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Taxes in Italy Drive Economy Underground

Taxes in Italy Drive Economy UndergroundTaxes in Italy Drive Economy Underground
Italy’s income and social security taxes are among the highest in the OECD at 48% which encourages greater tax avoidance

Italy grew rapidly over the 20th century, and its black market was part of an important economic recovery after World War II. Italians made everything, from low-cost toys to high-quality cars, and from world-renowned coffee to thousands of movies.

However, in 2018, Italy is one of only two European countries where GDP per capita has not recovered from the financial crisis. Italy has an unemployment rate of 11% and a youth unemployment rate of about 35%. In addition, Italians have the second-largest government debt in the world relative to their GDP, Seeking Alpha reported.

Italy’s problem, similar to many of its southern European neighbors, is an oppressively high tax burden, irresponsible welfare programs that encourage high measured unemployment and increase the debt, and high levels of regulation.

Consider Italy’s performance compared to Germany. Italy went from being 2% poorer than the Germans in the year 2000 to 21% poorer in 2017, therefore its gap widened by 19 percentage points.

One reason for this might be that Germany grew faster because it made reforms and became more competitive, while many other European countries did not. The gap between Portugal, Spain and Greece, and Germany widened by 2%, 3%, and 16% respectively. Therefore, Italy’s gap with Germany widened the most.

  Poorer Than Germany

Alternatively, a stronger explanation for Italy’s underperformance is its tax and welfare systems, together with its budget deficit and regulations. While Germany implemented the “Agenda 2010” in 2003—a plan that reduced welfare benefits, regulations, taxes, and the deficit—Italy increased its debt and has not meaningfully changed policies.

Today, the share of average wages collected by the Italian government via income and social security taxes is among the highest in the OECD at 48%. In addition, the country imposes a value-added tax of 22% on most goods and services, one of the highest in Europe. Plus, Italy’s corporate, capital gains, gift, and myriad other taxes are passed on to individuals and borne directly by workers.

These high taxes lead to a growing shadow economy, where people under-report work to avoid paying taxes. Many Italians save their income from tax collectors by illegally working in construction or services, transferring an apartment before the death of a relative, and hiding savings from the wealth tax in Swiss bank accounts. Italy’s shadow economy is about 21% of its GDP, compared to Germany’s, which is about 12% of its GDP.

Therefore, while Italy is 21% poorer than Germany in official terms, it is only 15% poorer when the shadow economy is accounted for, since its shadow economy is larger. Moreover, many estimates point to more than $175 billion in lost tax revenue.

Higher taxes both depress economic activity and encourage greater tax avoidance. While this may sound good for those who hide their income from taxation, not all activities can be transferred into the shadow economy, nor can the activities that are transferred operate like before.

  Evading Taxes

Another reason for the weak employment situation is that workers are entitled to earn up to $1,510 (€1,300) per month for up to two years of unemployment, depending on how much they earned and how long they have been unemployed. If a legal low-paying job is offered, the unemployed have two choices: lose unemployment benefits and pay almost half their income in taxes, or work in the shadow economy, keeping unemployment benefits, earning money and evading taxes.

It is understandable why so many Italians would rather stay unemployed. Countries with more generous unemployment insurance programs not only have longer average unemployment durations but also higher levels of unemployment.

  Cumbersome Regulations

At the same time, Italy’s complex regulations are a barrier to starting or continuing productive activities. A study by economist Raffaela Giordano of the Bank of Italy concluded that the main reasons behind the country’s underperformance were burdensome regulations and a corrupt and inefficient government structure. Higher costs related to opening a business lead to fewer recorded businesses.

Instead of cracking down on tax evasion and the shadow economy, Italy’s new government needs to rethink long-standing policies to bring a real economic recovery. Taxes need to be lowered so more businesses open and already-existing businesses and individuals come out of the shadows, broadening the tax base and raising revenue.

This would allow those in the shadow economy to expand their businesses. Additionally, the welfare state should be trimmed so that people do not have an incentive to stay unemployed and young Italians are less burdened by government debt. Moreover, Italy needs to become more competitive by slashing the number of regulations. These pro-growth and fiscally responsible policies would bring a drastically lower unemployment, higher wages and a more prosperous society.

 Lowering Debt

Italy must keep its pledge to reduce its massive debt, although economic growth must accelerate to meet the government forecasts for this year, Italy’s Economy Minister Giovanni Tria said Tuesday.

Speaking in the lower house of parliament, Tria said lower debt will help economic growth and reassure markets about the solidity of the country’s finances and economy.

“A lower level of debt reduces the expenditure for interests, freeing up margins in the country’s budget to reinforce growth and inclusion,” he said, adding that markets react on the perceived dynamic of national debt rather than on its level.

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