This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 ROME 000028 
 
SIPDIS 
 
SENSITIVE 
 
DEPT FOR EUR/WE, EUR/ERA, EB;IFB/OMA 
DEPT PASS TO CEA 
PARIS ALSO FOR USOECD 
TREAS FOR HULL 
USDOC 4212/ITA/MAC/OEURA/CPD/DDEFALCO 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ELAB PGOV IT KPRP
SUBJECT: ITALY'S BUDGET: SQUEEZED BY ELECTION-YEAR SPENDING 
AND EU AUSTERITY COMMITMENT 
 
REF: A. ROME 27 
     ¶B. 2005 ROME 3697 
 
Introduction, Summary, and Comment 
---------------------------------- 
 
¶1. On December 22, Parliament approved the 2006 budget which 
includes euro 27.5 billion in spending cuts and new revenue 
measures to shrink the deficit/GDP ratio to 3.8 percent 
(Italy's EU ceiling for 2006).  Italy's budget process faced 
the double pressure of EU deficit ceilings, and front-loaded 
election-year spending. 
 
¶2. On defense, spending as a percentage of GDP amounts to 
0.90 percent, down from 0.99 percent.  The budget mandates a 
5.1 percent nominal cut from 2005 levels, but funding for 
existing multi-year programs and investments remains about 
the same.  Specifically, the 2006 budget includes a nominal 
55 million euros a year through 2020 (or, a nominal 825 
million a year over fifteen years) for &Major International 
and Interforce Programs.8 However, procurement programs not 
already under contract, such as the Joint Surveillance and 
Command Program (JSCP) and C-17, may be at risk. 
 
¶3. On peace-keeping (a separate line item from defense), the 
budget appropriates one billion euro, down 20 percent from 
2005; and on foreign assistance, 400 million euro, down 28 
percent from 2005.  Italy's high-priority assistance to 
Afghanistan, however, will remain uncut in FY 2006. 
 
¶4. Because of front-loaded spending (or, &pork8) this year 
before the April elections, the European Stability Pact 
requirement to keep the budget deficit below the 3.8 percent 
of GDP-ceiling will mean the new Government will be faced 
with a fiscal balancing act in 2006. 
¶5.  In sum, Italy is scrimping to meet its international 
obligations (on foreign assistance and defense), continues to 
over-rely on undependable tax amnesty proceeds, has taken 
some steps to curb spending, but has not mustered the 
political courage before an election year to make the 
necessary  structural changes, especially on pensions and 
wages. 
 
¶6. Next steps: On January 12, the European Commission will 
review the euro 27.5 billion budget package to see if the 
numbers are real and if budget reduction measures (either 
budget cuts or revenue-generating measures) are bona fide 
(long-term) structural measures, or one-off measures, not 
always guaranteed to generate savings or revenue.  End 
Introduction, Summary, and Comment. 
 
Nibbling at the Deficit... 
-------------------------- 
 
¶7. The bill includes 15.9 billion euro in spending cuts, 
including 9.8 billion euro from central government 
administration and 6.1 billion euro cuts in regional/local 
government transfers.  The Finance Ministry explains the 
transfer cuts as a continuation of the 2005 budget strategy 
to cut all government spending. In particular, some 
public-sector wages will be capped; Members of Parliament 
will take a ten percent pay cut.  While all GOI Ministries 
and administrations will be affected, cuts affect only 
discretionary spending, not guaranteed employee salary and 
benefits. 
 
But There Is New Spending. 
-------------------------- 
 
¶8. The budget also contains 3.3 billion euro in new spending 
programs: inter alia, family support (1.2 billion euro), 
public-sector wage increases (0.6 billion euro), and pension 
measures (0.3 billion euro). 
 
Some New Revenue and Another Tax Amnesty 
---------------------------------------- 
 
¶9.  The budget provides for new revenue of 7.3 billion euro, 
mostly from increased business and real estate taxes and 
reduced tax deductions. 
 
¶10. The budget also includes a tax amnesty, despite Finance 
Minister assurances there would be no further recourse to 
this flawed, one-off deficit reduction measure.  The latest 
amnesty permits recalcitrant firms and self-employed to pay 
only a percentage of delinquent 2003-2004 taxes and to pay a 
percentage of taxes due in advance for the next three years 
in lieu of regular annual tax returns. 
 
¶11. Both tax amnesties would net three billion euro.  This is 
one budget measure the EU Commission will review in January. 
¶12. Finally, the budget also includes a 25-percent 
&porno-tax8 on income from pornographic material production 
and distribution. 
 
