategy to foster distressed-debt market — main impediments and policy actions - Three main areas: judicial reform, prudential policies, tax policy. - Judicial reform: expand specialized bankruptcy courts, accelerate foreclosures with standardized procedures, encourage out-of-court workouts with similar tax/regulatory treatment as courts. - Prudential policies: strengthen provisioning coverage via asset quality reviews, conservative collateral valuation, harmonize write-off guidelines to accelerate disposals. - Tax policy: align deductibility of provisioning/write-offs to international levels; staff estimate full deductibility of new loan loss provision would cost ~3 billion (0.2 percent of GDP) in tax revenue. ### Corporate Restructuring Vehicles (CRVs) and international lessons - CRVs: private SPVs where banks partner with outside investors to collect/resolve problem loans. - Benefits: tap outside financing/expertise, bridge pricing gap, accelerate NPL disposal and restructuring. - Safeguards: transfers and debt-to-equity conversions at fair market value to prevent hiding bad assets. - Korea lessons: government-led legal/regulatory changes, public funds, AMCs, CRVs, CRCs, CRFs, C-REITs facilitated rapid resolution; success factors included supportive regulatory, tax and market environment and transparent transfers at fair value. ### Recommended combined approach - Strengthen provisioning practices. - Remove fiscal disincentives for write-offs. - Expand market for distressed assets. - Accelerated write-offs would strengthen bank confidence and support recovery. --- ### Bank Corporate Governance — foundations, cooperatives, and regulatory recommendations - Foundations: despite Law 461/98 diversification requirement, some foundations concentrated portfolios in original banks (30–90 percent stakes), used bank credit for capital increases/real estate, invested in risky derivatives — increasing portfolio risk and pressure on banks. - Stress test findings (adverse scenario: "double dip" with growth of -5.6 percent till 2015): - Banks influenced by foundations: Tier 1 ratio fall from 8.8 percent (Dec 2012) to 2.5 percent in 2015. - CET1 capital shortfall: €3.2 billion (0.2 percent of GDP). - Tier 1 capital shortfall: €5.4 billion (0.3 percent of GDP). - These account for 40–50 percent of all Italian banks’ shortfall in test. - Definition: banks influenced by foundations = single foundation controls ≥20 percent of shares; this subcategory = 11 percent of Italian banking assets. - Banks with highest foundation ownership (14 banks with ≥50 percent shares owned by foundations): - NPL ratios 2 percentage points above system averages. - NPL provision coverage 9 percentage points below average. - Capital ratios 2 percentage points below average. - Cooperative banks (Banche Popolari): - Lend up to two-thirds of funds to SMEs; account for three quarters of new SME loans since 2008. - Increased capital by 24 percent vs 13 percent for other banks. - Example: one bank's risk weighted assets fell from €90 billion to €50 billion moving to IRB. - Governance constraints: one person one vote, limits to vote proxies, transfer approvals impede capital raising. - Stress test results for cooperatives (adverse scenario): - Account for ~half of capital shortfall: CET1 shortfall €2.4 billion; Tier 1 shortfall €6.8 billion. - Tier 1 ratio drops from 9.3 percent (2012) to 4.2 percent (2015). - Large cooperatives: NPL ratios nearly 14 percent; provisioning 10 percentage points below average; capitalization below market average at 12 percent of total capital. ### Governance regulatory framework and reforms - EU directives and recommendations implemented: 2003 Action Plan, board structure recommendations (2003/2005), disclosure directives (2005), shareholder rights (2004/2007). - Revised Code of Conduct (Dec 2011): "comply or explain"; FTSE-Mib issuers must have "at least one third" independent directors and at least two independent directors; stricter independence definition than law. - Decree banning interlocking directorates in financial sector (Dec 2011) affected 10 percent of institutions. - BoI Circular (Jan 2012): requires board members to be appropriately skilled; reinforces non-executive directors’ role; periodic self-assessment. - Related-party lending regulations strengthened (Banking Law amendments and Circular 263 in 2011); new provisions governing related-party transactions in force end-2012; BoI draft requires nominative reporting of exposures to related parties. ### Recommendations to enhance governance (FSAP-aligned) - Strengthen "fit and proper" rules: include adverse regulatory judgments and shareholders' financial soundness (capacity to provide capital). - Empower supervisor to change board composition if fit and proper duties not met. - Tighten definition of connected parties for related-party lending to include economic influence; ensure related-party transactions not on more favorable terms; exclude conflicted directors from decisions. - Oversight of foundations: - Caps on leverage. - Strict disinvestment procedures and governance rules. - Diversify portfolios, prudent investment policies, minimum safe asset reserves. - Term limits for foundation board members and cooling-off periods between political office and foundation appointments. - Subject foundations to strict oversight with prompt corrective action by MEF or other supervisor. - Cooperative banks: - Encourage conversion to joint stock companies or, at minimum, increase shareholder rights (raise proxy voting limits, facilitate share transfers, facilitate shareholder meeting agenda additions). ### Conclusion — banks and governance - Corporate governance crucial for banking system functioning and financial market integrity. - Strengthened regulation and supervision should ensure ownership/control differences do not impede bank performance and resilience. - Improved governance will support bank capacity to lend, contribute to financial stability, and make banks more attractive to private capital. *Italicized source attribution: IMF staff summary based on chapter text in the supplied document.* ### Executive Summary ### Executive Summary ### Italian Productivity, Innovation, and Competitiveness - Objective: provide a comprehensive assessment of Italian export competitiveness with a focus on the evolution of Italy’s export market share. - Key finding: competitiveness is a matter of concern but "perhaps not as critical as some assessments have claimed." - Strengths: - Italy maintains a high-quality export mix and adaptability of small-scale specialized firms. - According to the WTO/UNCTAD Trade Performance Index, Italy is the world’s top-ranked exporter in textiles, clothing and leather goods; and is ranked second in the world (behind Germany) for non-electronic machinery and manufactures (basic and miscellaneous). - Structural challenge: small firm size is now less of an asset; structural barriers have depressed Italian productivity broadly. - Policy implication: Italy’s future competitiveness depends on successful implementation of the authorities’ full structural- and institutional-reform agenda. - Classification of export industries (extended Pavitt taxonomy), five groups: - Science-based industries (e.g., pharmaceuticals, high-end electronics, aviation). - Specialized supplier industries (SMEs producing tailored equipment). - Traditional industries (e.g., textiles, furniture, food, basic manufactures). - Scale-intensive: technology-based (e.g., motor vehicles, transport equipment). - Scale-intensive: resource-based (e.g., industrial chemicals, refined petroleum products, basic metals, processed foodstuffs). - Sectoral observation: Italy’s export mix has a substantial weight of traditional products and a large and stable share of specialized-suppliers, comparable to Germany or the United States. ### Price Competitiveness - Mixed indicators: - ULC-based indicators suggest a substantial loss in competitiveness: "deteriorated by up to 5 percent since adoption of the euro." - Germany, by contrast, shows an "improvement in Germany of nearly 20 percent." - PPI-based measures show a considerably narrower gap; Italy is "not materially less competitive than it was in 1999" using PPI-based measures. - Diagnostic: labor-cost measures (ULC) may present an incomplete picture because globalization and international supply chains reduce the share of domestically employed labor in total production costs. - Example: wage shares in the manufacturing sector fell sharply in Germany between 1998 and 2007, but only marginally in Italy over the same period. - Alternative measures developed by IMF staff to account for supply chains: - Value-added Real Effective Exchange Rate (VA-REER): adapts REER to competition in supply of value-added (or "tasks") rather than finished goods. - Supply-chain adjusted REER (Bayoumi, Saito, & Turunen, 2013): modifies standard price-based REER to include an outsourcing term offsetting domestic factor-price inflation. - Implication: supply-chain-aware price measures can provide a better guide to actual price competitiveness of gross exports than labor-focused ULC measures. ### Judicial System Reform—A Key to Growth - Finding: the inefficient Italian judicial system has contributed to a difficult business environment and lower investment. - Key reform areas: - Strengthen the mediation system. - Enhance court management and accountability. - Reform the appeal system. - Policy objective: improving judicial efficiency to improve business environment and support investment. ### Reforming Capital Taxation in Italy - Scope: reviews capital taxation issues using a comprehensive definition including taxes on income, transactions, and ownership. - Analytical focus: - Options to enhance neutrality of the capital income tax system. - Detailed analysis of the property tax, the inheritance tax, and various transaction taxes. - Examination of whether substituting a single net wealth tax for existing taxes could be beneficial in the medium-term. - Policy aim: reform capital taxation to reduce distortions and improve fairness and efficiency. ### Reforming Tax Expenditures in Italy - IMF advice: roll back tax expenditures to support fiscal consolidation. - Chapter content: - Analysis of tax expenditures in Italy. - Assessment of the extent to which expenditures are part of an optimal tax system. - Possible reforms to reduce inefficient tax expenditures. - Objective: identify and prioritize tax-expenditure reforms that support fiscal consolidation and economic efficiency. ### Strategy for Fostering a Market for Distressed Debt in Italy - Focus: framework for resolving NPLs and accelerating write-offs through tax policies, legal reforms, and regulatory policies, drawing lessons from other countries. - Goal: develop a private market for restructuring distressed assets to help banks clean balance sheets and expand lending. - Diagnostic: identifies reasons behind slow pace of write-offs and proposes a strategy to develop a distressed-debt market. ### Reforming the Corporate Governance Framework of Italian Banks - Finding: corporate governance is key for a well functioning banking system. - Areas examined: - Corporate governance of Italian banks. - Regulatory framework. - Specific challenges from dependence on foundations and cooperatives. - Recommendations: in line with the FSAP, strengthen corporate governance mechanisms for banks, addressing concentrated ownership, foundation-influenced banks, and cooperative bank structures. *Source: _cr13299 - Executive Summary, September 6, 2013.