Ben Conigrave
OECD
OECD Economic Surveys: Romania 2024
OECD Economic Surveys: Romania
Abstract
Romania’s economy proved resilient to external shocks following Russia’s invasion of Ukraine and the ensuing energy crisis. The immediate task for macroeconomic policy is to tame inflation, which is well above target. Fiscal consolidation would complement tighter monetary policy in cooling demand. However, increased government spending commitments – including on defence, pension reform and public sector wages – could impede fiscal repair unless important reforms are also made to raise Romania’s low tax revenues. Efficient tax system reform is needed to put the public debt on a sustainable track without derailing the rapid economic growth required for income convergence.
Romania’s economy proved resilient to large shocks following Russia’s invasion of Ukraine and the ensuing energy crisis and surge in inflation. But while still solid compared with results in many advanced economies, output growth slowed in 2023 from fast rates recorded the previous year. Tighter monetary policy is helping to cool domestic demand while weak economic conditions in Romania’s trading partners weigh on the country’s exports. Economic growth is expected to remain below potential in the near term even with significant support from EU-funded investments. A period of moderate output growth (Figure 2.1) should help to reduce wage and core price inflation, which remain elevated.
Strong price growth has outlived the supply shocks that caused inflation to accelerate in 2022. Growth in the headline consumer price index (CPI) moderated in 2023 with lower energy prices and weaker food price inflation. Government schemes capping food product mark-ups and prices of electricity and natural gas are further mitigating volatility in inflation. But despite easing growth in import prices, and softer private demand, underlying price pressures are strong. In the year to January 2024, harmonised core inflation (excluding food and energy prices) was high at 10.2%, above headline inflation of 7.3%. Price growth remains elevated across a range of services, even as inflation in goods prices has moderated. In a tight labour market, large wage increases threaten to erode international competitiveness. Unit labour costs have been rising at rapid rates.
Slow fiscal consolidation has left more of the burden of stabilising macroeconomic conditions on Romania’s central bank. Significant monetary policy tightening saw the National Bank of Romania (NBR) raise its policy interest rate from 1.25% in late 2021 to 7% by January 2023, the highest level since the Global Financial Crisis. The effects of an extended period of tight monetary policy continue to propagate through asset markets and the real economy.
Note: Panel A: The pre-crisis output path is based on a linear extrapolation of estimated trend growth in 2019.
Source: OECD Economic Outlook database; OECD Quarterly National Accounts database; and OECD calculations.
Investment is supporting activity amid slower growth in consumption and exports
Growth in private spending has moderated. Housing market activity is subdued, with high borrowing costs reducing home loan demand and depressing sales (NBR, 2023[1]). Modest growth in housing prices has weighed on the real value of household net worth. Negative wealth effects, slow hiring, and elevated uncertainty about future labour market conditions are dragging on consumer spending. Refugee inflows following Russia’s invasion of Ukraine have likely contributed to broader variation in private consumption growth, which spiked in the war’s first year (8.3% in the year to the fourth quarter of 2022) and subsequently declined. Data reported by the UN Refugee Agency (UNHCR) indicate that as of January 2024 over 3.8 million people (equivalent to 20% of Romania’s population in 2021) had crossed the border from Ukraine to Romania since the war’s outbreak. A further 1.5 million border crossings from Moldova occurred in the same period. Most of those entering Romania transited on to third countries. Roughly 86 000 refugees were recorded as being in Romania at the end of 2023. On top of other integration support, the Romanian government provided subsidies for refugees’ housing costs in 2023. Aid was retargeted in May to assist those working, studying or caring for young children (Dopomoha, 2024[2]).
Business conditions are challenging in some sectors. Higher credit costs and frequent fiscal policy corrections are complicating firms’ investment decisions (Chapter 3). Reduced credit growth appears consistent with reported moderation in firms’ capital expenditure plans. In manufacturing, a cyclical pullback in sales is exacerbating longer-running structural challenges in European car making. Industrial output in Romania is below levels seen in 2018.
Export volume growth has slowed. External demand is subdued amid weak conditions in Romania’s trading partners. Rapid unit labour cost growth in Romania’s regional peers helped contain damage to Romania’s own cost competitiveness in the past year. However, recent data show real wage increases outstripping productivity gains, putting downward pressure on profits. Reduced export growth could limit further improvement in external balances. Romania’s trade deficit narrowed recently due to slower growth in imports. The import intensity of economic activity has returned to pre-pandemic levels as tighter macroeconomic policies cool demand. The current account deficit remains large but narrowed in the past year, the relative contribution from net inflows of direct investment increasing over the same period.
EU-funded infrastructure investments are supporting activity. With the newly modified programme’s total cost for 2022-2026 estimated at EUR 28.5 billion (10% of GDP in 2022), spending tied to Romania’s Recovery and Resilience Plan (RRP) is helping offset growth drags from softer household consumption. Construction activity has increased on the back of major energy-efficiency and transport projects and is contributing to lift the economy’s capital intensity (Figure 2.2). Maximising potential gains to Romania’s productive capacity and living standards will depend on rapid and effective absorption of available EU funds (Chapter 3).
Note: Panel B shows real net capital stock per person employed.
Source: OECD National Accounts Statistics database; European Commission, DG ECFIN AMECO Online Dashboard.
The labour market is tight but hiring has eased
Employment has plateaued. While Romania’s job market remains tight, hiring has begun to slow amid reduced growth in production and rising labour costs. Worker inflows from abroad are helping fill vacancies. Skill shortages have been acute in construction, among other sectors, risking delays and higher costs in implementing EU-funded infrastructure projects. With significant worker intakes from central Asia and inflows of Ukrainian refugees, net international migration to Romania turned positive in 2022 (+85 480) for the first time since 1975 (Figure 2.3 Panel A and B). Unemployment is relatively low (5.7% of the labour force in January 2024) (Figure 2.3 Panel C). However, large numbers of working-age Romanians in rural areas are outside the formal labour market. Participation by older workers and women is also low in international comparison (see Chapter 4).
Following declines in real terms in 2022, wages are now increasing at a faster rate than consumer prices (Figure 2.3 Panel D-F). In manufacturing, construction and business services, wage inflation has returned to double digit levels last seen in 2019, when pro-cyclical fiscal policy was causing the economy to overheat. Industrial activity defeated a government attempt to curb public-sector remuneration in 2023, resulting in bigger-than-planned pay increases (see below). Large minimum wage awards – the most recent of which a 10% increase in October – have been compensating low-paid workers for past price inflation but will contribute to broader cost pressures in the economy. From 2024, Romania is due to adopt a new minimum wage setting regime, with aims of better linking determinations to objective criteria, including labour market conditions (Chapter 4).
Note: Panel C and Panel E: 'Peers' refers to the unweighted average of Bulgaria, Czechia, Hungary, and Poland. Panel D: The labour cost index covers total wages and salaries. Panel E and Panel F: Data are based on harmonised consumer price indices.
Source: Eurostat; OECD Labour Force Statistics database; OECD Economic Outlook database.
