A brief summary on the last book by Cottarelli: “Seven Sins of the Italian Economy”.

I have recently finished reading the book “the seven sins of the Italian economy” published by Feltrinelli and written by the Italian almost-premier Carlo Cottarelli. For those who don’t know him, he is an Italian economist and former Director of the Fiscal Affairs Department of the International Monetary Fund.

In the book, Cottarelli describes seven “sins” of the Italian economy, responsible of slowing down the country’s economic growth. I have found the book of particular relevance for both its objectivity and for the author’s clarity of thought. These seven sins can be divided into two categories, the long-standing ones and those more recent. Those that are within the Italian economy’s DNA make most of the list, these are: tax evasion, corruption, slow justice, excessive bureaucracy and the disparity between the North and the South. On the other hand, the most recent ones are: the fast aging of the population and the difficulty of Italy in adapting to the common currency. In this brief article I will only focus on the first sin, the one on tax evasion. I have decided to proceed in this way because numbers have played a primary role in the political debate in Italy (see the reference to 5 billion euros needed for the refugees, or the €50 billion that could allow a flat-tax), and this chapter is the one where figures are particularly reliable and of primary importance.

As mentioned before, the first long-standing problem of Italy according to Cottarelli is tax evasion. Very interesting here is the distinction between nominal and real fiscal pressure. To compute the percentage of income taxes payed by the average Italian, the National Institute of Statistics (ISTAT) estimates the ratio between the billions payed to the Fiscal Agency and the Italian Gross Domestic Product (GDP). Therefore, when it is reported that in 2016 the fiscal pressure in Italy was 42.8 percent, it was computed the simple ratio of 720 billion (the taxes paid) over the GDP (around 1,681 billion)[1]. The difference between this estimate and the real fiscal pressure derives from the methodology used by the Italian National Institute of Statistics in computing the overall country’s GDP. This is indeed comprehensive of the shadow economy, estimated to be around 13 per cent of GDP (i.e. around 218 billion)[2]. Inside the umbrella of the shadow economy there are all those productive activities that escape to the knowledge of the Fiscal Authority. These are generally legal activities (12 per cent of GDP for Italy), plus illegal ones (the remaining 1 per cent). When this discrepancy is taken into account, and the above-described ratio is computed again (hence eliminating the share of the shadow economy from the estimate of the GDP) the fiscal pressure in Italy shifts from 42.8 to 49.2 per cent. Restated, this means that if everyone was paying their taxes correctly, these could be reduced of at least 13 percentage points for those who pay them already (Cottarelli writes about a possible reduction of 20 percentage points, because a more correct fiscal behaviour of the Italians would have positive effects on national GDP and on employment, effects that would allow a further reduction of the fiscal imposition).  This discrepancy between nominal and real fiscal pressure has been underlined for many years by several bodies (e.g. the IMF and the ECB) and it is present as much in Italy as in the other European countries. The problem is that the size of the Italian shadow economy, and consequently of tax evasion, is much bigger in Italy than it is in the other countries of the euro area (except for Greece and Malta). As a matter of fact, while nominal taxation is high but not extreme (we are sixth in the EU), the real one is much higher (placing Italy in the very first positions of the ranking).

Data from Closing the European Tax Gap, Richard Murphy, 2012

But how much is lost to tax evasion in Italy every year? To answer this question, Cottarelli turns to a yearly study made by a commission of experts led by Erico Giovannini, composed of university professors and representatives of national ministries, of the Fiscal Authority, of the ISTAT, of the Bank of Italy, etc[3].

Source: Relazione annuale sull’economia non osservata e sull’evasione fiscale e contributiva 2017

Beginning from this study, Cottarelli estimates that tax evasion in Italy in 2014 was close to 130 billion, which is the 15 per cent of the whole amount of taxes due that year and 8 per cent of the national GDP. The author then notices how, simplifying a little, if in 2014 the Italian government had collected all the due taxes, then the public balance would have passed from a 3 per cent deficit (in terms of GDP) to a 5 per cent surplus. Therefore, in Italy tax evasion has a considerable effect on public debt as well. For example, one can estimate that if since 1980 tax evasion was lower of just one percentage point of GDP, the current public debt would be around 70-75 per cent of GDP (instead of 130 per cent).

Source: Relazione annuale sull’economia non osservata e sull’evasione fiscale e contributiva 2017

At this point, Cottarelli analyses the propension to tax evasion according to geographical areas and for the different types of taxes. The analysis is totally worth attention, however for space constraints I will here report only the data concerning the value added tax (VAT). According to the above-mentioned Giovannini’s report, in 2014 VAT evasion in Italy was very close to 28 per cent. This estimate coincides with that made by the EU, which has compared VAT gaps among the European countries for years now. According to their estimates the average figure of VAT evasion in the EU is around 12 per cent, less than half than the Italian data (worse than Italy we find only Greece, Slovakia, Malta, Lithuania, and Romania). Now, if we consider that the government revenues coming from the VAT sum up to the 6 per cent of the country’s GDP, it is possible to calculate how VAT evasion alone costs us at least 30 million a year (34.7 in 2015 according to Giovannini’s report).

But why is tax evasion this high in Italy? And what can be done about it? Here the answers provided are various, but all very straightforward. First, the professor states the obvious, noticing that if tax evasion is high in Italy this means that evading taxes is not that complicated.  Moreover, Cottarelli underlines how the prolonged period of the country’ slow or null growth has not helped in fighting tax evasion: some firms evade taxes in their struggle to stay afloat, taxes in Italy are clearly too high. This said, it is also true that tax evasion in Italy had been higher than in most other European countries for years before the crisis. Therefore, there must be some pathological problems in our economic system. Let us see the structural problems identified by Cottarelli.

