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Tax Policy Under the Curse of Low
Revenues: The Case of Romania
by
Daniel Daianu, Professor of Economics, SNSPA Bucharest
Ella Kallai, Chief Economist, Alpha Bank Romania
Laurian Lungu, Cardiff Business School and Macroanalitica
October 18, 2011, Bucharest
Agenda:
• Motivation
• The Current Crisis and the Role of Fiscal Policy Intervention in the EU,
2009-2010
• Taxes and Tax Revenues: the Romanian Experience
• Changes after the Introduction of the Flat Tax
• Taxpayers – Households and Companies
• The Shadow Economy – Implications for Tax Revenues
• Policy Recommendations
2
Motivation
Markets’ debt tolerance
reduced
Transition to harder
budget constraints in
public sector
•Is it due to poverty?
•Are legal taxes too small?
• Is it due to tax structure?
•Is collection inefficiency to
blame?
•Is it due to taxpayers?
•Is it tax evasion and
shadow economy?
Low budget revenues
•Limit redistribution
•Constrain public
investment
and supply of public
goods
Why budget
revenues are
low?
How budget
revenues can be
raised?
3
Current crisis and the role of fiscal policy intervention in the EU
10
Lu
5
stimulus (+)/consolidation (-) 20092010, %GDP
stimulus (+)/consolidation (-) 20092010, %GDP
10
0
RO
-5
Sk
Gr
Mt
Hu
Bg
-10
-15
Ie
Lv
-20
Ee
Lt
-25
Lu
5
Sk
0
-5
Mt
RO
Gr
Bg
Hu
-10
-15
Ie
Lv
-20
Lt
Ee
-25
0
30
60
90
120
General government gross debt 2009, %GDP
150
0
0.2
0.4
0.6
Tax revenue sensitivity to economic activity
• Fiscal austerity, or economic policies that compensate intense deleveraging in
the private sector growth? Short-term vs. medium/long-term fiscal correction.
• Large scale fiscal adjustment, in numerous developed countries, was needed
even before the crisis in order to deal with pensions and health care costs. EU27: 2007 vs 2010. Government deficit: 1% vs 7% of GDP. Public debt: 59% vs.
80% of GDP
• Scale and composition of adjustment tailored to the specific conditions of
individual countries.
Source: OECD, Commission services & 2010 Taxation trends
4
Current crisis and the role of fiscal policy intervention in the EU
(Cont’d)
• Consolidation was larger than stimulus measures; Scope of fiscal stimulus was
reduced in countries confronted with liquidity crises (Romania included)
• The rise in EU aggregate public debt (by 1/3) is caused by:
1. fall in tax receipts;
2. automatic stabilisers;
3. fiscal measures to mitigate decline;
4. bank bail-outs
• Ireland and Spain epitomize the role of excessive private sector indebtedness in
undermining financial stability and public debt sustainability
• Public debt sustainability hinges on economic competitiveness and growth
prospects (ex: Germany has a larger public debt than Spain)
5
The current crisis and the role of fiscal policy intervention in the
EU, 2009-2010 (Cont’d)
• The case of NMSs:
• Except Hungary, NMSs had low public debts before the crisis hit;
• A liquidity crisis threatened several NMSs which had run large
(double digit) external deficits and relied on heavy external borrowing
• Countries implementing fiscal stimulus have debt between 15-100%
of GDP
• The size of public debt is not always conclusive for making a
judgment on the need for immediate fiscal consolidation
• Not the size of gross debt-to-GDP drove the scale of stimulation/ consolidation, but
markets’ debt intolerance and tax revenue sensitivity;
6
The Romanian Experience
Revenues and expenditures of consolidated
budget
%
0
Romanian tax revenue-to-GDP gap
-2
-4
-6
-8
-10
-12
-14
-16
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
%GDP
43
41
39
37
35
33
31
29
27
25
total revenues
tax revenues
total expenditure
vs. NMS
vs. EU-27
• Objective: examine Romanian tax revenues performance over the last two
decades; look at stylised facts of tax revenues, their dynamics, and tax policies
• The decline in consolidated budget revenues in the 90s:
• a “disorganisation effect” due to economic regime change
• shrinking of the tax base; number of employees fell by 35% over ’89-’98
• tax rate cuts, adjustments in income tax brackets, tax exemptions/holiday
• Low tax revenues/GDP compared to NMSs (5% gap in 2009) and EU-27 (9%
gap in 2009) all over the last two decades
Source: Eurostat, European Commission Spring Forecast 2011
7
The Romanian experience (cont’d)
Is poverty responsible for low tax revenue?
