By Giuseppe Fonte
ROME (Reuters) - Italy's government reached a deal on Wednesday to reform an unpopular property tax, easing a source of persistent tension which had threatened to split the fragile coalition of traditional rivals from the left and right.
The cabinet agreed to abolish the housing tax IMU from the start of 2014, Prime Minister Enrico Letta told reporters, replacing it with a new levy known as the "Service Tax".
The two installments of IMU on principal residences which were due in September and December 2013 will be scrapped, Letta said after the cabinet meeting.
Silvio Berlusconi's centre-right People of Freedom (PDL) party has insisted that IMU on principal residences must be abolished as a price for backing Letta, raising fears that failure to reach a deal could provoke a political crisis.
The tussle over the tax has exacerbated an already bitter political climate caused by Berlusconi's conviction this month for tax fraud and an approaching vote in the Senate on whether to expel him from parliament.
Wednesday's deal removes an immediate headache for Letta, though tensions are likely to emerge over the formulation of the Service Tax which will take its place by combining IMU with another tax on refuse disposal.
What is certain is that Italy's strained public finances cannot do without the roughly 24 billion euros ($32 billion) currently yielded by IMU, which is also imposed on commercial property and secondary residences such a holiday homes.
"I am happy and satisfied, this is the most balanced solution that could be achieved," Letta said, adding that details of the Service Tax will be presented along with the 2014 budget in October.
The scrapping of the IMU payments on principal residences due this year will cost around 4 billion euros, to be funded partly by increased sales tax revenues from firms benefiting from an acceleration of back-payments owed by the public sector.
There will also be an increase in taxation of gambling and spending cuts which have yet to be been finalized, Economy Minister Fabrizio Saccomanni said.
Saccomanni also announced that the government would release a further 10 billion euros of payments to companies before the end of this year, on top of the 40 billion euros already agreed.
Berlusconi, who had made the abolition of IMU on primary residences a political crusade, was exultant.
"Promised and achieved," he said in a statement, adding that "ethics in politics means keeping promises. The PDL has respected its pact with its voters and Letta has respected his deal with the PDL".
Letta's centre-left Democratic Party (PD) had resisted demands to eliminate IMU on primary residences altogether, saying it would hit local services and other priorities including unemployment support.
It had proposed limited cuts that would have exempted most Italians while still imposing a levy on richer homeowners.
After weeks of relative calm for Italian government bonds, the uncertainty surrounding both the IMU issue and Berlusconi's conviction has unnerved investors, hitting Italian stocks this week and driving borrowing costs higher.
The main gauge of market sentiment, the spread between Italian 10-year bond yields and their safer German equivalents has widened markedly in recent days, climbing 30 basis points over the past two weeks to as high as 261 basis points on Wednesday.
The deal averts the threat of an immediate crisis which could bring on new elections, but the long months of wrangling have hurt the government's ability to achieve major economic reforms.
With Italy still struggling to emerge from its longest post-war recession, the government's problems range from 40 percent youth unemployment to the 2-trillion-euro public debt, and the long argument about the tax has bemused many observers.
"If the only problem facing Italy was IMU then you could say the country was doing pretty well," Riccardo Nuti, lower house parliamentary leader of the anti-establishment 5-Star Movement told RAI state radio. "But it's obvious the country isn't doing well and it has problems that are very different from IMU."
(Reporting by Giuseppe Fonte, writing by Gavin Jones and James Mackenzie; editing by David Stamp)