Anti-establishment Five Star Movement leader Luigi Di Maio (left) and leader of the far-right party Lega, Matteo Salvini. Photos: AFP, iStock

European equity and bond markets this week stumbled after Italy’s two populist parties, the League and the Five Star Movement, offered an economic program that implies a big jump in the country’s already-enormous debt burden. Government debt is 130% of GDP, and most of it is held by Italy’s commercial banks – which means that any problems for government debt turn into a problem for the banking system.

The League is a Northern Italian business party that wants tax cuts. The Five Star Movement is an anti-establishment carnival with strong support in the poor south, and it wants income redistribution. These are conflicting goals, but the proposed coalition wants to do both: cut the income tax from a 43% top rate to a 15% flat tax and provide a “universal income” for Italy’s poor.

The tax cuts are estimated to cost 70 billion euros, the universal income another 15 billion, and a further pension reform yet another 15 billion. That’s 100 billion euros or about 6% of Italy’s GDP. That’s a huge deficit to run for a country already swimming in government debt. In fact, a flat tax probably would cost a bit less than the estimates, by stimulating growth and broadening the tax base.

Even so, the budgetary problems implied by the populist coalition program are frightening.  It’s not clear which way Italy’s political future will land, but the news is not encouraging. Italy is a big country with US$2 trillion in government debt outstanding. A run out of Italian assets would have knock-on effects everywhere.

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