## 1. Defining a Growth-friendly Tax System ## Source details **Canonical URL:** [1. Defining a Growth-friendly Tax System](https://www.imf.org/-/media/files/publications/cr/2018/cr18149.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18149.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18149.pdf.json) --- ### Introduction and context - Romania’s tax system underwent substantial changes over the last five years, but its tax revenue ratio remains among the lowest in the Central, Eastern, and South-Eastern Europe (CESEE) region and does not reflect the country’s relative level of development. - Tax revenue in 2017 was 24.8 percent of GDP, down from 27.3 percent of GDP in 2013. - The paper reviews the level and structure of tax revenues in Romania, analyzes growth-friendliness and efficiency, and proposes options to improve revenue mobilization. ### Historical assessment and reforms since 2011 - Around 2011: - Romania had a fairly well-designed tax system supportive of growth despite low tax revenue collection. - The system was generally broad-based, with low rates and few exemptions. - Reforms after the 2008 crisis cut growth-harmful taxes such as social security contributions (SSC) and the corporate income tax (CIT). - Identified potential revenue sources included excises and property tax; areas for improvement included CIT, PIT, and VAT. - Since 2013: - Multiple changes to the tax code were implemented, seemingly without an overall tax policy strategy. - Changes included tax rate changes, introduction of new exemptions, incentives and special rates, and base modifications. - Some reforms (for example, changes to SSC) resulted in a tax structure that is less supportive of growth. - Progress in tax administration reform has been slow, contributing to Romania having the largest VAT gap in the EU for several years. - Measures implemented (2013–2018) by type and tax (counts from Figure 2): - Types of measures, by tax (2013-2018) — Tax rate: 28; Exemptions, incentives, special rates: 26; Administrative: 15; Base-broadening/shrinking: 17. - Number of measures implemented, by year and tax (total): 86. - Yearly totals of measures: 2013: 22; 2014: 9; 2015: 5; 2016: 23; 2017: 18; 2018: 9. ### Growth-friendly tax principles (Box 1) - Ranking of growth-friendliness (summarized): - Corporate income tax (CIT) has the most adverse impact on growth. - Labor taxes and SSC can reduce labor demand and supply; SSC can be especially harmful if interacting with withdrawal of social transfers. - Recurrent taxes on immovable property are least distortive, followed by broad-based consumption taxes (particularly VAT). - Empirical panel regressions for European countries show a negative and statistically significant relationship of CIT and SSC with growth; consumption and property taxes show no significant relationship with growth; PIT also not significantly negatively associated with growth. - Policy implication: - A growth-oriented revenue reform would shift the base away from CIT and SSC toward consumption and property taxes. ### Fiscal pressures and need for revenue - The government program envisages bringing more Romanians into the middle class with increased wages and pensions and tax cuts; a sizeable portion implemented since early 2017. - Budget deficit rose from 1.5 percent of GDP in 2015 to close to the EDP limit of 3 percent of GDP. - The share of rigid spending to tax has increased, undermining infrastructure spending. - More tax revenue will be needed to support the government program and fiscal consolidation toward the medium-term objective (MTO). ### Romania’s tax system in a regional perspective - Levels and trends: - In 2016, Romania’s tax revenue was on average 8 percentage points of GDP lower than in other CESEE countries, and about 11 percentage points of GDP lower than in other EU countries. - Tax revenue in Romania dropped by about 2½ percentage points of GDP since 2015. - Tax revenue in Romania remains below pre-crisis levels, in contrast to other CESEE countries. - 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). - The share of revenue from growth-supportive taxes (VAT, PIT, and property taxes) in Romania (and other CESEE countries) is about 43 percent of total tax revenue versus close to 53 percent in more advanced European economies. - Composition observations: - Romania raises less from direct taxes on personal and corporate income compared to advanced Europe. - For taxes on personal income and property, revenue yield in Romania—and more broadly in CESEE—is about half compared to advanced Europe. ### Tax rates - Tax rates in Romania were comparable to peers until 2016. - Since 2016, cuts in VAT, PIT and SSC rates have moved Romania below the CESEE average and would have negatively impacted tax collection. - Statutory rate trends shown for CIT, PIT, VAT, and total SSC indicate alignment with CESEE pre-2016 and divergence