* ### 10. For Italy, the differences between these alternative measures are illustrative. ### _cr13299 - 10. For Italy, the differences between these alternative measures are illustrative. ### Price-based competitiveness: comparisons and interpretation - The tasks-based VA-REER gives roughly the same assessment as the standard CPI-based REER when considering the cumulative Italian appreciation since adoption of the euro. - A modified price-based measure suggests a substantially less-marked decline in competitiveness. - Interpretation: rising factor costs in Italy have not translated into an equivalent increase in the relative price of Italian goods, owing in part to the role of low-cost imports from low inflation countries. - Contrast with Germany: falling factor costs in Germany imply a sharp increase in competitiveness that has not been fully matched by lower export prices, because Germany imports a large and increasing proportion of its inputs from countries with relatively high inflation. - Implication: the competitiveness challenge in Italy may not be as immediately dire as suggested by a focus solely on cost-based measures. ### Non-price competitiveness — Quality indicators - Italian exporters have upgraded product quality; export unit values provide the clearest evidence. - Averaging across all export sectors, unit values in Italy are around 1½ times higher than the global mean. - IMF staff research (Henn, Papageorgiou, & Spatafora (2013)) constructs a more consistent quality indicator based on unit values estimated within a sector-specific gravity-equation framework. - Result: Italy remains at the top of the global quality ladder across all its major exports, including traditional industries. ### Market-share dynamics — Shift-share (constant market-share) analysis - Rationale: raw market-share changes are affected by world trade growth, a country's trading-partner mix, and product mix; a more representative measure strips out product and geographical effects. - Method summary: - Uses mid-point growth rates to account for entry and exit (extensive margin). - Employs a fixed-effects regression with exporter, importer, and product fixed effects (Cheptea (2005); Bricongne and others (2013)). - Decomposes market-share growth into: - Sectoral component (product mix) - Geographical component (trading-partner distribution) - Adjusted market share (performance component reflecting underlying price and non-price competitiveness) - Data: bilateral dataset from Gaulier & Zingano (2010); BACI product-level database (reconciled USD flows, roughly 5000 HS 6-digit products, years 1995-2011). For regressions, 6-digit product data are aggregated down to the 2-digit level. ### Results — key findings and exact figures - General assessment: Italy's market share has been weighed down by an unfavorable product mix; after accounting for geography and product mix, Italy's adjusted market share is disappointing but compares favorably to France and the United Kingdom and broadly comparable to Germany. - For the pre-crisis period (1995-2007) Italy oriented exports to markets with rapidly expanding import demand but had a product mix biased toward less dynamic products. - Post-crisis (2007-2011): most European countries saw a sudden downturn in demand from main export partners; Italy additionally held back by poor product mix; adjusted measure broadly in line with France or the United States. Selected exact annualized figures from Table 1 (Changes in World Market Share and Shift-Share Decomposition: Large Exporters, 1995.2011 — percentage points): - All Export Industries — Italy - 1995-2007: Market Share -1.5; Adjusted Share -1.4; Geography 0.4; Product Mix -0.6 - 2007-2011: Market Share -4.1; Adjusted Share -2.6; Geography -1.2; Product Mix -0.3 - Science-Based Industries — Italy - 1995-2007: Market Share -1.2; Adjusted Share -4.7; Geography 0.2; Product Mix 3.4 - 2007-2011: Market Share 1.6; Adjusted Share -1.7; Geography -0.9; Product Mix 4.3 - Specialized Supplier Industries — Italy - 1995-2007: Market Share -1.5; Adjusted Share -2.7; Geography 0.7; Product Mix 0.5 - 2007-2011: Market Share -4.9; Adjusted Share -4.1; Geography -1.3; Product Mix 0.5 - Traditional Industries — Italy - 1995-2007: Market Share -2.2; Adjusted Share -2.5; Geography 0.5; Product Mix -0.3 - 2007-2011: Market Share -5.1; Adjusted Share -4.4; Geography -0.6; Product Mix -0.2 - Scale-Intensive Technology-Based Industries — Italy - 1995-2007: Market Share -0.7; Adjusted Share -0.1; Geography -0.5; Product Mix 0.0 - 2007-2011: Market Share -5.7; Adjusted Share -4.3; Geography -1.4; Product Mix 0.0 - Scale-Intensive Resource-Based Industries — Italy - 1995-2007: Market Share 0.8; Adjusted Share -1.0; Geography 0.2; Product Mix 0.0 - 2007-2011: Market Share 3.3; Adjusted Share -0.9; Geography -1.7; Product Mix -0.6 - Note: Figures above are annualized growth, percentage points, as reported in Table 1. Additional findings: - Focusing on science-based industries, Italy has generally targeted products with better prospects for growth and has mostly maintained or increased market share; however, adjusted market-share measure suggests an underlying lack of competitiveness within the sector. - For specialized suppliers, Italy has had some success in product choice but an underlying competitiveness deficit continues to erode global market share. - Possible causes for erosion in competitiveness: - Structural distortions, rigidities, and administrative impediments that have depressed productivity across the Italian economy. - Changing global production where larger scale firms gain advantages in brand recognition, access to finance, and integration into global supply chains; small firm size is less of an asset. ### Policy implications and recommendations - Structural reforms to remove barriers to firm growth and encourage inward FDI are indicated, especially if firm size and global reach are increasingly important for global competitiveness. - The science-based sector would benefit from the same structural reforms to allow it to play a larger role in Italy's export base. - Conclusion: Italy maintains a high-quality export mix and firm adaptability remains a source of strength; however, competitiveness is a matter of concern and will depend on successful implementation of the authorities' full structural- and institutional-reform agenda. *Source: IMF staff calculations using BACI database, developed by Gaulier & Zingano (2010)* ### References ### _cr13299 - References ### Key references cited - Aghion, P., and P.Howitt, 2009, The Economics of Growth, (MIT Press). - Bank of Italy, 2009, ―Reports on Trends in the Italian Productive System,‖ Occasional Paper No.45 (Bank of Italy: Rome). - Bayoumi, T., J.Turunen and R.T.Harmsen, 2011, ―Euro Area Export Performance and Competitiveness,‖ IMF Working Papers 11/140, (International Monetary Fund). - Bayoumi, T., M.Saito and J.Turunen, 2013, ―Measuring Competitiveness: Trade in Goods or Tasks?,‖ IMF Working Papers 13/100, (International Monetary Fund). - Bems, R. and R.C.Johnson, 2012, ―Value-Added Exchange Rates,‖ NBER Working Papers 18498, (National Bureau of Economic Research, Inc). - Bogliacino, F. & M.Pianta, 2010, ―Innovation and Employment: a Reinvestigation Using Revised Pavitt Classes,‖ Research Policy, Elsevier, vol. 39(6), pages 799-809. - Bricongne, J., L.Fontagné, G. Gaulier, D.Taglioni, and V.Vicard, 2012, ―Firms and the Global Crisis: French Exports in the Turmoil,‖ Journal of International Economics, Elsevier, vol. 87(1), pages 134-146. - Cheptea, A., G.Gaulier and S.Zignago, 2005, ―World Trade Competitiveness: A Disaggregated View by Shift-Share Analysis,‖ Working Papers 2005-23, CEPII research center. - Cheptea, A. L.Fontagné, and S.Zignago, 2012, ―European Export Performance,‖ Working Papers 393, (Banque de France). - Codogno, L., 2009, ―Two Italian Puzzles: Are Productivity Growth and Competitiveness Really so Depressed?,‖ Working Paper 2009-2, (Department of the Treasury, Italian Ministry of the Economy and of Finance). - Crafts, N., and M.Magnani, 2011, ―The Golden Age and the Second Globalization of Italy,‖ Quaderni di storia economica No.17, (Bank of Italy: Rome). - Crafts, N., 2012 ―Western Europe‘s Growth Prospects: A Historical Perspective,‖ CEPR Discussion Paper 8827. - Di Mauro, F., R. Rüffer, and I. Bunda, 2008, ―The Changing Role of the Exchange Rate in a Globalised Economy,‖ Occasional Paper Series, No 94, (European Central Bank). - ECB, 2012, ―Competitiveness and External Imbalances within the Euro Area,‖ Occasional Paper Series 139, (European Central Bank). - Gaulier, G., and S.Zignago, 2010, ―BACI: International Trade Database at the Product-Level. The 1994-2007 Version,‖ Working Papers 2010-23, (CEPII Research Center). - Gaulier, G., D. Taglioni, and S. Zignago, 2013, ―Export Performance in the Wake of the Global Crisis: Evidence from a New Database of Competitiveness Indicators‖, mimeo. - Ginsborg, P., 2003, Italy and Its Discontents: Family, Civil Society, State, (Palgrave Macmillan). - Giordano, C. and F.Zollino, 2013, ―The Divergent Behaviour of Different Competitiveness Indicators for Italy: An Assessment,‖ Bank of Italy, mimeo. - Henn, C., C. Papageorgiou, and N.Spatafora, 2013, ―Export Quality in Developing Countries,‖ IMF Working Papers 13/108, (International Monetary Fund). - Kubielas, S., 2007, ―Geographical and Sectoral Pattern of Knowledge Spillovers and Productivity Growth in Polish Industry,‖ Paper for the DIME Workshop on Agglomeration and Growth in Knowledge-Based Societies, April 20-21, 2007, (IfW: Kiel). - Lissovolik, B., 2008, ―Trends in Italy's Nonprice Competitiveness,‖ IMF Working Papers 08/124, (International Monetary Fund). - Pavitt, K., 1984, ―Sectoral Patterns of Technical Change: Towards a Taxonomy and a Theory,‖ Research Policy, Elsevier, vol. 13(6), pages 343-373. - Porter, M., 1990, The Competitive Advantage of Nations, (Free Press: New York). ### Judicial system reform — findings, diagnostics, and remedies - Role of judicial efficiency - An efficient justice system requires decisions taken within a reasonable time, predictability, effective enforcement, and protection of individual rights including property rights. - Improving judicial efficiency can improve the business climate, foster innovation, attract FDI, secure tax revenues, and support economic growth. - Performance indicators and magnitudes - It takes an average of 1,200 days to enforce a contract in Italy. - OECD average to complete a civil case up to the Supreme Court level is 788 days; in Italy it is almost 8 years. - Italy ranks 112th in legal enforcement of contracts (Fraser Institute) and 139th in efficiency of the legal framework (World Economic Forum, 2013 Report). - Pending cases: 9.7 million pending cases (end 2012), including about 5 million pending civil cases (end 2012). - Pending tax-related cases: about 870,000 (end 2011). - Italy is the country with the highest number of violations of the ―reasonable time‖ requirement in Article 6 of the ECHR. - Growth projections and context: - Growth is projected to average 0.7 percent during 2013–18. - In the absence of deeper structural reforms, potential growth is estimated at around ½ percent. - Channels linking judicial inefficiency to economic outcomes - Foreign direct investment: - Inward FDI over 2005-11 were about 1/3 of the euro area average as a percent of GDP; FDI is positively correlated with quality of legal institutions. - Credit markets and cost of credit: - Weak contract enforcement reduces willingness to lend, raises borrowing costs, and shortens maturities. - Firm size and labor market: - Positive correlation between judicial quality and firm size; SMEs account for nearly 70 percent of value added in Italy. - Halving length of civil proceedings could increase average firm size by 8–12 percent (Giacomelli and Menon, 2012). - Long judicial proceedings for worker dismissals result in higher firing costs for firms with more than 15 employees. - Enforcement and liquidity: - Weak enforcement leads to late payments, liquidity problems, higher insolvency, and increased unemployment. - The "culture of late payments" is linked to weak enforcement (Intrum Justitia, 2013). - Entrepreneurship and innovation: - Judicial efficiency correlates with entrepreneurship rates; high-quality enforcement associated with more complex exports and less sophisticated imports. - High-technology products account for only 7 percent of manufactured exports, 9 percentage points below the OECD average. - Diagnostic factors causing inefficiency - Court structure and fees: - Italy has 1,231 first instance courts of general jurisdiction (CEPEJ, 2012). - Historically low court fees; share of court fees in supporting court expenditure ranked Italy in the bottom 6 countries of Council of Europe states in 2012. - Low fees lead to larger inflow of cases, higher appeal rates, and increased public