Italy’s Tax Evasion Crackdown is Beginning to Yield Results

Amid fears in the first half of 2012 that Italy could be the next eurozone country to need a bailout, and that the sheer size of its public debt would make this impossible, Mario Monti, the Italian Prime Minister began to introduce a range of measures to combat Italy’s pervasive culture of tax evasion. They appear to be working as there has been an increase in tax revenue in 2012, yet there is still much progress to be made to restore the health of the Italian economy.

Total Tax Rate in 2010 and Corruption Perceptions Index Ranking in 2011 in Selected Eurozone Countries

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Sources: Tax Rates: Doing Business, World Bank. Corruption Perceptions Index: Euromonitor International from Transparency International

Note: (1) Total tax rate measures the amount of taxes and mandatory contributions payable by the business in the second year of operation, expressed as a share of commercial profits. The taxes included are profit or corporate income tax, social security contributions and other labour taxes paid by the employer, property taxes, turnover taxes and other small taxes (such as municipal fees and vehicle and fuel taxes).

(2) Doing Business paying taxes data refers to January–December 2010. The Corruption Perceptions ranking is based on scores in the Corruption Perceptions Index. This relates to perceptions of the degree of corruption as seen by business people and country analysts, and ranges between 10 (highly clean) and 0 (highly corrupt).

  • In order to compensate for the loss of government revenue to tax evasion, Italy’s total tax rate is one of the highest in the world according to the World Bank’s Ease of Doing Business 2012, at 68.5% of total commercial profits. Only 13 other countries out of 183 included in the ranking had a higher total tax rate;
  • Italy’s public debt to GDP ratio has risen from 106% of total GDP (or US$2.0 trillion) in 2006 to 120% (US$2.6 trillion) in 2011, prompting the government to introduce greater cross checks between bank accounts and to order police to stop those with conspicuous high value assets such as yachts and expensive cars to verify that they pay enough tax.

Implications

  • Greece and Spain both had bailout packages from the troika of the IMF, the EU and the European Central Bank agreed in 2012 of US$172 billion and US$123 billion respectively. The sheer size of Italy’s public debt (meaning that it would likely be impossible for the troika to give it a bailout) and also the damage to investor confidence in both Greek and Spanish government bonds as a result of their bailouts, are reasons why Italy has introduced measures to combat tax evasion, one of the root causes of its debt, instead of seeking external funding;
  • Italy’s tax evasion means that an estimated 16.5% of its total 2011 GDP was lost according to a statement by the Bank of Italy in June 2012. Silvio Berlusconi, Monti’s predecessor, had a case brought against him for tax evasion in 2012. Although the case was dropped under the statute of limitations, the charge arguably contributed to a perception that tax evasion in the country was rife among, and condoned by Italy’s leadership, harming business confidence;
  • Crackdown measures in 2012 have included an increase in cross checking between bank accounts and police stopping drivers of high end cars in January 2012 to check if their owners had declared enough of their earnings. This has harmed sales of high end cars in Italy, with Ferrari and Maserati both reporting sharp falls in their sales in Q1 2012 as some consumers shy away from these conspicuous purchases. 433,800 households were officially registered in 2011 as having an annual disposable income over US$300,000 per year, though the true figure may be far higher;
  • Italy’s efforts seem to be reaping rewards already. A long-term Italian government bond auction scheduled for August 14th 2012 was cancelled as the government announced it was collecting more revenue from the tax crackdown than it had anticipated.

Italy Real GDP Growth and Public Debt as a Percentage of Total GDP: 2006-2011

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Source: Euromonitor International from national statistics/Eurostat/OECD/UN/International Monetary Fund (IMF), World Economic Outlook (WEO)

Prospects

If Italy succeeds in reducing its tax evasion levels further it will have many positive effects:

  • Real GDP in Italy is forecast to decline by 1.7% in 2012 and 0.3% in 2013, but if the measures continue to prove successful this could increase foreign direct investment inflows to Italy in the long term, stimulate real GDP growth and reduce its public debt. Italy could also reduce its total tax rate, which would encourage businesses to pay taxes legitimately and attract investment from abroad;
  • The tax crackdown could improve the long term prospects for the survival of the eurozone itself as other countries where tax evasion is rife, such as Greece, may be inspired to adopt similar stringent measures. This could prevent the need for future further bailouts and unpopular austerity measures, and avoid the build-up of resentment towards these countries among the public in more stable eurozone countries such as Germany;
  • At the time of writing, Berlusconi has indicated that he may run in the 2013 Italian elections. If he does and is re-elected this could reverse some of the progress made, if he does not continue to implement Monti’s tax crackdown measures.