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Ion Ghizdeanu, Fănel Videanu, St. Cristian Stănică, Daniela Plăvicheanu*
The Effects of Flat Tax in Romania
Over the last years, the business environment has
accumulated structural, institutional and
behavioural tensions. The only viable solution was
the introduction of a flat tax which was meant to
bring a fiscal expansion. It was indeed the time of
taking the decision, in spite of critics and
opposition from former governance.
The introduction of the flat tax led, first of all, to
a simplifica-tion and a more efficient computation
system of global income taxation, to a significant
reduction of bureaucracy and to an increase of
transparency in tax collection and administration.
On the other hand, a fiscal expansion was necessary
from the following points of view:
• Structural and behavioural inertia in real
economy decrease the effect of fiscal expansion
of low amplitude, although they are repeated
at regular time spans.
• A big share of hidden economy does not react
to such low institutional shocks.
Introduction of 16 percent f lat tax was launched
by decreasing the taxation rate at the level of direct
taxation of income and profit, because the
economic behaviour is directly generated by this
type of taxation, and not at the level of indirect
taxation or consumption.
The expected impact was mainly the change in
economic behaviour of business environment, by:
• Increasing the tax base by extending the formal
economy and making official a part of the
hidden economy.
• Increasing the voluntary compliance in paying
budgetary obligations.
• Increasing the arrears recovery, depending on
the change in financial position of economic
agents, following the reduction in profit taxation.
According to the new fiscal policy, duties and taxes
should have a stimulative and orientative role for
an economic growth and development, a fiscal
consolidation and a middle class progress.
* Government of Romania, National Commission for Economic Forecasting
Together with the main measure applied in 2005
of introducing the flat tax of 16 percent both on
profit and income, a process to align towards the
level of flat tax the legal rates of taxation of the
other sources of revenues (dividends, interests,
capital revenues) started as well.
In the area of income tax, the global system of
taxation of income achieved by private persons that
assumed the use of a taxation standard with
progressive quotas between 18 and 40%, was replaced
by a system based on proportional quota of 16%,
applied to the largest part of the income categories.
According to the new system, the procedure of
globalizing several incomes is given up while the
tax becomes final as the system by the taxation of
the incomes by each source of income in each
category is being replaced.
The categories of income for which the tax is
computed by levying the 16% quota on each source
of income in the respective category are: incomes
from independent activities; incomes from wages
and salaries; incomes from yielding the use of goods;
incomes from pensions; incomes from agricultural
activities; incomes from prizes; incomes from other
sources.
The 2005 budget was computed so that it ensures
the sustainability of the budget itself and the
aggregate demand.
The modelling of the tax bases’ reaction to the
variation of the legal tax rates was made through a
logistic function, function that is, nevertheless, the
most adequate for modelling the institutional
impulses’ transmission. The logistic function was
calibrated at the level of parameters in line with
the dynamics of indicators from the SAM-MEGA
economic model, an annual model for financial
programming, based on the equilibrium relations
of the national accounts system, used for the
macroeconomic forecast and financial program-
ming on medium term.
In the budgetary revenues projection, one took into
account the behaviour of economic agents as well,
108     UMAR      IB revija  1-2/2006
although at this moment no behavioural relations
have been built on, expressed by:
• The favourable reaction of companies to the fiscal
relaxation policy, in the sense of the partial
formalization of employment; as a result, one
estimated for the entire period a growth of the
number of employees by 415 thousand persons,
double as compared to what it would have
resulted from the normal elasticity between
economic growth and employment;
• The improvement in propensity to pay the debts
to the budget, expressed for example by the
increase of collection rate for social security
contribution by almost 2% on an yearly basis;
in the same sense one estimated that the taxes
on product will maintain their dynamics over
the Gross Domestic Product’s one;
• The preservation of economic agents’ behaviour
oriented toward competitiveness and a
moderate growth of salaries, in accordance with
the economic achievements; as a result, one
took into considera-tion that the gross average
wage earning by total economy will not exceed,
during the entire period, the increase foreseen
in the Governing Programme, of 60%.
From this point of view, the scenario resulted from
SAM-MEGA model for the level and structure of
budgetary revenues in 2005 does not significantly
differ to the rectified budget of 2005.
A comparison between the rectified budget of 2005
(September 2005) and the Governing Programme
stresses out the following:
• The revenues estimated for 2005 by the
Ministry of Public Finance are 5% higher than
the budgetary revenues in the Governing
Programme;
• The tax revenues have equal shares in GDP in
both cases (27.1%), both for direct taxes and
the indirect ones;
• The only difference can be found in the profit
tax. The fact that the achievements in the first 9
months determined the Government to increase
the provisions concerning the levies from profit
tax (29% larger than in the Governing Program-
me) ref lects only the fact that the economy
responded to the reduction of this type of tax
even better than expected at the moment of
elaboration of the Governing Programme.
The positive effects of fiscal expansion are
significant and emerge mainly from the incentive
role of the direct taxation on labour and capital
reduction. The assumption according to which the
transfer of resources from the budget to the
population and society has a multiplying effect in
economy, by generating superior revenues for the
budget, on the background of more intense
economic activity, has proven to be realistic. The
main conclusions emerged from pertinent statistical
data analyses which are presented below:
1. Stimulating the economic growth.
• The profit tax reduction assured important
financial resources to the economic agents for
production and investment.
