* Tunisia is facing tough discussions with IMF
* North African country praised for democratic transition
* Government has failed to get economic reforms underway
* Labour unions to water down latest reform proposal
TUNIS, Dec 4 (Reuters) - Tunisia plans to launch long-awaited reforms to reduce its chronic budget deficit, but the measures could harm investment if the government imposes new taxes and resists cutting the bloated public sector in order to avoid social unrest.
The International Monetary Fund is in Tunis this week to review the government's efforts to fix an economy in turmoil since President Zine El-Abidine Ben Ali was ousted in the first of the Arab Spring rebellions in 2011.
Tunisia has been praised as the only democratic success among the Arab Spring nations. But economic performance has lagged, with phosphate exports hit by strikes and tourism suffering from Islamist attacks.
Hoping to secure further IMF finance to fund the 2018 budget, Economic Reforms Minister Taoufik Rajhi said the government would launch "unprecedented reforms" to cut the deficit to 4.9 percent in 2018 from 6 percent this year.
Tunisia wants to reduce the public workforce by 20,000 from 800,000, overhaul loss-making state firms, and increase taxes and social security contributions, Rajhi told Reuters.
Rajhi said the government is serious about reforms this time, but analysts say Prime Minister Youssef Chahed is likely to amend the proposals in order to calm social tensions.
That would put Tunisia at odds with its lenders. Since 2011, nine governments have failed to cut the deficit and the country needs $3 billion in foreign loans next year alone.
"The government is heavily reliant on financial assistance from multilateral lenders such as the IMF which are putting pressure and conditioning their support on the implementation of structural reforms, notably on the fiscal front, (and) job cuts in the public sector in particular," said Raphaele Auberty, Tunisia analyst at BMI Research.
On the other hand, "risks of social instability in the country are limiting the scope for fiscal consolidation without triggering large-scale protests", she said.
Under pressure from unions, officials have agreed to increase public sector salaries in 2018 and avoid compulsory lay-offs which could provoke protests.
The government wants to cut the public sector wage bill to 12.5 percent of GDP in 2020 from 15 percent by offering voluntary redundancies, although that would be expensive.
A spokesman for the IMF said the fund and Tunisia agreed urgent reforms were needed, "including tax reforms and measures to limit the further growth of the public wage bill that risks becoming unaffordable and is among the highest in the world."
Tunisian officials also want to raise taxes on bank profits to 40 percent from 35 percent. Tax on real estate deals will rise to 19 percent from 6 percent, which businesses say will undermine their competitiveness.
"Taxes kill investors' desire to come here," said Nafaa Naifer of the business association UTICA, which says companies will close if the tax plan goes ahead.
"We cannot tolerate more sacrifices if our sacrifices only go to boost the public sector salaries ," he said.
Last year, the government imposed a temporary 7-percent tax on companies to help finance the budget, 45 percent of which is spent on public sector salaries.
Western countries are keen that Tunisia should attract investment because high unemployment has forced many young Tunisians to go abroad in search of better fortune or even war.
The number of boats smuggling migrants to Italy has risen sharply, while Tunisia has produced the largest number of jihadists heading for battlefields in Iraq, Syria and Libya.
In April, the IMF agreed to pay out a delayed $320 million second tranche of a $2.8 billion loan to Tunisia after complaining about lack of progress in cutting the public sector.
Chahed is walking a tightrope, presiding over a coalition of secularists and Islamists who have repeatedly clashed over the country's transition since 2011.
He especially needs to listen to the powerful labour union UGTT, which mediated in 2013 when tensions between Islamists and secular forces were threatening Tunisia's stability.
The UGTT opposes deep cuts, saying people are worse off than before the revolution due to inflation of around 5.8 percent.
The dinar has fallen by 35 percent since 2011 as tourists have stayed away. Two big militant attacks almost killed off the sector in 2015.
Tunisia lost nearly $2 billion due to a drop in phosphate exports when jobless youths blocked rail tracks near the mines.
The IMF wants to cut subsidies on bread, petrol and other goods but the government plans to keep the bill stable at the equivalent of $1.4 billion next year.
The sensitivity of the issue was apparent when a minister told Reuters recently that bread prices would rise by a few cents because the government could not absorb the cost of an increase in global wheat prices.
Local media jumped on the story and the UGTT leader met Chahed to press him to keep prices stable.
Opposition parties expect the reforms to cause protests.
"These measures are painful and 2018 will be the most difficult year for Tunisians. I don't think it will go without a popular reaction," said Jilani Hammami, an official in the left-leaning Popular Front movement.
The government plan calls for an overhaul of overstaffed state firms but avoids any mention of layoffs.
"We will determine what should be kept entirely under the state and what should be a partnership between the public and private sectors, and what should privatised," said Rajhi, the reform minister, without elaborating.
The UGTT's opposition to privatisations has alarmed investors.
Dubai Holding sold its 35 percent stake in Tunisie Telecom after labour unions forced the state cellphone operator to cancel listing plans which would have meant job cuts.
There are other problems too. Restrictions on the availability of hard currency to pay for imports, imposed by the government to support the dinar, could spell trouble with the IMF, London-based Capital Economics said.
Investors also dislike Tunisia's "inefficient bureaucracy, high-level corruption and favouritism toward well-established firms", said Charlene Rahall at Arabia Monitor Economic Research & Strategy. (Editing by Giles Elgood)