expenditure. - Large inflow and stock of pending cases: - High inflow to both first instance and appellate courts; ease of appeal and ability to go directly to the Court of Cassation increases appellate inflow. - Court of Cassation inflow rose from 3,000 per year in the 1960s to nearly 30,000 in recent years. - Legal profession: - Number of practicing lawyers per 100,000 inhabitants in Italy is very high and is considered a factor behind high incoming case volumes. - Appeal system and predictability: - Law 83/2012 introduced measures to rationalize appeals, including excluding a case from appeal if it "does not have a reasonable chance of being accepted" (Article 348 bis of the Code of Civil Procedure). - High reversal rate in appeal courts incentivizes appeals; Italy‘s reversal rate is 34.54 versus France‘s 11.74. - Frequent legislative changes and high case volume at the Court of Cassation reduce legal predictability and allow conflicting case law to coexist for long periods. - Procedural complexity: - Court procedures are rigid and fragmented, with numerous interim and interlocutory procedures that fragment disputes into sub-disputes and create multiple appeals. - Enforcement procedures (including foreclosure) are complex, with long durations and high costs; World Bank estimated average foreclosure duration in Italy as 90 months. - Enforcement of money claims involves complex rules and difficulties in asset identification; no obligation for debtor to provide full disclosure. - Measures taken by the authorities and outcomes - Measures introduced: - Increase court fees, create appeal barriers, change lawyers' fee structure. - Promote out-of-court settlements and enhance mandatory mediation. - Reduce number of courts to create economies of scale and foster specialization. - Strengthen court management (greater management role for Chief Judge, case schedules, workload management). - Speed case processing and improve first-instance court quality. - Observed effects: - A 43 percent decline in the inflow of small claims following increased fees. - Remaining challenges: - Some measures have had mixed results; high reversal rates and ease of access to higher courts continue to drive inflow and delays. - The dismissal of appeals may still be appealed before the Court of Cassation, and measures to filter appeals raise practical questions about assessment without re-hearing parties. - Recommendations and policy options to consider (inter alia) - Review and adjust court fee structure to better align costs with case inflow and discourage frivolous litigation. - Further improve the mandatory mediation scheme to promote out-of-court settlements. - Strengthen court management by empowering court leadership, implementing case scheduling, and managing judges‘ workloads. - Reform the appeal system to reduce unnecessary appeals while safeguarding access to justice and predictability of legal outcomes. - Consolidate and specialize lower courts to improve first-instance quality and reduce appeal incentives. - Improve enforcement procedures, including easing access to public records for bailiffs and considering coercive order regimes to increase recovery rates and speed of collection. *Source: _cr13299 - References* ### 12. The Pinto Law attempted to improve the situation in 2001 by giving litigants right to ### 12. The Pinto Law attempted to improve the situation in 2001 by giving litigants right to ### Effects and evaluation of the Pinto Law - Law No. 89/2001 (the Pinto Law) aimed to give litigants the right to damages in case of excessively lengthy court proceedings. - The Pinto Law did not have the intended effect of speeding up the court process because it failed to build in the necessary incentives for the judiciary to reform. - Consequences observed: - The law generated additional litigation and budgetary costs, and worsened the problems it meant to address (Fabbri 2009, Bossi, 2012). - By 2011, about 50,000 Pinto Law cases were filed before the Italian Courts of Appeal. - The compensation awarded for actions filed under the Pinto Law amounted to €200 million by 2011. - As of 2011, approximately, 5,000 of the 14,500 pending applications against Italy before the European Court of Human Rights (ECtHR) concerned Pinto proceedings, with more than 300 such applications arriving each month. - Design shortcomings noted: - The law did not create effective individual and institutional incentives for judges to reduce case length; the Italian Court of Auditors’ right to impose contributions on judges was hardly exercised. - Compensation payments were met from a special allocation and did not cut into courts’ budgets, reducing pressure for judicial reform. ### Alternative uses of Pinto-related funds - Observation: - Funds used to compensate litigants under the Pinto Law (€200 million by 2011) could have been invested in measures to improve judicial efficiency instead of compensating delays. - Legislative response: - In 2012 the Government enacted legislation aimed at clarifying the scope of the Pinto Law (Article 55 Decree-Law 83/2012 and conversion Law no.134 of August 7, 2012), but it did not address the underlying incentive problems. ### Mediation and out-of-court dispute settlement - Mandatory mediation introduction and trajectory: - Decree-Law 28/2010 introduced mandatory mediation in 2010, with scope extended in 2011. - Reports indicate the use of mediation increased following the enactment of the law. - According to the International Institute for Conflict Prevention & Resolution, the number of mediation procedures increased from 1,000 to 250,000 over 2009–10. - The Constitutional Court declared the mediation legislation unconstitutional in October 2012; compulsory mediation was later reinstated in 2013. - Challenges to mediation uptake: - Logistical and institutional challenges. - Lack of strong incentives for parties and limited public knowledge of mediation. - The inefficiency of the justice system reduces mediation’s attractiveness, especially for parties expecting to lose. - Policy considerations to strengthen mediation: - Reconsider compulsory presence of lawyers in all mediation proceedings: - Compulsory lawyer presence may create unnecessary reserved areas, increase costs, hamper competition, and reduce involvement of other professionals. - New legislation requires lawyers to be trained in mediation, but training will take time and compulsory mediation was introduced for an initial period of four years only. - Suggested supportive measures: - Allow mediation to take place without the compulsory presence of lawyers. - Develop standards for selection, responsibilities, training and qualification of mediators. - Inform market participants and the public about which procedures are subject to mediation and about time, process, and costs of mediation. ### Other judicial reforms and pilot initiatives - Pilot and managerial measures: - Streamlined first-instance court proceedings and online civil case management in pilot courts. - Backlog-reduction teams in certain courts and civil procedure reforms. - Torino and Bolzano courts presented as success stories; some measures supported by EU structural funds. - Since 2004 EU supported roll-out of Torino and Bolzano experience nationally; central government strengthened program management in 2010-2011; Ministry of Public Administration set up central monitoring in 2011; Ministry of Justice put in place professional management in 2012. - Recent measures in Decreto del Fare (Law 98/2013, August 2013) include: - Law-clerk apprenticeships to work in courts and support judges. - A task force of 400 magistrates to clear the backlog in the courts of appeal. - Compulsory mediation (see above). - New associate judges in the Court of Cassation. - Concentrating in the Naples, Milan, and Rome Courts all disputes involving foreign investors. - First hearing to be mandatory scheduled within 30 days and settlement of litigations expected at the first hearing in most cases. ### Key recommendations for further reforms - Overall objective: - Further reform the judicial system to better support effective and efficient enforcement of civil and commercial claims, reduce incoming case volumes while preserving access to justice, and ensure timely and effective resolution when cases enter the court system. - Policy areas and suggested actions: (i) Public finance and litigation incentives—court fees - Carry out a comprehensive assessment (including both an impact and a policy assessment) of court fees for civil, commercial and tax cases. - Explore increasing court fees, while upholding access to justice (e.g., through a properly developed legal aid system). - Rationale: increased or introduced court fees can (a) help prevent spurious litigation; (b) shift expenditure burden from taxpayers to litigants and, if targeted, to those most able to bear it; and (c) increase overall public revenue. - Context: court fees remain modest and capped in Italy (even for large commercial litigation); court fees have generally increased throughout Europe. (ii) Strengthening out of court dispute settlement—mandatory mediation - Continue to promote mediation and strengthen incentives and public knowledge to increase consistent use. - Consider removing compulsory lawyer presence in mediation, develop mediator standards, and better inform stakeholders about mediation procedures and costs. (iii) Improving court management - data systems and performance accountability - Strengthen court organization and management to enable proactive case management, including: - Reorganization of courts (consolidation, professionalization of management, specialization of judicial functions). - Simplification of administrative procedures and digitalizing processes. - Proactive case management, improved budgetary mechanisms, and performance accountability. - Implement and process the planned “data warehouse” of litigation; translate data into policy and institutional accountability. - Consider setting performance targets for judges, tracking performance for internal monitoring and publication. (iv) Strengthening and streamlining civil procedure and enforcement—the appeal system - Strengthen civil procedure through measures such as: - Effective regime of pre-trial disclosure and interim measures. - Enhanced role for judges in managing cases and increased use of single judge processes. - Simplification of decision-format for lower courts. - Review of the appeal system (court of appeals and Court of Cassation), possibly introducing filters or pre-selection regimes similar to other European Supreme Courts. - Stronger IT-based processing and effective enforcement. - Undertake a comprehensive review of the appeal system in line with Council of Europe Recommendation R(95)5 and European Judicial Network recommendations. *Italicized source attribution: IMF staff summary based on chapter text in the supplied document.