• Excluding the f loods’ impact on agriculture,
and on the household industry (part of industry
with a share of 4 percent in Gross Domestic
Product), the Gross Domestic Product of the
other branches increased, in the first 9 months,
by 6.5 percent as compared to 6 percent in the
same period of 2004.
- GDP growth on 9 months: 3.6 percent
- GDP growth, without agriculture:
5.8 percent
- GDP growth, without agriculture and
household industry: 6.5 percent
2. Technological modernization of economy has
accelerated, with positive impact for the future
economic growth.
• Gross Fixed Capital Formation has accelerated
its growth in the third quarter as well, by 10.5
percent, respectively, determining an increase
on 9 month by 9.4 percent.
• The import of capital goods increased in the
first 9 months by 31.2 percent, as compared to
the average increase of imports of 23.7 percent
and with the one of consumption goods of 24.7
percent.
3. Improvement of the effective rates of taxation
The introduction of flat tax has a significant effect
on the taxpayers’ behaviour, in the sense of
increasing the degree of voluntary compliance, of
paying the budgetary obligation, respectively.
a) To the profit tax – according to the balance
sheets of economic agents, on the first 6 months
the gap between the legal rate and the effective
one, computed on the base of the due tax, was
improved:
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IB revija 1-2/2006       UMAR    109
• The differences between quotas have been
reduced together with the increase of the profit
mass in economy and the diminishing – in real
terms – of losses.
In the first quarter, the total profit increased
in real terms by 1 percent, and the total loss
has been reduced by 5 percent.
The introduction of f lat tax together with the
strengthening of the  financial discipline led in
the first semester to a budget revenue from the
profit tax 50 percent higher than the due profit
tax.
b) To VAT (as compared to the market consump-
tion of population), the effective collecting rate
has been improved, reflecting the reduction in fiscal
evasion:
  14.3% in 2004
  15.4% in 2005
The improvement in VAT collecting rates leads to
an increase of 36.2 percent of VAT that was
reflected in the increase in indirect taxes by 25.3
percent, for 12 months 2005.
4. Budgetary revenues
For the 12 months of 2005, the revenues of the
general consolidated budget were higher by 17.8
percent than in the same period of 2004, meaning
in real terms an increase by 8.1 percent.
• In absolute terms, the increase in revenues was
mill. RON 12,608.7, of which the increase of
the state budget was mill. RON 4,404.6.
These results were obtained in the condition in
which the appreciation of national currency (unlike
in the year 2004 when the national currency had
depreciated) has influenced in a negative way the
cashing of excises (the excises are computed in
Euro and if we have had depreciation, the payment
in lei would have been greater).
• Due to the increasing number of both employe-
es and average earning salary, the revenues of
the main social security funds (social security
fund for health, the state social security budget,
the social security budget for unemployment)
increased by 11 percent in 12 months 2005.
• The Value Added Tax on whose evolution
contribu-ted mostly the reduction of direct
taxation at the income level, generating  this
way an increase of disposable income of
population, meaning a higher consumption of
goods and services, presented the most signifi-
cant nominal increase of the total budgetary
revenue sources, by 36.2 percent respectively,
meaning 24.9 percent in real terms.
5. The effects of introduction of the flat tax rate
on employment
• The introduction of flat tax assured the reversal
of previous historical evolution of annual
increase of employees’ number from the hidden
economy.
• Even if the monthly data regarding the number
of employees has shown a seasonality pattern,
yet the significant increases registered this year
(the highest ones since 2000) showed that the
fiscal expansion encouraged employment.
- In the delivered materials there is a detailed
analysis of flat tax effects on employment.
• The final statistical data regarding the first
semester (households’ inquire) show that the
increase in employees’ number in the first
semester totally represented a transfer from the
hidden economy to the official one, by 125
thousand persons, respectively.
• A second conclusion – emerged from the
operative data at the end of October – reveals
that the employees’ number was higher by 140
thousand persons, as compared to December
2004.
• One has to highlight that if we do not take into
account the reduction in industry - due to the
reorganisation and the need of increasing
competitiveness of some activities - the net
increase of employees in other activities is 193
thousand persons, as compared to 2004.
6. The effects of flat tax on average wage earning
• Flat tax introduction was ref lected in the
increase in salary incomes, but these results
were pointed out in the evaluations made before
the flat tax introduction, meaning a correct
substantiation of usefulness of fiscal reduction
for Romanian economy.
• During January–November 2005, the increase
of gross average wage earning is only by almost
2 percent over the forecasted level.
• The share of net average wage earning in the
gross average wage earning became 76.4 percent,
exactly as anticipated.
For the next period, fiscal legislation reform will
grant priority to the consolidation of competitive-
ness advantages obtained by flat tax introduction
and to the continuation of the process of alignment
to the aquis communautaire. The process of
110     UMAR      IB revija  1-2/2006
supplementary diminishment of contributions to
social security will continue in short run together
with the increase towards the level of flat tax of
legal taxation rates for the other income sources.
The main objective is represented by the increase
of transparency and predictability degree of fiscal
policy and creation of non-discriminatory business
environment.
The fiscal policy measures, being applicable
starting 2006, follow the increase of taxation base
and alignment to flat tax rate of 16 percent for the
entire revenue category. For example, in this sense,
the flat tax of 16 percent will be applied on incomes
from dividends, interests, earnings from bonds,
from operations of selling and buying foreign
currency in time, based on contract, on the incomes
from liquidation of a juridical person.