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August 17, 2022
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Study: Why the cost of living in Romania is increasing, which are the main mistakes of the Government and what is there to be done

Three academics from Bucharest and Cluj-Napoca have analysed the evolution of prices and propose some solutions to improve the situation

The recent rapid rise in consumer prices is largely caused by government intervention through taxes, subsidies and regulations, is the conclusion of the recent study “Bad public policies increase the cost of living”, conducted at the Institute for Economic Studies – Europe by three researchers from the University of Bucharest, The Academy of Economic Studies (ASE) Bucharest and Babeș-Bolyai University Cluj-Napoca. The authors of the report, Christian Năsulea, University Lecturer PhD, University of Bucharest, Radu Nechita, Associate Professor PhD, Babeș-Bolyai University Cluj-Napoca and Diana Năsulea, PhD Candidate, ASE Bucharest show that no matter how severe the situation may be on a given market, price controls enacted by the government will only make it worse in the long run. They propose a series of recommendations, including five things that need to be done urgently, solutions that “will do more to raise people’s standards of living than any programme of government handouts.”

The study “Bad public policies increase the cost of living “, which can be consulted here (https://ies-europe.ro/studii/bad-public-policies-increase-the-cost-of-living), analyses the Total Consumer Price Index (CPI), which rose in Romania by 17.45%, almost twice the EU average (10.29%), between April 2020 and April 2022, a period associated with the introduction of COVID and post-COVID measures. For food products, the increase was 14.4%, for non-food products 22.41%, of which 6.33% only in March this year. For services, the CPI had a much lower growth rate (9.91%).

When we talk about the areas with the highest CPI increases in the last 12 months, there are dramatic developments in fuels (the “pump” price of diesel has increased by 58.30% and that of gasoline by 41.37%), housing (the national real estate price is 22.30% higher than it was a year ago) or transport (+ 15.96%), while clothing and footwear (3.75%), health (3.30%) and telecommunications (1.63%) recorded much smaller increases.

One of the oldest mistakes in attempts to combat rising prices is blocking them (capping them) by way of regulatory interventions. Measures of this kind have always had the same effects everywhere: the ‘disappearance’ of products from the market and/or their rationalisation and the emergence of a black market and corruption, all against the background of an even greater reduction in the supply of goods. In short, no matter how critical a situation the market is in at a given time, government price control will worsen it in the long run.“, says Radu Nechita, Associate Professor PhD, Babeș-Bolyai University Cluj-Napoca.

According to the data used by the three academics, the average gross income of households in Romania was 6,055 lei / month in the fourth quarter of 2021 (2,395 lei / person). Romanians spend 67.6% of their income on consumption, pay taxes amounting to nearly a third of that same income (32.1%), and only devote 0.3% to investments. VAT applicable to household expenses, should also be considered, potentially accounting for as much as 12.8% of the total income of a household, which could bring the total tax burden of the average Romanian household to 44.9%. According to the National Institute of Statistics, the highest percentage of average household expenditure, 32.3%, is represented by food and non-alcoholic beverages. This is followed by housing costs, including heating, electricity and running water (16.3%).

Based on this information, the authors of the study warn that future increases in food prices and already visible increases in energy and fuel prices will have a negative effect on the well-being of Romanians and their ability to adequately cover the cost of living. The high rate of homeownership will save many of the lowest-earning Romanians from complete ruin, but they will still face significant difficulties in procuring even the bare necessities,” says Diana Năsulea, PhD Candidate ASE Bucharest.

 

The Romanian state performs poorly in three areas in particular: housing, fuel and energy

 

The areas most severely affected by price increases, with a direct effect on Romanians’ pockets, are housing, fuel and energy, according to the study’s authors.

