Tax Policy Under the Curse of Low Revenues: The Case of Romania
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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

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October 18, 2011, Bucharest

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October 18 2011 bucharest

Tax Policy Under the Curse of Low Revenues: The Case of RomaniabyDaniel Daianu, Professor of Economics, SNSPA BucharestElla Kallai, Chief Economist, Alpha Bank RomaniaLaurian Lungu, Cardiff Business School and Macroanalitica

October 18, 2011, Bucharest


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


October 18 2011 bucharest

Motivation

Markets’ debt tolerance reduced

  • Low budget revenues

  • Limit redistribution

  • Constrain public investment

  • and supply of public goods

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?

Why budget revenues are low?

How budget revenues can be raised?


October 18 2011 bucharest

Current crisis and the role of fiscal policy intervention in the EU

  • 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. EU-27: 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


October 18 2011 bucharest

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:

    • fall in tax receipts;

    • automatic stabilisers;

    • fiscal measures to mitigate decline;

    • 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)


  • October 18 2011 bucharest

    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;


  • October 18 2011 bucharest

    The Romanian Experience

    • 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


    October 18 2011 bucharest

    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

    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


    October 18 2011 bucharest

    The Romanian experience (cont’d)

    • Are legal tax rates too small in Romania?

    • 2000-2004

    • 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

    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


    October 18 2011 bucharest

    Changes in Tax Revenues After the Flat Tax phased in

    Social Security Contributions (SSC)

    Direct taxes

    Personal income tax (PIT)

    Employees

    Indirect taxes

    Employers

    VAT

    Corporate income tax (CIT)

    Self employed +non-employed

    Excise duties & consumption tax

    other

    Other taxes on products (import duties including)

    ~consumption tax

    Other taxes on production

    PIT+SSC (compulsory) ~ labour tax

    CIT+PIT+ other taxes on products + other tax on production ~ capital tax

    Source: Eurostat


    October 18 2011 bucharest

    Changes in tax revenues after the flat tax phased in (Cont’d)

    • 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

    • Only VAT approaches and CIT is slightly above NMS level, potential for other taxes (excise, royalty, environmental taxes)

    Source: Eurostat


    October 18 2011 bucharest

    Changes in Tax Revenues After the Flat Tax phased in (Cont’d)

    • 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

    Source: Eurostat


    October 18 2011 bucharest

    Implicit Tax Rates and Tax Collection Efficiency

    • 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


    October 18 2011 bucharest

    Implicit Tax Rates and Tax Collection Efficiency (Cont’d)

    • Revenues from VAT,SSC,PIT and CIT 80% of tax revenues

    • After 2005:

    • 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

    Source: Eurostat, European Commission Taxation trends, 206-2011


    October 18 2011 bucharest

    Implicit Tax Rates and Tax Collection Efficiency(Cont’d)

    • Before 2005:

    • CIT collection efficiency was better than in NMSs

    • After 2005:

    • 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)

    15

    Source: Eurostat, European Commission Taxation trends, 206-2011


    October 18 2011 bucharest

    Taxpayers: Tax Revenues

    • 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


    October 18 2011 bucharest

    Taxpayers: Households (HH)

    • 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


    October 18 2011 bucharest

    Taxpayers: Households (Cont’d)

    • 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)

    • The higher the in-kind income the lower the tax contribution

    Source: Households budget survey, INSSE


    October 18 2011 bucharest

    Taxpayers: Households (Cont’d)

    • 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


    October 18 2011 bucharest

    Taxpayers: Households (Cont’d)

    • 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


    October 18 2011 bucharest

    Taxpayers: Households (Cont’d)

    • 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


    October 18 2011 bucharest

    Taxpayers: Companies

    • 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


    October 18 2011 bucharest

    The Shadow Economy – Implications for Tax Revenues

    • 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

    23

    Source: European Commission Spring Forecast 2011


    October 18 2011 bucharest

    Shadow Economy, Estimated Size (Cont’d)

    • Diminishing the size of informal economy would have considerable positive budgetary implications

    24

    Source: European Commission Spring Forecast 2011


    October 18 2011 bucharest

    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 forward-looking 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


    October 18 2011 bucharest

    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


    October 18 2011 bucharest

    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


    October 18 2011 bucharest

    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


    October 18 2011 bucharest

    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


    October 18 2011 bucharest

    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


    October 18 2011 bucharest

    Tax Policy Under the Curse of Low Revenues: The Case of RomaniabyDaniel Daianu, Professor of Economics, SNSPA BucharestElla Kallai, Chief Economist, Alpha Bank RomaniaLaurian Lungu, Cardiff Business School and Macroanalitica

    October 18, 2011, Bucharest


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