How to make the state stronger in a peripheral European economy?

13 Nov

First, lets start with the state’s money. In 2011 Romania and Lithuania had the lowest tax receipts per GDP in the EU and at 29 percent of GDP tax collection was below the 38 percent average for the new member states. IFIs and the EU pushed for better tax collection and the World Bank in particular contributed useful expertise in 2012 on how to boost the tax collection capacity of the Romanian state. Yet political backing for massive tax evasion rather than the incompetence of tax collectors that is the main issue. For in reality there is a lot of room for increasing government revenue.

If one looks at the implicit tax rates (i.e. the ratio between actual revenue collected from a given tax handle to the size of the tax base for that tax handle) the picture is very bleak: individuals and firms pay only 40 percent of what they owe. Indeed, no less than 4.3 percent of GDP is lost through the government’s failure to shrink the size of the informal labor market. This is not for lack of simplicity. The introduction of a flat tax in 2005 is the epitome of a simple tax system yet it only marginally increased tax compliance for personal income, while for corporations it was even lower in 2010 than in 2004. Moreover, the Romanian tax system is the worst in the EU at collecting VAT, leading to a loss of 3.8 percent of GDP through tax fraud. Summing up, even if the tax system would not be made more progressive, the Romanian tax collectors could raise for the government 8.1 percent of GDP.

Oh, and did I mention the corporate sector? There is a lot of noise around state owned corporations not paying their taxes. Yet any straight talking economist in the Ministry of Finance would tell you that of the roughly ten billion euros owed to the government every year and never paid, only one is owed by the much maligned public sector. The rest is owed by Schumpeterian heroes in the private sector. So much for self-serving morality tales.

As for calls to privatize all state enterprises let’s just consider for a second the fact that two thirds of SOEs are both profitable and solvent. A little more than a third of them are loss-making, thus generating quasi fiscal deficits for the state that remain off budget. The distribution is sectoral, with energy and gas having net operating profits and transportation producing loses (Romanian Fiscal Council 2011). These loses make to arrears, undermining tax and social insurance revenue. Following the introduction of Eurostat rules, around 30 SOEs have more than half of their revenues from government subsidies over a three-year period. This means that the general government balance will lose .5 percent of GDP. Yet the bulk of loses (1 percent of GDP and growing) are concentrated in rail and coal mining. Only one manufacturing plant (Oltchim) was loss making. The next biggest miscreants were private firms in tobacco and food processing. Just for the record.

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