BREAKING BAD:

[T]he Italian government implemented the wrong kind of austerity.

First, it raised the tax burden on its workers.  Tax revenues consumed an additional 2.5 percent of GDP, bringing the total up to 45 percent.  While some of those increases were already in place when Monti took office in November 2011, he chose to continue with the tax hikes.  Considering the large amount of tax evasion in Italy (estimated conservatively at around 15 per cent of GDP) those who actually pay their taxes are truly squeezed.

Second, with the exception of good pension reform, the effect of which will not be felt on the budget for a few years, the actual spending cuts have been minuscule. Traditionally, the "cuts" in the budget presented in parliament are mostly a reduction in transfers from the central government to local governments. But the latter often reacts by raising local taxes, effectively wiping out the good from "spending cuts."  The only real cuts approved by the Monti government in 2012 were tiny; somewhere between 1 billion and 8 billion euros, representing at best, less than 1 percent of the $790 billion budget. These are a tiny fraction of Italy's GDP, plus it remains uncertain whether or not they'll be fully implemented to begin with.

This is unfortunate when we consider a 2012 report by a government appointed commission that suggested a better path: major cuts to corporate subsidies and elimination of "tax expenditures" in exchange for generalized reduction of taxation on labor costs for firms. However, the suggestions were ignored, possibly, but not exclusively, for lack of time. One result of ignoring these recommendations is increasing unit labor costs in Italy, while they are falling in countries like Spain and Greece. This, in turn, makes it more expensive for firms to hire workers, and exacerbates already high unemployment.

Even worse, the Monti government was unable to aggressively attack what has become the most odious form of government spending in Italy:  the pure waste taking place among elected officials locally and nationally; the latter rationalized as "the cost of doing politics." Under the pretense of austerity, Italians were asked to pay more taxes while observing inept politicians enjoy their luxurious life style.

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