IMF board to meet possibly on Wednesday to decide over the next disbursement.
The government ruled to increase VAT from 19 pc to 24 pc, without also raising the flat tax rate, and will ask Parliament to speed up the procedure of enforcing the laws that will cut salaries in the public system and will recalculate special pensions. The move comes in the wake of Friday’s rejection by the Constitutional Court – with majority of votes – of the law that provided for a general 15 pc pension cut. The law was part of the austerity package passed by the Executive by taking responsibility in Parliament, whose main measures were lowering salaries in the public system by 25 pc and pensions by 15 pc.
The proposed VAT hike will be sent to the IMF, which will meet on Wednesday – most likely – to make a decision about granting the next disbursement to Romania. The news was confirmed, at the conclusion of a Cabinet meeting, by PM Emil Boc, who added that the VAT increase will come in effect on July 1.
“We had no better solution, given the Constitutional Court’s decision. We’ll correlate our fiscal-monetary policies with those of the National Bank, so that we san keep inflation and EUR/RON exchange rate under control,” Boc explained. The premier urged county prefects to get “actively” involved in publicising other measures considered as positive, which were passed by the government, assuring them he knows how “delicate” their position will be in doing so.
In the case of the VAT, the International Monetary Fund had asked for a 25 pc increase, but accompanied by the elimination of the minimum tax, government sources told Mediafax news agency. “The IMF asked for a 20 pc flat tax, an increase of welfare contributions and of the VAT to 25 pc, but simultaneously with eliminating the minimum tax, to avoid thus excessively affecting the business environment. During negotiations, the government however insisted that only the VAT increase to 24 pc will secure enough funds to meet the deficit target,” said the sources.
In his turn, Finance Minister Sebastian Vladescu declared, at the end of the Cabinet meeting, that the VAT increase was already agreed with the IMF and will secure extra incomes worth RON 3.5-4 bln that will allow Romania to range within the deficit target of 6.8 pc of the GDP. “I am voicing my deep disappointment for raising the VAT today (Saturday),” Vladescu pointed out. This is, “by no means,” the best measure for Romania, but it was imposed by the CCR decision, he said.
According to the minister, the VAT increase will affect “everyone,” including the economic sector that was expected to be the driver of economic recovery in 2010 and 2011, but the decision was made in view of securing macroeconomic stability and the financing need by the state. Vladescu explained that the pension system must be reformed and balanced soon, otherwise fund transfers from the state budget to the pensions budget will soar from 2 pc of the GDP now to 5 pc of the GDP in the next years.
“This trend must be stopped. Though we will not reach a balanced budget very soon, at least we must stop the increasing trend of the GDP percentage that is transferred. I believe this is a matter of political responsibility for everybody, also for those who are deploring the situation of pensioners today. They keep deploring because they don’t know what they are doing,” the finance minister pointed out. According to Vladescu, quoted by Realitatea.net, Romania will receive the next instalment of the IMF loan on July 1 or 2. Both money and capital markets will react positively to the Fund releasing the fifth tranche, the minister believes. Vladescu gave assurances that the risk of economic instability in Romania is still very low, even in these conditions.
Vladescu would have rather endorsed PSD’s solution
Vladescu said on Realitatea TV that taxing all incomes is an absolute must, and will become real in Romania at a certain moment. “The differentiated taxation of all incomes – pensions included – would have better solved the problems of the budget, but this measure cannot be enforced simultaneously with cutting salaries, would have affected the incomes of people with high salaries,” believes the finance minister, who – surprisingly – would have favoured the economic solution proposed by PSD. The minister made similar comments to Antena 3, adding that a variant that enforced the differentiated tax and set the profit tax at 10 pc has been discussed along with 15 other scenarios. Vladescu proposed the solution of a differentiated income tax, plus a profit tax reduction to 10 pc, as measures for saving the economy. This would have avoided both the 25 pc salary cut and the VAT hike. However, PM Boc and Economy Minister Adriean Videanu refused, because the measure was proposed by PSD, according to Jurnalul.ro.
According to law experts, the Fiscal Code cannot be changed by Government Emergency Ordinance, which could result in yet another anti-crisis measure being blocked by court. PNL legislator Ciprian Dobre insisted to remind authorities that, under Article 4 of the Fiscal Code, any change of the Code must be made through a Law and comes into force January 1 of the next fiscal year. Vasile Blaga, the minister of Administration and Interior, said it is impossible that the ordinance on raising the VAT is also declared non-constitutional, as such changes have been always made.
The VAT increase will result in higher prices throughout the whole economy, a drop in the purchasing power of the population, plus inflation and higher unemployment, believe the representatives of business associations and employers’ organisations. In other words, as Minister Vladescu said, everything that happens now is only “the tip of the iceberg and nobody can say it for sure what will happen.” In the public sector, the number of layoffs will exceed the initially agreed 25 pc of the staff of some ministries and other public institutions, based on faster procedures, government sources declared for Mediafax.