post-2016. ### Efficiency of revenue collection - Overall tax efficiency: - Tax efficiency in Romania is lower than in peer countries, especially for VAT. - VAT C-efficiency indicator in Romania is 0.5, lower than in other CESEE or advanced EU countries (0.6). - Efficiency indicators for PIT and CIT in Romania are close to other CESEE countries but still below advanced EU countries. - The cost of collection in Romania is close to other CESEE countries but higher than in advanced EU countries. - Causes of low efficiency: - Compliance gap is the predominant cause of low tax efficiency in Romania. - Policy gaps (due to exemptions, reduced rates, special regimes) are relatively small, but compliance gaps (imperfect enforcement under current law) can be substantial, particularly for VAT. - VAT specifics: - Estimated VAT policy gap for Romania in 2013 was among the lowest in the EU, but the estimated VAT compliance gap was the highest in the EU in 2013. - More recent estimates (CASE, 2016) show a marginal improvement for Romania—an estimated VAT gap of about 37 percent. - Impact of frequent tax code changes: - Multiple changes since 2013 (lower standard rates, increased number of goods/services at reduced VAT rates, new special regimes and exemptions) have likely increased the policy gap and complicated tax administration, negatively impacting collection efficiency. ### Tax administration and reform priorities - Association between administration strength and efficiency: - Positive association exists between the tax administration strength index and tax efficiency (combined VAT, CIT, PIT) across CESEE and advanced European countries; strengthening administration can narrow compliance gaps. - Assessment approach: - Tax administration strength measured using objective OECD-based indicators aggregated into six key areas to form a tax administration strength index. - Areas for improvement in Romania’s tax administration (ANAF): - Become more service-oriented: proactively encourage accurate reporting, speed up dispute resolution and tax refund processing, and obtain taxpayer feedback on services. - Implement and operationalize a new IT infrastructure: current systems are outdated and fragile; e-filing take-up for main taxes is relatively low compared to other CESEE or advanced EU countries. - Adopt a modern compliance risk management approach: not fully adopted in Romania partly due to weak IT systems. - Strengthen administration of large taxpayers: effectiveness limited by legislative, procedural and structural constraints. - Manage high tax debt: relatively high level of tax debt requires allocation of resources to debt recovery instead of audit and verification, resulting in a relatively low value of completed verification actions. ### Policy recommendations and reform directions (summary) - Shift revenue base in line with growth-friendly principles: - Move away from reliance on CIT and SSC toward consumption and property taxes. - Address VAT issues: - Reduce VAT compliance gap through stronger administration and targeted measures. - Strengthen tax administration: - Modernize IT systems and increase e-filing uptake. - Adopt compliance risk management and improve large taxpayer administration. - Reorient ANAF toward a service-oriented approach with faster dispute resolution and refund processing. - Consider revenue-enhancing measures while preserving growth orientation: - Explore potential of excises and property taxes as additional revenue sources. - Reassess recent tax code changes that introduced exemptions and special regimes that may have reduced growth-friendliness and complicated administration. ### Estonia: reform features and outcomes (lessons for Romania) - Reform features and outcomes: - The Estonian Tax and Customs Board (ETCB) developed into a fully service-oriented revenue body enabling 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 via new methods for data analysis, development of a third-party reporting environment, and automated submission of third-party reports. - Information systems support administration of tax arrears, resulting in improved quality of tax recovery; tax debt is below 5 percent of revenues. - Reforms began in the 1990s with a new tax system, gained impetus as part of a wider public administration reform in 1996, and were reinforced during the global financial crisis to secure revenues after a severe recession. - As a result, Estonia stands out as having one of the lowest VAT compliance gaps in the EU and very strong tax efficiency for other taxes. - Evidence on potential revenue gains from improving tax efficiency (Romania context): - If Romania raised efficiency to the average level of other CESEE countries, the overall revenue gain could be conservatively estimated at about 2½ percentage points of GDP. - 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. - R² = 0.6 (in the relationship between