Romanian MPs finally reach agreement on VAT rate cuts

After being approved and then rejected by the President, Romania this week finally achieved cross-party agreement on the extent of VAT cuts; it will drop to 20% from next year, and to 19% from 2017.

Romanian lawmakers agreed to shave 4.4 billion lei ($1.1 billion) off planned tax cuts, amid worries the proposals may blow a hole in the budget next year.

The original package included a cut in value added tax to 19% from 24%, as well as reduced levies on fuel and dividends. However, MPs across parties agreed to cut VAT to 20% from next year and to 19% from 2017.

The European Commission, International Monetary Fund, and Romania’s own central bank and Fiscal Council watchdog had all raised concerns over the scope of the initial proposed tax cuts. To address those concerns, the MPs agreed to cut VAT in steps and delay lowering excise tax on fuels until 2017.

The Prime Minister believes the cuts will help to boost growth and fight tax evasion.

Impact of the VAT change

Positive impact Negative impact
  •  Finance Minister Eugen Teodorovici said the postponed fuel tax cut and the smaller VAT cut would save around 4.4 billion lei next year
  •  It was argued the cuts would swell the budget deficit and public debt while fanning consumption in one of European Union's fastest growing economies
  •  The cut in Romanian VAT will increase the Romanian deficit to 2% in 2016 compared to the forecast 2015 figure of 1.8% - but is lower than the Maastricht ceiling of 3% - this may prove optimistic
 
  •  There is also a risk of adding to high growth in consumption and retail, and a rise in inflation. Romania had previously promised to creditors a GDP to deficit ratio of 1.2%
 
  •  The central bank's stance is that the package does not destabilise macroeconomic stability and deficit; and public debt targets are agreed with international lenders
 
  •  A 2% deficit does not seem feasible especially if one takes planned wage hikes into account; this could lead to a reduction of credibility, problems with the debt cost, and the monetary policy will suffer

Our experts say...

Romania once held the second-highest rate in the region (after Hungary’s 27% rate) but this reduction brings its VAT in line with its neighbours. It will be interesting to see whether this decrease will ultimately lead to an increase in consumption, better compliance and economic growth.

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Peter  Goff
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