Output growth will strengthen but remain below potential
Real GDP growth is projected to pick up to 3.1% in 2024 and 3.3% in 2025, remaining slightly below potential (Table 2.1). Pension increases and reduced cost pressures will support real household incomes. But high interest rates, tax increases and slow growth in employment will keep near-term growth in private consumption moderate compared with recent historical averages. Investment will remain elevated, supported by EU-funded infrastructure projects. Exports will gradually recover with improving economic conditions in Europe. Below trend output growth will limit job creation over the next two years, keeping unemployment above pre-pandemic rates as wage growth moderates. Temporary price pressure from VAT increases in 2024 will be overwhelmed in the medium term by lower import price growth and negative demand effects from higher income taxes. By 2025, growth in the headline consumer price index will slow to 3.7%, near the top of the central bank’s target band.
Risks to the outlook are significant (Table 2.2). Sustained cost pressure could keep inflation higher for longer than assumed in the projections. In the near term, value added tax increases (see below) could make it harder to subdue high price growth. Slow progress correcting fiscal imbalances could contribute to wider current account deficits and more rapid expansion in Romania’s public debt. At a time of higher interest rates this could increase risks of destabilising capital outflows. There are also upside risks to the outlook. Strong translation of EU funds to investment would boost GDP growth and lift Romania’s future productive capacity.
Annual percentage change, volume (2020 prices)
Note: 2021 figures are in RON billion, current prices. 1. Contribution to real GDP growth; 2. Percentage of potential GDP; 3. Percentage of GDP.
Source: OECD Economic Outlook: Statistics and Projections No. 114 (database) and updated projections.
Monetary policy should remain contractionary in the near term. The National Bank of Romania will likely have to keep its policy interest rate high in 2024 to bring price inflation to target (Box 2.1). Additional rate rises may be needed if wage growth fails to slow or if medium-term inflation expectations drift above the top of the target band, where they have been in recent months. Liquidity in the interbank market will also influence market interest rates and may require tighter management if inflationary pressure mounts. The NBR allowed a liquidity surplus to accumulate in early 2023 following Treasury operations in foreign currency (NBR, 2023[3]) and in a context where carry trade was generating appreciation pressure on the local currency (IMF, 2023[4]). Excess liquidity caused interbank lending rates to decline towards the bottom of the corridor bounded by the NBR’s loan (8%) and deposit facility rates (6%). While still well above levels in late 2021, rates on new household deposits declined in early 2023. Larger rate falls were recorded for leu-denominated business loans, partly offsetting the effect of past policy rate increases.
The primary objective of the National Bank of Romania is to ensure and maintain price stability. In pursuit of this goal, the central bank formulates and implements monetary policy in the context of a direct inflation targeting strategy adopted in 2005. The inflation target is set as a midpoint within a variation band of ±1 percentage point. After a period of successively decreasing inflation targets, the target became stationary at the end of 2013, and is set at 2.5% ±1 percentage point. Open market operations, the NBR’s most important monetary policy instrument, are used to steer interest rates, manage liquidity in the money market and signal the monetary policy stance. The inflation targeting strategy coexists with a managed float exchange rate regime, aimed at allowing a flexible policy response to economic shocks.
Source: National Bank of Romania
The NBR is maintaining its “managed float” exchange rate policy (Figure 2.4). Central bank interventions contributed to keep the leu in a narrow value band around the euro through depreciation pressure after Russia’s invasion of Ukraine. In avoiding higher import prices this supported the objective of lowering inflation. On the other hand, increased euro-denominated borrowing by firms from mid-2022 (see below) threatened to weaken transmission of monetary policy to the economy. FX-based borrowing has since slowed as interest rate differentials with the euro area narrowed through 2023 and exchange rate volatility increased. As a share of debt held by non-financial corporations (46% in December), loans denominated in foreign currencies remain below levels seen after the Financial Crisis (a peak of 62% was reached in 2012).
Maintaining good progress in improving the transparency of central bank communications could support monetary policy transmission. The NBR has followed global trends towards increased transparency (Dincer, Eichengreen and Geraatsc, 2022[5]). Like other central banks, the NBR explains its policy goals, publishes relevant economic data and releases the inflation forecasts informing its decisions. In press releases, quarterly Inflation Reports and minutes of board meetings, the Bank articulates the economic context to its policy actions. While market sensitivities prevent regular disclosure of exchange rate policy aims, the NBR routinely notes obstacles to the achievement of its main goal of low and stable inflation. To build on good past progress, official communications could also note relevant macroeconomic indicators the Bank will be evaluating in future interest rate decisions – for instance, developments in inflation expectations, the state of the labour market, supply tensions, and the evolution of foreign demand. In periodically updating its communications, the Bank might draw on the example of its counterpart in Czechia, which is among the world’s most transparent central banks (Dincer, Eichengreen and Geraatsc, 2022[5]). Continuing to aim for best practice could support monetary policy transmission and enhance the NBR’s already strong credibility.
Note: Panel A compares the level of the harmonised consumer price index to thresholds implied by the upper and lower bounds of the NBR’s target band (2.5% ±1 percentage point), which was introduced in 2013.
Source: OECD Analytical Database and National Bank of Romania.
Banks tightened lending standards in 2023 as credit risk in the economy increased (NBR, 2023[6]). Prudential lending caps are helping limit loan delinquencies amid higher borrowing costs. Broader financial risks are mitigated by Romania’s relatively small private sector liabilities. At the same time, pockets of vulnerability remain and must be monitored as authorities recalibrate prudential instruments.
Firms’ foreign currency-denominated borrowing increased financial stability risks
Robust demand has until recently allowed businesses to defend operating surpluses in the face of rising costs. Electricity and gas price caps limited damage to profits in the acute phase of Europe’s energy crisis (NBR, 2023[7]). A period of soft private demand and higher labour costs could reduce profits and test firms’ ability to service their debts. The central bank continues to monitor pressures in interest-rate sensitive sectors, including manufacturing (NBR, 2023[7]). For the time being, however, non-performing loans have fallen as a share of credit extended to non-financial businesses (4% in September 2023) and in the overall economy (NBR, 2023[1]).
Past government moratoria on loan repayments bought distressed borrowers time to consolidate finances at a difficult stage of the energy crisis. The last debt holiday, which expired in 2022, was short in duration and targeted at solvent borrowers facing temporary business setbacks. This narrowed the scheme’s scope compared with more expansive measures in other East European countries, such as Poland, likely limiting impacts on the financial system (ECB, 2023[8]).
Increased foreign currency-based debt posed risks to financial stability in the past year. Large differences in interest rates on loans denominated in lei and euros enticed firms to take on more foreign currency debt from mid-2022 as total credit growth eased (Figure 2.5 and Figure 2.6) (NBR, 2023[7]). Similar to developments in other economies in the region, euro-based debt rose and by mid-2023 comprised 45% of total loans to non-financial corporations, above levels before the pandemic. Growth in FX-denominated loans subsequently slowed following ECB rate rises that narrowed interest rate differentials with the euro area. Past financial sector assessments have found that up to a quarter of Romanian firms do not take steps to mitigate their currency risks (NBR, 2023[7]). In part likely reflecting an illiquid local derivatives market (OECD, 2022[9]), a significant share of foreign-currency loans in Romania are unhedged (IMF, 2018[10]). Should it resume, rapid expansion in euro-denominated debt would increase risks to the financial system from potential future falls in the value of the leu. Local currency depreciation would increase businesses’ debt servicing costs. The leu value of firms’ liabilities would rise relative to their incomes – particularly for non-exporting businesses with output priced in lei – forcing more firms into financial distress.
