Romania’s new government comes up with radically revised fiscal policy

Romania’s new government comes up with radically revised fiscal policy
Prime Minister Mihai Tudose outlines his plans to the parliament.
By Iulian Ernst in Bucharest June 30, 2017

Romania’s parliament endorsed the new cabinet of Prime Minister Mihai Tudose by 275 votes to 102 on June 29. Tudose replaces Sorin Grindeanu, who was dismissed for delays in implementing the ruling strategy adopted after the 2016 general election. Broadly similar policies were expected under Tudose, but instead he prompted surprise and panic by unveiling a governing program that has at the core a radically revised fiscal and budgetary policy.

The ruling coalition formed by the senior ruling Social Democratic Party (PSD) and the Alliance of Liberals and Democrats (Alde), supported by the Democratic Alliance of Hungarians in Romania (UDMR), voted in a new cabinet. However, it is still unclear whether the fiscal reforms announced by Tudose are fully supported by Alde.

The paternity of the governing program also remains unclear. quoted unofficial sources who said central bank vice-governor Florin Georgescu and finance ministry state secretary Gheorghe Gherghina (the expert who has drafted Romania’s budgets for decades) contributed to the fiscal section. However, former finance minister Darius Valcov, who resigned when a corruption probe was launched against him but remains an in-house expert for the PSD, and other politicians are believed to have played the main role in authoring the populist strategy.

In general, the new program aims to distribute wealth more equitably. It aims to increase the share of labour in Romania’s GDP from 32-34% currently to above 40%, “versus 50-60% average in Europe,” the strategy reads. It also envisages higher taxes for companies. 

The sudden launch of a new governing program comes as a surprise after PSD leader Liviu Dragnea had threatened to resign if the original was not followed point by point and in a timely fashion. Grindeanu was dismissed precisely because he had not implemented the earlier program. But just six months after the December 2016 general election, the program appears to have been totally revised. This is likely to undermine the ruling coalition’s credibility, which has already been strained by the very public power struggle between Dragnea and Grindeanu. 

In addition, political support for the new governing program is not guaranteed. According to unofficial sources, Alde head Calin Popescu Tariceanu had been taken by surprise by the fiscal innovations disclosed to lawmakers by new Finance Minister Ionut Misa. Eventually, Alde voted in the new government, thereby also endorsing the newprogram — but the party still has the power to block specific policies that need a majority vote in parliament.

The new strategy has also caused concern among investors. Romania’s association of investors has summoned a press conference for June 30 in response to the new ruling strategy. 

Tax innovations

According to the program, the key fiscal innovations are the turnover tax to replace the 16% profit tax, and the global income tax tax to replace the 16% income tax. 

Higher taxes should be levied on companies (particularly multinationals), Dragnea told journalists on June 29, pointing to multinationals declaring profit margins in the region of 1-3% or even steady losses that would normally not justify their activity. 

The corporate turnover tax rate will reportedly range between 1% and 3%, but it is unclear on what grounds different tax brackets will be decided. 

The global income tax will reportedly be progressive, but the rates have not yet been disclosed. Alde senator Varujan Vosganian, the party’s main economic expert, said that the junior ruling partner would accept only global income tax rates below the current 16% income tax rate. 

Every year, individuals will also have to file a wealth statement similar to those filed by public servants under a law aimed at spotting an abnormal rise in their assets which could conceal gains from corruption. 

Social security contributions will be paid by the employer only (versus split payments made by both employer and employee currently). The minimum statutory wage will increase from RON1,450 currently to RON2,000 as of January 2018 and RON2,400 as of January 2020. For those with higher education, the minimum wages will increase from RON1,450 currently to RON2,300 as of January 2018 and RON3,000 as of January 2020.

The new government envisages boosting tax revenues by reducing tax evasion under a “split payment” VAT procedure (similar to that in Italy, according to the strategy). Supplementary revenues will be generated by regulating the markets for gold and other valuable metals. 

Further controversy was caused when new Misa told lawmakers of plans to “dismantle” the second pillar of the pension system. This was later denied by Dragnea, but not before the stock exchange’s indices had dropped by 4.6%

In the pensions sector, the ruling strategy stipulates an increase in public spending on pensions from 7.5% of GDP currently, “having in mind that the average in the rest of Europe is around 14% of GDP”.  Under the new strategy, the benchmark used for calculating individual pensions will increase from RON1,000 as of July 2017 to RON1,775 as of October 2020.

A measure with weaker economic impact, but envisaged rather for its expected political benefits, is the “solidarity tax” levied against those earning above 10 times the minimum statutory wage.

Sovereign wealth 

Romania’s new Sovereign Wealth Fund (FSDI) is the main element from the old program that has been incorporated in the new one. 

Tudose described the fund as “already done”, during his speech to lawmakers on June 29. According to the new prime minister, who designed the fund in his former position of minister of economy, it is based on the experience of countries such as Norway, France, Italy and Poland. 

“The FSDI will comprise profitable state-owned companies with a value of more than €10bn,” the strategy says. Tudose had explained previously that the €10bn would include the bond issued by FSDI and loans contracted for specific projects.

“The purpose of FSDI is developing or building from scratch businesses in priority areas, which [the fund] will support … on its own or in partnership with other funds or private investors,” according to the strategy.

“We estimate that some €10bn will enter the Romanian economy in the next four years through the FSDI,” the strategy also says. This means that the government is expecting companies in FSDI’s portfolio to generate (from dividends, privatisation revenues, bonds or sales of non-core assets) resources comparable to their market capitalisation within only four years. However, initially the launch of the fund is expected to lead to a contraction in budget revenues. 

The fund will also pour €3bn into motorways and high-speed railways, as well as spending €3.5bn to develop a national hospital and eight regional hospitals within four years.