The thesis that this is normal for an emerging economy does not stand scrutiny:
Bulgaria, Montenegro and Serbia collect more than Romania as % of GDP
GDP/capita, US$
2009
2006
2007
2008
2009
Tax revenue-to-GDP ratio
Albania
3,808
23
23.6
24.3
23.5
Bulgaria
6,423
34.1
34.8
33.3
30.6
Croatia
14,222
35.1
35.2
35.2
34.1
Macedonia
4,515
27.9
27.8
27.4
26.1
Montenegro
6,635
35.1
37.8
37.1
35.5
Romania
7,500
28.5
29
28
27.9
Serbia
5,872
38.2
36.8
35.8
35.5
Source: Albania-IMF 2010 Article IV Consultation Preliminary Conclusion of the Mission March 19, 2010, IMF Country Report
09/73; Bulgaria-and Romania European Commission, Croatia-IMF Country Report 10/179 and 9/185, Macedonia IMF Country
Report 11/42, Montenegro-IMF Country Report 9/88 and 11/100; Serbia-IMF Country Report 9/158, 10/25 and 11/95
8
The Romanian experience (cont’d)
%
60
Romania
Legal tax rates
Are legal tax rates too small in
Romania?
NMS
50
2000-2004
40
30
20
10
0
2000-2004
2005-2008
VAT
2000-2004
PIT
CIT
2005-2008
SSC
2000-2004 cuts were made to all main
taxes:
• SSC (60% to 49%),
• Corporate income tax (38% to 25%),
• VAT (22% to 19%).
These eroded the tax revenue to GDP ratio.
Source: European Commission, IMF
•VAT,PIT,CIT comparable with
average NMS
•SSC much higher than the NMSs
average
2005-2008
•VAT,PIT,CIT smaller than NMSs
average
•SSC remained higher than NMSs
average
9
Changes in Tax Revenues After the Flat Tax phased in
Direct taxes
Personal
income tax
(PIT)
Corporate
income tax
(CIT)
other
Social Security
Contributions (SSC)
Indirect taxes
VAT
Excise duties &
consumption
tax
Other taxes on
products
(import duties
including)
Employees
Employers
Self employed
+non-employed
~consumption tax
Other taxes on
production
PIT+SSC (compulsory) ~ labour tax
CIT+PIT+ other taxes on products + other tax on production ~ capital tax
10
Source: Eurostat
Changes in tax revenues after the flat tax phased in
(Cont’d)
Tax revenue
Tax revenue (including SSC)
45
EU-27
Romania
NMS
40
14
EU-27
Romania
NMS
12
35
10
%GDP
30
%GDP
25
20
15
8
6
4
10
5
2
0
0
2000-2004 2005-2008 2000-2004 2005-2008 2000-2004 2005-2008
actual
cyclically adjusted
2000-2004 2005-2008 2000-2004 2005-2008 2000-2004 2005-2008
VAT
PIT
CIT
SSC
other
• Budgetary effects difficult to estimate.
• Macroeconomic effects of flat tax introduction also difficult to disentangle from the
post-EU accession economic growth effects (massive capital inflows which bolstered
tax receipts)
After 2005
• No change in tax revenue as % of GDP; cyclically adjusted tax revenue has
declined
• VAT increased and PIT increased marginally as % of GDP:;SSC declined; No change
in CIT
11
• Only VAT approaches and CIT is slightly above NMS level, potential for other taxes
Source: Eurostat
(excise, royalty, environmental taxes)
Changes in Tax Revenues After the Flat Tax phased in
(Cont’d)
16
By tax categories
EU-27
Romania
NMS
By economic functions of taxes
25
EU-27
Romania
NMS
14
20
12
15
%GDP
%GDP
10
8
10
6
4
5
2
0
0
2000-2004 2005-2008 2000-2004 2005-2008 2000-2004 2005-2008
indirect taxes
direct taxes
SSC
2000-2004 2005-2008 2000-2004 2005-2008 2000-2004 2005-2008
tax on consumption
tax on labour
tax on capital
•The main pillars of tax revenues
•indirect taxes and SSC
•consumption tax and labor tax
After 2005
•The revenues from indirect taxes increased compensating the decline of SSC
•Revenues from consumption tax exceeded the revenue from labour tax
12
Source: Eurostat
Implicit Tax Rates and Tax Collection Efficiency
%
80
Rom ania
%
80
70
70
60
60
50
50
40
40
30
30
20
20
10
10
0
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
VAT
households' income tax
corporate income tax
social security contribution
NMSs
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
VAT
households' income tax
corporate income tax
social security contribution
• Graphs above show the ratio between implicit tax and legal tax, the closest to
100%, the most efficient tax collection/compliance is.