Close monitoring of currency-related risks should continue. Managing risks from firms’ foreign currency debts is important, and difficult, in a country with a managed exchange rate and a financial system dominated by foreign banks. Romania already has in place borrower-based measures curbing foreign-exchange exposures, with lower ceilings applied to foreign currency loan-to-value ratios and debt servicing costs (EMF, 2023[11]). Risks from foreign currency-denominated borrowing can also be managed by adjusting risk weights on banks’ capital requirements, or through use of the systemic risk buffer. The recent slowdown in growth of foreign currency-denominated loans suggests there is no immediate cause for tightening such regulations. However, the authorities should continue to closely monitor FX-based borrowing and stand ready to adjust macroprudential instruments should FX exposures increase further. Regulation and monitoring of non-bank financial intermediaries (NBFIs) will remain important. NBFIs engage in significant FX lending to firms whose main business is domestic and thus lack export incomes that might offset borrowing cost rises from a currency depreciation (NBR, 2023[7]).
Note: Households include non-private institutions serving households.
Source: ECB.
Note: Romania restricted access to foreign-currency mortgages after the financial crisis. New regulations in 2019 introduced a lower debt service-to-income ratio for foreign currency loans (20%) compared with local currency loans (40%), further restricting access to foreign currency home loans (EMF, 2023[11]). In panel A, “NPISHs” stands for non-private institutions serving households.
Source: ECB.
Household balance sheets are strong but vulnerable borrowers are under pressure
Tight monetary policy has increased pressure on households with mortgages. Whereas consumer debt in Romania is typically issued at fixed rates – reducing delinquency risks from higher borrowing costs – home loans are mostly offered at variable rates. Households that took out mortgages before large rate rises in 2022 now face higher debt servicing costs. The central bank’s June 2023 Financial Stability Report noted that loans granted from the first quarter of 2021 to the second quarter of 2022 – when borrowing costs were low – comprise 27% of the total housing loan portfolio (NBR, 2023[7]). The total stock of mortgage debt is, however, small compared with most OECD countries. Due partly to property distribution at the end of communism, the share of Romanians owning homes outright is large (Figure 2.7). Even in the lowest income quintile, most Romanian households own homes without a mortgage. Reforms restricting lending to households with high loan-to-value ratios (85% is the benchmark for leu-denominated mortgages) and elevated debt service costs (40% of income is the standard threshold for leu-denominated credit) further reduce the potential pool of financially-distressed borrowers (NBR, 2023[7]). Moreover, roughly a third of outstanding mortgages are government-guaranteed under Romania’s New House (Nova Casa) programme (EMF, 2023[11]). This mitigates immediate risks in the household sector. Still, authorities should keep tracking mortgage defaults, which could increase if employment falls.
Note: Panel B shows the outstanding amount of banks’ loans to businesses, households, and non-profit institutions as a percentage of GDP.
Source: OECD Affordable Housing database; OECD calculations based on ECB and Eurostat data.
Banking sector indicators are healthy
Banks’ profits are strong and there is excess liquidity in the system (NBR, 2023[1]). While still exposed to international credit conditions, confidence in Romanian banks held up through ructions in foreign financial markets in 2023. Lenders have not faced large calls on funds that might test their capacity to meet ongoing obligations. Rather, deposits have grown in a high interest rate environment (NBR, 2023[7]).
Capital ratios are above minimum thresholds, leaving banks some room to absorb shocks (Figure 2.8). Authorities lifted the countercyclical capital buffer rate from 0.5 to 1% from October 2023. This decision recognised risks from Romania’s still-large fiscal and external deficits (NBR, 2023[7]). Weak spots in loan portfolios may yet emerge, including as borrowers previously covered by debt holidays confront higher debt servicing costs.
A new 2% turnover tax, taking effect from 2024, is expected to reduce financial institutions’ after-tax profits. From 2026 the new turnover tax rate is programmed to decrease to 1%. Hungary, Italy and Czechia, among other European countries, recently introduced windfall taxes on banks. Governments run a gamble with such measures, particularly if they are left in place for an extended period. At a time of stronger profits, excess liquidity and adequate capital in the banking sector, the risk of throttling credit creation may be small, at least in the near term. There is a risk, however, that banks pass on higher operating costs to clients. Moreover, for lenders with lower profits, the new tax could reduce resilience to shocks and constrain banks’ capacity to lend. This reflects the levy’s design as a tax on turnover as opposed to profits. The measure’s surprise introduction also added uncertainty to an investment climate already complicated by frequent changes in tax policy in recent years. From a budgetary perspective, the new turnover tax is no substitute for proper corporate tax reform, which will be important for long-run fiscal sustainability (discussed below).
Sovereign risk exposure has increased. Bank holdings of government securities and loans (together 23% of assets) are large in international comparison (NBR, 2023[1]). Past IMF-World Bank financial sector reviews assessed that by loading banks with its own securities, the Romanian government may have at times crowded out other lending (IMF, 2018[10]). For now, broader risks to financial stability are mitigated by Romania’s still relatively small stock of public debt. Further expansion of the public debt relative to Romania’s GDP would increase risks borne by banks and other major holders of Romanian government bonds, such as private pension funds (10% of government debt issued as at September 2022) (NBR, 2023[7]). Lenders could be forced to realise large losses if, for instance, fiscal deficit deterioration were to drive sovereign yields higher and reduce confidence in banks’ balance sheets. The need to keep such risks contained strengthens the case for pursuing fiscal repair (see below).
Note: OECD is the unweighted average of OECD countries. In Panel B, 'Peers' refers to the unweighted average of Bulgaria, Czechia, Hungary and Poland.
Source: IMF, Financial Soundness Indicators database.
Fiscal consolidation has slowed. OECD forecasts show a general government fiscal deficit of 6% of GDP in 2023, a modest improvement on the budget position in 2022 (6.3% of GDP) (Table 2.1). In 2024, the budget deficit is projected to narrow further to 5.8% of GDP. New spending commitments, notably tied to pension reforms (see below), should contribute to keep budget deficits wide over the next few years, exceeding thresholds compatible with stabilising the public debt burden. This will prevent Romania from exiting the EU Excessive Deficit Procedure in 2024 as previously expected. Indeed, fiscal projections published in the annual budget in December suggest Romania’s EDP exit – requiring a deficit below 3% of GDP – will not occur until 2027 (Romanian Government, 2023[12]). Fiscal consolidation could be slower still if government spending exceeds targets or if tax receipts undershoot budget projections, as occurred in the past year. New tax measures (discussed below) are expected to raise additional revenues of around 1% of GDP in 2024 (Romanian Fiscal Council, 2023[13]). The government is also relying on a revenue boost from measures to strengthen tax enforcement and collection efficiency, the near-term results of which are difficult to predict.
