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Italy Treasury moving to shield budget from political turmoil - source

Giuseppe Fonte

ROME, Aug 9 (Reuters) - Italian Treasury officials are drafting a plan to protect the economy from political paralysis, concerned that this week's collapse of the ruling coalition could lead to a default hike in sales tax next year, a government source told Reuters.

A hike in value-added tax is scheduled to kick in from January, which can only be averted if the 2020 budget that must be approved by year end raises some 23 billion euros elsewhere.

However the budget approval process has been thrown into doubt after the far-right League party leader Matteo Salvini pulled the plug on Thursday on the governing partnership with anti-establishment 5-Star Movement.

Political parties of all stripes fear the VAT increase - the main rate is set to go up to 25.2% from 22% - would hurt already weak household spending and domestic demand.

Top Treasury officials are considering putting together an emergency decree that would temporarily suspend the increase if parliament has failed to find an alternative source of funds by the end of December.

"This solution would help avoid creating uncertainty for businesses and consumers," said the source, who asked not to be named.

The emergency decree could be approved by whatever government is in place at the end of December, the source said.

The collapse of the ruling coalition could lead to elections as soon as October, but the timing interferes with preparation of the 2020 budget and its approval in parliament.

This timing issue is the main reason why Italy has never held an autumn election in its post-war history.

The budget is supposed to be presented to parliament in October and approved by the end of the year.

Under the Italian Constitution, if it is not passed within the prescribed time frame, emergency rules can allow the draft budget to take effect temporarily but the VAT hike will kick in from Jan. 1.

In recent years Italy has repeatedly offered the VAT hike to the European Commission as a form of guarantee that it will meet agreed deficit limits if other spending curbs prove ineffective.

So far it has always managed to avoid actually implementing it.

In early July Italy dodged the threat of EU disciplinary action after persuading the European Commission that its finances were in line with EU fiscal rules.

Recent data suggest the deficit this year could be 1.9% of gross domestic product, below the 2.04% accepted by the EU, a second source said.

The Treasury estimates next year's deficit will be 1.8% of GDP or lower under an unchanged policy scenario, he added.

(Reporting by Giuseppe Fonte Writing by Giselda Vagnoni Editing by Gavin Jones and Frances Kerry)