The Romanian fiscal innovations

The governments of the Social Democratic Party have left more money in the pockets of the poor, have given greater power to the middle class and have tried to attract more budget income to the detrimental of the financial sector. All that happened through fiscal means. At the same time the fiscal system had low levels of effectivity, which negatively affected the quality of public services. Now the new government of the National Liberal Party promises reform of the fiscal agency, and Bulgaria is given as an example in tax collection

Vladimir Mitev

Bulgarians used to connect the governance of the Romanian Social Democratic Party with the redefinition of anti-corruption and the mass protests in protection of the judicial system. PSD’s actions in the fiscal sphere provoked less attention. However, they are also interesting and “innovative”. The comparison with Romanians could always be useful for understanding their and our situation on the road to “the shiny capitalist future”.

Starting in 2015 Romanians witnessed a special VAT rate for foods, lowering of the general VAT, fiscal stimulus for categories of employees such as the IT specialists, the so-called “fiscal revolution”, which transferred the payment of the social security contribution almost completely upon the workers’ shoulders, the introduction of “greed” tax upon the turnover of the banks and financial companies, the tax on microfirms was almost eliminated, while the dividend tax was reduced. These measures were introduced in a moment of economic growth, when the Romanian economy was leading in terms of GDP growth in the EU. The Romanians’ incomes grew – especially in the state sector. This was a consequence of social democrats’ policy of economic growth through higher salaries and greater consumption.

At the same time the tax collection remained low. Romania manages to collect only 70% of the VAT, only 28% of the profit tax, 70% of the income tax and 75% of the social security tax. No wonder that the budget income for 2018 is only 32,3% of GDP, according to Eurostat. Bulgaria collects 89% of the VAT, 51% of the profit tax, 93% of the income tax and 74% of the social securities. This permits Bulgaria to have budget income of 38,3% of GDP. No wonder that a December 2019 article in the Romanian site ”Curs de Guvernare” (Governance Course) tells about the reforms in the Bulgarian fiscal agency and gives Bulgaria as an example of success in tax collection. The new government of the National Liberal Party intends to make a reform of the Romanian fiscal system, exactly because in spite of all the fiscal innovations of the social democrats and in spite of the big GDP growth in the last years, the Romanian state is unable to benefit through larger tax collection. Next year the pensions will be increased by 40% and if the tax collection is not increased significantly large budget deficit will appear.

In this context the multidirectional fiscal measures of the last years provoke interest. In Romania just like in Bulgaria the banks, the mines, the distributors of electricity or gas are private and usually they are foreign owned. After the privatisation and the state’s withdrawal from the economy one of the few territories, where the state remains active and can influence the economy and the society is fiscal policy. The business is usually unhappy with the fiscal changes, because they prevent it from planning its activity. But fiscal policy is what allowed the Romanians social democrats and the Romanian state to put efforts so that more money are left at the poor’s disposal, so that the middle class is stimulated and greater budget income is collected from the corporations. PSD tried to do that, because in Romania unlike in Bulgaria, there is competition between two strong currents in politics – the technocratic one, where the secret services belong, and the political system (the oligarchy), whose most outspoken representative is the Social Democratic Party. In order to win elections in the conditions of competition, the social democrats had to give something to various social groups. This is where their fiscal innovations were necessary. It is another issue that a part of them were ineffective and were not well thought out.

On one hand the special VAT rate for food or the lowering of the VAT from 24%, first to 20%, and as of 1 January 2017 – to 19%, stimulated the consumption, and the economic growth. On the other hand, the fiscal revolution, which was introduced together with the lowering of the income tax from 16% to 10% increased the collection of social security contributions. Thirdly, measures such as “greed” tax, which affirmed the taxation of the turnover, not of the financial companies’ profits, were signs that the Romanian state tries to tax more effectively the foreign business, while many foreign companies in Romania don’t declare profit and don’t pay profit tax. Altogether, these measures have provoked contradictions, chaos, skepticism among entrepreneurs, who were constantly saying that they want predictable conditions. All the time dark scenarios for growth of the budget deficit and the current account deficit were made. It was said that the country will become indebted, the imports grew because of the increased consumption. At the same time the ideologues of growth through greater income and higher consumption pointed out that the external debt as a share of GDP gets lower, or that the new debt taken for a unit of growth is lower now than it was years ago. At the end, in October 2019 the social democrats were taken down from power and now the National Liberal Party rules. Its economic experts want balanced budget and austerity. Most likely the times of fiscal innovations is over and from now on the fiscal policy will get more boring and easy to predict.