Fiscal consolidation must continue. Romania’s access to EU funds under the Recovery and Resilience Plan could be reduced if the country continues to miss budget deficit targets agreed with the European Commission. There are other important reasons for correcting budget imbalances. Reducing fiscal deficits would support central bank efforts to slow activity; Romania’s fiscal stance remains too accommodative (Figure 2.10). Smaller deficits would also assist further improvement in the current account, stabilise the public debt burden and help build fiscal buffers for future adverse shocks. A credible medium-term plan is needed to consolidate fiscal balances and ensure the sustainability of Romania’s public finances.
10-year government bond yield, %
Source: OECD Economic Outlook database.
Spending restraint and tax reforms should be pursued in tandem to correct budget imbalances. In addition to new pension reforms, larger outlays on defence (2.5% of GDP in 2023), higher borrowing costs (Figure 2.9), and commitments to improve health care and education add to Romania’s medium-term fiscal challenge. Extraordinary living-cost support should continue to be stepped back. Efforts to curb waste in public expenditure must also continue. But with state outlays modest to begin with (Figure 2.10), scope for deep spending cuts seems limited. Indeed, viewed against peers in Europe, Romania’s weak budget position is less a reflection of excessive spending than of the country’s small tax revenues (27% of GDP in 2022, below the OECD average of 34%). In this context, the priority should be to contain growth in government consumption while stepping up efforts to eliminate distortive tax expenditures and modernise the tax administration. This section of the chapter considers measures relevant to limiting fiscal pressure and improving the medium-term fiscal strategy, including spending reviews, reforms to public wage setting, and pension reforms. Subsequent sections of the chapter examine Romania’s debt sustainability challenge (section 2.5) and tax reforms needed to correct structural budget imbalances (section 2.6).
Towards more efficient government spending
A new fiscal package announced in late 2023 curbs excesses in spending by public agencies and state-owned businesses. The new measures liquidate redundant special commissions, ban purchases by officials of expensive cars and mobile phones, and tighten rules on procurement. Further efforts to weed out waste in government should be pursued through spending reviews. Amendments to Romania’s Public Finance Law integrated spending reviews in the budget process. However, until now, such reviews have been conducted only occasionally. As part of the national Spending Review Strategy 2023-2030, Romania has appropriately committed to making systematic use of spending reviews going forward. Ongoing one-off evaluations of the health and education portfolios will yield lessons for future spending assessments. Romania can also draw on the experiences of peers in the region. In Czechia, capacity constraints and limited performance data impeded efforts to scale up spending reviews (OECD, 2023[14]). RRP measures to improve data management in government might mitigate such challenges in Romania, particularly if skilled reviewers can access useful performance information. Good governance, clear objectives, and effective collaboration with line ministries improve the odds of success in spending reviews. Best practice in OECD countries suggests integrating reviews in medium-term budget planning and publishing review findings for transparency (Tryggvadottir, 2022[15]). Beyond cutting budgets, spending reviews should help policymakers allocate resources effectively as priorities change. Among other things, spending reviews could identify efficiency gains in staffing. This would help avoid costs to service delivery from indiscriminate cuts to staff headcounts and job vacancies, such as the government ordered in 2023. Outside spending reviews, laws require that cost benefit analysis be carried out for major government-run projects. This is done as part of a feasibility study for publicly-funded projects with total minimum value above RON 100 million. Consistent use of cost benefit analysis in line with the existing laws is important to prioritise cost-effective public investments.
Note: Panel A: "Range" shows the difference between OECD countries with the highest and lowest government expenditure relative to GDP. Panel B: Underlying government primary balance is the difference between government revenues and expenditure, excluding interest payments, corrected for effects attributable to the economic cycle and one-off factors.
Source: OECD National Accounts database; OECD Economic Outlook database.
There is a need for predictable and fair public wage determination
Prudence in public-sector wage setting remains important. Compensation of employees has a large weight in government consumption in Romania (28% in 2021 compared with the EU average of 20%). Following successful protests in 2023, the government awarded larger-than-planned pay increases to teachers, health-sector workers and other public sector employees. Further large public wage awards could widen budget deficits while fanning higher inflation in private-sector wages. A reform priority is to make public wage determination fiscally prudent, fairer and more predictable. Romania’s RRP rightly identifies competitive recruitment, merit-based promotion, and performance-based pay as benchmarks for effective civil service management. Fiscal costs will also have to be considered in designing a forthcoming reform to public-sector wage setting.
The following estimates roughly quantify potential long-run fiscal impacts of selected reforms. The estimates are illustrative only. Impacts with a negative sign (-) represent net costs to the budget. Positive figures (+) represent net savings.
1. Does not include offsetting boosts to tax receipts from expected higher labour force participation by parents.
2. Indicative national contribution to energy, buildings and transport sector investments required this decade to stay on track to eliminate net greenhouse gas emissions by 2050. The scenario is adapted from estimates in World Bank (2023[16]).
3. Impact by 2050. The range draws on estimates from the OECD long-term model and the European Commission’s 2021 Ageing Report.
4. Savings from spending reviews depend on a review’s nature and objectives, which may be broader than cost reductions.
5. The estimate is adapted from scenarios released in the 2023 World Bank review of Romania’s tax system (World Bank, 2023[17]). The PIT schedule incorporates rates of 6% (for income up to RON 80 000), 12% (for income between RON 80 001 and RON 189 000) and 18% (above RON 189 000). The scenario assumes deductibility of social security contributions is removed.
6. Assumes most products shift to the standard VAT rate of 19%, excluding some food items, medicines and social housing.
7. The scenario is adapted from the 2023 World Bank review of Romania’s tax system conducted for the Recovery and Resilience Plan. Excise duties are assumed to increase to account for all climate and non-climate related externalities. The estimated impact is for 2030.
Source: OECD Social Expenditure Database; Eurostat; Romanian Government Budget 2023; EC Ageing Report 2021; World Bank Tax System Review of Romania 2023 and OECD calculations based on Long-term model simulations.
New pension reforms add near-term fiscal pressure but should improve the public pension system’s long-run sustainability
Population ageing will make it harder to fund Romania’s public pensions in the years ahead. The retirement of a large cohort of people a decade from now will accelerate changes in the age structure of Romania’s population. As in many OECD countries, lower fertility will contribute to this process. Particularly wide gaps between Romania’s current and past fertility rates are in part a legacy of extreme pro-natalist policies pursued under the country’s former communist regime. At a time when access to contraceptives was limited, a strictly enforced ban on abortion contributed to a spike in births from the late 1960s. Subsequent falls in fertility, together with improved life expectancy and ongoing emigration of prime-age workers will drive up Romania’s old age “dependency ratio” – the ratio of retirees to working-age people (Figure 2.11). OECD estimates suggest this ratio could increase by 13 points from 32% in 2022 to 45% in 2040. As pension beneficiaries increase in number relative to active contributors, current imbalances in the pension system will grow. Estimates from the OECD’s Long-term model suggest that, based on current policies, the fiscal cost of public pensions could rise by 4.5 percentage points of GDP between now and 2050 (Figure 2.11 panel C). Continuing to meet obligations to retirees could, without ongoing reform, require greater calls on revenues outside the system, weakening the budget position.
