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Fears rise that Italy's 2014 budget could spark further trouble

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Italy's cabinet is to get a first glimpse of the country's 2014 budget later Tuesday, with concerns rising that plans to cut spending to help finance tax cuts will spark further political and economic turmoil for the country.

The 2014 budget will be geared towards reviving the stagnant Italian economy by cutting taxes on companies and workers, according to various Italian and U.K. media reports.

The measures are seen as a chance for Italy, the euro zone's third largest economy, to focus on growth after several years of slowdown by encouraging businesses to produce and hire while cutting the tax bill for workers and Italian households.

(Read more: Italian companies implode amid government turmoil)

For instance, the government is expected to reduce municipal taxes by merging a housing and refuse disposal tax into an overarching "services tax" and to cut a regional tax on production to encourage Italian businesses. Furthermore, companies will have incentives to hire workers on a permanent basis, according to a Reuters report on Monday.

To be able to cut taxes, however, the government plans to cut public spending as it aims to reduce its budget deficit to 2.5 percent of gross domestic product (GDP) by 2014 from this year's 3 percent -- the limit set by the European Commission -- and to reduce Italy's debt pile which is still the second largest in the currency bloc at 130 percent of output.

(Read more: Monte dei Paschi CEO: We're ready to bounce back)

In the line of fire for spending cuts are public services such as the healthcare system. However, such a move would prove unpopular with Silvio Berlusconi's "People of Liberty" (PdL) party, which is expected to oppose spending cuts.

Ahead of the presentation of the budget to his cabinet at 16:00 London time, Italy's Prime Minister Enrico Letta said it would give certainty and solidity to the country's public finances for the next three years.

"The budget law that you will see tomorrow evening or afternoon will cover many years because we want a long-term intervention, for three years, to give certainty to entrepreneurs and workers," Letta said at a press conference on Monday.

The budget comes at a rare moment of calm in Italy's politics: the coalition government appears relatively stable after the recent victory for Letta in a vote of confidence.

(Read more: Letta wins confidence vote as Berlusconi backs down)

Italy's economic minister Fabrizio Saccomanni has said he expects the country to exit recession in either the third or fourth quarter and to consolidate growth in 2014.

"I think the emphasis on reviving growth and fighting unemployment while remaining within the limits agreed at the European level for our budget deficit [is] important," Saccomanni told CNBC on Tuesday.

He said he believed the budget would put the government in a better position to implement much-needed reforms that he has pushed for and, indeed, threatened to resign over if he could not implement them. Furthermore, Saccomanni said Italy would be "rewarded by the markets by lowering the cost of our debt."

However, one market-watcher was not as convinced in the budget's potential for success. "The road to hell is paved with good intentions," Michael Hewson, senior market analyst at CMC Markets told CNBC Tuesday.

"I'd love to be proven wrong but I can't see this budget succeeding. They always start with good intentions then by the end, they under-deliver. Irrespective of Berlusconi, vested interests in Italy will water down the proposals so much that the budget will miss the targets it has set for itself."

Another economist remained skeptical the budget would give Italy the firepower to return to growth, even if it was implemented.

"After winning an important political battle to remain in office, Mr Letta now faces a much more difficult challenge: approving a budget which helps foster much-needed growth yet maintains fiscal discipline," according to Nicholas Spiro, head of Spiro Sovereign Strategy, who told CNBC that the budgetary room for maneuver in Italy was insufficient to provide the kind of stimulus needed for a meaningful cut in labor costs.

"Despite having one of the lowest headline budget deficits in the euro zone - and a primary surplus to boot - Italy is severely constrained by its crushing public debt burden," he added.

Spiro forecast that disagreements over fiscal policy, "the biggest bone of contention between the PdL and the government," were likely to persist, a concern echoed by another market analyst and political expert.

Giovanni Orsina, professor of Italian history at the Luiss-Guido Carli University in Rome and author of a book called "Berlusconism," told CNBC that while Italy should indeed "seriously cut public expenditure," it remained to be seen how and where the coalition government would implement spending cuts.

What was sure, Orsina added, was that Italy was not looking forward to "a quiet political period" in the coming debate over the budget.

"What is certain is that the government needs to make cuts and for Italy to return to growth, some people in Italy will be very badly hurt by this, there's no escaping that. You can't return to growth without cutting services but we have to wait and see where those cuts will be made."

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt. Follow us on Twitter: @CNBCWorld

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