 

The special VAT rate

Starting from 2013 there is a special VAT rate in Romania – 9%, for bread and bread products. It was introduced in the times of the government of Victor Ponta. Before the dismissal of his cabinet at the end of 2015, the government upgraded the 2013 measures, by introducing a special VAT rate of 9% for all the food. Then the government reported an increase of VAT income, in spite of the lowering of the rate. At the same time, according to calculations of the social minister Rovana Plumb a household of pensioners,who receive social pensions (at that moment 400 lei – 90 euro), received a monthly increase in the purchasing power of 20 euro, because of the lowered VAT.

In parallel with the VAT change as of 1 October 2015 the salaries in health care system were increased by 25%, and as of 1 December 2015 those in education were increased by 15%.

This line of lowering the VAT and increase of salaries in the budget sector continued all through the times of the Social Democratic Party’s rule. Its opponents were the economists from the financial sector and the governor of the Romanian National Bank Mugur Isarescu. They claimed that it is impossible to simultaneously lower the taxes and increase the salaries in the state sector, because a budget deficit will appear. The IMF insisted that the country doesn’t have budget deficit, larger than 3% of GDP, and keep it 1-1,5% instead. Nevertheless, the social democrats relied on the fact that the country is in economic growth, the GDP grows, so the people have to feel the benefits of development.

As a result of a number of fiscal changes at this moment VAT is 19%. There are two special VAT rates – 9% and 5%. 9% is the VAT rate for orthopedic products; for medicines for people and animals, food, drinks (without the alcoholic ones); for water, when it is used for irrigation; for oils and pesticides used in agriculture; for seeds and other agricultural products, as well as for agricultural services; for water distribution and sanitation. The special VAT rate of 5% is valid for manuals, books, newspapers and magazines; for tourist services, catering, for access to fortresses, museums, memorial houses, historical monuments, architectural and archeological monuments; for hotel accommodation, restaurant services (with the exception of alcoholic beverage, different from beer), usage of sport places, transport of people with trains and ski-lifts; construction of social houses.

The IMF’s expectations are that in 2019 the GDP will grow by 4,2% and reach 225 billion euro. In 2015 the GDP was 159,6 billion euro. Stepping on this large jump the PSD not only increased the salaries in the budget sector, but also raised the pensions – with 15% as of 1 September 2019 and with other 40% as of 1 September 2020. The new government announced that it will not revoke this increase, in spite of the fact that the budget is burdened significantly. 2020 is election year. There will be parliamentary and local elections. So any cuts of already achieved increased will influence the election results.

 

The income policy

“The raise of income (salaries) was inevitable, because the flight of human capital – emigration, had to be reduced. But such a policy would create macroeconomic disbalances, if it is not supported by care for the increase of fiscal income… The data of Eurostat shows that Romania has the highest level of non-collection of VAT in the EU. In Poland and Bulgaria – two countries where reform of fiscal administration has taken place, there is a large decrease of this indicator – in Bulgaria from 22% in 2014 to 12% in 2018, in Poland – from 24% in 2014 to 14% in 2014”, writes the economist of the Romanian national bank Daniel Daianu in an article, which was published a few weeks before the fall of the PSD government in October 2019.

In Daianu’s view it is worrying that public investment have fallen significantly, so that the budget deficit be kept below 3% of GDP. The governor of the central bank Mugur Isarescu believes that the private investment should grow and then the public investment as well. Otherwise Romania will continue to have a lot of cars and few good roads. It looks like the expectations of the new government are in this direction – to stimulate the private sector to invest.

