Italian Prime Minister Mario Monti announced an income tax cut to help low earners, giving a rare lift to struggling households ahead of parliamentary elections next year.
The unexpected measure was presented in the early hours of Wednesday following a marathon cabinet meeting, along with a one percentage point increase in value added tax and a raft of spending cuts.
The combined package of stimulus measures and cuts, worth a combined 11.6 billion euros in total, is designed to keep Italy on course to meet budget goals agreed with the European Union.
Monti said the tax break, introduced a maximum of six months ahead of elections, showed that painful austerity measures implemented by his unelected administration were beginning to produce results.
"Today we can see that budget discipline pays and makes sense (because)... we can allow ourselves some moderate relief," he told reporters after the meeting.
The one-percentage-point cut in the two lowest income tax brackets is expected to cost 5 billion euros (4 billion pounds), according to a Treasury source.
The move won a cautious welcome by the head of the moderate CSIL union, who said it was "an important signal".
But Tito Boeri, professor of economics at Milan's Bocconi University, said the package could have gone much further.
"It's still a very timid measure because the provision is still very limited as far as reducing fiscal pressure on wage earners is concerned. They could have done much more," he said.
The income tax rate will drop to 22 percent from 23 percent for those earning less than 15,000 euros per year, and to 26 percent from 27 percent for salaries between 15,001 and 28,000 euros. The top three income tax bands will remain unchanged.
The government fell short of expectations that it would eliminate a planned two-percentage-point hike in value added tax, due to come into effect in June next year. But it did limit the increase to one point.
DIET OF AUSTERITY
The severe austerity imposed by Monti since he took over an unelected government in November has exacerbated a year-long recession in the euro zone's third-biggest economy and has been a focus of criticism by all political factions.
The former European Commissioner, appointed last year in the middle of a major financial crisis, has increased taxes and cut pensions to put the public accounts on track and head off a Greek-style debt disaster.
There were some signs of a pick-up in Italy's economy in data released on Wednesday, which showed a 1.7 percent month-on-month jump in industrial output in August while analysts had expected a decline. But statistics bureau ISTAT said the data may have been distorted by seasonal factors.
Italy will stick to its commitment to balance its budget in structural terms next year, as it has pledged its EU partners it would do, according to a statement from the cabinet meeting.
In addition to the tax cuts for low earners, spending cuts, a new financial transactions tax and unspecified "fiscal interventions" on banks and insurance companies will also help pay for the measures, the statement said.
The savings should amount to 3.5 billion per year when at full regime, the government said. Savings from a previous round of spending cuts will total 4.4 billion euros this year, and 10.3 billion euros next year.
Also decided during the cabinet meeting was a reform to the constitution to centralise spending controls over the country's 20 regional governments, which have been the focus of a recent series of high-profile corruption scandals.
That will involve reforms designed to regain coordination of spending on energy, tax collection, and the national transportation network, including measures to cut the cost of street lighting.
To address corruption, the position of anti-corruption commissioner, who will be given investigative powers, will be created with the passage of the budget.
(Additional reporting by Steve Scherer, Stefano Bernabei. Writing by James Mackenzie and Steve Scherer.; Editing by John Stonestreet)