Romania’s pension system comprises:
A points-based public scheme. Benefits are calculated with reference to a person’s earnings over their career. A minimum pension ensures a basic standard of living in retirement for low-paid workers. New legislation requires that pension points, which determine benefits in the public scheme, be automatically indexed to a weighted average of price and wage inflation from 2024. Past pension point adjustments often departed from indexation rules, with large discretionary benefit increases. In 2024, the contribution rate to public pensions from gross wages is 20.25%.
Mandatory private pensions. Romania’s defined-contribution private pension system started in 2007 and is mandatory for workers under 35. The contribution rate to Romania’s private pension schemes will be 4.75% in 2024.
Voluntary private pensions complement the mandatory private scheme. Capped tax-deductible contributions encourage additional saving for retirement.
Source: OECD (2023[18])
A new law on public pensions was approved in November 2023. The law corrects inequities in the public pension system and encourages Romanians to have longer working lives. Provisions in the law:
require automatic annual indexation of pensions with inflation in prices and wages. The measure will safeguard retirement income adequacy while improving predictability for pensioners.
recalculate entitlements using a formula that awards points based on income earned during one’s time in work. The measure will strengthen links between benefits and contributions to the pension system. It will address inequities in the existing system, notably the disparate treatment of people with similar past earnings and contribution periods depending on the year they retire.
increase the female pension age to match the male standard retirement age of 65 by 2035. The measure will encourage women to spend longer in work. However, the law will still allow mothers to retire early, lower pension ages applying to those with more children.
index pension age adjustments to gains in life expectancy to improve the financial sustainability of the public pension system.
allow older workers to work beyond retirement age with the consent of their employer.
Newly legislated public pension reforms will add near-term fiscal pressure. The government has committed to automatically index pension entitlements to price and wage inflation from 2024 (Box 2.4 and Box 2.5). Keeping this commitment would improve pension system predictability by putting an end to the discretionary entitlement adjustments of recent years; large ad hoc benefit increases improved pension adequacy (Figure 2.12 panel B) but raised the system’s cost. The new pension law also provides for recalculation of public pensions from 2024. This measure aims to improve consistency of treatment of pensioners through a points-based formula linking entitlements to earnings over a person’s working life. The reform would correct pension system inequities. It should proceed provided the government is able to implement viable offsetting measures, notably tax reforms (see below), to keep fiscal consolidation on track. Costs associated with the recalculation of public pensions are expected to increase after a first-year impact of roughly 0.6% of GDP in 2024.
Other reforms outlined in the new pension legislation will improve the system’s long-run financial sustainability. The low female statutory retirement age (currently 62) is gradually being increased to match the male pension age of 65 by 2035. Full contribution periods for women and men will also gradually be aligned. The new legislation will continue to allow mothers to retire early based on how many children they have and raise. Such provisions should eventually be removed. The new law does, however, appropriately require that future adjustments to the standard statutory retirement age be indexed to gains in life expectancy, with adjustments every three years. In encouraging higher participation by older Romanians, these welcome changes will help offset mismatches between system contributors and benefit recipients and help fund future public pension obligations (Box 2.2). The reforms should also mitigate risk of poverty in old age, which is declining towards EU average rates but remains high (Figure 2.12 panel A).
Note: Panel C shows OECD Long-term model estimates of changes in government expenditure linked to population ageing. OECD unweighted average excludes Chile, Colombia, Costa Rica, Mexico and Türkiye.
Source: European Commission, Ageing Report 2021; OECD Labour Force Statistics database; Guillemette, Y. and J. Château (2023), "Long-Term Scenarios Update: Incorporating the Energy Transition", OECD Economic Policy Papers, No. 33, OECD Publishing, Paris, forthcoming; and OECD calculations.
Gateways to early retirement should be narrowed over time. Current rules allow those eligible for the old-age pension to work beyond the standard retirement age with their employer’s agreement, up to age 70. Recent reforms have also tightened eligibility conditions for Romania’s early retirement pensions (pensie anticipate). Early pensions are accessible five years before the statutory pension age for those completing long contribution periods (five years more than a full contribution period). New stricter contribution requirements exclude non-contributory periods, such as time spent on paid child-raising leave or in full-time university study. This will reduce the number of people eligible for early pensions. In practice, the effective age of retirement (63.8 years in 2022) is already not far below Romania’s male statutory pension age of 65 and roughly aligns with the average effective retirement age for men in OECD countries (OECD, 2021[19]). Still, as rising life expectancy extends average time in retirement, paths to early labour market exits should continue to be narrowed. This would complement incentives for longer careers and improve the fiscal sustainability of public pensions.
Note: Panel A: The cut-off point for poverty risk is 60% of median equivalised income after social transfers. Panel B: Pension entitlements are based on current legislation. The values of pension system parameters reflect the situation in 2022 onwards. The calculations show the pension benefits of a worker who enters the system that year at age 22 and retires after a full career. Baseline results are shown for single individuals.
Source: Eurostat; OECD Pensions at a Glance 2023.
Romania’s special occupational pensions remain overly generous and unfair. Comprising 11% of pension spending in 2018, “special pensions” for the military, police, diplomats and judges contribute to system imbalances (Urse, 2020[20]). Policy changes in 2023 started to curtail opportunities for early retirement, ensure pensions do not exceed incomes earned while working, and rein in excesses including the possibility to obtain multiple pensions at once. For some recipients, including magistrates, new indexation rules tying benefits to price growth, as opposed to wage inflation, will help reduce outlays (World Bank, 2023[21]). Other perks remain, including formulas linking pension benefits to peak earnings near the end of a worker’s career. This results in high wage replacement rates and exacerbates disconnects between contributions and benefits – parameters better aligned in the normal points-based system. Including more workers in the normal public pension system would ensure comparability of benefits earned through employment in the civil service and the private sector. Pension system transparency would also improve and the government could avoid costs associated with administering different schemes for different categories of public sector employees (OECD, 2016[22]).
Policies to grow private pension schemes could strengthen incentives to save for retirement. Having been introduced only in 2007, and with low mandatory contribution rates, funded private pension plans remain small in Romania. In 2021, private pension assets were worth roughly 8% of GDP, below the OECD average of 105% (OECD, 2023[23]). Contribution rates to private pensions are set to rise by 1 percentage point to 4.75% in 2024. Public pension contribution rates will decline at the same time, reinforcing the need to move quickly to address public pension system imbalances (see above), which could otherwise expand. Exemptions from mandatory private pension contributions should be terminated. Growth in Romania’s funded retirement income schemes has been undermined by policies exempting workers in favoured industries (IT, construction and agriculture) from mandatory contributions (discussed under tax policy below). While employees in the affected industries can still opt to participate in the pillar II system, workers in other sectors face obligatory private pension contribution requirements. Such exemptions push back the goal of a large and stable funded private pension system. Closely linking participants’ contributions and benefits, the private scheme could play a bigger role in supporting pension-system sustainability in Romania, particularly once reforms ensure that the public system can fund itself.