* ### 1. This chapter reviews issues and options in capital taxation based on a comprehensive ### _cr13299 - 1. This chapter reviews issues and options in capital taxation based on a comprehensive ### Overview - The chapter reviews capital taxation using a comprehensive definition encompassing taxes on: - (i) capital income (business profit, dividends and interest received by individuals, capital gains, and rent); - (ii) capital transfer (inheritance and transaction taxes); and - (ii) capital ownership (property and net wealth taxes). ### Italy’s capital taxation: levels and structure - Capital taxes in Italy yielded 10 percent of GDP, the fourth highest revenue in the EU-27 in 2011. - The implicit tax rate on capital is 33.6 percent. - The share of capital taxes in total taxes is 23.5 percent. - Taxes on household income, capital stock and corporate income rank respectively 5th, 6th, and 9th in the EU (2011, Eurostat). - Italy relies heavily on transaction taxes: taxes on financial and capital transactions amounted to about half of total taxes on wealth in 2011 (compared to one fourth for the OECD average). - The reform of the real estate tax increased immovable property revenues from 0.7 percent of GDP in 2011 to 1.5 percent in 2012. - Comparisons for immovable property revenues (2012/benchmarks shown in text): - OECD average: 1.1 percent of GDP. - Japan: 2.2 percent of GDP. - France: 2.5 percent of GDP. - US: 3.0 percent of GDP. - UK: 3.3 percent of GDP. ### Recent fiscal measures and planned reform framework - About one-fifth of the July-September 2011 packages and half of the December 2011 package relied on capital taxation. - The financial transaction tax (FTT) introduced at the end of 2012 is expected to yield slightly above €1 billion per year and took effect from March 2013. - In August 2013, authorities announced that, as of 2014, property taxes (including those on non-primary residences) would be replaced with a local services tax; details are yet to be designed. - The authorities prepared a framework law (Delega fiscale, DF) to set strategic directions for a targeted tax reform; the DF would authorize the government to legislate details by decree. - Table 1 (summarized simulated impacts on 2012 revenues, in billions of Euros): - July-September Packages total: 5.5 (In percent of total 2012 package: 19%) - Stamp duty on securities accounts: 1.3 - Higher IRAP on banks: 1.0 - Capital income taxation: 1.4 - IRAP deductibility: -1.5 - Allowance for corporate equity: -1.0 - December Package total: 9.9 (In percent of total 2012 package: 49%) - First house property tax and base re-evaluation: 10.7 - Luxury good tax: 0.4 - Stamp duty (including on financial instruments): 1.2 - Tax on asset held abroad: 0.1 - Income surtax for energy sector: 1.8 ### Organization of the chapter (topics covered) - Section B: assesses taxes on capital income through the prism of neutrality. - Section C: analyzes the real estate tax with emphasis on properties‘ valuation. - Section D: discusses taxes on wealth transfers (transaction taxes). - Section E: discusses inheritance and gift taxes. - Section F: considers whether a comprehensive wealth tax could be warranted as a substitute for existing taxes. - Section G: concludes. - Note: Analysis focuses on selected issues of current interest; the regional production tax is omitted. ### Enhancing neutrality of the capital income tax system - Dual income tax (DIT) essentials: - Tax capital income at a low single rate and labor income under a progressive schedule. - DIT differs from a comprehensive income tax and from an expenditure tax (DIT taxes the return to capital). - Textbook prescription: set the corporate profit tax rate equal to the single rate on capital income and use a full imputation system to avoid double taxation of distributed profits. - Italy has evolved toward DIT features: - Single and similar rates: rental income (21 percent); interest income other than from government debt (20 percent); dividends not associated with a qualified shareholding (20 percent or more); capital gains on most financial instruments (20 percent). - Unification of withholding rates on interest income was a key measure of the August 2011 fiscal package. - Allowance for Corporate Equity (ACE): - Introduced in December 2011 (Aiuto alla Crescita Economica; ACE). - For the first three fiscal years (2011-13), the notional interest rate is set at 3 percent. - For subsequent years, it will be based on the Italian public debt securities‘ average return (adjusted for risk). - ACE provides a tax deduction to companies for a notional return on additional equity, easing the bias toward debt finance. - Remaining deviations from textbook DIT in Italy: - Half of dividends for qualified shareholdings are taxed under progressive IRPEF rates. - Potential taxation of capital gains on real estate at the IRPEF rate (no taxation if property held at least 5 years or used as primary residence). - Absence of differential taxation of labor and capital income for unincorporated businesses. - Distributed corporate earnings (in excess of a normal rate of return) are taxed at effective rates close to the top marginal IRPEF rate (43 percent) rather than the interest income rate (20 percent). - IRES rate is 27.5 percent, above the interest income rate. - Neutrality and organizational form distortions: - Retained profit of a corporation is subject to IRES (27.5 percent), while business income of partnerships and sole proprietorships is liable for IRPEF (range of IRPEF progressive rates is 23-43 percent). - Corporations can postpone personal tax payment by deferring distribution; partnerships and sole proprietorships cannot. - For distributed income, non-corporate entities generally are tax favored because progressive IRPEF can be below effective tax on corporate-distributed dividends. - ACE is particularly beneficial for partnerships and sole proprietorships: the notional return to equity is deducted at a higher rate (for those with reasonably high incomes) and applies to all equity for these entities, whereas corporations receive it only for equity built up since ACE introduction. - Policy proposal under consideration: - DF proposes introducing Imposta sul Reddito Imprenditoriale (IRI), a new business tax irrespective of legal form. - IRI would be levied on retained earnings at the same rate as IRES; outflows to owners or managers would be deductible but fully taxable at personal level under IRPEF. - Firms liable to IRI would be taxed like corporations with respect to retained earnings; difference concerning distributions would be small. - Making IRI optional could complicate the tax system, create budgetary risk, and increase administration and compliance costs; optionality might be considered temporarily, but ideally a single regime (other than for the smallest enterprises) is preferred. - Determining which companies the IRI would be mandatory for is a critical design element. ### Implementing a fairer and more effective property tax - Economic rationale: - Recurrent property taxes on land and buildings are generally considered more efficient than other taxes because real property is less mobile and affects allocation of resources less adversely. - If increases in property taxes are fully capitalized in property prices, the tax increase would not affect the rate of return for new owners and could be neutral to investment behavior. - Property taxes can function as a "benefit tax" financing local government services, potentially neutral with respect to labor supply, investment and savings decisions. - Property taxes are a relatively stable revenue source and require little international tax coordination. - Italy’s recent property tax developments: - The Imposta Municipale (IMU) introduced at the start of 2012 replaced the Imposta Comunale sugli Immobili (ICI). - IMU brought primary residences back into the tax base and scaled up cadastral values by adjusting them with ad hoc factors. - Property tax revenue more than doubled in 2012 to 1.5 percent of GDP. *Prepared by Luc Eyraud (FAD).* ### 16. As part of the implementation of the IMU, cadastral values were adjusted by a ### 16. As part of the implementation of the IMU, cadastral values were adjusted by a ### Revaluation implemented and immediate effects - Cadastral values were adjusted by a common factor within each property type as part of the IMU implementation. - The current property valuation system is based on estimates of market rental values from 1988–89. - Revaluation coefficients applied: - houses: 1.6 - other types of properties: revaluation ranged from 1.2 to 1.6 percent - These multiplicative factors resulted in a significant increase in taxable value by about 50 percent overall. - Despite revaluation, national average ratios of market to taxable value remain: - primary residences: 2.2 - other dwellings: 2.4 - Since 1988-89, real estate prices have diverged geographically, with increases of up to five-fold in some regions and about half that in others. ### Shortcomings of the common-factor approach - Common multiplicative factors did not fully address valuation inaccuracies and inequities because: - The cadastre is based on 1988–89 “cadastral rental value” estimates and omits key property characteristics (type of construction, building condition, age). - Property value changes have been asymmetric and spatially variable, so simple uniform adjustment factors cannot eliminate disparities in assessed values nor resolve equity concerns. ### Options for revaluation and valuation methodologies - Policy approaches range along a continuum (market-driven to non-market): - Market-driven: comparable sales approach for properties regularly exchanged in the market (collect data on recent sales of similar properties to estimate average price per square meter by building type and location). - For unique properties lacking comparative sales: individualized valuations using - cost-based approach for owner-occupied properties (estimate reproduction/replacement cost by component and adjust for obsolescence), - income approach for income-producing properties (capitalize expected income flows). - The Revenue Agency (now incorporating the Land Agency) could implement a comparable sales approach where feasible. ### Revenue implications from comprehensive revaluation - The taxable base for housing is still less than half the average market value nationally. - After comprehensive revaluation, comparable revenue at the national level could be raised with less than half the current tax rate. - Policy implication: some of the revenue increase from revaluation could finance a large reduction in IMU rates and/or cuts in distortionary transactions taxes. ### Administrative requirements and maintenance - Maintaining land and building records for over 83 million parcels and conducting individualized appraisals for over one million specialized cadastral properties will strain the Revenue Agency. - Management tasks can be shared with municipalities and other local agencies, but this requires resources. - Cadastral values must be maintained and updated regularly (example periodicity suggested: every three years) to prevent return of valuation inaccuracies and inequities. - One effective approach used elsewhere: dedicate a small portion of property tax revenue to maintenance of the assessment and collection system. ### Data collection via taxpayer self-declaration - Self-declaration by taxpayers of objective property descriptions is a feasible option to collect additional data and reduce costs. - Drawbacks and controls required: - Not all taxpayers will comply; some will submit erroneous data. - The Revenue Agency will need audit staff, verification strategies, well-publicized appeals procedures, and penalties for deliberate falsification. - Many taxpayers are expected to submit reasonably accurate data; self-reporting could accelerate progress cost-effectively. ### Review of exemptions and base broadening - Roughly 60 percent of the land in Italy is currently exempted from the property tax. - Broadening the property tax base (particularly agricultural land exemptions) could substantially reduce tax rates or enhance local revenues. - Recommendation: carefully review all exemptions to ensure objectives remain valid and that exemptions are effective relative to alternative instruments. ### Transaction taxes: scale, structure, and distortions - Transaction taxes were estimated at 1.0 percent of GDP in 2011, twice the OECD average of 0.5 percent. - Transaction tax composition (2012 revenues from transaction taxes): - Registration taxes: 30% - Duty in lieu of registration taxes and stamp duties: 20% - Mortgage tax and land registry duties: 12% - Stamp duties: 32% - Surcharges on cadastral acts: 6% - Transaction tax features and rates: - Tax base typically market value (except for houses bought by individuals, where different bases may apply). - Rates range from 0.5 to 15 percent depending on the asset type. - Buyers pay three taxes on real estate purchases: registration tax (imposta di registro), mortgage tax (imposta ipotecaria), land registry tax (imposta catastale). - Registration tax on sales: rates ranging from 3–15 percent (depending on property type); for business assets, charged as a flat amount. - Land registry tax: 1 percent. - Mortgage tax rate: 2–3 percent. - VAT on new housing: 4–21 percent depending on the property; if sale is subject to VAT, registration and land registry taxes reduced to a small flat amount (except for business assets). - Transaction