ROME (Reuters) – Italy's two anti-establishment parties met Thursday to pass an intergovernmental agreement that will cut taxes, increase social spending and be the biggest challenge facing the European Union, since the UK two years ago Leaving the block has decided.
FILE PHOTO: Anti-Establishment 5-Star Movement Chief Luigi Di Maio speaks after a conversation with Italian President Sergio Mattarella at the Quirinal Palace in Rome, Italy, April 1
2, 2018. REUTERS / Max Rossi / File Photo  The right-wing extremist league and the 5-star movement, which became the two largest parties to a fruitless election on March 4, have debated a common political agenda to form a coalition government and end more than 10 weeks of stalemate.
According to a recent draft of the Reuters agenda, both sides would pursue a policy that would violate EU rules on budget discipline: tax cuts, increasing welfare for the poor, and eliminating unpopular pension reform.
The policy would cost many billions of euros and have put investors in Italian debt, stocks and the euro. Italy is the third largest economy in the Eurozone.
In a direct challenge to EU budgetary rules, the draft also seeks to give the Union a fiscal leeway by adjusting the formula used to calculate Italy's debt burden, which has to be reduced according to the rules.
In calculating the debt as a share of gross domestic product – Italy's quota of 130 percent is the second highest after Greece in Europe – the draft proposes, in hundreds of billions of euros of Italian debt bought by the European Central Bank as part of quantitative easing ECB to discount (QE) program.
News of the draft agreement raised concerns in Brussels when European Commission Vice-President Valdis Dombrovskis told the European Parliament on Thursday that the new Italian government should respect budgetary discipline and further reduce public debt ,
"This is our message to the new government, it is important to stay the course," said Dombrovskis.
FILE PHOTO: League chief Matteo Salvini (C) speaks after a conversation with Italian President Sergio Mattarella in the Quirinal the next president of Fratelli d Italia (brothers of Italy) Giorgia Meloni (L) and the chairman of Forza Italia Silvio Berlusconi Palace in Rome, Italy, April 12, 2018. REUTERS / Max Rossi / File Photo
Italy's borrowing costs have risen as details of the deal emerge. The spread between Italian benchmark bond yields and safe German bonds has been at its highest since the beginning of January, as Italian 10-year bond yields have risen to their biggest two-day jump since March last year.
Outgoing Italian Prime Minister Paolo Gentiloni said at a meeting of EU Heads of State and Government in Bulgaria that he and other leaders were concerned that basic issues such as the need to protect public accounts were now being addressed political discussion.
The draft pact proposed a new "universal income" for the poor estimated at 17 billion euros, while saying that a planned weakening of an unpopular pension reform would cost 5 billion.
The plan was to introduce a flat tax rate of 15 percent for businesses and two tax rates of 15 and 20 percent for individuals – a reform that was long promoted by the league. Economists say it would cost well over 50 billion euros in revenue.
There was still no word on the thorny question of who would be the Prime Minister. Neither League boss Matteo Salvini nor the five-star leader Luigi Di Maio want the other to get the job, but they still need to find a mutually acceptable alternative.
President Sergio Mattarella, who has repeatedly emphasized the importance of maintaining a strong, pro-European stance, can also be dismayed at any deal the league and the 5-Star treaty make.
Each party plans to consult with its supporters over the weekend to see if they support the emerging government pact. The program is expected to be released on Thursday, said 5-Star.
Additional coverage by Huw Jones and Crispian Balmer; Cut by Mark Bendeich and Peter Graff