​Tax changes that will affect taxpayers will continue in the coming years to gradually return the state budget to a negative balance close to the 3% of GDP threshold. Over the next three years, the budget deficit targets are: 5% in 2024, 4.7% in 2025 and 4.2% in 2026. 2024, a four-election year, is likely to be quieter, but 2025 will bring taxes back. on the short list of government priorities.

The forecasts begin with several prerequisites, which the Ministry of Finance also takes into account when drawing up the fiscal and budgetary strategy for the period 2024-2026 and which, briefly, can be summarized as follows: fiscal measures already taken in the last months of 2023 should supplement budget revenues at 1% of GDP, but they may not be enough to meet the budget deficit target, the improvement in collection through administrative measures, also projected at 1% of GDP, has a high risk of not materializing, and the election period puts serious pressure on public spending. But these concerns about the effectiveness of measures to reduce the budget deficit concern 2024, since from 2025 the commitment to the European Commission to further reduce the budget deficit, as well as the commitment of the PNRR to continue reforming the tax system, will come into effect. The Ministry of Finance refers to both, which we will talk about below in the article.

As discussed, Romania has a fragile macroeconomic situation due to large deficits – the current account deficit and the budget deficit, which actually show that the economy is growing due to consumption supported by debt imports. To mitigate the risk, the budget deficit should become sustainable, i.e. no more than 3% of GDP by European standards. But the mission is not that simple, as the past few years have meant overlapping crises caused by pandemics, disrupted supply chains and wars that have exacted unexpected costs. This was compounded by rising costs of public personnel and social assistance, including pensions, while tax revenue remained frozen at around 27% of GDP, according to Eurostat, compared with the EU average of 40% of GDP.

Low revenues to the budget, losses of VAT

There are many reasons for low revenues to the budget: a low number of taxpayers, tax evasion, weak administrative capacity and even the phenomenon of undeclared work. Let’s break them down one by one. Last year, the number of income tax payers was 120,000 legal entities. Instead, the number of micro-enterprises reached about 800,000, which is a consequence of the change in their tax regime, by increasing the turnover threshold from 65,000 euros ten years ago to 1 million euros in 2017. The number of employees who contribute to the pension and health care systems is 5.5 million people, and pensioners – almost 5 million people, which creates pressure on social insurance systems. At the same time, there were many exceptions, exemptions from all sections of the Fiscal Code for certain categories of people or goods or services: income tax, insurance contributions, VAT and others. Practically in recent years, the number of taxpayers has decreased, which has become noticeable in the revenues to the budget, contrary to the expectations of the initiators of these measures, who hoped that a lower tax burden would contribute to greater compliance with payment and appropriate collection. And we see this best in the case of VAT, for which the European Commission annually analyzes the collection gap caused by evasion, bankruptcy or poor administration.

In Romania, the VAT collection gap is 36%, so more than a third of VAT does not go to the budget, while the EU average is 5.4%. States in our geographic region had large gaps, similar to Romania, but they took very effective measures. For example, Bulgaria, which has a worse VAT collection performance than Romania, has so far achieved a VAT collection gap of only 4.9%, which is below the EU average. Poland managed to reduce it from 25% to 3.3%. What is common: a combination of reforms and digitization of tax administrations, modern legislation and cooperation with the business environment in defining measures. In addition, Romania has an important informal economy, namely self-employment in rural areas, and a significant share of 26%, according to Eurostat, of people of working age (15-64) who are neither working nor studying. This indicates the problem of undeclared work, as well as the policy of stimulating the employment of certain social categories.

What tax changes to expect?

Based on this context, let’s return to the expectations for the post-election period, which we mentioned at the beginning of the article. The Ministry of Finance’s document, which is the basis for writing the budget, the Fiscal Strategy, refers to the fact that “the World Bank is conducting an analysis of the way capital is taxed against labor tax”, as well as recommendations taken into account by the Romanian government. a taxation system adapted to the evolution of the economy will be introduced to promote economic growth and increase the share of tax revenues in GDP.” As you know, progressive personal income taxation is constantly discussed, and the World Bank’s proposal is referred to in support of returning to the system of progressive quotas. The ministry’s document leaves this possibility open for future years.

Regarding the income tax, the document talks about simplifying the tax relief for research and development, conducting an analysis of the effectiveness of the exemption from taxation of reinvested profits and continuing the gradual reduction of the scope of the special tax regime for micro-enterprises.

Other changes will occur in real estate taxation, which will be based on market value, and property tax benefits provided by law will be limited and revised.

We don’t think that after all the excitement of Fall 2023, anyone will be surprised that there are other changes. The reduction of the budget deficit will occur mainly due to the increase in revenues from fees and taxes and to a lesser extent due to the rationalization of expenses. This signal was evident in the recently adopted significant increase in pensions. Even if the government has taken some measures to reduce public spending, it will never be enough to cover the state’s resource needs. It is a reality that with tax revenues of 27% of GDP, we cannot expect public services of the same quality as those in states with revenues of 40% of GDP. Of course, such a jump is not possible in the foreseeable future, but an improvement of at least 30% of GDP is as reasonable as possible. How can you get it?

In our view, removal of distortions in the tax system and ensuring fairness are sound principles to be put into practice and being envisaged in the PNRR, they were also envisaged. By changing the taxation system and increasing the tax payer base, the budget revenues can certainly be replenished, but the measures taken also included experiments that, in our opinion, will very soon show their limits and even have a harmful effect, such as the minimum tax turnover. The companies’ efforts, both financial and compliance, will mean an increase in the budget of approximately 6 billion lei. Compared to the amount of about 40 billion lei that Romania loses from VAT, according to the European Commission, it goes without saying that mobilizing the tax administration to collect VAT would be incomparably more efficient and beneficial for the budget and the economy than the several billion that could potentially be obtained from companies. We note that some companies may decide to abandon investment if this tax becomes too much of a burden and reduces their competitive advantage, accordingly, they will not achieve high enough profitability to financially support the minimum tax, precisely because of the investment effort.

As a result, we believe that reforming and equipping the tax administration with new technologies can significantly increase tax revenues by combating tax evasion, increasing control capacity and simplifying compliance for taxpayers. We are currently seeing efforts to implement a common e-invoicing system, SAF-T, e-Transport and e-Receipt systems and data analytics modules that will facilitate better tax collection in the coming years.

Accelerated implementation of the digitalization of tax administration is estimated at 1% of GDP in the period 2024-2027, but the fiscal and budgetary strategy determines that the preliminary consideration of additional amounts from these sources poses a great risk to the budget deficit.

In conclusion, the budget deficit will remain a serious problem that will need to be solved in the coming years, and a set of measures aimed at the two pillars of the fiscal system, legislation and administration, will be needed, but based on political will, impact studies and close cooperation with the business environment. Reliable fiscal consolidation can increase budget revenues to 30% of GDP, keep the economy attractive to investors, and accompanied by structural reforms can lead to sustainable economic growth.

The article was signed by Daniel Angel, Ionuts Simion and Dan Daskalou.

Article supported by PwC Romania