Postponing Lisbon-Fund Commitments Till 2007? 
--------------------------------------------- 
 
¶13. The 2006 budget authorizes raising three billion euro 
through real estate sales and privatizations to support 
Italy,s reforms under the EU Lisbon Agenda to make the EU 
(and Italy) more competitive and knowledge-driven.  In view 
of Italy,s budgetary difficulties, Italy may shift its 
program to 2007. 
 
Military Funding: Peacekeeping Cut, but Only on Paper. 
--------------------------------------------- --------- 
 
¶14. Peacekeeping mission funding is not a part of defense 
operations funding and is carried as a separate line item 
apart from the budget.  In 2006, the deficit reduction 
package ) on paper -- cuts peacekeeping funding for all 
peacekeeping missions, including to Iraq, from 1.25 billion 
euro in 2005 to 1.0 billion in 2006.  However, since 
peacekeeping funding is authorized every six months through a 
decree law, the GOI could make up for a mid-year funding 
shortage by a decree law then transferring funds from other 
miscellaneous line items in the general budget (ref B). 
 
Defense Operations Funding 
-------------------------- 
 
¶15. Defense funding (MOD budget, net of domestic security/law 
enforcement, or Carabinieri, expenditures) will decrease from 
13.6 billion euro in 2005 to 12.9 billion euro in 2006, or by 
5.1 percent.  As percentage of GDP, 2006 defense funding, as 
defined just above, amounts to 0.90 percent of GDP, compared 
to 0.99 percent in 2005.   To minimize the 2006 reduction,s 
impact on defense operations, the GOI last October approved a 
decree law to, inter alia, authorize the sale of 968 million 
euro in MOD real estate in 2006.  The 12.9 billion euro 
figure does not include the hypothetical real estate sale 
proceeds because the Finance Ministry has now earmarked them 
for debt reduction. 
 
¶16. On multi-year programs and investments, funding remains 
just about the same.  The defense budget figure of 12.9 
billion euro does include 55 million this year for MOD 
&Major International and Interforce Programs.8 (Funding 
will continue at this amount through 2020.)  However, 
procurement programs not already under contract, such as the 
Joint Surveillance and Command Program (JSCP) and C-17 may be 
at risk this year. 
 
¶17.  The 2006 Ministry of Productive Activities budget also 
allocates an additional 1.9 billion euro for technological 
innovation, managed by this Ministry, and of which some is 
available to private firms conducting defense research. 
(This figure is not included in the para 14 defense funding 
figure.) 
 
¶18.  For the Italian-French multi-mission frigate program 
(FREMM), the 2006 Ministry of Productive Activities budget 
allocates 30 million euro for 2006, 30 million euro for 2007, 
and 75 million euro for 2008.  These amounts fund Italy,s 
obligation to the program and are carried in the Productive 
Activities Ministry budget and are not considered part of 
&Major International and Interforce Programs.8 
 
Foreign Assistance 
------------------ 
 
¶19. Foreign assistance will decline 27.6 percent, from 552.6 
million euro in 2005, to 400 million euro in 2006.  FY 2006 
foreign assistance represents 0.3 percent of GDP, down from 
0.4 percent in 2005.  Adding 2006 foreign assistance to 
official (e.g., Paris Club) debt relief totals 0.12 percent 
of GDP (short of the 0.7 percent Monterrey Conference target 
and the 0.36 percent EU average).  While it is unclear where 
cuts will be made, we do know there will be major cuts to NGO 
support.  (Comment, as reported Ref A Italy's Special Envoy 
for Afghanistan, Anna della Croce, told Charge January 3 that 
Italy will not cut its approximately 50 million euro in 
Afghan assistance already pledged for 2006. End Comment.) 
 
April Elections Could Mean Early Spending Spree. 
--------------------------------------------- --- 
 
¶20. While politicians have made strong denials that the 
budget contains election-year pork, most expect the ruling 
conservative coalition to front load budget expenditures 
(especially public works and tourism promotion) to build 
support in the run-up to April national elections.  This 
strategy would mean that the winning coalition may need to 
implement a supplemental revenue package (e.g., tax and fee 
increases or more tax amnesties) or severely cut spending 
after elections to keep the budget deficit below the 
Stability Pact 3.8 percent of GDP ceiling.  Otherwise, Italy 
will again find itself in hot water with the EU for its 
excessive deficit. 
BORG