By Giuseppe Fonte and Gavin Jones

ROME (Reuters) -Italy will cut its budget deficit to 3% of national output this year, the government said on Thursday, respecting the European Union’s ceiling for the first time since 2019, before the COVID-19 pandemic, and below a previous target of 3.3%.

Rome’s 2026 budget framework approved at an evening cabinet meeting projected that the deficit would fall to 2.8% of gross domestic product (GDP) next year, maintaining a previous target set in April.

“We are confirming the line of firm and prudent responsibility that takes into account the need to maintain public finance stability,” in compliance with European rules, Economy Minister Giancarlo Giorgetti said in a statement.

The fiscal consolidation should allow Giorgia Meloni’s government to exit an EU infringement procedure for countries running excessive deficits by mid-2026, provided Brussels is convinced that Rome’s improved finances can be sustained in coming years.

The procedure restricts offending countries’ flexibility with regard to taxation and spending policies, forcing them to cut their fiscal deficit by a prescribed amount each year.

Last year’s Italian deficit came in at 3.4%, comfortably inside the government’s 3.8% goal.

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The improvement is being driven by stronger-than-expected tax revenue — in turn supported by job growth and inflation-driven fiscal drag — and lower debt servicing costs for the euro zone’s third-largest economy.

The fiscal gap is falling despite weak and deteriorating growth prospects, hit by U.S. trade tariffs.

Italian exports to the United States fell in August by 21% on annual basis, data from the country’s statistics office ISTAT shows.

The most recent data for the economy as a whole showed Italy’s GDP contracted by 0.1% in the second quarter from the previous three months.

The government marginally lowered its forecast for full-year 2025 growth to 0.5% from April’s projection of 0.6%, and trimmed next year’s outlook to 0.7% from 0.8%.

A summary of the budget projections published by the Treasury contained few numbers on Italy’s huge public debt — the second highest in the euro zone after Greece’s — but said it would rise through 2026 from 134.9% of GDP last year.

The 2026 level will be below a previous target of 137.8% of GDP and will begin a downward trend the following year, the Treasury said, falling to 136.4% in 2028.

The budget deficit is targeted to fall to 2.6% in 2027 and 2.3% in 2028.

Most countries in the 20-nation euro zone already had budget deficits below the EU’s 3% ceiling last year, with Italy and France being the largest of the eight members above the threshold, running fiscal gaps of 3.4% and 5.8% respectively.

Once Italy has exited the EU procedure, it can decide next year, probably in the autumn, whether to activate the bloc’s so-called “escape clause” designed to boost defence spending.

DEFENCE SPENDING TARGETED TO RISE

Italian defence expenditure will rise by 0.15% of GDP in 2026, by 0.3% in 2027 and by 0.5% in 2028, the Treasury said.

It added, however, that this planned increase was dependent on the EU giving a green light to Italy’s exit from the excessive deficit procedure.

Rome will present its full 2026 budget document to parliament by October 20, to be approved by the end of the year.

The outline published on Thursday made no reference to the politically sensitive “tax burden” measuring taxes and social contribution as a proportion of GDP.

This stood at 42.5% last year – higher than the EU average of 40% – despite Prime Minister Giorgia Meloni’s tax-cutting pledges.

With national elections due in 2027, Meloni is looking to cut income taxes in the budget for those earning between 28,000 and 60,000 euros ($70,356.00) per year, politicians have said.

($1 = 0.8528 euros)