Taxation Blues

Romania, Volume 100
08.09.2005

The debate on how to ease an overstretched budget and adapt tax policies has been dominating the Romanian parliament in recent days. In particular, arguments over what to do about social security contributions and value-added tax (VAT), along with the grander pros and cons of the government's radical flat tax policy, have been grabbing business headlines.

Eventually, the government decided to keep VAT at 19%, retain its 16% flat tax and reduce social security contributions by an amount yet to be determined.

"We decided not to increase VAT to let the economy breathe and grow stronger," Prime Minister Calin Popescu-Tariceanu told parliament on September 5, "but I want to make it clear that should the measures fail, we would increase the tax."

Meanwhile, newly installed Minister of Public Finance Sebastian Vladescu was discussing social security contributions. Businesses have been complaining that these are currently too high, encouraging the growth of micro-businesses which exploit legal loopholes to dodge payment.

Currently, social insurance contributions are 32.5% of gross wages for companies and 17% for employees.

Vladescu therefore announced that there would be a reduction in contributions for employers in 2006. President Traian Basescu then also expressed his support for such a move, which would support the primary goal of increasing government revenues. "I am convinced the secondary goal will be achieved - the decrease of social insurance contributions," he said.

Romania has never been so obsessed with taxes as it is today. This trend was set by the 16% flat tax which was adopted by the new government back in January 2005 - a policy that angered the International Monetary Fund (IMF), which feared budgetary revenues would decrease.

This fear was then borne out as lower taxes in the first half of 2005 brought in reduced revenues for the government. Now the need to increase these revenues in 2006 is a real concern, with two options being bandied about in Bucharest presently. First, there is a possible move towards increasing taxation, or second, an overall enlarging of the tax base by including more taxpayers in budgetary collection.

One view is that the way to go is to reduce social security contributions - thus encouraging businesses to register workers and enlarging the tax base.

The size of the unregistered economy and its draining effect on government resources was highlighted by Popesu-Tariceanu in early September, when he said that "A normal health system cannot be functional with 20m beneficiaries and only one-quarter of [them] contributors."

Yet it has not been a smooth road trying to get all parties to agree on what to do. One party in particular which was quick to judge these measures was coalition government member, the Democratic Party (PD). The PD announced that it would not back a move to enlarge the tax base, and then suddenly backed down by agreeing it was necessary to bring in a "fair collection system".

Health Minister Eugen Nicolaescu stated that as pensioners, farmers and socially assisted persons are the main categories to be affected by such measures, this would finally put an end to discrimination within health insurance. Nicolaescu also said that by taking such steps the health budget would increase by RON1.1bn-1.3bn (305m-361m euros).

Despite further opposition towards the proposed steps, National Liberal Party (PNL) Vice-President Dan Radu Rusanu said that it was "certain" that there would be a reduction in social contributions in 2006 - and highly likely too that there would be an increase in VAT to 22%.

However, PD Executive Chairman Adriean Videanu warned that with a larger number of taxes being collected, there could be an increase in the unregistered economy.

"Such a measure may lead to the taxed money becoming part of the unregistered economy and this may trigger adverse macro-economic and inflationary outcomes," he told reporters.

Higher VAT is also of great concern to those sectors operating in highly competitive markets, such as tourism. The fear in this sector was that a VAT hike up to 22% would inevitably push up consumer prices and therefore drive tourist revenues away, as holiday makers looked for a better deal elsewhere.

To try and allay these fears, Vice Prime-Minister George Copos responded early September that VAT in tourism would remain at 9% for accommodation and breakfast.

Meanwhile, behind the current tussle there is an ongoing debate too about the efficacy of the government's flat tax policy. Many have suggested that the flat tax has done little to inspire growth and stimulate the economy.

A recent report from the National Institute of Statistics stated that while the period January-June 2004 saw 6.6% GDP growth on the same period of 2003, the first quarter of 2005 saw only 4.9% growth. This has led to annual forecasts of 5.5-6% for the whole of 2005.

The report showed that services were the main growth area during the first quarter of this year, showing a 6.9% boost, whereas industry and construction came in below average at 3.6% and 3.9% growth respectively. Meanwhile, agricultural production was down, 7.1% lower than at the end of June 2004.

One reason for this was undoubtedly the bad weather conditions and flooding which affected the country's crops this summer.

While the debate ended with little changed, except a commitment to reduce social security, steps do need to be taken quickly to lighten the load of overstretched finances, as the IMF will not take kindly to further widening of the budget and current account deficits. Meanwhile, as a meeting of the Romanian Association of Business People (AOAR) concluded on September 7, perhaps more effective collection of taxes is really the key to stimulating better fiscal performance.

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