costs in the housing market are about 25 percent above the OECD average. - Transaction taxes administration: relatively easy to administer due to infrequent ownership changes and clear purchaser interest in legal requirements. - Efficiency costs and adverse effects: - Impede mutually beneficial transactions, hindering efficient allocation of assets. - Reduce market liquidity and may increase price volatility (theoretical and empirical evidence mixed). - Inflate housing prices and mitigate response to supply shocks by raising elasticity of demand w.r.t. pre-tax prices. - Create incentives for collusion and tax evasion (lower declared prices with separate payments). - Create lock-in effects, reducing residential and job mobility, impeding labor market matching and increasing structural unemployment. - Residential mobility: Italy’s residential mobility is significantly below the OECD average (Figure cited average = 12.5 percent of households changed residence within the last two years). ### Recommendation on transaction taxes - Strong case for reducing transaction taxes on real property, potentially using part of revenue gains from an improved IMU. - Legislative Decree 23/2011 (context of fiscal federalism reform) planned substitution of a single rate for most transaction taxes on immovable property from 2014: - 2 percent for primary residences - 9 percent on other properties - These compare with current rates that range between 3 and 18 percent. - Recommendation: continue streamlining transaction taxes; the order of magnitude of these rate cuts seems reasonable, though possibly still low for non-primary residences. - Further IMU reform and cadastre review could allow offsetting an increase in the IMU base by cutting registration taxes. ### Financial Transactions Tax (FTT) and risks - Italy adopted a FTT effective March 2013 targeting: - transfers of equity instruments, - equity derivative trades, - high-frequency trading. - Tax rates vary by transaction type and whether executed on a regulated market. - Risks of the FTT: - May reduce trading volume and liquidity, and lower asset prices. - Unclear effect on leverage because of lower tax rates on derivatives. - Risk of displacement of trading activities difficult to enforce outside Italy. - If FTT taxes transactions between businesses, it can distort business decisions and reduce total output. - IMF (2010) preference noted for a Financial Activities Tax levied on the sum of profits and remuneration of financial institutions. ### Inheritance and gift taxation (summary points) - Italy taxes lifetime gifts and inheritances; allowances are lifetime amounts from a specific donor and must be tracked per donor. - Transfers net of financial liabilities; different rates and allowances apply by degree of kinship. - Inheritance and gift tax yield in 2012: - €520 million, equivalent to 0.03 percent of GDP or 0.1 percent of total tax revenue. - Reasons for low yield: - Generous rates and allowances relative to peers. - For real property gifts/bequests, assessment base is cadastral not market value. - Current structure: - Donee-based (accession) tax design: each donee taxed to extent transfers received from a specific donor exceed a lifetime limit. - Weaknesses: - Transfers from different donors treated separately, allowing cumulation of allowances and potential unequal treatment. - Allowance thresholds are not automatically updated and require a new ministerial decree, creating equity, liquidity, and acceptability issues as asset prices rise. - Policy options: - Apply allowances to the sum of all prior gifts and inheritances received by a donee from different donors (as in Ireland). - Introduce automatic adjustment of allowance thresholds for inflation. *Source: IMF staff text in content unit _cr13299 - 16. As part of the implementation of the IMU, cadastral values were adjusted by a* ### 33. The tax is likely to have little impact. The purpose of the inheritance tax is to equalize ### Inheritance and Wealth Taxation in Italy ### Inheritance tax: likely limited impact - Purpose: equalize opportunities and mitigate adverse effects of wealth transmission on donee effort and saving. - Current design likely has little redistributive effect due to high allowances and low flat rates. - Key figures and features: - Allowance example: up to €2 million can be transferred tax-free if the estate is owned in equal shares by the parents and is given to their only child. - Only 1 percent of households have net wealth above €2 million (Bank of Italy 2010 Survey on Household Income and Wealth). - Suggested progressive banding: lower rate equal to the lowest PIT rate (23 percent) and a top marginal rate close to the highest PIT rate (43 percent). ### Questionable exemptions and interaction with capital gains taxation - Exemptions under scrutiny: - Transfers of enterprises or controlling stakes to descendants or spouses are exempt if beneficiary continues business activity for the next 5 years; concern: may entrench inefficient management. - Family home relief: significant reduction of transaction taxes if donee uses property as main residence; concern: incentive to over-invest in homes and no obligation to maintain primary residence for a minimum period. - Government bonds exempt from inheritance tax but not from gift tax; rationale unclear. - Capital gains on inheritances: - General rule: capital gains on assets acquired by inheritance are taxed only on the share accrued by the donee; gifts taxed on the full amount. Numerous exceptions exist (detailed in source). - Arguments for taxing capital gains at death include: different roles of taxes (capital gains vs transfer taxes); behavioral distortions from exemption (hold onto appreciated assets, convert income into capital gains); compounded reliefs on owner-occupied homes yield very light taxation of their value increases. - Specific reliefs: sale of a primary residence, and sale of a secondary home held for more than five years, are exempt from capital gains tax; inherited buildings and agricultural land have varying exemptions as noted. ### Existing taxes on assets and recent changes - Italy taxes various financial and real assets; December 2011 fiscal package included primary residences in the property tax and new taxes on luxury goods and assets held abroad. - Aggregate revenue from these taxes: - About 1.6 percent of GDP in 2012 (slightly above the OECD average of 1.4 percent of GDP in 2011). - Table 2 (Revenues from Taxes on the Wealth Stock in 2012): - Real estate held domestically: 23.80 billion, 1.51 percent of GDP - Real estate held abroad: 0.01 billion, 0.00 percent of GDP - Financial assets held domestically: 0.00 billion, 0.00 percent of GDP - Financial assets held abroad: 0.01 billion, 0.00 percent of GDP - Financial assets (tax shield): 0.88 billion, 0.06 percent of GDP - Luxury goods: 0.13 billion, 0.01 percent of GDP - Source: Italian authorities’ projections. (Note: bank accounts included; negligible in 2012 as banks used tax credits from previous years.) - Box 1: key rates and fees - Real estate: 0.4 percent for the primary residence and 0.76 percent for other properties. - Bank accounts: annual flat fee of €34 for individuals, and €100 for businesses. - Financial assets (excluding bank accounts): taxed at 0.15 percent; the financial sector does not pay this tax. - Financial assets held abroad: taxed at 0.15 percent annually (excluding bank accounts in EU/EEA states with information exchange, which are subject to the €34.2 lump sum fee). - Tax shield program: amounts repatriated under the 2001 and 2009 disclosure schemes and still not disclosed are taxed at 1.35 percent in 2013, and 0.4 percent from 2014. ### Interest in a comprehensive Net Wealth Tax (NWT) - Motivation: public resistance to spending-only austerity; need to reduce public debt; spread fiscal adjustment burden; difficulty distinguishing capital and labor income; concentrated wealth. - Key statistics on wealth concentration and scale: - Net household wealth: €8.6 trillion at end-2011. - Net household wealth about 4.5 times the public debt. - Wealth-to-income ratio: about 770 percent of household disposable income in 2011. - The richest 10 percent households hold about half of total net wealth; income inequality above the OECD average. - Current redistributive impact: - Excluding the property tax, these wealth taxes raise only 0.1 percent of GDP in 2012. - Wealth taxes mainly bear on real property, the main asset of the middle class; top 10 percent hold almost one-fifth of their gross wealth in financial securities and business equity, which face lower taxation. ### Composition of household wealth (Table 3 highlights) - Reading: shares of total (real+financial) assets by decile; select figures for the top decile (Decile 10): - Real Estate: 78 - Business Equity: 10 - Valuables: 1 - Deposits: 4 - Government Securities: 1 - Other Securities: 5 - Trade Credit: 1 - Note: data from 2010 Survey on Household Income and Wealth (BOI); possible understatement of assets held abroad. ### Efficiency, administrative, and behavioral considerations - Piecemeal approach vs comprehensive NWT: - Efficiency argument: real property is less internationally mobile, so higher taxation on property is efficient. - Distortions: steep increases in property taxation may harm the real estate market; exemptions and preferential treatments enable avoidance (e.g., flat fee on bank accounts may encourage keeping savings in bank accounts). - Current wealth taxes are levied on gross assets, biasing against leveraging and potentially amplifying high household saving propensity; recommendation: deduct financial liabilities from gross wealth to mitigate bias. - Administrative costs and unit of taxation: - A comprehensive NWT often seen as having higher compliance and administrative costs; however, Italy already taxes financial and real assets, so transition costs may be moderated, though collecting information on financial liabilities is needed. - Need to define taxable unit appropriately (currently individual in Italy); consider options to minimize incentives to split wealth among family members (e.g., joint filing options with specific rates and allowances). - Potential negative effects on capital accumulation: - Layering an NWT atop existing capital income tax could raise effective marginal tax rates, especially at lower real returns and with inflation. - Illustration: an investor earning a 5 percent real return; a 1 percent NWT effectively doubles the current 20 percent capital income tax to 40 percent; with 2 percent inflation the tax on the real return could rise to 67 percent in the short term (if inflation not anticipated and pre-tax real rate declines) and 48 percent in the medium term (after nominal pre-tax rates adjust). - Possible behavioral responses: shift from savings to consumption, lower domestic investment and growth, seek opportunities abroad and expatriate. ### Conclusions and policy recommendations - Progress and remaining challenges: - Considerable progress toward neutral capital income taxation has been made (notably ACE); remaining issues include non-neutrality across organizational forms and retained distortions. - Authorities propose a new business tax to unify treatment of retained earnings across business types. - Specific policy directions recommended in the source: - Align cadastral values closer to market values: - Property tax assessments are more than 20 years out of date; relative property prices have diverged widely (in some regions increased by 500 percent; in others by half that). - Aligning cadastral prices with market prices would improve fairness; tax rate cuts could partially offset revaluation effects; some revenue gains should reduce transaction taxes tied to immovable property. - Reduce significantly taxes on asset transactions: - Transaction taxes are large in Italy but have little justification beyond administrative simplicity; they distort behavior and hinder efficient asset allocation. - Reform inheritance tax design: - Inheritance tax is well designed but has little redistributive impact due to low rates and high allowances; adopting a progressive rate schedule could better equalize opportunities. - Consider medium-term move toward more comprehensive wealth taxation: - Substituting a single NWT for existing taxes could enhance equity, but piecemeal approaches allow asset-differentiated rates by mobility (efficiency advantage) while creating cross-asset distortions and difficulties netting liabilities. *Source: IMF staff analysis as presented in the supplied chapter on Italy’s inheritance and wealth taxation.