Romania: Parliament approves larger-than-expected cut to VAT despite EU and IMF warnings
July 1, 2015
Romania’s parliament approved far-reaching tax cuts on 24 June in spite of warnings from key international bodies that the move could trigger an unsustainable increase in the country’s fiscal deficit next year. The key measure consists of the reduction of the general value-added tax (VAT) from 24% to the 2010 rate of 19%, which is a 1.0 percentage point deeper cut than outlined in earlier proposals. Other measures comprise the elimination of special levies and the reduction of excise duties. The approved tax package will be included in Romania’s 2016 budget and is planned to be effective from 2016 through 2019. However, according to a recent statement from Prime Minister Victor Ponta, the government is currently discussing the possibility of enacting the approved measures this year.
At 24%, Romania’s VAT is one of the highest rates in the European Union (EU) and the recently-approved tax cuts form part of a wider initiative to loosen fiscal policy and partly reverse the tough austerity policies that were implemented in the aftermath of the 2009 financial crisis. This year, Romania’s government lowered the VAT on food items from 24% to 9% and increased both the minimum wage and state subsidies for children.
Prior to the parliament’s decision, the International Monetary Fund (IMF) and the EU cautioned that such fiscal easing threatened to undermine the country’s fiscal consolidation efforts and pointed out that Romania had not examined the sustainability of the plan thoroughly enough. Romania managed to reduce its fiscal deficit from 8.9% of GDP in 2009 to 1.5% of GDP last year. According to the Finance Minister, the new fiscal measures will widen Romania’s fiscal deficit to up to 2.9% of GDP in 2016, which by far exceeds the 1.2% of GDP that had been projected. The European Commission recently warned that the approved changes in the tax code could drive next year’s fiscal deficit above the EU’s threshold of 3.0% of GDP.
In breaking the fiscal targets that had been agreed on with the EU and the IMF, Romania risks not completing a EUR 4 billion precautionary loan agreement that ends in September and therefore may not achieve a new deal with the two bodies. Moreover, breaking the EU’s fiscal rules can jeopardize Romania’s envisaged entry to the Euro area in 2019. However, Romania claimed that these concerns were unjustified, arguing that the fiscal easing would boost economic growth and help fight tax evasion. The government also pointed out that the country’s tax revenues were higher than expected in the first months of this year.