 

HOUSING. Even though Romanians are in the European top of homeowners and the population is declining every year (on 1 January 2022 we were 0.6% fewer than the year before), the general demand for housing is higher than the supply, which has an impact on prices. The most convenient solution, the increase of the offer, is hindered by problems generated by the state: Romania is on the 147th place in the world, out of 190, at the ease of obtaining the building permits, according to “Ease of Doing Business” (2020), ranking made by the World Bank. Specifically, the issuance of a construction permit requires 24 procedures, takes an average of 260 days, and the cost of doing so approaches 2% of the value of the construction. Another problem reflected in the same ranking: Romania ranks 157th in terms of electrification (9 procedures, 174 waiting days, at a cost 4 times higher than the average annual income).

At the same time, the average salary in the construction sector represents 94% of the average salary in the economy, and the authorities have found a pseudo-solution: exempting employees in this sector from paying the 3.5% contribution to the 2nd Pillar of the pension system, the one based on capitalization in individual accounts. In other words, real estate developers have been helped to reduce the gross salary paid to employees without reducing their net salary now, but at the cost of reducing their future pension.

 

FUELS. Taxes and excise duties applied to the production, distribution and sale of fuels in Romania are responsible for a significant part of the price paid by final consumers. The excise duty for petrol is 2,458.10 lei / ton (1.89 lei / litre), and the excise duty for diesel is 2,052.89 lei / ton (1.73 lei / litre). On April 25, 2022, a litre of gasoline cost, on average, 7.84 lei “at the pump”, and diesel cost 8.72 lei. Excluding VAT and excise duties, the litre of gasoline would have cost 4.7 lei, and that of diesel 5.6 lei. It turns out that no less than 39% of the amounts paid for gasoline, respectively 36% of those for diesel go to the state budget on account of VAT and excise duties.

The excise tax formula, which is correlated with the exchange rate, has increased the excise tax on petrol and diesel by 3.6 per cent in 2022 compared to 2021. As the price of fuel influences the prices of all products in the market that require to be transported to be sold, any increase in the price of fuel produces a domino effect that leads to an increase in all market prices. Generalised price increases lead to a decrease in the exchange rate used to calculate the value of the excise duty. We are thus dealing with a vicious circle that contributes to the increase in the price of products and services and a sustained loss in purchasing power”, says Radu Nechita, Associate Professor PhD, Babeș-Bolyai University Cluj-Napoca.

 

ENERGY. The general situation, marked by the COVID-19 pandemic, the gas shortage, deliberately deepened by Gazprom since the summer of 2021, and the invasion of Ukraine by Russia in February 2022, invoked by the Romanian authorities, should not be used as a pretext to hide the government’s wrongdoing. “Energy prices have increased in Romania because they have increased in Europe in general, but also because Romania has adopted bad policies, like the law on capping and offsetting,” said Radu Nechita.

Natural gas prices for non-household consumers began to rise in the first half of last year (+80% between January and November 2021) and saw a rapid increase for industrial consumers in the second half of last year, before the increase of prices for household consumers. Without being able to limit energy costs by transferring part of the cost to the state budget, laws to cap and offset energy prices have taken several forms, which has increased uncertainty, aggravating the situation. Indeed, the elimination of competition from the system, which motivated sellers to sell at the best possible price, led to a general increase in prices.

“Allocating large amounts of money from the state budget to offset energy costs makes a balanced budget even more unlikely and drives politicians to consider actions that may be even more harmful to the economy in the long run, such as switching back from a flat personal income tax rate to a progressive one”, says Christian Năsulea, who draws attention to other errors: delayed investments in the development of new energy production capacities or failure to use EU funds that were available specifically for this sector (EU Modernisation Fund).

Given the significant involvement of the Romanian government in its energy sector, both through hostile fiscal policy and through direct ownership, this is likely the sector that produces the largest impact on the rising cost of living“, adds Christian Năsulea.

 

Recommendations. Five things that need to be done urgently

 

The authors of the study have several public policy recommendations that, if followed, would improve the situation. The main recommendations refer to the simplification of taxation, the maintenance of fiscal facilities for SMEs, the reduction of budget expenditures, the reduction of excise duties on fuel and energy taxes, the reduction of the non-fiscal burden.

