This Selected Issues paper reviews the level and structure of tax revenues in Romania and proposes options to improve revenue mobilization drawing from other countries’ experiences. Tax revenue in Romania is low compared with peers and has been declining over time. Strengthening the tax administration is crucial to improving tax collection efficiency in Romania, and requires commitment and ownership at the highest levels. Implementing and operationalizing new information technology infrastructure in Romania is a key priority, given its outdated and fragile systems. Romania should also conduct a comprehensive review of its tax system. This review would guide future reform needs in the area of tax policy with the primarily focus on improving revenue productivity and the growth-friendliness of the tax system.

Abstract

This Selected Issues paper reviews the level and structure of tax revenues in Romania and proposes options to improve revenue mobilization drawing from other countries’ experiences. Tax revenue in Romania is low compared with peers and has been declining over time. Strengthening the tax administration is crucial to improving tax collection efficiency in Romania, and requires commitment and ownership at the highest levels. Implementing and operationalizing new information technology infrastructure in Romania is a key priority, given its outdated and fragile systems. Romania should also conduct a comprehensive review of its tax system. This review would guide future reform needs in the area of tax policy with the primarily focus on improving revenue productivity and the growth-friendliness of the tax system.

Options for Tax Revenue Mobilization in Romania

Romania’s tax system went through substantial changes over the last five years. However, its tax revenue ratio remains among the lowest in the Central, Eastern, and South-Eastern Europe (CESEE) region and does not seem to reflect the country’s relative level of development. Against this backdrop, this paper reviews the level and structure of tax revenues in Romania, analyzes the growth-friendliness and efficiency of its tax structure, and proposes options to improve revenue mobilization drawing from other countries’ experiences.

A. Introduction

1. Around 2011, Romania used to have a fairly well-designed tax system that was supportive of growth, despite low tax revenue collection. The findings of the last tax policy diagnostic from 2011 (IMF, 2011) concluded that Romania’s tax system was generally broad-based, with low rates and few exemptions (Figure 1). Moreover, after the 2008 crisis, the tax structure became more supportive of economic growth, with successive tax rate cuts and other reforms to growth-harmful taxes such as social security contributions and the corporate income tax (Box 1). However, Romania stood out in the EU context for having a very low tax-to-GDP ratio, and several areas for revenue improvement were identified. Excises and the property tax were proposed as potential sources for additional revenue, and some areas for improvement in Corporate Income Tax (CIT), Personal Income Tax (PIT) and Value-Added Tax (VAT) were highlighted.

Figure 1.
Figure 1.

Summary of Romania’s Main Taxes in 2011

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

Source: IMF (2011)

2. Multiple changes to the tax code have been implemented since 2013, seemingly without an overall tax policy strategy, while progress in revenue administration has been slow. These changes included tax rate changes, introduction of new exemptions, incentives and special rates, as well as modifications that have impacted the tax bases (Figure 2 and Appendix I). Some of these reforms (for example, changes to the social security contributions (SSC)) have also resulted in a tax structure that is now less supportive of growth. At the same time, progress in tax administration reform has been slow, failing to strengthen compliance and resulting in Romania having the largest VAT gap in the EU for several years. Consequently, the revenue envelope has structurally shrunk: tax revenue in 2017 was 24.8 percent of GDP, down from 27.3 in 2013, making it among the lowest in the EU (Appendix Tables IIA and IIB).

Defining a Growth-friendly Tax System 1/

A growth-oriented revenue reform would shift the revenue base away from corporate income tax and social security contributions, toward consumption and property taxes. Economic theory offers some broad principles into how budgetary policies can support growth. A ranking of growth-friendly taxes has been developed (Arnold, 2008; Johansson et al., 2008), according to which taxation of corporate profits has the most adverse impact on growth, as it reduces the return on savings and investment, thus discouraging domestic investment, foreign direct investment and productivity improvement. Labor taxes can reduce both the demand for and supply of labor. Social security contributions (SSC) can be especially harmful to employment if they interact with the withdrawal of social transfers upon taking up work. By contrast, recurrent taxes on immovable property are the least distortive tax instrument, followed by broad-based consumption taxes, particularly VAT, as they discourage neither savings nor employment. The composition of spending also matters for growth, especially if the reduction in tax revenue undermines infrastructure spending.