“All taxes must be paid by someone. Who else will pay them, if not the end consumer? The VAT increase will have as effect price hikes and, implicitly, declining sales and higher unemployment,” the owner of European Drinks group of companies, Viorel Micula said on Friday for Mediafax. Dragos Anastasiu, who controls the Eurolines group, believes the VAT hike will make everybody “suffer.” “Purchase power will decrease and the economy will never recover. It would be better to gather money by decreasing taxes, rather than raising them. It will hamper recovery attempts and will be a new blow against the economy,” Anastasiu added. In his turn, the CEO of freight carrier Unifetrans, Constantin Pestrea says the measure will be equally detrimental to companies and the population, and shows how precarious the situation of the country is.
The president of the Food Industry Trade Unions Federation (FSI), Dragos Frumosu considers that the foodstuff market will diminish by up to 40 pc, resulting in many food companies going bankrupt and a higher rate of unemployment. The president of the Romanian Pork Processors’ Association, Gheorghe Caruz believes the VAT increase might force about 25 pc to close doors, plus a general increase of prices. Romulus Dascalu, the president of the liquors producers’ federation Garant sees a price explosion ahead. “Inflation will reach 10 pc and the price of all food products and services will go up. We’ll see firms going insolvent, especially small and medium sized companies,” Dascalu warned. The secretary general of the Romanian Union of Transporters, Radu Dinescu considers foreign investors will avoid Romania from now on, while another effect of the VAT hike will be a decrease of salaries.
Referring to the effects of the VAT increase to 24 pc, Minister Vladescu said it will necessarily translate into higher inflation. “Now, the idea is: prices will go sky high. Everybody is prey to this hysteria of rocketing prices, which leaves people with two options: limiting their purchases, and trying to put pressure on the market, so that prices don’t go up. This is a discussion about the resistance limits of each system; who will give up first: the seller, or the buyer? Who can keep prices up without buying?” Vladescu concluded.
The decision to raise VAT from 19 per cent to 24 per cent will lead to a rise in inflation rate at 7-8 per cent and a contraction of the economy beyond present estimates, several chief analysts of merchant banks stated, in unison, for Mediafax. Analysts claim, however, that investors are more concerned than ever about the government’s capacity to implement the necessary steps to maintain the IMF agreement, according to Reuters.
M. Tanasescu, Romania’s representative at the IMF: “This decision to raise VAT is a measure which fails to tackle the core measure of the deficit the pension fund is faced with. Therefore, to make it crystal clear, this measure will lead to financial and fiscal balance and stability, but the problem endures, the pension fund remains in deficit and this deficit grows by the year, as the number of contributors is ebbing, and the number of beneficiaries is growing, and the population is affected by an aging process for which there is no solution.”
A. Vasilescu, advisor to the Central Bank governor: “The Romanian society at large, not only the National Bank of Romania (BNR), will have to wage a war against inflation. (…) I’m striving, at the moment, to prevent false hopes, along the lines of ‘BNR can fix it’, from emerging in the public debate. BNR cannot work miracles. Some harm can be as significant as to no longer be undone. Romania will have to wage war against inflation, which has to be borne by the society at large, not just by BNR. The depreciation of the RON because of higher inflation is a risk, and, in theory, raising the VAT at 24 per cent could lead inflation to up to 10-12 per cent, although this scenario need not be translated, verbatim, in practice.”
L. Croitoru, advisor to the BNR governor: “In Romania, suppliers and distributors instantly transfer the VAT onto consumers and refuse to accept the reduction of profit margins. The VAT takes its toll directly from the citizen’s pocket. (…) If the Ministry of Public Finance manages to remain in deficit, we will see how the economy evolves. If the deficit slides, it will certainly affect the interest policy”.
V. Blaga, Minister of Internal Affairs: “If the measures the government took responsibility for are applied and taxes are still raised, in the end, then the government should go. This is not the case. The government is far from having applied the measures proposed by taking responsibility.”
M. Bela, deputy prime-minister, president of the Democratic Union of Hungarians in Romania: “On grounds of efficiency, we’ve reached the conclusion that the reduction of wages and pensions, rather than raising taxes, could lead to the desired results and to maintaining the deficit. By the calculations made by the Ministry of Finances, this should be enough.”
M. Geoana, Speaker of the Senate: “The decision to raise an important tax, such as the VAT, at a time of recession, is a fundamentally ill-advised decision, as it is a pro-cyclic measure, which would put a strain on the economy. Practically, following today’s decision, private consumption would drop by at least 4 per cent, in a context in which it accounts for approximately 60 per cent of GDP. Consequently, raising the VAT would lead, in the next six months, to an added reduction of GDP, by at least 1 per cent, which would perpetuate recession and would boost the number of the unemployed. Moreover, the reduction of public sector wages determines an added reduction of GDP, of at least 1 per cent.”
V. Ponta, president of the Social Democrat Party: “The raising of VAT will be the death of private economy. Economy was already brought to its knees, and now it will be totally vanquished, while corruption and tax evasion will soar exponentially. Public servants who should conduct inspections will have their wages reduced by 25 per cent, which means 50 times higher corruption levels, and private companies will close down, leading to a rise in unemployment as well. This is a scenario which spells doom.”
M. Gitenstein, US Ambassador to Romania: “Reducing wages by 25 pc and pensions by 15 pc are better solutions than any other solutions I’ve heard mentioned. (…) Raising taxes is not a solution. I think that Mugur Isarescu was right: one does not raise taxes in the midst of recession. Raising taxes would discourage companies which wish to invest here and would also stall economic growth.”