ANALYSIS-Letta plays safe with solid but unambitious Italian budget
* Budget cuts taxes, spending less than expected
* Targets 2.5 pct of GDP deficit, gives minor fiscal stimulus
* Criticised by employers, unions
* Economists say plan is in right direction but too timid
ROME, Oct 16 (Reuters) - Italy's 2014 budget plays by the European Union rules, but seems designed more to offend nobody than to give the euro zone's most chronically sluggish economy a decisive boost.
Prime Minister Enrico Letta largely avoided unfunded tax cuts in the budget, which his cabinet approved late on Tuesday, meaning the deficit should stay within the EU ceiling set at 3 percent of economic output.
However, Letta also disappointed expectations he had raised for a large cut in taxes on employment, reflecting the fragility of his left-right coalition even after he survived an attempt to topple the government by conservative leader Silvio Berlusconi.
"This is a budget of ordinary administration," said Giacomo Vaciago, economics professor at Milan's Cattolica University.
"It has lots of very gradual, small steps which need a long period of political stability to bring any benefits, but the risk is that the government won't even be here in three months."
Letta had said the main pillar of the budget would be a reduction in non-salary labour costs to lift business investment and stagnant consumer spending through higher take-home pay. Business, unions and economists all applauded.
Employers lobby Confindustria had called for a cut in the "tax wedge" - the difference between how much it costs business to employ workers and how much they take home in pay - of at least 10 billion euros next year. Many economists had urged the government to be even bolder.
But the tax cut needed to be funded by unpopular spending cuts and the coalition proved unable to find them. In the end the budget reduced the tax wedge by just 2.5 billion euros, half the amount that the Treasury had originally pencilled in, which was already widely considered insufficient.
The result is a budget which makes only marginal adjustments to tax and spending trends, reinforcing the reputation of Letta's government as being more concerned with political survival than bold decision-making or reform.
Letta focused at a news conference on the cumulative tax cuts envisaged over the next three years, yet the budget really sets policy only for 2014. Longer term goals are inevitably overtaken by intervening events, which are reflected in the following year's fiscal plan.
Last month Letta overcame Berlusconi's attempt to sink his government, but many analysts still expect elections next year. This situation was reflected by Letta's abdication of responsibility over how to distribute the budget's tax cuts among income groups.
That would be "up to parliament and the social partners to decide", he said, signalling a possibly difficult passage of the budget bill through parliament, where it must be approved before the end of the year to become law.
Despite Letta's caution on tax cuts, the budget gap is unlikely to fall to 2.5 percent of gross domestic product as targeted, although it should remain under the EU ceiling.
"The deficit will stay below 3 percent if the economy recovers," said Mizuho chief economist Riccardo Barbieri.
Italy has been in recession since the middle of 2011 and has averaged no growth at all over the last decade.
Vaciago said the government's 1 percent growth forecast for 2014, which is double the expectation of most economists, was reasonable so long as there were no external shocks. If there are any, Italy's weak domestic demand and lack of international competitiveness will make it "very vulnerable to future downturns".
Tough austerity adopted by Letta's predecessors meant the deficit was already projected to fall to 2.3 percent in 2014 from 3 percent this year, thanks to a return to modest economic growth and lower debt servicing costs.
Therefore the budget needed merely to redistribute resources to make the economy more likely to grow.
"It gives a very small stimulus, but I would have liked to see deeper cuts in expenditure and more significant cuts in the tax burden," said Barbieri. "The budget ticks all the boxes but it does everything on a very small scale because the government is unable or unwilling to cut spending more."
Barbieri said he was also disappointed to see the government aims to raise just 500 million euros next year from selling public buildings. Letta's predecessor Mario Monti targeted asset sales of around 16 billion euros per year, though he failed to achieve anything like that.
Confindustria and the unions gave the package an icy reception, pointing out the tax cuts would bolster average take home pay next year by no more than about five euros per month.
"It turns out that the cut in labour taxes is a fiction and so the economic recovery will be no more than a fiction as well," said Luigi Angeletti, leader of the moderate UIL union.
(editing by David Stamp)