Italy’s cabinet on October 17, 2025 approved a draft budget law for 2026 that includes €18.7 billion in combined tax cuts and increased public spending, according to Prime Minister Giorgia Meloni. (The government intends to submit the proposal to parliament for final approval before year’s end. Meloni affirmed that no cuts will be made to welfare programs, and that authorities will evaluate invoking an EU “escape clause” to expand defense outlays without breaching fiscal rules.
Fiscal Strategy and Defense Spending
The budget scheme signals a shift toward more expansive policies after years of austerity. Meloni’s administration plans targeted income tax reductions, along with higher spending across various sectors. To support the plan, the government will explore using the EU’s national escape clause, which allows member states temporarily to exclude defense expenditure from deficit calculations.
Between 2026 and 2028, Italy aims to collect €11 billion from banks and insurers via a permanent levy, amounting to 0.19% of GDP in 2026–27 and 0.10% in 2028, as per the draft fiscal document. The budget also proposes €8 billion in ministerial cuts over the same period. Additionally, the second IRPEF bracket is slated to fall from 35% to 33%, costing roughly €8.5 billion across the three years. In response to NATO obligations, the plan foresees a defense spending boost amounting to 0.5% of GDP by 2028.
Macroeconomic Outlook and Debt Profile
Italy’s recent fiscal performance has impressed the International Monetary Fund (IMF), which observes that the country is exceeding deficit targets and entering a “virtuous cycle.” The deficit plunged from 8.9% of GDP in 2021 to 3.4% in 2024, and is projected to reach 2.9% by 2026.
Nonetheless, growth remains weak. Italy’s annual expansion has averaged near 0.7% since 2023, and sluggish growth is expected to persist. External pressures—especially U.S. trade tariffs—may reduce 2026 GDP growth by approximately 0.5 pp.
From a debt perspective, government liabilities remain daunting. Italy’s debt-to-GDP ratio is forecast to climb to 137.4% in 2026, before modestly easing to about 136.4% in 2028.
Rome is also on track to reduce its deficit to 3% of GDP in 2025, in compliance with EU rules—potentially enabling the country to exit the European excessive deficit procedure by mid-2026. Once freed, Italy could fully leverage the EU’s defense-spending clause without incurring disciplinary measures.
Political Stakes and Market Signals
The 2026 budget emerges against a backdrop of electoral concerns, with national elections due in 2027. Meloni’s government is thus attempting to balance fiscal consolidation with popular tax relief measures.
Markets have reacted favorably. The spread between Italian 10-year bonds and German equivalents has narrowed to around 80 basis points, down from nearly 250 bps in mid-2022. This compression is partially attributed to stronger debt metrics and improved investor confidence.
Still, analysts caution that Italy must pursue structural reforms, for example in areas like productivity, tax collection, and governance, in order to sustain momentum beyond short-term fiscal gains.