Empirical evidence for European countries supports the ranking of a growth-friendly tax structure. Results based on panel regressions that relate real per-capita GDP growth to a country’s cyclically-adjusted revenue categories (as a share of potential output) show a negative and statistically significant relationship of corporate income taxes (CIT) and social security contributions (SSC) with growth among European countries (box figure), as suggested by theory. In contrast, neither consumption nor property taxes show a significant relationship with growth. Interestingly, personal income tax (PIT) is also not associated with a significant negative growth effect.

uA01fig01

Estimated impact of taxes on growth

(Percentage points of real per capita GDP growth, 95 percent confidence interval)

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

1/ This box draws on the analysis and conclusions in IMF (2015), where extensive details are provided, including on the regression analysis.
Figure 2.
Figure 2.

Changes to the Tax Code in Romania (2013–2018)

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

Source: Ministry of Public Finance, Romanian Fiscal Council, and IMF staff.

3. More tax revenue will be needed in Romania to support the implementation of the government program and fiscal consolidation towards the medium-term objective (MTO). The government program envisages bringing more Romanians into the middle class, with increases in wages and pensions as well as tax cuts. A sizeable portion of the program has been implemented since the beginning of 2017, raising the budget deficit from 1.5 percent of GDP in 2015, to close to the excessive deficit procedure (EDP) limit of 3 percent of GDP. The share of rigid spending to tax has increased in recent years, undermining infrastructure spending (Figure 3). Government’s priorities of reducing poverty and increasing incomes will likely continue to require a significant increase in spending over the medium-term. In this context, tax revenue reform is key to preserving fiscal sustainability.

4. This paper conducts a diagnostic analysis of Romania’s tax system and proposes policy options to improve its revenue mobilization. Section B reviews the level and structure of tax revenue in Romania, including its growth-friendliness, in comparison to regional peers and other EU countries. Section C examines the efficiency of the tax system. Section D discusses revenue administration reform priorities drawing from other countries’ experiences, and how these reforms can help address efficiency gaps and thereby improve revenue mobilization. Section E provides some policy recommendations.

Figure 3.
Figure 3.

Rigid Spending and Tax Revenues in Romania

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

Source: WEO, IMF staff calculations

B. Romania’s Tax System in a Regional Perspective

5. Tax revenue in Romania is low compared to peers, and has been declining over time. In 2016, Romania’s tax revenue was on average 8 percentage points of GDP lower than in other Central, Eastern, and South-Eastern European (CESEE) countries, and about 11 percentage points of GDP lower than in other EU countries. The difference to CESEE countries is mostly explained by lower collection of VAT and SSC (Figure 4, Panel 1 and Appendix Table IIB). In addition, tax revenue in Romania has dropped by about 2½ percentage points of GDP since 2015 (Figure 4, Panel 2), and seems too low for its relative level of development measured by per capita GDP (Figure 4, Panel 3).1 Finally, in contrast to other CESEE countries, tax revenue in Romania remains below pre-crisis levels (Figure 4, Panel 4).

6. While Romania’s tax structure is similar to that of other CESEE countries, it has large discrepancies compared to advanced Europe. Romania raises a significant share of revenue from consumption taxes (26 percent of total tax revenue) and social security contributions (31 percent of total tax revenue), similar to other CESEE countries (Figure 4, Panel 5). However, Romania raises less from direct taxes on personal and corporate income. For taxes on personal income and property, the revenue yield in Romania—and more broadly in CESEE countries—is about half compared to that in advanced Europe.

Figure 4.
Figure 4.

Tax System in Romania – A Regional Perspective

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

Source: Revenue Analysis Tool (RAT), IMF fiscal Affairs Department, Tax Policy Division; WEO; IMF staff calculations

7. The growth-friendliness of Romania’s tax structure improved after the 2008 crisis, but may have deteriorated with recent changes to the tax system. Revenue from social security contributions and the corporate income tax declined substantially in the period 2008–16, following successive tax rate cuts and other reforms to these taxes (Figure 4, Panel 6). Up until 2011, the resulting revenue loss was compensated with an increase in VAT revenue. Overall, this contributed to a tax structure that turned more supportive to economic growth. Since then, however, successive VAT tax cuts, and extension of the number of goods and services subject to VAT reduced rates, have resulted in an overall drop in VAT revenue of around 1 percentage point of GDP. As a result, the share of revenue from most growth-supportive taxes (VAT, PIT, and property taxes) is still lower in Romania (and other CESEE countries)—at about 43 percent of total tax revenue—when compared to more advanced European economies (close to 53 percent).