* ### 1. Tax expenditures are government revenues foregone as a result of differential, or ### _cr13299 - 1. Tax expenditures are government revenues foregone as a result of differential, or ### B. Why Should Tax Expenditures Be Reformed? - Tax expenditures are government revenues foregone due to differential, or preferential, treatment of specific sectors, activities, regions, or agents. - Forms include allowances (deductions from the base), exemptions (exclusions from the base), rate relief (lower rates), credits (reductions in liability) and tax deferrals (postponing payments). - International comparisons are complicated by different methodologies and assessments; practice is pervasive and tax expenditures in Italy are clearly elevated. - Consequences for fairness, complexity, efficiency and effectiveness: - Fairness: provisions that reduce taxable income tend to benefit those in the highest marginal tax bracket; reduced VAT rates in Italy increase progressivity but much of the benefit accrues to the better off. - Efficiency and targeting: example — deduction of mortgage interest now encourages leveraged housing finance. - Vulnerability to lobbying: tax breaks can bypass scrutiny accorded to spending and may not require annual renewal in the budgetary process. ### C. Are All Tax Expenditures Bad? - Some tax expenditures can have administrative economies of scale and reduce need for spending ministries to administer substitute programs. - Some are integral to fair and efficient taxation: - The largest single tax expenditure in Italy is a tax credit that serves the same purpose as basic tax-free thresholds elsewhere. - Table comparison (summary features preserved as described): - Accessibility for beneficiaries: Tax Expenditures — Simple, because of their automatic nature. Direct Spending — More complex, requiring selection. - Administrative and compliance costs: Tax Expenditures — High, if exemptions are properly monitored. Direct Spending — Medium, due to necessity of a selection and allocation system. - Possible abuses: Tax Expenditures — Evasion, avoidance, and rent seeking. Direct Spending — Arbitrariness, inefficiency, and capture of the allocating body. - Flexibility: Tax Expenditures — Work with permanent laws, generating stability but also inertia. Direct Spending — Work with budgets, evaluations, and regular reallocations (note: not the case in Italy where the budget contains many legal rigidities). - Transparency and accountability: Tax Expenditures — Automatic nature does not contemplate control mechanisms or accountability. Direct Spending — Must be approved by the legislature. - Expenditure control: Tax Expenditures — Expenditure determined ex-post; uncertain and unlimited. Direct Spending — Programmed and controlled, limited by budget law. - Equity: Tax Expenditures — Only potential taxpayers benefit, often highest income benefit most. Direct Spending — Discretion can provide more equitable access. ### D. How Can Tax Expenditures Be Identified and Quantified? - First step: define a benchmark tax system; no consensus on tax norm. - Main distinction: benchmark based on theoretical income/consumption/value-added concepts versus using the country’s own tax laws as the benchmark. - Second step: quantify budgetary cost based on actual uptake of differential treatment. - Italy: substantial work undertaken; a report commissioned by the Ministry of Economy and Finance (MEF) identifies and costs 720 tax expenditures amounting to about 16 percent of GDP. - Since 2010, annual State Budget documents include a list of all tax expenditures, but only at the level of central government and measured against current legislation (narrower benchmark than MEF report). ### E. Once Identified, How Should Tax Expenditures Be Evaluated? - Need clear and frequent evaluation to scale back those not generating benefits commensurate with cost. - Evaluative framework (questions to apply to each tax expenditure): 1. Does the tax expenditure promote or hinder economic efficiency? To what extent does it influence taxpayer behavior in desirable ways or distort behavior in undesirable ways? 2. Is the tax expenditure fair? Are similar individuals treated similarly? Does it account for individuals' different capacities to bear the burden of taxation? 3. Is the tax expenditure simple and easily administered? (calculating tax liability, filing taxes, government administration, enforcement and ease of evasion) 4. Is the tax expenditure vulnerable to lobbying? Does it benefit very specific interest groups and how frequently are costs and benefits scrutinized? - Also compare tax expenditures with alternative spending measures; some tax expenditures with social objectives may overlap with social assistance programs (example: dependent relative tax credit). ### F. What Types of Tax Expenditures Are There in Italy? Personal Income Tax (PIT) - Establishing a benchmark for PIT is difficult because it is a prime tax instrument for redistribution; literature suggests natural benchmarks but requires subjective assessment of equity-efficiency trade-off. - In Italy, tax expenditures were measured both against a measure of comprehensive economic income (consumption plus change in net worth) and against a dual income tax (DIT) system (progressive labor taxation, low single rate on capital). - Many of the largest PIT tax expenditures may be desirable parts of a normal tax system. Summary of largest PIT tax expenditures (values and comments preserved): - Tax credit for wage income from employment, pensions, self-employment and similar income. - Value (billions): 37.73 - Percent GDP: 2.41 - Comment: This regime is a substitute for the fact that Italy has no lower personal income tax threshold. - Various financial substitute taxes (lower rates) on interests, dividends, capital gains and other forms of return. - Value (billions): 13.17 - Percent GDP: 0.84 - Comment: Substitute tax regime bypasses the requirement to tax capital income according to the progressive PIT schedule by mimicking a Dual Income tax regime. - Tax credit for dependent relatives. - Value (billions): 10.50 - Percent GDP: 0.67 - Comment: Sometimes considered a measure of ability to pay and part of the benchmark system rather than a tax expenditure. - Tax exemption (excluded from base) for contributions to welfare and pension schemes for employees. - Value (billions): 10.10 - Percent GDP: 0.64 - Comment: Pension contributions are excluded and pension income is taxed. Avoids double taxation. - Lower PIT rates for payment of separation allowances and "golden handshakes" - Value (billions): 5.10 - Percent GDP: 0.33 - Comment: Unwinds tax progressivity that would come from receipt of multi-year income in one period. - Tax exemption (excluded from base) for compulsory contributions to welfare and pension schemes for self-employed. - Value (billions): 4.31 - Percent GDP: 0.28 - Comment: Pension contributions are excluded and pension income is taxed. Avoids double taxation. - Tax credit for medical expenses and health assistance services. - Value (billions): 2.36 - Percent GDP: 0.15 - Comment: Considered to have welfare objective. - Sum of largest PIT tax expenditures. - Value (billions): 83.26 - Percent GDP: 5.32 Corporate Income Tax (CIT) - Applied a concept of net business profit to measure CIT tax expenditures. - Largest CIT tax expenditure: measure to avoid double taxation of foreign sourced dividends. - Other measures include deductibility of social security costs from the regional business value added tax (IRAP) to reduce labor tax wedge and incentivize hiring. - Allowance for Corporate Equity (ACE): provides tax deduction for a notional return on additional equity, reducing incentive to use debt rather than equity and moving toward greater neutrality in business investment and financing decisions. - Summary of largest CIT tax expenditures (values and comments preserved): - Foreign-source dividends received by a resident corporate taxpayer are 95% exempt from CIT. - Value (billions): 8.38 - Percent GDP: 0.54 - Comment: Measure to avoid double taxation. - Substitute tax (16 percent) for capital gains from goodwill, trademarks and other intangible assets resulting from extraordinary operations, such as restructuring and mergers. - Value (billions): 7.43 - Percent GDP: 0.47 - Comment: Tax provision to promote firm dynamism and incentivize new activity. - Full deduction from IRAP tax base of SSC costs related to permanent workers; full deduction from PIT and CIT tax base of IRAP on labour costs (plus partial deductability of interests costs). 1/ - Value (billions): 6.69 - Percent GDP: 0.43 - Comment: Provision mainly to reduce labor tax wedge. - Substitute tax for capital gains arising from "extraordinary" operations, suchs as mergers, divisions, and transfers of companies. - Value (billions): 6.40 - Percent GDP: 0.41 - Comment: Measure to favor restructuring. - Substitute tax on capital gains (lower rate) from revaluation of assets held on the balance sheet at historical cost. - Value (billions): 4.18 - Percent GDP: 0.27 - Comment: Generates current revenue for the authorities in exchange for higher depreciation charges (lower taxes) from corporates in the future. - Sum of largest CIT tax expenditures. - Value (billions): 33.08 - Percent GDP: 2.11 - Footnote 1/: Full deduction of IRAP labor costs from PIT and CIT was introduced in Law 214/2011 and is not explicitly costed in the table, which instead includes estimates based on earlier lump-sum deductions per employee. Value Added Tax (VAT) - Benchmark: a uniform rate with a broad base is a good benchmark; VAT not optimal for externalities or redistribution. - C-efficiency concept: ratio of VAT revenues to the product of the standard VAT rate and consumption. - For Italy, C-efficiency estimated at around 41 percent in 2010. - Combining with a compliance gap of around 30 percent implies a policy gap also of around 41 percent (illustrative calculation). - Halving the compliance gap, maintaining all tax rates unchanged, would raise about 1.3 percent of GDP. - Halving the policy gap, keeping the standard rate unchanged, would raise about 2.7 percent of GDP. - Decomposition (Box 1 / De Mooij and Keen (2012)): - (1 - policy gap) = (1 - exemptions) × (1 - rate dispersion) - MEF report implies rate dispersion at about 0.25 percent; combined with a policy gap of 41 percent, implies an "exemptions" gap of 0.22 percent in 2010. - In percent of GDP (2010), lost revenue: 2.5 due to exemptions (including those mandatory under EU rules), 2.9 due to lower rates, and 2.6 due to non-compliance. - Actual revenue collection: just over 6 percent of GDP — potential revenue at unchanged standard rate: 15 percent of GDP. - Largest VAT tax expenditures (values and comments preserved): - VAT reduced rate (10 percent). - Value (billions): 24.60 - Percent GDP: 1.57 - Comment: Including food items, restaurants and hotels, pharmaceutical and medical products, energy products and recreational services. - VAT reduced rate (4 percent). - Value (billions): 14.60 - Percent GDP: 0.93 - Comment: Including food items, books and newspapers, and school and company canteens. - VAT Exemptions — Italy Specific: - Special regime/s for agricultural producers - Value (billions): 0.29 - Percent GDP: 0.02 - Special regime for publishing sector - Value (billions): 0.24 - Percent GDP: 0.02 - Special regime for tobacco and match producers; supplies of goods to (solely) charitable, educational or research bodies - Value (billions): 0.17 - Percent GDP: 0.01 - Exemption for funeral services - Value (billions): 0.12 - Percent GDP: 0.01 - Miscellaneous other regimes (EC regulations including financial sector, travel agencies, used cars, secondhand goods, antiques, sales by auction etc.) - Sum of largest VAT tax expenditures. - Value (billions): 40.02 - Percent GDP: 2.56 Excise Taxes - MEF benchmark is the legal tax system; excise taxes can be assessed against Pigouvian rates in principle. - Most excise tax expenditures provide competitive advantage to sectors that could be better achieved through other reforms (example: structural reforms to reduce cost of energy). ### Key Policy Implications and Recommendations (implicit in analysis) - Identify and quantify tax expenditures using a clear benchmark and publish results to inform public discussion. - Evaluate tax expenditures regularly against efficiency, equity, simplicity, and vulnerability to lobbying. - Compare tax expenditures with alternative spending measures—some social objectives may be better achieved through targeted spending. - For VAT: address both compliance gap and policy gap — potential revenue gains: - Halving the compliance gap could raise about 1.3 percent of GDP. - Halving the policy gap could raise about 2.7 percent of GDP. - Scrutinize reduced VAT rates and exempt regimes (including EC-mandated exemptions) given their large contribution to the VAT policy gap. *Sources: MEF, 2011; and IMF staff estimates.