Geofinancial Analysis

Marco Valerio Lo Prete

Italy’s long “fiscal illusion”


Unlike past public debt’s peaks, Italy's current debt load is the long term consequence of a fiscal illusion

According to the International Monetary Fund, Italian public debt will reach its peak this year, rising to 133% of GDP and will then begin to fall over the coming year to 131.4%. According to the Italian government, debt will fall from last year’s 132% of GDP to this year’s 131.6% of GDP. In brief, for the first time in ten years, Italian public debt is stabilizing.

Slightly more robust growth than expected in the current year, coupled with a substantial primary surplus and the effects of extraordinary monetary stimulus by the European Central Bank, have been the main drivers of this turning point.

The Italian debt-to-GDP ratio has been rising by 32.8 points since 2007 and the outbreak of the world crisis, while the same debt-to-GDP ratio declined by 17.1 points during the 1995-2007 period. This is all true, but the manner in which it is approached may be excessively narrow.

In fact, if one takes into account the entire history of Italian public debt – based on long-term data recently compiled by the historian Guido Pescosolido in his book “La questione meridionale in breve” – one observes three major peaks of the debt-to-GDP ratio over the last 150 years. From this perspective, what we are witnessing today is not simply a series of ups and downs in public indebtedness caused by the recent Great Recession, but the second highest debt-to-GDP ratio peak in Italy’s history as a unified nation.

Underlining the peculiarities of the contemporary peak might be useful for highlighting lessons concerning public debt evolution in contemporary Italy.



The first debt-to-GDP ratio peak (Peak 1 on the graph) was experienced throughout the first decades following Italy’s unification in 1861. The new-born national state had to take upon itself the public debt of the various pre-unification nations. At the same time, the kingdom had to finance the military effort for the so-called Wars of Independence against foreign powers, combined with an extraordinary internal struggle against a few southern rebels opposing unification.

In addition to all this, public investments were made in administrative unification and infrastructure projects. In such a difficult situation for the state budget, austerity was still pursued – also in order to show foreign partners that the government could honour its debt obligations – both by cutting public sector expenditure and by raising taxes.

Although national debt grew during those years, reaching a peak of 125% of GDP in 1894, this leverage proved to be useful in terms of revenue, paving the way for debt reduction through sustained growth in the following years.

The second debt-to-GDP peak (Peak 2 on the graph) corresponds to the World War I period. Not only did state subsidies and protectionism become a normal tool used by the national industrial policy – as happened in many European states – but military spending also relied mainly on an expanding monetary base and rising public debt.

According to some estimates, public revenue financed just one-fifth of the Italian military build-up on the eve of World War I, with the rest relying mainly on new public debt emissions. This contributed to the highest debt-to-GDP ratio (159%) in modern Italian history, reached during the six-year period between 1919 and 1924.

A new trend involving rising debt associated with World War II in the 1940s was then reversed thanks to a spectacular growth rate labelled “the Italian Miracle”, reaching the lowest debt-to-GDP ratio in Italian history during the seven-year period between 1960 and 1967. Growing levels of private investment and employment, along with a renewed openness to international markets, explain the “miracle”.

Italian public debt’s present third peak (Peak 3 on the graph) has no unification or state-building process behind it, no extraordinary infrastructure programme and no military build-up or war in sight. This huge debt load is the long term consequence of a “fiscal illusion” put in place by the Italian ruling classes since the 1970s.

The “fiscal illusion” theory was hypothesized by Amilcare Puviani, an Italian economist at the turn of the 20th century, and far more appreciated in American thinking (for example by Nobel Prize–winning economist James M. Buchanan) than within the Italian intellectual debate. Fiscal illusions are “errors […] that the political elite uses to reach its objectives” and these errors concern both “revenue” and “public expenditure”.

One way in which governments create and take advantage of fiscal illusions, according to Puviani, is a systematic preference for relying on borrowing rather than on higher taxes, as public borrowing is a less immediate and less obvious burden.

Since the end of the 1960s, public expenditure in Italy quickly grew without the central government raising enough revenue to balance it. Public expenditure rose from 33% of the GDP in the second half of 1960s to 41% of the GDP in 1975; with stable public revenue, the debt-to-GDP ratio rose from 38% in 1970 to 57% in just five years.

The central state fostered the illusion that more generous welfare and a larger public administration came free of charge. From 1971 onwards, public expenditure has been higher than public revenue for decades.

The quality of public expenditure in Italy – from the 1970s to today – did not help; current expenditure gained ground compared to public investments, finally overshadowing them. Welfare spending benefited older people and not the unemployed or the poor, while self-employed workers and those employed by large firms were privileged compared to other groups.

Furthermore, one must remember that deficit financing, funded through the expansion of the monetary base, was common in Italy until 1980, imposing an inflation tax on citizens that is another form of fiscal illusion. There was the so-called “snowball effect”, with interest payments on previous debt becoming higher and higher.

It is no surprise that the debt-to-GDP ratio skyrocketed due to this combination of factors. Adjustments were made after a major economic and political crisis in 1992 and significant primary surpluses were reached, but Italian public debt remained a burden for the country, a ticking bomb exposed to the volatility of international markets.

After the last world crisis, Italian taxpayers have now been reawakened from the “fiscal illusion” they lived with during the 20th century. Public debt always comes at a cost, even when driven by productive investments in infrastructures or by war, while unproductive public debt accumulation – to broaden the welfare state and political consensus with no interest in reducing waste in the process – is always a curse for economic growth.

Like dwarves standing on the shoulders of giant public debt, at a time when this Moloch is finally experiencing a welcome stabilizing process, Italian élites and voters should now beware not to walk in their footsteps of their ancestors and not fall prey to their same fiscal illusions.