 

The fiscal revolution

Such an encouragement was attempted by the social democrats through their fiscal policy as well. In order to stimulate the requalification of workers into programmers in the summer of 2017 the social democrats liberated the IT specialists from payment of the income tax. This liberation is valid for programmers, who have created income of more than 10 000 euro per year. But it is valid also for the employees of the newly-created software companies, who don’t have to prove that 10 000 euro / programmer are generated.

The measure will certainly brought about the boom of the Romanian software industry, which has large international players. In 2018, the first Romanian unicorn appeared – the company UI Path, which is active in the field of artificial intelligence and automation. According to an evaluation of the Romanian Association of the Employers in the Software Industry until the end of 2019 the Romanian IT sector has reached the turnover of 5,9 billion euro. 80% of this volume are generated by exports. The expectations are that until 2022 the turnover will reach 7,3 billion euro.

However, the programmers were among the main victims when the so-called “fiscal revolution” was introduced. It meant that the large part of social contributions payment was transferred from the employer to the employee. As of 1 January 2018 out of a social security burden of 37,25% the employee has to pay 25% social security contributions, 10% health contributions, while the employer has to pay only 2,25% for unemployment compensation, maternity support, etc. The transfer of the social contribution burden towards the employee was combined with the reduction of the income tax from 16% to 10%. This reduction corrected the negative effect of the social contributions transfer to an extent. But given that the programmers didn’t pay income tax, their net income fell.

In order to compensate for the increase in the burden of the social security contributions the employers in all sectors should have increased if they wanted the gross remuneration of their employees. The gross remuneration in 1,9 million labour contracts – 30% of the overall number of labour contracts in the Romania economy, were not increased after the fiscal revolution, said an answer of the Labour Ministry on 31 March 2018 to a question by the independent member of the parliament Adrian Dohotaru. 143 427 employers – or 28% of the overall number of the employers, had not increased the salaries. The fiscal revolution was explained by the government’s desire to increase the collection of social security payments. It is believed that their transfer upon the shoulders of the employee will allow employers to pay them on behalf of the employees, while in the previous state of affairs the state was unable to collect what the employers owed. However, even after the fiscal revolution the practice that the employers don’t transfer the social security contribution to the budget continued. Something more – 22 months after the revolution was introduced half of the firms had not introduced it. 2 billion lei were the unpaid social security obligations in November 2019, according to the financial minister Florin Citu.

The fiscal revolution itself was introduced through an emergency decree of the government and was complemented with a few new decrees, who entered in force. But in the months after January 2018 until today it was underlined in media that the fiscal revolution “stays” in Parliament, awaiting its final form. That is why some firms claimed that they don’t know how to apply it or how it will look like in its complete form. The constant changes of the rules in the Romanian business environment are probably one of the explanations why the fiscal income and tax collection in Romania have low levels and even Bulgaria is given as an example for a more effective fiscal system by the Romanian experts.

 

The “Greed” tax

The government of Viorica Dancila undertook another decisive measure in the second half of 2018 – the introduction of ”the greed tax” in order to increase the fiscal income. It was a tax upon the financial institutions. It was to be applied when the quarterly medium ROBOR index was higher than 2% (ROBOR is the interest rate, at which the banks, which contribute to this index’ calculation are ready to give loans in lei to other banks, which participate in the index, under the form of deposits). In this case the companies owed tax upon their turnover. In December 2019 the National Liberal Party government eliminated the “greed” tax. The logic behind it was that the large companies in Romania often don’t pay profit tax, because they can transfer their profit abroad through accounting operations and to report losses. However these companies operate in Romania and the state had interest to generate income from their activity. That is why the tax upon turnover was imposed. The financial minister in the present government – Florin Citu, comes from the financial sector. So the elimination of this tax was a priority for the government under his rule. The government has to find another way to fill the gap in the budget and one of the decisions was already seen – the expenditures cuts in health care and environment protection in the 2020 budget.