Tax Administration Strength Index and Tax Efficiency Index). ### Estonia-based policy recommendations (for Romania) - Strengthen tax administration with commitment and ownership at the highest levels. - Implement and operationalize new IT infrastructure as a key priority, given Romania’s outdated and fragile systems. - Note: Significant funding agreed in 2013 under the World Bank’s Revenue Administration Modernization Program has not succeeded in bringing needed IT reforms, primarily because of lack of ownership. - Improve ANAF’s organizational structure to better deliver reforms by simplifying the law and procedures. - Address legislative, procedural and structural constraints limiting the effectiveness of the administration of large taxpayers. - Adopt modern compliance risk management approaches, especially targeting large taxpayers and high-wealth individuals, to better identify, assess, and quantify key compliance risks. - Improve management of tax arrears to make more efficient use of limited human resources. - Move ANAF towards a service-oriented revenue agency by: - Proactively encouraging accurate reporting. - Speeding up dispute resolution and tax refund processing. - Obtaining taxpayer feedback on services. - Ensure strong political ownership for successful implementation of these reforms. - Conduct a comprehensive review of the tax system to guide future tax policy reforms with primary focus on improving revenue productivity and the growth-friendliness of the tax system. - Interim recommendations: - Until the review is conducted—and until tax efficiency has improved considerably—avoid further tax rate cuts and the introduction of new exemptions or special regimes. - Resist further increasing the number of goods and services subject to VAT reduced rates because this: - Results in significant revenue losses. - Gives incentives for misclassification of goods. - Increases the demand for refunds. - Assess a determined effort to gradually withdraw excessive tax incentives as part of the tax system review. *International Monetary Fund — OPTIONS FOR TAX REVENUE MOBILIZATION IN ROMANIA (May 18, 2018).* ### 1. Defining a Growth-friendly Tax System __________________________________________________ 3 ### 1. Defining a Growth-friendly Tax System ### Introduction and context - Romania’s tax system underwent substantial changes over the last five years, but its tax revenue ratio remains among the lowest in the Central, Eastern, and South-Eastern Europe (CESEE) region and does not reflect the country’s relative level of development. - Tax revenue in 2017 was 24.8 percent of GDP, down from 27.3 percent of GDP in 2013. - The paper reviews the level and structure of tax revenues in Romania, analyzes growth-friendliness and efficiency, and proposes options to improve revenue mobilization. ### Historical assessment and reforms since 2011 - Around 2011: - Romania had a fairly well-designed tax system supportive of growth despite low tax revenue collection. - The system was generally broad-based, with low rates and few exemptions. - Reforms after the 2008 crisis cut growth-harmful taxes such as social security contributions (SSC) and the corporate income tax (CIT). - Identified potential revenue sources included excises and property tax; areas for improvement included CIT, PIT, and VAT. - Since 2013: - Multiple changes to the tax code were implemented, seemingly without an overall tax policy strategy. - Changes included tax rate changes, introduction of new exemptions, incentives and special rates, and base modifications. - Some reforms (for example, changes to SSC) resulted in a tax structure that is less supportive of growth. - Progress in tax administration reform has been slow, contributing to Romania having the largest VAT gap in the EU for several years. - Measures implemented (2013–2018) by type and tax (counts from Figure 2): - Types of measures, by tax (2013-2018) — Tax rate: 28; Exemptions, incentives, special rates: 26; Administrative: 15; Base-broadening/shrinking: 17. - Number of measures implemented, by year and tax (total): 86. - Yearly totals of measures: 2013: 22; 2014: 9; 2015: 5; 2016: 23; 2017: 18; 2018: 9. ### Growth-friendly tax principles (Box 1) - Ranking of growth-friendliness (summarized): - Corporate income tax (CIT) has the most adverse impact on growth. - Labor taxes and SSC can reduce labor demand and supply; SSC can be especially harmful if interacting with withdrawal of social transfers. - Recurrent taxes on immovable property are least distortive, followed by broad-based consumption taxes (particularly VAT). - Empirical panel regressions for European countries show a negative and statistically significant relationship of CIT and SSC with growth; consumption and property taxes show no significant relationship with growth; PIT also not significantly negatively associated with growth. - A growth-oriented revenue