 

The first one concerns our economic structure:

  • In Italy the share of autonomous workers is very high (almost the 25 per cent of the total, against the 10th of Germany and France) and it is well documented how the portion of tax evasion for this category is much more elevated than that of employees, who have their taxes payed by employers[4].
  • Furthermore, Italy is a country of small and micro enterprises; these are subject to fewer fiscal controls and tend to evade more than big-size firms (this clearly is in relative terms)[5].
  • Finally, the Italian economy is characterised by the extensive and predominant use of cash, which is by far preferred to more traceable instruments of payment such as credit cards (in Italy the 85 per cent of transactions happen through cash, against a European average of 65 per cent)[6].

 

The second problem concerns the fiscal structure of Italy:

  • As anticipated before, the fiscal burden in Italy is very high and, as any economist can confirm, the propension to tax evasion is due to two factors: the amount that can be saved in evading and the risk of doing so (what is the likelihood of being caught and how severe are the sanctions). Therefore, if tax rates are very elevated this means that the saving resulting from evading taxes are very high and tax evasion is higher.
  • Another reason involves the composition of public revenues. In Italy taxes on work and businesses should be loosen up, while taxes on property, such as the house, should be increased (path started by the ex prime minister Monti). This would also show benefits on the collecting capacity of the government because it is much harder to evade taxes on immovable properties such as houses.
  • Finally, another problem of the country’s fiscal structure is represented by the bureaucratic compliances needed to be fiscally in order. If the energies and the time requested to be honest are excessive, some will prefer not to be.

 

The third problem involves our repressive system:

  • Here Cottarelli mentions the relation between the Italian Guardia di Finanza and the Agenzia delle Entrate, these are the two main bodies that have the duty of guaranteeing a correct functioning of the fiscal relations between citizens and the government. However, to date there still is an overlapping of duties and tasks. Moreover, regardless of the recent efforts in the direction of a better coordination, the databank exchange is still partial.
  • Another important problem of the Italian system is represented by the detrimental effect of the wide-ranging tax amnesties, which punctually come with new governments (hence pretty often). These comprehensive tax amnesties are particularly dreadful because they undermine the relation between citizens and their government. In fact, allowing who was not compliant with the rules, not only to get away with it, but also to pay less than what he would have had, promotes the non-compliancy behaviour.

 

The fourth and last structural problem of the country is the lack of social capital:

  • Unfortunately, in Italy we lack of civil duty. Too often we tend to exclusively look at our private gains without making ours the effect of our actions on the community. This has been indicated by Cottarelli as the main reason for the Italian high rate of tax evasion.[7]

At this point of the chapter it is presented a summary of the measures adopted throughout the years to fight tax evasion, what has been their utility and the progresses obtained (unfortunately still limited and modest in significance). In the following chapters, the other sins of the Italian system are presented, and it leaves speechless realizing how problems such as corruption, slow justice, excessive bureaucracy, the disparity between North and South, and the aging of population are detrimental for the Italian economy. Finally, the last chapter is dedicated to the problem of the single currency. Here, I have particularly liked the objectivity with which the professor presents the problem, recognizing that it has some unfavourable characteristics. It is indeed evident that all the above-mentioned sins were present also during the economic boom (except for the problem of a declining population), notwithstanding a considerable growth. Adopting a single currency prevents us from implementing devaluation policies, operations that were often recurred to in the past. That said, Cottarelli makes clear how the problem is not the euro per se (which actually carries along multiple advantages) but the fact that Italy never really adjusted to it. Basically, the difficulty with a single currency is that this pretends the respect of economic rules that are probably even more important than the treaties themselves. Cottarelli here refers to rules of productivity and competitiveness, which ask for structural reforms. A serious commitment to facing the above-mentioned issues would surely go in such direction.

I conclude inviting the reader to both buy the book here presented (by the way the copyright’s profits go to Unicef),  and, more importantly, to highly doubt those who claim the problems of the Italian economy are external to it, because unfortunately they are not.

Giovanni Sgaravatti

References:

[1] Here I used data from the Eurostat, which are slightly different from those used by the author.

[2] There are several estimates of this figure, often very different among them, here it is taken the one from ISTAT, which corresponds to that published by Eurostat.

[3]The document can be found at the link http://finanze.gov.it/export/sites/finanze/it/.content/Documenti/Varie/Relazione-evasione-fiscale-e-contributiva.pdf

[4] The abovementioned report by Giovannini estimates the tax gap for the autonomous workers to be around 67%. Moreover, it is reported how, even representing a quarter of the national workforce, autonomous workers contribute only to 8 per cent of the working income tax.

[5] Please see, for example, page 97 of the document “Risalita in cerca di slancio. L’evasione blocca lo sviluppo.” by the research centre of Confindustria, December 2015.

[6] Please see the study published by the Bank of Italy on the link http://bancaditalia.it/pubblicazioni/tematiche-istituzionali/2013-sepa/index.html (quote at page 14).

[7] Here Cottarelli mentions a study by Luigi Guiso, Paola Sapienza and Luigi Zingales: “Social Capital as the Missing Link” included in the 2011 Handbook in Economics , published by Elsevier.

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