Matteo Renzi’s government has already toughened up an earlier version of its budget at the Commission’s request.
After the changes, Renzi expressed confidence Italy would not be asked to do more.
The Commission’s decision, to be announced by the end of November, is likely to set the European Union’s executive body on a collision course with Renzi, 39, who has accused Brussels of being too rigid in view of the euro zone’s economic weakness.
Renzi’s original budget was an expansionary, tax-cutting package he said was needed to drag Italy out of recession. He agreed to toughen it when Brussels said it did not meet debt reduction rules.
However the EU source said even the latest budget plan fell short. The extent of the additional fiscal correction it will demand of Italy remains unclear.
The Treasury in Rome declined to comment.
The dispute revolves around the so-called “structural” budget deficit, adjusted for the business cycle, which Rome originally proposed to trim by just 0.1 percent of gross domestic product next year. That compared with a request from Brussels for a 0.7 percent cut.
After the Commission objections, Renzi presented a revised budget that increased the deficit reduction to 0.3 percentage points, or 4.5 billion euros.
European Economic Affairs Commissioner Jyrki Katainen said in late October that Italy, along with France and a few other countries which had agreed to toughen their draft budgets, no longer seemed to present “particularly serious non-compliance” with EU fiscal rules.
That judgement, however, did not amount to a definitive green light ahead of a final decision.
The source said the Commission was considering issuing a formal report on Italy’s debt, which far exceeds EU limits and is on a rising trend. Such a report could be a first step towards formal action against Italy by the EU.
This could eventually lead to Italy being fined for breaching the rules, though this would be an explosive political decision by EU governments and has no precedent.
Italy’s public debt exceeds 132 percent of GDP, the highest in the euro zone after Greece. It is forecast to rise next year.
(Reporting by Francesco Guarascio, writing by Gavin Jones; editing by James Mackenzie and Gareth Jones)