reform would shift the base away from CIT and SSC toward consumption and property taxes. ### Fiscal pressures and need for revenue - The government program envisages bringing more Romanians into the middle class with increased wages and pensions and tax cuts; a sizeable portion implemented since early 2017. - Budget deficit rose from 1.5 percent of GDP in 2015 to close to the EDP limit of 3 percent of GDP. - The share of rigid spending to tax has increased, undermining infrastructure spending. - More tax revenue will be needed to support the government program and fiscal consolidation toward the medium-term objective (MTO). ### Romania’s tax system in a regional perspective - Levels and trends: - In 2016, Romania’s tax revenue was on average 8 percentage points of GDP lower than in other CESEE countries, and about 11 percentage points of GDP lower than in other EU countries. - Tax revenue in Romania dropped by about 2½ percentage points of GDP since 2015. - Tax revenue in Romania remains below pre-crisis levels, in contrast to other CESEE countries. - 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). - The share of revenue from growth-supportive taxes (VAT, PIT, and property taxes) in Romania (and other CESEE countries) is about 43 percent of total tax revenue versus close to 53 percent in more advanced European economies. - Composition observations: - Romania raises less from direct taxes on personal and corporate income compared to advanced Europe. - For taxes on personal income and property, revenue yield in Romania—and more broadly in CESEE—is about half compared to advanced Europe. ### Tax rates - Tax rates in Romania were comparable to peers until 2016. - Since 2016, cuts in VAT, PIT and SSC rates have moved Romania below the CESEE average and would have negatively impacted tax collection. - Statutory rate trends shown for CIT, PIT, VAT, and total SSC indicate alignment with CESEE pre-2016 and divergence post-2016. ### Efficiency of revenue collection - Overall tax efficiency: - Tax efficiency in Romania is lower than in peer countries, especially for VAT. - VAT C-efficiency indicator in Romania is 0.5, lower than in other CESEE or advanced EU countries (0.6). - Efficiency indicators for PIT and CIT in Romania are close to other CESEE countries but still below advanced EU countries. - The cost of collection in Romania is close to other CESEE countries but higher than in advanced EU countries. - Causes of low efficiency: - Compliance gap is the predominant cause of low tax efficiency in Romania. - Policy gaps (due to exemptions, reduced rates, special regimes) are relatively small, but compliance gaps (imperfect enforcement under current law) can be substantial, particularly for VAT. - VAT specifics: - Estimated VAT policy gap for Romania in 2013 was among the lowest in the EU, but the estimated VAT compliance gap was the highest in the EU in 2013. - More recent estimates (CASE, 2016) show a marginal improvement for Romania—an estimated VAT gap of about 37 percent. - Impact of frequent tax code changes: - Multiple changes since 2013 (lower standard rates, increased number of goods/services at reduced VAT rates, new special regimes and exemptions) have likely increased the policy gap and complicated tax administration, negatively impacting collection efficiency. ### Tax administration and reform priorities - Association between administration strength and efficiency: - Positive association exists between the tax administration strength index and tax efficiency (combined VAT, CIT, PIT) across CESEE and advanced European countries; strengthening administration can narrow compliance gaps. - Assessment approach: - Tax administration strength measured using objective OECD-based indicators aggregated into six key areas to form a tax administration strength index. - Areas for improvement in Romania’s tax administration (ANAF): - Become more service-oriented: proactively encourage accurate reporting, speed up dispute resolution and tax refund processing, and obtain taxpayer feedback on services. - Implement and operationalize a new IT infrastructure: current systems are outdated and fragile; e-filing take-up for main taxes is relatively low compared to other CESEE or advanced EU countries. - Adopt a modern compliance risk management approach: not fully adopted in Romania partly due to weak IT systems. - Strengthen administration of large taxpayers: effectiveness limited by legislative, procedural and structural constraints. - Manage high tax debt: relatively high level of tax debt requires allocation of resources to debt recovery instead of audit and verification, resulting in a relatively low value of completed verification actions. ### Policy recommendations and reform directions (summary) - Shift revenue base in line with growth-friendly principles: - Move away from reliance on CIT and SSC toward consumption and property