Both the fiscal revolution and the “greed” tax have provoked a lot of passions and unhappiness. There were labour unions protests against the fiscal revolution. In its turn, the business positioned itself against any fiscal innovation of the government, because the entrepreneurs thought that these innovations make the business activity more difficult and insecure. However the social democrats unloaded the business from the payment of taxes through a number of innovations. For example, they introduced a tax of only 1% for the microfirms (with turnover of up to 1 million euro). Practically, given that it can’t collect effectively the owed taxes, the Romanian state renounced on a large number of them. The explanation is that through its fiscal policy, the Social Democratic Party tried to win a part of the business on its side. Positioning itself against the corporations and technocratic sector, the social democrats directed their attention to this part of the middle class, which sees its interests as contrary to those of the corporations.

 

Opinions

In its analyses from the end of 2017 the deputy governor of the Romanian central bank Florin Georgescu explained that the fiscal changes of PSD are procyclical – in times of economic growth they stimulate additionally the economy. In their turn, they will probably lead to a moment, when during a slowing of the economy or crises another political force introduces other procyclical measures on the way down, cutting expenditures and raising taxes and thus deepening the crisis. What the social democrats do in the last years increases the volatility of the economy and creates greater risk for creditors and investors in the Romanian economy. Therefore “not all the policies, which stimulate demand, lead to an increase in the standard of living,” concludes Georgescu. The prime minister Ludovic Orban and the financial minister Citu don’t stop repeating that they have found large budget holes and that the social democrats’ rule was a failure, which has left a difficult heritage.

“If the disaster in economy means a medium growth of 5%, the budget deficit in accordance with the European methodology below 3% of the GDP, a falling share of the state debt in the GDP, falling gross and net external debt as a share in the GDP and growth of purchasing power, of the medium salary and of the medium pension with more than 25% for 2 years and 9 months of rule, then the sense of “economic and social disaster has changed”. My economic vision led to nominal growth of GDP with more than 30% in the last 3 years (2017-2019), an increase of 50 billion euro. For sure, from an ideological point of view of the capital it is a disaster to increase in two years the share of the workers’ remuneration as part of GDP from 35% in 2016 to 40% to 2018. Therefore, the increase of workers’ remuneration got higher by 28 billion euro for 3 years. Yes, probably from the standing point of the neoliberal paradigm this was indeed a disaster”, exclaims the economist Cristian Socol, who is considered the ideologue of the economic policies of the PSD in the last years, which achieved economic growth through higher income and more consumption.

“As a citizen, I am interested to be a balance between the business environment stimulation and the realisation by the state of certain obligations towards the citizens. At this moment the situation is completely unbalanced – and it will not get better, until the state start increasing its fiscal income, so that it could offer public services of quality… The few budget incomes mean less money for public goods and services. In my view of a citizen the government has lowered the taxes and thus it has benefited the rich”, explains Victoria Stoiciu – the programme director of the Friedrich Ebert Romania Foundation, before the blog “The Bridge of Friendship”. She gives as an example the labour taxation and the taxation of small firms. In the small firms with a turnover of up to 1 million euro and medium profit of 10% a tax of 1% must be paid upon 100 000 euro. At the same time the people who receive minimal salary take annually 3000 euro and owe a tax of 10%. That is how the Romanian fiscal system, just like the Bulgarian one taxes predominantly labour and consumption, but not the capital, says Stoiciu.

The fiscal innovations, which Romania applied in the last years are multidirectional and contradictory. They were introduced in a moment of economic growth, when even the mistakes, the poor organisation or unclear rules didn’t stop the macroeconomic move onward. The forces, which were looking for macroeconomic stability have taken a revanche and now it remains to see what will be kept and what will be eliminated from the applied measures. Probably there will be certain continuity. Even if it is unwanted, the salary and pensions increases cannot be renounced without a punishment at the election boxes. However the business wanted a balanced budget and predictability, so there will probably be no more surprises and rapid movements from now on. Is it possible that the private sector be the center, around which a new model of growth is formed, after the growth was coming for the time being from the raise of income and consumption? The National Liberal Party will have to answer this question. Most of all, it will look for a way to increase the tax collection through a more effective fiscal administration. In this regard surprising or not Bulgaria is given as example in Romania.

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