8. Tax rates in Romania were comparable to peers until 2016 (Figure 5). This may suggest that its fairly low tax revenue relative to CESEE peers could be mostly explained by the low efficiency of tax collection. It should be noted, however, that since 2016, cuts in VAT, PIT and SSC rates have moved Romania below the CESEE average, and would have negatively impacted tax collection.

Figure 5.
Figure 5.

Tax Rates in Romania – A Regional Perspective

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

Source: Revenue Analysis Tool (RAT). IMF fiscal Affairs Department, Tax Policy Division.

C. How Efficient is Revenue Collection in Romania?

9. Tax efficiency in Romania is lower than in peer countries. Although tax rates are broadly aligned with peers in CESEE, tax efficiency2 lags behind, especially for VAT (Figure 6, Panel 1). The VAT C-efficiency indicator in Romania (0.5) is lower than in other CESEE or advanced EU countries (0.6). For the other main taxes, such as the PIT and CIT, efficiency indicators in Romania are close to other CESEE countries, but still below advanced EU countries. Similarly, the cost of collection in Romania is close to other CESEE countries but higher than in advanced EU countries.

10. The compliance gap is the predominant cause of low tax efficiency in Romania. Tax efficiency gaps can arise either because of a policy gap, which reflects deviations of current tax rules from the benchmark—as a result of tax exemptions, reduced rates, and special regimes—or the so-called compliance gap, which refers to imperfect compliance under the current tax system (Keen, 2013). While on the rise, policy gaps are relatively small in Romania (and more generally in emerging Europe), partly because tax systems in the region were designed from scratch during the transition from socialism in the early 1990s. In contrast, the compliance gaps, which are most closely related to the inefficiency of the tax administration, can be substantial in emerging Europe. This finding is particularly true for the VAT (Figure 6, Panel 2), where the estimated policy gap for Romania in 2013 was among the lowest in the EU but the estimated compliance gap was the highest in the EU. More recent estimates (CASE, 2016) show a marginal improvement for Romania—an estimated gap of about 37 percent.

11. Multiple changes to the tax system may have resulted in rising policy and compliance gaps in Romania. Since 2013, multiple changes to the tax code have been legislated (Figure 2 and Appendix I). While some of these changes have simply lowered standard rates (for the VAT, PIT), several changes have also introduced special tax regimes, loopholes and exemptions (for example, the number of goods and services subject to reduced VAT rates has increased). Besides the higher policy gap, multiple changes to the tax code in a relatively short period of time may have complicated tax administration and thereby negatively impacted revenue collection efficiency.

Figure 6.
Figure 6.

Efficiency of Tax Collection in Romania – A Comparison

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

Source: European Commission (2015).Note: Estimates for 2013. The VAT policy gap is the difference between the potential VAT that could be collected if all final consumption were taxed at the current standard VAT rate and the VAT that is actually collected. The VAT compliance gap is the difference between actual VAT collections and those that could be obtained if the existing VAT laws were perfectly enforced.

D. Tax Administration Reform and Tax Efficiency

12. Tax efficiency is tightly associated with the strength of tax administration. Figure 7 shows that there is a positive association between the tax administration strength index and tax efficiency—as measured by the combined tax efficiency indicators for the VAT, CIT, and PIT—for the sample of CESEE and advanced European countries. This suggests that addressing weaknesses in tax administration would help improve tax efficiency by narrowing compliance gaps.

13. The strength of the tax administration in Romania has been measured by objective criteria. Based on previous IMF work (IMF, 2016), a set of objective indicators have been compiled based on data from the OECD, to assess the strength of the tax administration in Romania. These indicators can be grouped into six key areas reflecting key organizational and operational aspects of revenue administrations in different countries relative to best international practice (Figure 8, Panel 1). The indicators were compiled for all CESEE and advanced European countries and scores were assigned to each of these indicators. The individual scores were subsequently aggregated into an overall index capturing the overall strength of tax administration—the tax administration strength index.

Figure 7.
Figure 7.

Tax Administration Strength and Tax Collection Efficiency

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

Source: IMF Staff calculationsNote: Red dots are CESEE countries, blue dots are advanced EU countries.

