The 22-year-old AC Milan forward has been ruled out of not only the semi-final against Spain on Thursday, but now also Sunday's final or third-place play-off.
Enrico Castellacci, the head of Italy's medical staff, said on figc.it: "I met with Balotelli this morning. The medical condition is not satisfactory, he cannot recover even for the finals on Sunday.
"To avoid unnecessary risks we decided, in agreement with (coach Cesare) Prandelli and after talking to the medical staff of AC Milan, to send the player back to Milan."
Balotelli picked up his injury in Saturday's 4-2 defeat by hosts Brazil.
Castellacci said midfielder Andrea Pirlo, who missed the Brazil game with a leg injury, had a chance to be fit for the Spain match.
He said: "He is continuing to work hard and we are cautiously optimistic. But we have to evaluate his case day by day and if he does play against Spain it will be decided only at the last moment."
Riccardo Montolivo sat out training on Sunday after picking up a head injury in the previous night's game, but Castellacci said he was "fine and available".