• Corporate income tax is collected in a proportion of 33% of potential, rising after
2004.
• There is a relatively high degree of tax compliance by individuals
• Efficiency of SSC collection far below other NMSs
• VAT collection efficiency also lower
• Differences can be explained by tax exemptions, loopholes and more tax
avoidance possibilities in Romania vs NMSs
13
Source: own computation based on Eurostat
Implicit Tax Rates and Tax Collection Efficiency (Cont’d)
VAT
25.0
R omania
gap= 9%
NMS
gap= 7.3%
gap= 7.4%
gap= 5.8%
20.0
• Revenues from
VAT,SSC,PIT and CIT
80% of tax revenues
%
15.0
10.0
After 2005:
5.0
0.0
2000-2004
2005-2008
legal tax rate
2000-2004
2005-2008
implic it tax rate
SSC
60.0
50.0
R omania
gap= 26.9%
NMS
gap= 20.7%
gap= 9.3%
gap= 11.1%
%
40.0
30.0
20.0
10.0
0.0
2000-2004
2005-2008
legal tax rate
2000-2004
2005-2008
implic it tax rate
Source: Eurostat, European Commission Taxation trends, 206-2011
• Tax collection efficiency
increased for both VAT
and SSC (gap between
legal tax rate and implicit
tax rate reduced)
• Tax collection efficiency
for VAT approaches NMSs
performance
• SSC collection
efficiency remained far
bellow NMSs
performance
14
Implicit Tax Rates and Tax Collection Efficiency(Cont’d)
C IT
30.0
25.0
R omania
gap= 19.8%
gap= 18%
20.0
Before 2005:
NMS
gap= 12.7%
%
gap= 10.2%
• CIT collection efficiency was
better than in NMSs
15.0
After 2005:
10.0
5.0
0.0
2000-2004
2005-2008
legal tax rate
2000-2004
2005-2008
implic it tax rate
P IT
30.0
25.0
NMS
gap= 15.8%
gap= 19.1%
gap= 8.3%
gap= 13.6%
%
20.0
R omania
15.0
10.0
• Tax collection efficiency of PIT
and CIT improved
• The gap between legal taxes
rates and implicit tax rates more
than halved for PIT
• Tax efficiency for both PIT and
CIT exceeds the efficiency from
NMSs (lower gaps between
legal and implicit tax rates)
5.0
0.0
2000-2004
2005-2008
legal tax rate
2000-2004
2005-2008
implic it tax rate
Source: Eurostat, European Commission Taxation trends, 206-2011
15
Taxpayers: Tax Revenues
%GDP
17
Personal income tax and social
contribution paid by individuals
15
13
11
9
7
5
ro
EU27
NMS
% GDP
12.5
12
11.5
11
10.5
10
9.5
9
8.5
Corporate income tax and social
contribution paid by employers
ro
EU27
NMS
• The taxes paid by employers was around 9% of GDP (2002-2008) and 8.5% of GDP
in 2009;
• Taxes paid by individuals increased from near 5% of GDP in 2005 to 7% of GDP in
2009;
• Voluntary payment compliance for all taxpayers was 78.9% in 2010
Source: European Commission, Taxation trends in 2011
16
Taxpayers: Households (HH)
Taxes* paid by households
Number of households
1.5 4.5
11
17
8
77
employees HH
agricultural HH
37
44
retiree HH
other HH
employees HH
agricultural HH
retiree HH
other HH
Households' income-to-GDP/capita
%
50
45
40
35
30
25
20
15
10
5
0
emploees HH
agricultural HH
retiree HH
2000-2004 2005-2008 2000-2004 2005-2008 2000-2004 2005-2008
In 2009
• 37% of HH are employee HH
and pay 77% of HHs’ taxes
• The tax revenue from
agricultural income extremely
small
• 44% of HH retirees and pay
1.3% of HHs’ taxes
In 2005-2008
• Employees HH average
annual income ~ 44% of
GDP/capita
• Agricultural HH average
annual income ~ 25%of
GDP/capita
• Retiree HH average annual
income ~36% of GDP
Note: * taxes on wages, pensions, independent activities, social security contribution, unemployment contribution and health insurance
Source: Households budget survey, INSSE
17
Taxpayers: Households (Cont’d)
Household's budget income
% income
80
70
60
50
40
30
20
10
0
emploees HH
agricultural HH
retiree HH
• Still large is the un-taxable part of
households income (in-kind
income mainly from own
agricultural products) after the