14. There is scope for improvement in several areas of Romania’s tax administration. The revenue administration agency (ANAF) should become more service-oriented, by proactively encouraging accurate reporting, speeding up dispute resolution and tax refund processing, as well as obtaining taxpayer feedback on services. Special attention should be given to implementing and operationalizing a new IT infrastructure, given ANAF’s outdated and fragile systems. This is borne out by the relatively low take-up of e-filing for the main three taxes in Romania as compared to other CESEE or advanced EU countries (Figure 8, Panel 2). Partly due to its weak IT systems, a modern compliance risk management approach has not been fully adopted in Romania. In addition, the effectiveness of the administration of large taxpayers continues to be limited by legislative, procedural and structural constraints. Romania also faces a relatively high level of tax debt, which requires resources to be allocated to debt recovery instead of audit and verification functions, consequently resulting in a relatively low value of completed verification actions.

15. Estonia provides a good example of how improving tax administration has resulted in high levels of tax efficiency (Figure 8, Panel 3). The Estonian Tax and Customs Board (ETCB) developed into a fully service-oriented revenue body, which allows for maximum simplification in the fulfillment of tax liabilities, through extended use of information technology (e-filing now covers almost 99 percent of total tax declarations). Risk analysis has been substantially upgraded, supported by the introduction of new methods for data analysis, development of a third-party reporting environment and automated submission of third-party reports. Information systems have also supported the administration of tax arrears, resulting in improved quality of tax recovery (tax debt is below 5 percent of revenues). These reforms started in the 1990s, with the adoption of a new tax system, but got new impetus in the context of a wider public administration reform in 1996, aimed at establishing an efficient and citizen-oriented administration that would meet the demands for the EU membership. Tax administration reform strengthened further during the global financial crisis in order to secure revenues following a severe recession. As a result of these reforms, Estonia stands out as having one of the lowest VAT compliance gaps in the EU and very strong tax efficiency also for other taxes.

Figure 8.
Figure 8.

Tax Administration Strength

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

Source: IMF (2016), IMF staff calculations

16. By improving tax collection efficiency, tax administration reform could generate sizable additional fiscal revenues in Romania. Considering the average tax efficiency for the main three taxes (VAT, CIT, and PIT), if Romania would raise efficiency to the average level of other CESEE countries, the overall revenue gain could be conservatively estimated at about 2½ percentage points of GDP (Figure 9, Panel 1). Moreover, raising tax efficiency to the level of the best performers in advanced Europe or Estonia would bring higher revenue for Romania, estimated in the range between 5–6 percentage points of GDP in the medium-term (Figure 9, Panel 2).

Figure 9.
Figure 9.

Potential Revenue Gains from Efficiency Improvements in Romania

Citation: IMF Staff Country Reports 2018, 149; 10.5089/9781484359563.002.A001

Source: IMF staff calculations

E. Policy Recommendations

17. Strengthening the tax administration is crucial to improving tax collection efficiency in Romania, and requires commitment and ownership at the highest levels. Implementing and operationalizing new IT infrastructure in Romania is a key priority, given its outdated and fragile systems. The significant funding agreed on in 2013 under the World Bank’s Revenue Administration Modernization Program (World Bank, 2016) has not succeeded in bringing the much-needed IT reforms, primarily because of lack of ownership. In addition, ANAF’s organizational structure needs to be improved to better deliver reforms, by simplifying the law and procedures. The effectiveness of the administration of large taxpayers continues to be limited by legislative, procedural and structural constraints. Modern compliance risk management approaches should be adopted, especially those that target large tax payers and high-wealth individuals, to better identify, assess, and quantify key compliance risks. Management of tax arrears should be improved, also to make more efficient use of limited human resources. Finally, ANAF should move towards a service-oriented revenue agency by proactively encouraging accurate reporting, speeding up dispute resolution and tax refund processing, and obtaining taxpayer feedback on services. All these reforms require strong political ownership to be successful in improving ANAF’s efficiency.

18. Romania should conduct a comprehensive review of its tax system. This review would guide future reform needs in the area of tax policy with the primarily focus on improving revenue productivity and the growth-friendliness of the tax system. Until this review is conducted—and until tax efficiency has improved considerably—further tax rate cuts and the introduction of new exemptions or special regimes should be avoided. In this context, further increasing the number of goods and services subject to VAT reduced rates should be resisted as this results in significant revenue losses, gives incentives for misclassification of goods, and increases the demand for refunds. Instead, a determined effort to gradually withdraw excessive tax incentives should be assessed as part of the tax system review.

Romania: Selected Issues
Author: International Monetary Fund. European Dept.