By Gavin Jones
ROME (Reuters) - Italian Prime Minister Matteo Renzi on Wednesday presented a sweeping package of tax cuts, saying they could help economic recovery in the euro zone's third largest economy without breaking EU budget deficit limits.
Renzi, in his first full news conference since taking office last month, said income tax would be reduced by a total of 10 billion euros ($14 billion) annually for 10 million low and middle income workers from May 1.
"This is one of the biggest fiscal reforms we can imagine," he told reporters after a cabinet meeting that approved the measures.
The cuts will be financed by reductions in central government spending, extra borrowing and by resources freed up thanks to the recent fall in Italy's borrowing costs, he said.
Daniel Gros, the head of the Brussels-based think tank CEPS, said it was worrying that Renzi appeared to be back-tracking on previous pledges to finance any tax cuts entirely with structural spending reductions.
"This is not what Italy needs," he said. "We don't know what bond yields will do in the future and, with its huge public debt, the government cannot afford more deficit spending."
Economy Minister Pier Carlo Padoan said the government would have to evaluate the effect of its measures on public finances and would need to seek EU approval if deficit and debt targets appeared in doubt.
Renzi, the 39-year-old former mayor of Florence, said his agenda to stimulate the economy and reform Italy's political system was the most ambitious Italy had ever seen as he reeled off tax-cutting plans that he insisted were fully funded.
Italy is struggling to emerge from its longest post-war recession and Renzi has said job creation and growth, rather than austerity, are his priorities.
The tax cuts would mean an extra 80 euros per month in the pay packets of workers earning up to 1,500 euros, Renzi said, adding that the details would be set out in the government's annual forecasting document to be released next month.
He said the budget deficit goal would be raised while remaining below the EU's ceiling of 3 percent of output. Italy is currently targeting a deficit of 2.5 percent of GDP this year after 3.0 percent in 2013.
Renzi, who ousted his predecessor Enrico Letta in a party coup in January, was speaking after the lower house of parliament approved a new electoral law on Wednesday aimed at ensuring more stable governments.
JOB ON LINE
That reform, aimed at preventing a repeat of last year's deadlocked election by favoring bigger parties and stronger coalitions, must now go to the Senate, where it is likely to face additional amendments from Renzi's own center-left Democratic Party (PD).
It is part of a broader constitutional reform involving the abolition of the Senate as a legislative assembly and Renzi said if he failed to pull it off "I will consider my government experience and my political career to be over."
"I am not here for my personal ambition," he added.
This month the European Union put Italy on a watch list of just three countries with severe macro-economic imbalances, along with Slovenia and Croatia, due to its weak productivity and massive debt.
"We will respect our European commitments," Renzi said, adding that he expected EU authorities would take note of Italy's reform efforts in judging its public finances.
As well as the income tax cuts, Renzi said the regional IRAP business tax would be reduced by 10 percent, to be financed by an increase in taxation of income from financial instruments to 26 percent from 20 percent, with the exclusion of government bonds, which are popular with Italian savers.
He also promised that around 90 billion euros of debt arrears owed by the state to private sector suppliers would be fully paid off by the end of July.
Letta paid off around 22 billion euros of these arrears in 2013, pushing up the vast public debt as a result.
Renzi did not explain how he would pay the remaining 68 billion euros without adding to public debt, which is already the second biggest in the euro zone after Greece's at around 133 percent of gross domestic product.
Economy Minister Padoan said the tax cuts should stimulate growth, jobs and therefore revenues, but also acknowledged they would push up the 2 trillion euro debt pile in the near term . He said he would hike the deficit target as little as possible.
The impact on the economy and public finances would need to be monitored constantly and "wherever there is a change in position, we would have to obtain the approval of parliament and the European Commission," he said.
The electoral reform, agreed with center-right leader and former Prime Minister Silvio Berlusconi, has faced increasing criticism from within the PD, where party critics say Renzi made too many concessions to Berlusconi.
The law sets higher minimum thresholds for entry to parliament to limit the number of smaller parties, and provides for a run-off round to decide the winner if no coalition or party reaches a minimum of 37 percent of the vote.
(Additional reporting by Steve Scherer, Giuseppe Fonte, Giselda Vagnoni and Paolo Biondi, Roberto Landucci,; Editing by Ruth Pitchford)