* ### 18. Some very large tax expenditures have already been removed with recent reforms. For ### _cr13299 - 18. Some very large tax expenditures have already been removed with recent reforms. For ### Recent removals and context - The proposed revaluation of property cadastral values will eliminate previously identified tax expenditures related to property and transfers taxes (see chapter 3). - The MEF has undertaken substantial work on the identification and quantification of tax expenditures. - The draft tax reform law (Delega Fiscale) provides for the annual publication of a list of tax expenditures according to criteria and a methodology supported by an external review body, going beyond the IMF Code of Good Practices on Fiscal Transparency and the OECD Best Practices for Budget Transparency. ### Recommended governance and review measures for tax expenditures - Ideally, all tax expenditures should be regularly and systematically reviewed, like regular government expenditures; tax expenditure reviews should be combined with spending reviews to analyze holistically government support to particular sectors, activities, regions, or agents to avoid overlapping objectives and expenditures. - Consider legislating expiry clauses for all tax expenditures (especially those benefiting particular groups). - Any extension of existing tax expenditures, or granting of new ones, should only be possible as part of the annual budget process. - Exercise caution when aggregating tax expenditures because the aggregate revenue gain from eliminating two tax advantages may differ from the sum of the gains from eliminating each in isolation. - Prioritize reviews for tax expenditures that: - are not fully quantified (e.g. VAT exempt regimes); - are poorly targeted (e.g. VAT reduced rates); - are better covered by expenditure programs (e.g. for medical services); - benefit only certain groups that also receive spending support (e.g. reduced VAT and excise tax for public transport companies and agriculture); - are distortionary (e.g. preferential treatment for government bonds). ### Illustrative figures for selected tax expenditures and budget support (agricultural sector) - Reduced excise tax for agricultural sector: Value 0.96 (billions); Percent GDP 0.06 - Special VAT regime for agriculture: Value 0.31 (billions); Percent GDP 0.02 - Reduced IRAP rate for agricultural sector: Value 0.23 (billions); Percent GDP 0.01 - CIT exemption for certain agricultural cooperatives: Value 0.17 (billions); Percent GDP 0.01 - Reduced transaction taxes for rural property: Value 0.16 (billions); Percent GDP 0.01 - National funds for rural development: Value 1.5 (billions); Percent GDP 0.10 - EC Common Agricultural Policy (mainly single payment): Value 5.9 (billions); Percent GDP 0.38 - Selected support for agricultural sector (additional entries / comments): - Reduced excise tax for public transport companies: Value 1.67 (billions); Percent GDP 0.11; Comment: Sectoral benefits. - Reduced excise tax for agricultural sector: Value 0.96 (billions); Percent GDP 0.06; Comment: Sectoral benefits. - Tax exemption for houses with monthly energy consumption between 3 and 120 KWH: Value 0.55 (billions); Percent GDP 0.04 - Sum of largest Excise tax expenditures: Value 3.17 (billions); Percent GDP 0.20 ### Illustrative Table of Tax Expenditures for Priority Review (Table 6) - VAT Reduced Rates: Value 39.20 (billions); Percent GDP 2.50; Comment: Not all of this can be saved, but some reduced rates could be eliminated and others harmonized. Expenditure programs may be needed to offset some redistributive impact. - VAT Exempt Regimes: Value ... (billions); Percent GDP 2.52; Comment: Top-down estimate. Some are EC requirements. - Fuel excise tax exemptions and reduced rates: Value 3.17 (billions); Percent GDP 0.20; Comment: Accelerated structural reforms could provide alternative support to productivity. - Income tax credit for medical expenses and health assistance services: Value 2.36 (billions); Percent GDP 0.15; Comment: Objectives potentially better achieved by spending program. - Income tax credit for interest paid on mortgage for principal residence (or construction of principle residence): Value 1.34 (billions); Percent GDP 0.09; Comment: A complete repeal could create budget difficulties for some households, so a review should proceed with caution focusing first on new mortgages. - Reduced income tax rates on the interest and bonuses from government securities and other forms of public debt e.g. postal bonds: Value 1.38 (billions); Percent GDP 0.09; Comment: Supports government bond market over other forms of investment. - CIT: substitute taxes to encourage restructuring, mergers and transfers: Value 13.83 (billions); Percent GDP 0.88; Comment: Objectives potentially better achieved through structural reforms. Estimates should be treated with caution as some may be one-off. - Total (illustrative): Value 61.28 (billions); Percent GDP 6.44 ### NPLs and strategy for fostering a market for distressed debt in Italy — key findings - Italy‘s NPL definition covers four categories: bad debt, substandard, past due (beyond 90 days), and restructured loans; includes restructured loans whose initial terms have been altered. - Since 2007, the ratio of nonperforming loans (bad, substandard, restructured and past-due) has nearly tripled to 14 percent. - Loan loss provisioning coverage has fallen from 45 percent to 39 percent. - Collateral backing (real estate and guarantees) in Italy covers nearly two-thirds of all loans. - The pace of write-offs has increased to over 6 years, from just under 4 years before the crisis. - Simulations: At current write-off rates, under the baseline scenario of a modest recovery, the bad debt ratio would peak in 2015 and decline only gradually; in the absence of a stronger recovery, it would take a substantial increase in write-offs—nearly a tripling compared to the historical average—to bring down the bad debt ratio to pre-crisis levels within ten years. - NPL write-off pricing gap with the market is currently about 10-25 percent. - In 2012, rising loan losses absorbed nearly all of operating profits of the large banks. ### How high NPLs affect banks - NPLs create a negative carry by not generating an interest return while requiring funding at positive market rates, reducing net interest margins. - For banks using standardized methods, a higher risk weight (up to 150 percent) is required for the portion of NPLs that are not provisioned or collateralized. - For banks using internal models under Basel 2, expected losses on NPLs require deduction from core capital the part not covered by specific provisions (―expected IRB shortfall‖). - A large NPL portfolio ties up human and operational resources, reducing capacity to support more profitable lending. - Worsening asset quality is associated with higher CDS spreads and lower market valuations; banks with worse asset quality are more sensitive to sovereign distress, increasing the cost of funding and tightening credit conditions. ### Reasons behind the slow pace of write-offs - Push factors (limited incentives for banks): - Lower provisioning reduces incentives to write-off, because writing off requires booking a loss up to the difference between book value and provisions. - Heavy reliance on collateral (covering some 48 percent of total loans) encourages waiting for foreclosure processes rather than disposing quickly. - Lower provisioning hampers sales to third parties; the pricing gap with the market is about 10-25 percent. - Tax regime: write-offs are not tax deductible without a court declaration of insolvency; banks may deduct loan-loss provisions from taxable income only up to 0.3 percent of outstanding loans. Remaining provisions are treated as a deferred tax asset (DTA) deductible in equal installments over 18 years but at a lower net present value, reducing the tax benefits of provisioning. - Pull factors (limited options for restructuring bad loans): - Lengthy and inefficient judicial process: average 3 years to foreclose and collect real estate collateral; bankruptcy procedure takes on average more than 7 years. - World Bank Doing Business rankings: resolving insolvency (#20 out of 31 OECD countries); enforcing contracts (#30 out of 31). ### International practices and precedents (Box 1) - U.S. regulators overlay accounting standards with detailed regulatory guidance including time-limits on writing off NPLs; e.g., after 180 days past due, a mortgage loan is valued exclusively based on the underlying collateral and any excess should be written off regardless of foreclosure time. - Japan: emergency measures of 2001 required major banks to remove near-bankruptcy and lower quality loans (―bad debt‖) within three years after their recognition; helped remove book value of old loans worth 270 billion USD from bank balance sheets from 2001 to 2004. - Brazil: distressed loans (―H‖ loans) must be written-off after 6 months; they continue to be accounted for off-balance sheet, provisioned at 100 percent. *Source: _cr13299 (extracted content).* ### 12. A market for restructuring distressed debt exists but is small and not well developed. ### 12. A market for restructuring distressed debt exists but is small and not well developed. ### Current market structure and scale - NPL sales have recently picked up but remain low at around €2 billion annually compared to €122 billion stock of bad loans. - The market for distressed debt is small and consists of only a few domestic investors specializing mainly in collection. - This contrasts with some other advanced economies where an active market for distressed debt expanded rapidly in response to banks‘ growing needs to unload their NPLs. ### Benefits of developing a distressed debt market - For banks: - Relieve the burden of collection and restructuring. - Free up resources to support new lending. - Potentially boost loan recovery values versus lengthy court procedures. - Assist banks in managing portfolio risk by providing a liquid channel to dispose of NPLs or real estate collateral. - For financial markets: - Improve secondary market liquidity for loans. - Support new lines of business, such as NPL securitization. - Attract more outside investors, including from overseas. - For the broader economy: - Diversify sources of financing through another nonbanking channel. - Allow earlier and faster resolution of bad loans during a downturn. - Possibly enhance corporate productivity by supporting restructuring and reallocation. ### European context and recent trends - The distressed debt market in Europe is in early stages but growing. - Since 2010, NPL sales in Europe have risen from €11 billion to over €30 billion in 2012. - Most activity has taken place in Germany, Ireland, Spain and the United Kingdom and focused mainly on commercial real estate and consumer loans. - The majority of investors represent private equity funds from both Europe and the United States. - There is little cross border activity in the distressed debt market. ### International experience and past approaches - NPL resolution