 

# 1 Tax simplification. Given the most recent developments in Romania and the current government’s intention to reintroduce a progressive personal income tax, the number one public policy recommendation we make for Romania is to keep things simple. In theory, Romania has a fixed income tax rate of 16 per cent. In practice, there are already a large number of exceptions and deductions in place for different categories of workers and an increasing number of different tax rates for income earned from sources other than salaries. It is problematic enough as it is for citizens to file their tax statements correctly. The introduction of a progressive income tax scheme would further complicate things and very likely lead to a decrease in the net amounts collected through income taxation”, say the authors of the study.

 

# 2 Maintain tax facilities for microenterprises. The tax on the revenues of microenterprises (3% tax for companies with a turnover of less than EUR 1 million, or 1% for microenterprises with at least 1 employee) and the 5% dividend tax offer one of the most favourable frameworks for entrepreneurs in the European Union. These fiscal facilities should be at least maintained and, when possible, made even more appealing to investors.

 

# 4 Reducing the excise tax on fuel and reductions in taxes on energy would have a net positive ripple effect on the Romanian economy. “At certain levels of tax reduction or tax elimination, the increase in economic activity induced by lower taxes, as well as other mechanisms described by the Laffer Curve, can also lead to an increase in the net amount collected by the state through these taxes,” add the authors of the cited study.

 

# 5 Reduce the non-fiscal burden of government regulation, including a quantitative reduction of regulations in general and improving the stability of the legislative framework. “Decisions must not be made overnight. Citizens and companies should be given enough time to prepare in advance for any new rules coming into force. For example, simply enforcing article 4 of the Fiscal Code, according to which a minimum of 6 months must pass between a change in the law and its entering into force, would bring a significant improvement over the current situation,” said the three Romanian academics.

 

Other recommendations of the authors of the study “Bad public policies increase the cost of living” refer to the removal of bottlenecks highlighted by the Ease of Doing Business report (focusing on obtaining building permits, electrification and resolving insolvencies), digitizing services, improving infrastructure, strengthening the rule of law and improving the predictability of regulations.

 

About the authors

 

The study “Bad public policies increase the cost of living” was conducted by the Institute for Economic Studies – Europe (ies-europe.ro), relying on data analysis using information from databases belonging to Eurostat, the OECD, the World Bank and the National Institute of Statistics of Romania, and is part of a pan-European research project coordinated by the Epicenter Network (epicenternetwork.eu). IES-Europe is a non-governmental organisation founded in 1989, whose main activities are related to economic education and the promotion of the classical liberal principles in public policy and society in general. Epicenter, the European Policy Information Center, is an independent network of nine leading think tanks from across Europe. It seeks to inform the EU policy debate and promote the principles of a free society by bringing together the economic expertise of its members.

Associate Professor Radu Nechita teaches Microeconomics, European Economic Integration, Globalisation and Development at Babeș-Bolyai University, Cluj-Napoca (Department of European Studies). His general topics of interest gravitate around the institutional factors of development, with emphasis on regulations, monetary and fiscal policies. He promotes economic education, and since 2003, he organizes the “Friedrich von Hayek Seminar”, an extracurricular weekly series of interactive conferences, open to all students from the Cluj-Napoca area.

Christian Năsulea teaches Economics at the Department of International Relations and Universal History at the Faculty of History of the University of Bucharest. He is the Executive Director of the Institute for Economic Studies – Europe and a fellow of the Institute for Research in Economic and Fiscal Issues. His areas of research interest include public policy and stimuli for economic development, political and commercial negotiation in international relations, behavioural economics and decision processes.

Diana Florentina Năsulea holds a BA in International Relations and European Studies and a MA in the History and Practice of International Relations. She is currently a PhD candidate with the Economics and Economic Policies Department at the Bucharest University of Economic Studies. Her thesis focuses on the development of the sharing-economy as a driver of economic growth in Romania and the public policies affecting it. She is the Programs Manager of the Institute for Economic Studies – Europe and a fellow of The Institute for Research in Economic and Fiscal Issues.

 

 

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