post 2005 decline (8% for
employee HH, 44% for agricultural
HH and 21% for retiree HH)
2000-2004 2005-2008 2000-2004 2005-2008 2000-2004 2005-2008
gross salaries
independent activities
own agricultural products
other
% income
50
45
40
35
30
25
20
15
10
5
0
social provision
Households' taxes and social benefit
emploees HH
agricultural HH
retiree HH
• The higher the in-kind income the
lower the tax contribution
2000-2004 2005-2008 2000-2004 2005-2008 2000-2004 2005-2008
taxes
social benefit
Source: Households budget survey, INSSE
18
Taxpayers: Households (Cont’d)
Households' income-to-GDP/capita, by income deciles
%
d1
d2
d3
d4
d5
d6
d7
d8
d9
d10
100
80
60
40
20
0
• 80% of HH have the average annual income lower than 60% of GDP/capita
• Only the richest 10% of households’ annual average income exceeds the
GDP/capita
Source: Households budget survey, INSSE
19
Taxpayers: Households (Cont’d)
Households' taxes and social benefit, by income deciles
taxes
social benefit
% income
30
d1
d2
d3
d4
d5
d6
d7
d8
d9
d10
25
20
15
10
5
0
After 2005
• More than 25% of 70% of households’ average income represents social benefits
• The share of social benefits in the richest 10% of households’ average income
increased, while the share of taxes has declined
Source: Households budget survey, INSSE
20
Taxpayers: Households (Cont’d)
Households' taxes and social benefit shares
taxes
social benefit
% total
40
d1
d2
d3
d4
d5
d6
d7
d8
d9
d10
35
30
25
20
15
10
5
0
After 2005
• The tax burdenslightly shifted towards the middle income 60% of households; they
pay 42.6% of total taxes (vs. 41% before 2005)
• The poorest 20% of households pay 1.9% of taxes (vs. 2.1% before 2005)
• The richest 20% of households pay 55.5% of taxes (vs. 56.9% before 2005)
• The tax contribution of all households increased, excepting the richest 10% of
households
Source: Households budget survey, INSSE
21
Taxpayers: Companies
% GDP
5.0
Fig. A3.1 Arrears to consolidated general
budget, by type
5.03
0.26
4.0
2.40
3.0
2.0
1.0
% GDP
3.0
3.7
0.12
2.89
1.73
0.10
0.19
3.36
1.30
0.15
2.19
Fig. A3.2 Arrears to consolidated general
budget of state companies, by type
1.69
0.15
1.34
2.51
0.09
1.09
0.08
2.3
0.14
3.57
0.09
1.50
1.60
0.12
0.13
1.66
1.76
2.0
1.03
0.83
1.0
0.12
1.22
0.0
1.89
0.04
0.04
1.14
0.04
0.99
1.48
0.05
1.4
0.04
0.55
0.04
0.79
0.78
0.03
0.61
1.99
0.04
2.07
0.04
0.78
0.79
0.05
0.06
1.13
1.18
0.0
dec.2005 dec.2006 dec.2007 dec.2008 dec.2009 iun.2010
social insurance
special funds
state budget
local budgets
dec.2005 dec.2006 dec.2007 dec.2008 dec.2009 iun.2010
social insurance
special funds
state budget
local budgets
• CIT revenues 2.5% of GDP; SSC paid by employers 6.1% of GDP in 2009.
• Arrears a systemic problem. Arrears to GCB rose to 4.2% of PIB in 2010.
• 45% of the arrears to the consolidated budget represent arrears to state
budget
• More than half of tax arrears are created by state companies
• Mining, manufacturing and services are major arrears generators: they
generate 30.5%, 21% and 21% respectively of all arrears to GCB
Source: Eurostat, European Commission Spring Forecast 2011
22
The Shadow Economy – Implications for Tax Revenues
GDP shadow economy (bn RON)
GDP shadow economy as % of 2010 GDP
Total fiscal evasion (as % of GDP), of which:
SSC
VAT
PIT
180
35
16.0
5.9
8.4
1.8
139
27
12.3
4.5
6.5
1.4
98
19
8.7
3.2
4.6
1.0
• Estimations of the shadow economy vary substantially – 3 scenarios
considered
• If the size of the shadow economy were 27% of GDP, or RON 139
Ron, fiscal evasion would amount to some 12.3% of GDP. In this
case, full compliance of paying taxes would bring to the budget
revenues equivalent to 12.3% of GDP (assuming a VAT rate of 24%).
