Premier Mario Monti's government has agreed to a substantial rewrite of the budget measures in its so-called Stability Law bill in the face of opposition from the main parties supporting the emergency administration.
The biggest change is that a 1% cut in the two lower bands of income tax is to be scrapped to avoid an increase that would have taken the second-lowest bracket of VAT up from 10% to 11% next year.
However, a 1% increase in the top band of VAT, taking it up to 21%, remains.
The government will also scrap reductions in tax deductions for the current tax year, which would effectively have made this a retroactive measure, saying the reductions will now come into force in 2013.
Business associations and consumers have joined many politicians in raised concerns that increasing VAT will further depress the Italian economy after austerity measures Monti's government passed last year deepened the recession Italy is enduring.
Italian consumer spending and industrial production levels have been falling for months and Istat onWednesday said that unemployment reached 10.8% in September, its highest level since 2004. The national statistics agency said youth unemployment levels were particularly alarming, with 35.1% of 15-to-24-year-olds jobless. The government said earlier this month after presenting the bill, which also features a series of cuts hitting sectors including health and eduction, that it was willing to accept some amendments during its passage through parliament as long as the bottom line is not affected.
Industry Minister Corrado Passera said the deal with the parties had not "turned upside down" the budget because "the philosophy and analysis at the basis of it are maintained". Ex-premier Silvio Berlusconi's People of Freedom (PdL) party and the main centre-left Democratic Party (PD) said the agreement on changes to the bill was a step forward.
"The PdL is totally satisfied with the results achieved (to amend the Stability Law) in the parliamentary budget committee, where most of our proposals have been accepted by the government," said PdL Secretary Angelino Alfano.
Around 1,600 amendments were presented to the Stability Law bill on Thursday, although these were presented by individual MPs rather than being changes sanctioned by the government in the light of the deal with the parties.