taxes. - Address VAT issues: - Reduce VAT compliance gap through stronger administration and targeted measures. - Strengthen tax administration: - Modernize IT systems and increase e-filing uptake. - Adopt compliance risk management and improve large taxpayer administration. - Reorient ANAF toward a service-oriented approach with faster dispute resolution and refund processing. - Consider revenue-enhancing measures while preserving growth orientation: - Explore potential of excises and property taxes as additional revenue sources. - Reassess recent tax code changes that introduced exemptions and special regimes that may have reduced growth-friendliness and complicated administration. *International Monetary Fund — OPTIONS FOR TAX REVENUE MOBILIZATION IN ROMANIA (May 18, 2018).* ### 15. Estonia provides a good example of how improving tax administration has resulted in ### 15. Estonia provides a good example of how improving tax administration has resulted in ### Estonia: reform features and outcomes - The Estonian Tax and Customs Board (ETCB) developed into a fully service-oriented revenue body enabling 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 via new methods for data analysis, development of a third-party reporting environment, and automated submission of third-party reports. - Information systems support administration of tax arrears, resulting in improved quality of tax recovery; tax debt is below 5 percent of revenues. - Reforms began in the 1990s with a new tax system, gained impetus as part of a wider public administration reform in 1996 (to meet EU membership demands), and were reinforced during the global financial crisis to secure revenues after a severe recession. - As a result, Estonia stands out as having one of the lowest VAT compliance gaps in the EU and very strong tax efficiency for other taxes. ### Evidence on potential revenue gains from improving tax efficiency (Romania context) - Considering the average tax efficiency for VAT, CIT, and PIT: - If Romania raised efficiency to the average level of other CESEE countries, the overall revenue gain could be conservatively estimated at about 2½ percentage points of GDP. - 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. - Figures cited: R² = 0.6 (in the Tax administration strength and tax collection efficiency analysis). ### Key statistics (preserved exactly as presented) - E-filing coverage: almost 99 percent of total tax declarations. - Tax debt: below 5 percent of revenues. - Potential revenue gain vs. CESEE average: about 2½ percentage points of GDP. - Potential revenue gain vs. best performers/Estonia: between 5-6 percentage points of GDP. - R² = 0.6 (in the relationship between Tax Administration Strength Index and Tax Efficiency Index). ### Policy recommendations (for Romania, based on Estonia lessons) - Strengthen tax administration with commitment and ownership at the highest levels. - Implement and operationalize new IT infrastructure as a key priority, given Romania’s outdated and fragile systems. - Note: Significant funding agreed in 2013 under the World Bank’s Revenue Administration Modernization Program has not succeeded in bringing needed IT reforms, primarily because of lack of ownership. - Improve ANAF’s organizational structure to better deliver reforms by simplifying the law and procedures. - Address legislative, procedural and structural constraints limiting the effectiveness of the administration of large taxpayers. - Adopt modern compliance risk management approaches, especially targeting large taxpayers and high-wealth individuals, to better identify, assess, and quantify key compliance risks. - Improve management of tax arrears to make more efficient use of limited human resources. - Move ANAF towards a service-oriented revenue agency by: - Proactively encouraging accurate reporting. - Speeding up dispute resolution and tax refund processing. - Obtaining taxpayer feedback on services. - Ensure strong political ownership for successful implementation of these reforms. - Conduct a comprehensive review of the tax system to guide future tax policy reforms with primary focus on improving revenue productivity and the growth-friendliness of the tax system. - Until the review is conducted—and until tax efficiency has improved considerably—avoid further tax rate cuts and the introduction of new exemptions or special regimes. - Resist further increasing the number of goods and services subject to VAT reduced rates because this: - Results in significant revenue losses. - Gives incentives for misclassification of goods. - Increases the demand for refunds. - Assess a determined effort to gradually withdraw excessive tax incentives as part of the tax system review. *Source: cr18149 - 15. Estonia provides a good example of how improving tax administration has resulted in (IMF PDF content).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18149.pdf_