VAT revenues alone would rise by 6.5% of GDP
Source: European Commission Spring Forecast 2011
23
Shadow Economy, Estimated Size (Cont’d)
Share of
informal
economy
brought to light
0.3
0.5
0.7
The size of the informal economy, % of total output
SSC
VAT
PIT
Increase in
budgetary
revenues
SSC
VAT
PIT
Increase in
budgetary
revenues
SSC
VAT
PIT
Increase in
budgetary
revenues
35
1.0
1.5
0.4
2.9
27
0.8
1.1
0.3
2.2
19
0.6
0.8
0.2
1.6
1.7
2.4
0.7
4.8
1.3
1.9
0.5
3.7
0.9
1.3
0.4
2.6
2.4
3.4
1.0
6.8
1.8
2.6
0.8
5.2
1.3
1.9
0.5
3.7
• Diminishing the size of informal economy would have considerable
positive budgetary implications
Source: European Commission Spring Forecast 2011
24
Conclusions and Policy Recommendations
• Fiscal consolidation is not achieved. Tolerance of markets to high budget
deficits is increasingly lower.
• Tax revenues to GDP ratio in Romania is extremely low  there is much
leeway for raising the revenue/GDP ratio significantly. How to do it?
• Need a fiscal strategy for the long term. Define a clear tax policy concept: tax
more personal income or consumption? Such an approach involves a forwardlooking attitude to tax policy.
• Any change in fiscal policy should have its main objective in keeping budget
deficit below 3% of GDP in the medium and long term - and as close to zero
as possible.
• Strive towards achieving optimal tax – more analyses need to be done here.
The implicit tax rates suggest the current tax structure is not optimal.
25
Policy recommendations (Cont’d)
• Is there a potential to raise the tax base? Potential tax adjustments relating to
household’s wealth (including agricultural land) or royalties. However, such
tax adjustments should pay attention to household’s work/saving incentives,
poverty of many farmers, as well as the effects on companies’ investment
plans.
• Fiscal strategy should focus on fiscal consolidation. Fiscal consolidation
should target raising fiscal revenues, since there is an enormous
leeway in this respect. Follow a ratio of 4:1 between reduced government
spending and tax increases? Fiscal consolidation should entail restructuring
government spending to support economic growth.
• EU funds could much mitigate the pains and pro-cyclicality of fiscal
consolidation in an adverse external environment.
26
Policy recommendations (Cont’d)
• Changes in fiscal policy should be pre-announced after comprehensive
analyses estimating the impact of the changes on the economy. Predictability
of fiscal policy is paramount in times of global uncertainty.
• Pay attention to the impact of the EU governance reform
• Reduce shadow economy: compliance procedures, efficiency in detecting
non-compliance, severe penalties for those who practice and perpetrate tax
evasion (including lay-offs of public sector employees)
• Increase administrative effectiveness and efficiency : Consolidating local tax
offices; Improving information systems and information technology
management as well as the operational capacity; Improve human resource
management function and strategy
• Stimulate domestic savings via tax allowances and support activities that can
improve Romania’s competitiveness – the fairness concept
27
Adopt a ‘Transparency and Credibility’ Package
• Causes for low tax revenues collection:
• Weaknesses of institutions responsible for collecting tax revenues
• Population’s perception that the value of public services offered in
exchange for the taxes it pays is extremely low
• Fairness. Government spending on various projects is often perceived (
and sometimes it is proved to be so) to be made to firms belonging to a
political clientele
• Individual ethical conduct, an important disciplining device based on the
principle of self regulation, is permanently dissuaded
28
Adopt A ‘Transparency and Credibility’ Package; Suggestions
• Announce full transparency of government spending programs- open
bidding process; spending benchmarks.
• Announce clear strategies for investments in infrastructure, health care and
education by nominating specific projects together with their costs and
completion time.
• Local public utilities: have tariffs and costs be published on the internet so
as to foster benchmarking and competition.
• Cost-benefit analysis should be done effectively (no public investment
above a certain threshold be done without such a thorough analysis).
29
Adopt A ‘Transparency and Credibility’ Package; Suggestions
(Cont’d)
• Budgeting and human resource management in the public sector should
shift from inputs to objectives and performance.
• Set up an independent Audit Office to monitor public sector spending.
• Make it easier for companies and individuals to pay their taxes. Simplify tax
forms and improve mechanisms for online payment.
• Announce a firm plan for tax reductions (SSCs for instance).The plan
should have a 2-3 years horizon and its continuation should be conditional
on the increased compliance in paying taxes.
• Raise penalties for tax evasion so that these would act as a deterrent.
30
Tax Policy Under the Curse of Low
Revenues: The Case of Romania
by
Daniel Daianu, Professor of Economics, SNSPA Bucharest
Ella Kallai, Chief Economist, Alpha Bank Romania
Laurian Lungu, Cardiff Business School and Macroanalitica
October 18, 2011, Bucharest