Pursuant to new laws, Romania is due to apply automatic indexation of pension benefits from 2024. Under the rules, pension point increases are pegged to a weighted average of price and wage inflation. Specifically, the value of the pension point will increase each year in January with the rate of price inflation plus half the real increase in the average gross salary. This mechanism applies to benefits after retirement (“indexation”) and to revaluation of entitlements up until retirement (“valorisation”). During their careers, contributors will be rewarded with part of the returns to incomes from productivity gains. Other pension systems instead often uprate past earnings based on wage growth (fully rewarding contributors for productivity gains and treating in an equivalent way entitlements accrued at different stages of a career) while indexing pensions in payment to prices (defending purchasing power in retirement). Compared with such systems – for instance, those in Canada and the Slovak Republic – Romania’s new indexation system will be less generous during a pension’s contribution phase and more generous after retirement. An advantage of regular indexation is that it will help workers plan for retirement.
Note: The table shows future parameters of selected countries’ earnings-related pensions based on legislation in 2021. Parameters are those applicable to a full-career worker starting work at 22 in 2020. Some countries allow discretionary adjustments, for financial sustainability. 1: Formally, pension points are indexed to price inflation plus half the real increase in the average gross salary.
Source: OECD (2021[19])
As in many other countries, Romania’s public debt swelled with major financial and economic crises of the past 15 years – the Financial Crisis, the euro zone crisis, the COVID-19 pandemic. As a share of GDP, general government gross debt (Maastricht definition) increased from 11.9% in 2007 to 47.2% in 2022. Persistent revenue shortfalls have required significant borrowing to sustain even low levels of public spending (discussed above). Strains on Romania’s public finances will increase with accelerated population ageing in the next decade. Demographic change will drive up public spending on pensions, health and long-term care just as employment falls weigh on income tax receipts. In such circumstances, the country’s public debt could quickly become unmanageable based on current policies. A particular concern is that Romania might not be able to rely on the low interest rates and rapid GDP growth that provided a stabilising force for the public debt in recent years. Left unchecked, ballooning government financial liabilities could disturb the macroeconomic stability needed to sustain growth in living standards, or require painful fiscal corrections.
OECD long-term projections highlight the risks Romania runs if it fails to correct current fiscal imbalances. Scenarios estimated with the long-term model recognise that as Romania’s productivity approaches outcomes in higher-income countries, output growth will slow. Model estimates also factor in higher interest rates than in the recent past. Specifically, borrowing costs are assumed to adjust over time to eliminate interest rate-growth differentials that in past years helped stabilise Romania’s debt burden (Figure 2.13). Without major fiscal reforms to shrink the deficit from current levels (Figure 2.14: “Baseline” scenario), slowing growth and higher interest rates would see government financial liabilities quickly get out of hand.
Fiscal reform can avoid adverse debt scenarios materialising (Table 2.3). Legislated reforms to public pensions should encourage stronger labour market attachment and reduce long-term ageing-related fiscal costs (see above). In the “Spending reform” scenario shown in Figure 2.14, policies linking statutory pension ages to improvements in life expectancy reduce the fiscal deficit by 1 percentage point of GDP in the long run. Additional reforms to broaden VAT and income tax bases ("Tax and spending reforms” scenario) could reduce budget deficits further, to 2% of GDP. Under the scenarios’ assumptions of higher interest rates and lower growth, this budget position is compatible with stabilising Romania’s gross public debt at 48% of GDP, close to the 2022 level. Romania has more room than many OECD countries to expand tax bases and lift revenue collections, which are low relative to national income (discussed below).
Contributions to change in general government gross debt (Maastricht definition)
Note: “Valuation effects and other” includes debt changes due, among other factors, to shifts in exchange rates.
Source: OECD calculations based on data from OECD Analytical database.
Note: GDP growth is assumed to slow over time and interest rates are assumed to evolve to eliminate interest rate-growth differentials. Price growth is assumed to converge on the central bank’s 2.5% target. In the “Baseline” scenario, fiscal policies keep the budget deficit near its 2022 level of around 6% of GDP in the long run. In the “Spending reforms” scenario, policies to link statutory pension ages to improving life expectancy reduce the budget deficit to 5% of GDP. In the “Tax and spending reforms” scenario, additional reforms to broaden consumption and income tax bases and raise revenue from taxing immovable property improve the deficit to 2% of GDP, stabilising the public debt burden.
Source: Guillemette and Turner (2021[24]), European Commission (2021[25]), and OECD estimates.
Romania needs to raise more tax revenue, and more efficiently than in the past. With narrow tax bases, undercut by evasion, tax revenues in Romania are low in international comparison (Figure 2.15). Higher taxes are needed to fund emerging spending priorities while keeping public debt manageable (discussed above). To limit the toll on growth from higher taxes, distortions must be eliminated from Romania’s current tax system. To encourage employment, large tax burdens on low-skilled workers must also be reduced. Between goals of lifting receipts, supporting growth and reducing income inequality, trade-offs must be struck. Policymakers must also consider interactions between tax system changes and Romania’s transfer system. With these ends in mind, this section identifies priority reforms to the taxation of consumption, income and property which can correct current fiscal imbalances. A recently announced package of tax measures – with base broadening reforms to VAT, and business and personal income tax (discussed below) – goes only part way to resolving Romania’s structural revenue shortfalls. Chapter 5 evaluates the role of tax policy in a cost-effective strategy to mitigate greenhouse gas emissions.
Note: Panel C shows the share in total tax receipts of employers’ and households’ compulsory actual social contributions.
Source: OECD Revenue Statistics database, OECD National Accounts database, and OECD calculations.
Improving tax collections by modernising the tax administration
Low rates of tax compliance impair Romania’s capacity to raise revenue. Recent estimates suggest the country’s informal economy remains large (29% of GDP in 2022) (Schneider and Asllani, 2022[26]). Widespread non-compliance reduces the size of major income and consumption tax bases. In the case of value added tax (VAT), high rates of fraud and evasion are reflected in a large and persistent gap between VAT collections and the revenue VAT could generate based on full compliance (Figure 2.16). New reforms, many of which pursued under Romania’s RRP, aim to reduce tax evasion with measures to digitalise taxpayer interactions; limit cash transactions; enforce mandatory electronic invoicing for firms; upgrade government IT networks, and tighten tax risk management. Completing these investments will reduce costs associated with identifying irregularities in tax declarations and penalising non-compliance. Stronger enforcement would also better ensure that higher tax rates – on consumption, income, or property – translate to stronger government revenues. The government projects that planned tax administration reforms could increase the ratio of tax collections to GDP by 2.5 percentage points (European Commission, 2021[27]). While the long-term gains from better compliance are undoubtedly large, the immediate revenue impact of the new enforcement measures is highly uncertain. Failure to properly factor that uncertainty into fiscal planning increases risks to budget deficit projections, which proved optimistic in 2023 (see above).
