Italian Prime Minister Silvio Berlusconi's failure to introduce broad income tax cuts from 2005 represents an embarrassing U-turn that has revealed the economic straightjacket encasing his government. Barely a week has passed in recent months without Berlusconi promising to slice 6 billion euros ($7.7 billion) off income tax bills next year despite repeated warnings from both the Treasury and his cabinet that the plan could not be paid for.
Berlusconi finally bowed to the inevitable at a heated coalition meeting late Tuesday, accepting to delay the bulk of the fiscal reform until 2006 and in the meantime offering only limited tax breaks for companies and families.
For one of the first times in his political career, Berlusconi admitted defeat. "If it had been for me, I would have done things differently," he said on Wednesday.
His retreat not only highlighted his isolation within the cabinet, where he has lost two of his closest allies this year, but also Italy's limited room for manoeuvre over the budget.
The proposed income tax cut for 2005 represented barely 0.5 percent of Italy's gross domestic product (GDP). By comparison, US President George W. Bush introduced cuts worth some 2.5 percent of US GDP after he took office in 2001.
While Bush could be expansive, Berlusconi has had to curtail his own ambitions because of the European Union's Stability and Growth pact, which imposes rigid rules on deficits and debt.
The government has already introduced some 24 billion euros of cuts and spending freezes for next year to keep the deficit within 3 percent of GDP and ensure that the debt mountain, which stands at some 106 percent of GDP, does not grow any further.
Economy Minister Domenico Siniscalco made clear this week that there were no funds to cover tax cuts - a point rammed home by a visiting International Monetary Fund delegation.
"While tax cuts are important over the medium term to stimulate growth, achieving the 2005 budget targets is the first priority," the IMF said in a letter released on Wednesday.
La Repubblica newspaper reported on Thursday that the IMF had warned of a possibly disastrous ratings downgrade if Berlusconi went ahead with his plan. Ratings agency Standard and Poor's only downgraded Italy's creditworthiness in July.
Facing ridicule from opposition politicians, Berlusconi immediately upped the volume in his long-running battle with Brussels to change the terms of the Stability Pact and take items such as investment spending out of the deficit equation.
"If we want tax cuts to have an impact on the economy then they should be introduced during times of deficits," he said on Thursday while attending a Finance Police ceremony in Rome.
The rhetoric is likely to increase in the coming months as Berlusconi strives for Stability Pact leeway to fund lower income taxes in 2006, when Italy holds general elections.
While Berlusconi might seek to blame EU treaties for his inability to move on the tax front, the failure also exposed a serious flaw in the prime minister's political tactics, which might hurt his standing with the electorate.
Despite constant warnings from his coalition, the central bank and big business that Italy could not afford an income tax handout, Berlusconi carried on making impossible promises.
Used to getting his way in the boardroom, Berlusconi is not comfortable with the rigours of consensus politics, and clearly misses heavyweight allies Umberto Bossi and former Economy Minister Giulio Tremonti who quit the cabinet this year.
"Unfortunately in a war, a general has to fight with the soldiers he finds on the battlefield," a downcast Berlusconi was quoted as saying by newspapers following his tax retreat.
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