Romania to push ahead with tax cuts despite IMF opposition

By bne IntelliNews March 30, 2015

bne IntelliNews -

 

Romanian Prime Minister Victor Ponta has appointed a new finance minister as the government prepares to push a revised Fiscal Code through parliament in April. However, the International Monetary Fund (IMF) warns that the impact of the new code, which will introduce a raft of tax cuts ahead of elections in 2016, should be more carefully evaluated.

The government endorsed the new Fiscal Code, which includes cuts in profit and income taxes and VAT, on March 25, ignoring earlier warnings from the IMF. Bucharest also plans to introduce a substantial VAT cut in June, ahead of the introduction of the new fiscal regime in January 2016.

Ponta told a press conference on March 27 that the government expects to post a RON1.5bn (€340mn), or 0.2% of GDP, surplus in Q1 instead of the expected 0.85% of GDP deficit, Romanian daily Adevarul reported. This would pave the way for the government to cut the VAT rate in June, by either 4pp to 20% for all goods, or to just 9% for selected food items, Ponta told journalists.

Securing parliamentary approval for the Fiscal Code is a priority for the government. This process suffered a setback in March, when a corruption probe was launched into finance minister Darius Valcov on March 19, just days before the revised code was approved by the government. 

Ponta personally took over as interim finance minister for a few days, before nominating European funds minister Eugen Teodorovici as Valcov’s replacement. Teodorovici’s appointment has been approved by President Klaus Iohannis and he is due to be sworn in on March 30.

However, the government still faces opposition to the new tax regime from the IMF, and Ponta’s determination to go ahead with the planned changes is likely to hold back future discussions over Romania’s stand-by arrangement (SBA).

At a press conference on March 27, the IMF mission chief for Romania Andrea Schaechter warned that sustainable fiscal consolidation and particularly improvements on the revenues side are needed before tax cuts are introduced.

Schaechter added that for “any additional tax cuts, offsetting measures need to be carefully considered” to ensure Romania meets its budget targets.

“There’s a trade-off here of going ahead with a very aggressive large reduction in a tax cut as long as maybe not all conditions are yet in place; at the same time to improve the compliance and the tax collections. So one would have to very carefully balance these. And this has to go hand in hand,” she said.

Schaechter also stressed that basing critical decisions on only two months of budget data (March data has not yet been officially released) is premature. “We would also have to caution that most of the surplus was registered because spending was much lower as laid out in the budgetary plans. So what would be important for tax cuts would be to see that we see some improvements on the revenue collection side,  that these are indeed permanent improvements,” Schaechter told journalists.

While Romania’s current VAT rate is high - a legacy of the recent economic crisis - Schaechter stressed that the size of the tax cuts and their timing have to be considered in the context of the current environment. “To better understand how the tax cuts, in their current form … would fit in with the commitments that the government also has under the Stability and Growth Pact, under its own fiscal rule, and what are the expected offsetting effects or measures that it plans to take,” she said.

The Romanian government’s decision to enforce fiscal cuts is likely to make it more difficult for Bucharest to revive its SBA, which was frozen in June 2014. At the latest round of talks in February, Romanian officials failed to reach agreement with an IMF mission on gas price liberalisation and other key issues including the fate of state mining and power companies CE Hunedoara and CE Oltenia. A new round of talks is expected in April.

The government also defied the IMF with a decision to cut the social security contributions rate by 5pp, which came into force in October 2014, a month before Romanians went to the polls in the November presidential elections. Plans for tax cuts under the revised fiscal code are also widely seen as a move to drum up support for Ponta’s Party of Social Democrats ahead of the 2016 parliamentary elections. While the main opposition party, the National Liberal Party, has criticised the revisions, it has outlined plans for a similar set of cuts. 

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