Broadening the value added tax base
Widespread evasion and excessive use of low rates reduces the revenue-raising potential of Romania’s value added tax. Consumption taxes contribute 24% of tax receipts in Romania. The 19% standard rate of value added tax (VAT) is in line with the OECD average. As is the case in many other countries, VAT exemptions apply to the banking and finance sector, as well as to medical and education services. Reduced rates (either 5 or 9%) apply to essential items (including housing, medicines and food) but also discretionary spending (for instance, hotels, restaurants, and amusement parks). Excessive use of low VAT rates distorts consumer behaviour, with benefits accruing disproportionately to those with higher incomes, particularly when low rates apply to non-essentials. The tax revenue foregone as a result of exemptions and beneficial rates is also significant, estimated at 1.4% of GDP in 2022 (Finance Ministry, 2023[28]). Reforms since 2016 expanded the categories of products subject to reduced rates and lowered the standard VAT rate. Authorities meanwhile were unable to materially reduce a large VAT compliance gap (Figure 2.16). Accordingly, receipts decreased relative to nominal consumption. Peers in Romania’s region, such as Hungary, have in contrast managed to improve the revenue raising capacity of their value added taxes in recent years. While Romania stepped up action to combat fraud in the previous decade, it has only recently (since 2022) followed the example of other Eastern European countries, such as Hungary and Latvia, in requiring VAT payers to report their transactional data (European Commission, 2023[29]). Slow progress digitising the tax administration also impeded past efforts at improving compliance.
Value added tax compliance gap, 2021, % of estimated total VAT liability
Note: The VAT gap measures the difference between the VAT revenue that would be collected if there were full compliance and actual VAT receipts. The VAT gap covers revenues lost due to fraud and evasion but also insolvencies, administrative errors and legal tax optimisation.
Source: European Commission (2023), Directorate-General for Taxation and Customs Union, VAT gap in the EU‑ 2023 report; Eurostat and OECD calculations.
More goods and services should be shifted onto the standard VAT rate over time. Romania’s new fiscal package moves alcohol-free beer and sugary foods onto the standard rate of 19%. Items including delivery of high-priced food, solar panels and heat pumps moved from the bottom rate of 5% to the higher rate of 9%. These adjustments, while modest, are appropriate in the current economic climate, where broader VAT increases could make it harder to tame high inflation. As price growth slows, the goal should be to levy the standard rate on more goods and services, starting with non-essential spending. This would reduce policy distortions to consumer behaviour while limiting potential hardship for low-income households from higher-cost essential items. Down the track, an expanded transfer system could top-up poor households’ disposable incomes, compensating for a more uniform application of the standard VAT rate. For instance, monthly cash transfers might compensate those on low incomes for VAT paid on an average consumption bundle. Provided the country’s tax administration is able to effectively identify poor people, this could be a more effective way to support those on low incomes and avoid potential regressive effects from excessive use of discount rates. The standard rate itself might need to be raised if other fiscal reforms fail to free up sufficient resources to stabilise Romania’s public finances.
Preparing a move to progressive taxation of wages
Romania’s taxes on personal income do little to reduce income inequality. Compulsory social security contributions (SSC) make up a large share of government revenue (37.3% of tax receipts in 2022). Romania applies a flat 10% tax to personal income from wages and most sources of capital income. While the country’s personal income tax (PIT) rate is low, total employee contribution rates, covering health insurance (10%) and pensions (25%), are higher than in most OECD countries. Levied without concessions on low incomes, high employee contribution rates significantly reduce low-skilled workers’ take-home pay, despite Romania’s relatively low employer SSC rates (Figure 2.17). The phase out of a basic PIT deduction causes average effective tax rates to plateau at modest income levels (roughly two-thirds of average earnings) (World Bank, 2023[17]).
Reforms should aim to lower tax burdens on low-wage employees’ incomes over time. Introducing an earned income tax credit (EITC) could encourage stronger formal labour market attachment by low-skilled workers. Such a measure might be feasible with further progress closing income tax loopholes (see below). In the long run, it might alternatively be possible to reduce employee social contribution rates. This could require greater calls on general taxation to fund social security, particularly while public pension system imbalances persist (see above). For higher income earners, PIT rates on salaries should be increased, while heeding risks of arbitrage of Romania’s business and personal income taxes (Box 2.6). Romania should begin plotting a gradual transition to progressive wage taxation, which would complement transfer reforms aimed at reducing income inequality (Chapter 4).
Note: Panel A: The Gini coefficient shown is a measure of income inequality. A coefficient value of 0 represents perfect equality. A coefficient value of 1 represents maximum inequality. Panel B: The chart shows the tax wedge for an individual with no children.
Source: OECD Income and Wealth Distribution database; OECD Taxing wages database; and OECD calculations.
There is scope to broaden the personal income tax base to help offset future reduced taxation of low wages. The first priority should be to end distortive sectoral tax breaks. Employees in construction (10% of employment), IT (3%) and agriculture (11%) are exempt from PIT and part of their mandatory social contributions. Since this includes contributions to funded private schemes (discussed above), the measures reduce workers’ future benefits and savings for retirement. Finance Ministry estimates suggest revenues worth RON 9.2 billion (2% of tax receipts) were lost to such tax breaks in 2023 (World Bank, 2023[30]). New fiscal measures curtail, but do not eliminate, sector-specific concessions for higher-income employees. Removing these distortive tax privileges could push some workers and firms back into the informal economy – particularly in construction and agriculture. Tax administration upgrades could mitigate such risks in future. Going forward, the government should avoid using taxes to support favoured industries, focusing instead on improving the regulatory environment for businesses (Chapter 3). There is also scope to curb tax concessions benefiting self-employed workers. As in other countries, independent workers face lighter social contribution obligations than employees. Reforms to more closely align contribution rules for self-employed workers and employees would reduce tax incentives favouring one type of work arrangement over another.
In reforming the personal income tax system, care is needed in calibrating effective tax rates on top earners. High taxation of wages can encourage well-off people to incorporate in order to reduce their tax bill. This is a greater risk if, as in Romania, taxes on company profits and dividends are low. Countries often tax capital income at lower rates than salaries; common goals are to entice investment, or to avoid over-penalising savings. But the gap in effective taxation of labour and capital income is larger in Romania than in most OECD countries, including for those earning big incomes. Figure 2.18 below illustrates this by comparing the tax treatment of distributed company profits and wages in Romania and other countries in 2021. For individuals with incomes five times average earnings or higher, effective tax rates on wages are much higher than those on dividend income. Reforms to reduce the large gap in taxation of labour and capital income could limit arbitrage of Romania’s systems for taxing personal and business income.
Gap between integrated average effective tax rates on labour and distributed dividend income, 2021, % points
Note: The graph shows the gap between integrated average effective tax rates on labour and distributed dividend income. ETRs are calculated for an individual without children earning an income worth five times the average wage. The modelled tax parameters are from 2021; for Romania they include the personal income tax (PIT) rates applied to wages and dividends, the basic PIT allowance available to low-income earners, employer and employee mandatory social security contributions, and corporate income tax (CIT). In 2023, Romania increased the personal income tax rate payable on dividends from 5% to 8%. This change slightly reduced the gap in effective taxation of wages and dividend income compared with that shown in the graph.
Source: Hourani et al (2023[30]) and OECD calculations.
Removing distortions in corporate income tax
More businesses should be shifted from distortionary turnover-based taxes to Romania’s corporate income tax regime. Direct taxes on corporate income contributed 14% of Romania’s tax revenues in 2021. Whereas bigger businesses pay Romania’s 16% corporate income tax on profits, small firms instead participate in a micro-enterprise tax regime, where depending on their size they pay as little as 1% tax on their turnover. This section in turn considers priority reforms to the taxation of small, medium and big businesses in Romania.