approaches have ranged from: - Large-scale, centralized intervention to address systemic crises (examples: Japan early 2000s; Korea late 1990s; Sweden 1990s; United States 1980s/1990s). - Purely private-led markets for disposing of NPLs. - Some countries (Korea, Malaysia, Sweden) relied on a publicly owned bad bank to transfer and dispose of distressed loans from weak banks. - Over time many approaches evolved into hybrid solutions combining public intervention and private-led restructuring, along with reforms to insolvency frameworks, out-of-court workouts, and market infrastructure improvements. - Post-crisis, financial institutions used new institutions to actively manage bad loan portfolios through the business cycle. ### Strategy for fostering a distressed debt market in Italy — main impediments and policy actions - Three main areas to address: judicial reform, prudential policies, and tax policy. - Judicial reform (policy directions): - Improve efficiency of the legal system, including by expanding use of specialized bankruptcy courts beyond Milan. - Accelerate foreclosures by introducing more standardized procedures for collateral assessments and allowing for online court application and decisions. - Encourage out-of-court workouts by issuing best practice guidelines and providing similar tax and regulatory treatment as under court-led insolvency. - Prudential policies (policy directions): - Strengthen provisioning coverage, including through forward-looking, comprehensive asset quality reviews and conservative valuation of real estate collateral, to ensure banks face proper incentives to write-off or dispose of bad loans. - Ensure a minimum level of harmonization and strengthen prudential guidelines on write-off practices to accelerate NPL disposals (as noted by the FSAP). - Tax policy (policy directions and cost estimate): - Align tax deductibility of loan loss provisioning and write-offs to international levels to accelerate disposals. - Staff estimates that allowing for full deductibility of new loan loss provision would cost around 3 billion (0.2 percent of GDP) in tax revenue. ### Corporate Restructuring Vehicles (CRVs) as a market tool - CRVs defined: private special purpose vehicles (SPVs) where banks partner with outside investors to collect or resolve problem loans. - Benefits: - Tap outside financing and expertise to assist in restructuring. - Bridge the pricing gap for distressed loans by allowing banks and investors to share gains from credit recovery. - Accelerate NPL disposal and corporate restructuring (experience from Korea cited). - Key safeguards: - Ensure transfers of bad assets or conversions of debt to equity are done at fair market value to prevent banks from hiding or “warehousing” bad assets off their balance sheets. ### Korea’s experience (Box 2) — relevant lessons - Context: - Korea after its late 1990s financial crisis had NPLs reaching nearly 30 percent of GDP. - Government played a leading role via legal/regulatory changes, public funds, and new crisis management institutions. - KAMCO purchased distressed assets and disposed of them quickly through various channels. - CRVs and related instruments used to facilitate market-based restructuring and rehabilitation of distressed firms. - Types of restructuring vehicles used in Korea: - Corporate restructuring funds (CRFs): Funds which issued securities, invested in distressed firms, and received regular dividends. - Corporate restructuring companies (CRCs): Restructuring companies which took majority stakes in firms, reshuffled management, restructured operations, and sold back to market. - Corporate restructuring vehicles (CRVs): SPVs set up by banks to pool distressed assets and transfer to AMC for specialized management with help of outside experts. - C-REITs: Real estate investment trust investing in properties from distressed firms. - Success factors: - Supportive regulatory, tax and market environment. - Transparent transfers at fair market value to ensure proper incentives and avoid hiding bad assets. ### Conclusion and recommended overall approach - Accelerating write-offs of bad loans would strengthen confidence in Italian banks and support the recovery. - Combined policy actions recommended: - Strengthen provisioning practices. - Remove fiscal disincentives for write-offs. - Expand the market for distressed assets. - While the market for distressed debt in Italy is small, it is expanding with the rise in NPLs and could serve as a useful instrument for banks to reduce their NPL holdings. *Source: IMF staff report chapter titled "A market for restructuring distressed debt exists but is small and not well developed."* ### 10. Risk management at the foundations is also weak. Despite provisions in law 461/98 that ### _cr13299 - 10. Risk management at the foundations is also weak. Despite provisions in law 461/98 that ### Risk management at the foundations - Law 461/98 requires diversification of obligations, yet some large foundations maintain portfolios heavily concentrated in their "original" bank, with stakes varying from 30 to 90 percent. - Some foundations used bank credit (mortgages, credit lines) to fund capital increases, real estate acquisitions or restructuring. - Some foundations invested in risky derivative products. - These activities increased portfolio risk and raised pressure on banks to generate dividends to support the weak financial position of the shareholder foundation. ### Foundation-owned banks are less resilient (Stress test results) - IMF FSAP stress tests included a baseline and two downside scenarios. - Banks influenced by foundations are particularly vulnerable to slow growth or adverse macroeconomic conditions. - In the "adverse" scenario (simulates a double dip with growth of -5.6 percent till 2015): - Tier 1 ratio for these banks would fall from 8.8 percent in December 2012 to 2.5 percent in 2015. - CET1 capital shortfall: €3.2 billion (0.2 percent of GDP). - Tier 1 capital shortfall: €5.4 billion (0.3 percent of GDP). - These shortfalls account for 40–50 percent of the shortfall of all Italian banks in the test. - Definition: banks influenced by foundations are those in which one single foundation controls at least 20 percent of shares. This subcategory accounts for 11 percent of the Italian banking assets and excludes Banca Intesa or Unicredit. - Banks with the highest proportion of foundation ownership (14 banks with 50 percent and above shares owned by foundations) display: - NPL ratios 2 percentage points above system averages. - NPL provision coverage 9 percentage points below average. - Capital ratios 2 percentage points below average. - A BoI study indicates bank performance has been negatively correlated to the proportion of foundation ownership. ### Cooperative banks (Banche Popolari): role and vulnerabilities - Cooperatives typically provide loans to local firms and avoid exposure to financial markets and the international economy. - Banche Popolari (BPs) lend up to two-thirds of their funds to SMEs and account for three quarters of new SME loans since 2008. - BPs increased their capital by 24 percent (through retained earnings and new capital placed) compared with 13 percent for other Italian banks. - Example: Between December 2011 and June 2012, risk weighted assets of Banca Popolare fell from €90 billion to €50 billion when the bank moved to IRB modeling. - Ownership and governance constraints: - Ownership limit set at 0.5 percent of capital (amendable to 0.5 to 1 percent after reform). - "One person one vote" rule and limits to vote proxies; transfers of shares need board approval. - These restrictions can impede effective shareholder control and make raising private capital difficult. - Stress test outcomes for cooperative banks in the adverse scenario: - Account for around half of the capital shortfall of Italian banks: CET 1 shortfall €2.4 billion; Tier 1 shortfall €6.8 billion. - Tier 1 ratio drops from 9.3 percent in 2012 to 4.2 percent in 2015. - Large cooperatives feature NPL ratios approaching nearly 14 percent and provisioning 10 percentage points below average. - Capitalization remains below market average, at 12 percent of total capital. ### Governance regulatory framework and recent reforms - Italy implemented successive EU directives and recommendations on corporate governance: 2003 EU Action Plan, recommendations on board structures (2003 and 2005), directives on disclosure (2005), and shareholder rights (2004 and 2007). - Minority shareholder protection: at least one board member to be appointed by minority shareholders ("slate voting"); this member chairs the internal control body (collegio sindacale). - Revised Code of Conduct for listed companies updated in December 2011: - "Comply or explain" mechanism promoting board diversity (gender, experience, functions). - Issuers in the FTSE-Mib Index must have "at least one third" of independent directors on their boards and at least two independent directors in any case. - The Code includes a more stringent definition of independence than current Italian law. - Decree law banning interlocking directorates in the financial sector in force since December 2011; affected 10 percent of financial institutions. - BoI Circular (January 2012) requires BoD members to be appropriately skilled (risk management and control tasks included) and reinforces role of non-executive directors; criteria subject to periodic self-assessment. - Related party lending regulation strengthened: - Amendments to the Banking Law of 2006 and Circular 263 in 2011; new provisions governing related-party transactions entered into force end-2012. - BoI draft implementing regulation requires banks to submit information on exposures to each related party and connected persons, on a nominative basis. ### Enhancing the governance framework in Italian banks (FSAP recommendations) - Strengthen banking regulations with: - Stricter fit and proper rules for directors and major shareholders. - Implementation of the new related party lending regulation. - Credible oversight for foundations when they are influential shareholders. - Facilitation of transformation of large cooperatives into joint stock companies. - Specific recommendations: - Expand "fit and proper" criteria to include adverse regulatory judgments for directors and financial soundness (including capacity to provide additional capital) for shareholders. - Grant the supervisor the power to change the composition of the bank‘s Board if individuals are not fulfilling fit and proper duties. - BoI should use supervisory discretion to tighten the definition of connected parties for related party lending, including economic influence. - Amend related party regulation to ensure related party transactions do not carry more favorable terms relative to those with unrelated parties and exclude conflicted board members from the decision. - Foundations that are major shareholders should: - Apply a cap on leverage. - Institute strict disinvestment procedures and governance rules. - Move toward a more balanced portfolio and follow prudent investment policies (diversification policies, minimum reserves invested in safe assets). - Introduce term limits for foundation board members and a cooling-off period between political office and appointment to a foundation (or vice-versa). - Be subject to strict oversight with prompt corrective actions by the MEF (or another supervisor). - Largest cooperative banks should be encouraged to convert to joint stock companies or, at minimum, increase shareholder rights (raise limits on proxy voting, facilitate transfer of shares, facilitate addition of new items at shareholder meeting agendas). ### Conclusion - Effective corporate governance is important for a well functioning banking system and the integrity of financial markets. - Regulation and supervision need to ensure ownership and control differences do not impede bank performance and resilience. - More effective corporate governance will help banks support the economy, contribute to financial stability, and make banks more attractive to private capital. *Source: IMF mission report content unit _cr13299 (chapter/section 10).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13299.pdf_