More small businesses should pay corporate income tax. Recognising the administrative burden of complying with more complicated profit-based CIT, OECD countries often have simplified tax regimes for small businesses. Eligibility requirements for Romania’s micro-enterprise tax regime have tightened in recent years. The revenue ceiling for entry was lowered to EUR 500 000 in January 2023 (previously EUR 1 million). As part of efforts to mitigate risks of high earners gaming the system, rule changes last year required that firms have at least one employee (ie, a two-person operation). New fiscal measures split the micro-enterprise regime in two. The former 1% rate applies below a turnover threshold of EUR 60 000; a 3% rate applies to firms with revenues up to EUR 500 000. The upper eligibility threshold for the microenterprise scheme remains very high in international comparison (Wen, 2023[31]). The regime should be reserved for firms with lower turnover. In terms of implied taxation of profits, the current minimum microenterprise tax rate of 1% is low compared with Romania’s CIT (IMF, 2022[32]). Implied tax rates on distributed dividends are in consequence very low for small firms. This can encourage businesses to decapitalise, potentially making it harder for many to access external finance to support investment (Chapter 3). Raising the micro-enterprise tax rate could help address this issue and reduce the gap in effective tax rates with the corporate income tax system. This would address distortions that likely discourage some high-performing firms from growing, or give high-income individuals tax reasons for incorporating. Set against this objective is the reality of small firms’ often poor access to debt finance (costs of which are deductible under CIT) and greater risks of non-compliance, especially while Romania’s tax administration is still improving. In enhancing the design of the micro-enterprise tax over time, Romania should draw on OECD best practices. These suggest that simplified tax regimes should be built to limit tax compliance costs, and encourage formalisation of businesses, while not deterring firms’ migration to the standard tax system (Mas-Montserrat et al., 2023[33]).
For medium-sized and big businesses (those with incomes above EUR 50 million), Romania has brought in a minimum tax on turnover to lift revenues (OECD, 2022[9]). Firms with corporate income tax liability below a threshold equivalent to 1% of turnover will have their tax bills raised to that amount. Levying the new tax on a simple base (turnover as opposed to profits) will facilitate enforcement. While the near-term budget position will benefit, the measure should not distract from the main task of corporate income tax reform, which international commitments make more pressing (discussed below). Because turnover taxes do not allow cost deductions, they penalise input-intensive firms and risk distorting business structures, favouring vertical integration (Xing, Bilicka and Hou, 2022[34]). Taxing turnover could also compound firms’ financial troubles at a time of elevated cost pressures. Such risks are mitigated by the low rate at which the tax is being levied. Still, the new turnover tax should be rolled back as soon as possible. Compliance-based arguments for turnover taxes will lose relevance as authorities grow better equipped to clamp down on fraud and evasion.
For large multinational enterprises (MNEs), new international commitments set a floor under effective taxation of profits. Romania is set to adopt the global minimum tax introduced by the Global Base Anti-Erosion Rules (GloBE) (OECD, 2021[35]). The new rules subject large MNEs to a 15% minimum effective tax rate on their profits. Affecting MNEs with worldwide turnover above EUR 750 million, the global minimum tax requires in-scope businesses to pay a top-up tax, bringing total tax on the group’s excess profits in low-tax jurisdictions up to the 15% minimum rate. The likely impact on tax revenues in Romania is uncertain and will depend on how companies respond to the global minimum tax. Those currently using Romania’s valuable tax concessions – such as those aimed at IT investments (Box 2.7) – may currently be paying less than the new minimum effective tax rate. In this case, a national top-up tax on profits may need to be introduced to lift effective corporate tax rates of the businesses concerned to 15%. Introducing a top-up tax would avoid revenues shifting to other countries, notably those home to parent companies of firms operating in Romania.
In addition to PIT exemptions for IT workers (up to gross monthly wages of RON 10 000), Romania’s CIT system offers tax incentives aimed at boosting investment in IT and research and development. These include:
50% deduction of R&D-based expenses
Accelerated depreciation treatment of equipment used in R&D activities
CIT exemption for earnings reinvested in IT equipment
10-year CIT exemption for firms involved in scientific research and technology
While many OECD countries use expenditure-based exemptions to encourage investment, long tax breaks – such as Romania’s 10-year exemption for new R&D firms – are rare outside developing and emerging economies. Tax holidays can benefit high-profit firms, many with large budgets for investment already. Such provisions also encourage firms to channel incomes through entities eligible for the tax incentive (OECD, 2022[36]).
2022
Note: The effective average tax rate (EATR) reflects the average tax contribution a firm makes on an investment project earning above-zero economic profits. Economic profits are defined as the difference between revenue and economic costs, including costs involved in the production of goods and services and opportunity costs; for example, revenue foregone by using company-owned buildings or self-employment resources. It is calculated as the net present value (NPV) over all cash flows associated with the investment project. The EATR is defined as the difference in pre-tax and post-tax economic profits relative to the NPV of pre-tax income net of real economic depreciation.
Source: OECD Corporate Tax Statistics database.
Raising revenue efficiently through taxes on immovable property
Romania raises little revenue from recurrent taxes on immovable property (4% of tax receipts in 2021). As in many countries, tax rates differ for residential and non-residential properties, but also for buildings and land. Building tax rates depend additionally on whether the owner is a natural person or a company, a feature that could influence decisions on incorporation. Methods used in Romania to assess properties’ taxable value are problematic. Whereas non-residential buildings are assessed on their market value, the taxable value of dwellings and land is based on a property’s area. Adjustments are made for location and characteristics including a property’s use, building type, and age of structures, but these fail to adequately capture the market value of homes and land (World Bank, 2023[17]).
Recurrent property taxation in Romania can be improved. While arguments exist for taxing land and buildings at different rates (OECD, 2021[37]), valuation tends to be simpler when both are assessed together (OECD, 2021[38]). Tax liability should be determined based on a property’s market value. Moving away from area-based valuation, as required in Romania’s RRP, would address inequities in an assessment system which rewards owners when their properties are undervalued. Model-based valuation can complement sales-based estimates, particularly in regions where property market activity is limited. Such approaches are used in Norway (OECD, 2022[39]). Allowing owners to override tax-agency estimates with self-reported valuations could mitigate risks of overtaxing homeowners when model assessments miss the mark. Abuse of such a system might be curtailed through selective auditing.
Raising proportionally more revenue from property taxes could reduce the tax system’s total drag on economic activity. The chief advantage of taxing property is that – unlike labour and capital – land cannot move to escape taxation. This reduces behavioural distortions from taxation. Building on RRP commitments, the central government should progressively raise a lower limit on locally-set property tax rates. To enable owners to plan ahead, and to avoid big market corrections, changes in property tax should be gradual. Property taxes could be means-tested, with lower rates levied on those less well-off, or part of a property’s value might be excluded from taxation, at least for single-property owners. This could avoid financial hardship for Romania’s large number of low-income owner-occupiers. Effective reform of property taxation also depends on completing the national land cadastre (Chapter 3).
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