Romania: Reduction of undeclared work and contributions to social security

Undeclared work has been a major issue in Romania for many years. One of the latest laws to try to tackle it has reduced social security contributions by five percentage points. Social partners cannot agree whether this will have the desired effect; some suggest that reducing VAT may have been a better solution.

Undeclared work

Undeclared work, paid work that is legal but not declared to public authorities, has a negative impact on employment, labour productivity and working conditions, on skills development and lifelong learning. It leads to lower pension rights and it limits access to medical care. It risks undermining the financing of social services in Europe, already under pressure; it decreases individuals’ social protection status and labour market prospects; and it may affect competitive conditions. It also runs counter to European ideals of solidarity and social justice.

Competent bodies in combating undeclared work are fiscal authorities, which deal with tax evasion, and labour inspectorates, which monitor working conditions and health and safety rules. In Romania, the Labour Inspectorate’s powers have been reinforced by Law No. 51/2012, which is consistent with the provisions of the ILO Convention on Labour Inspection (No. 81), ratified by Romania.

Background

So far, Romania has tried to reduce undeclared work in three ways.

First, in 2011, an amendment was made to the Labour Code stipulating that any contract of employment must be in writing. The amendment states that a written contract is a condition of its validity (Art. 16 para. (1) of the Labour Code).

The second means of trying to reduce undeclared work is through sanctions. Both employer and employee can be punished for being involved in undeclared work. Moreover, hiring more than five people without written employment contracts (in Romanian, 975 KB PDF) is a criminal offence.

Finally, national programmes have been put in place, such as improvements in the way labour inspections are carried out (in Romanian, 2.2 MB PDF) and in the national strategy for reducing the incidence of undeclared work for 2010–2012, approved by Government Decision No. 1024/ 2010

Legislative amendments

A proposal to the European Parliament for preventing undeclared work (in Romanian, 240 KB PDF) states that there is a common perception that labour taxation and excessive regulation can boost undeclared work. The European Parliament Resolution of 9 October 2008 on stepping up the fight against undeclared work (758 KB PDF), recommended that Member States should use innovative methods tailored to the various business sectors in order to combat undeclared work and tax erosion.

Consequently, Law No. 123/2014 was enacted to amend the Fiscal Code, with the idea that reducing social security contributions by five percentage points would help reduce undeclared work. From 1 November 2014, the new values are:

  • 26.3% for normal working conditions (currently 31.3%), meaning workers contribute 10.5% of their wages and employers contribute 15.8% (currently 20.8%);
  • 31.3% for difficult working conditions (currently 36.3%), with workers contributing 10.5%, and employers 20.8% (currently 25.8%);
  • 36.3% for special working conditions (currently 41.3%), with workers contributing 10.5% and employers 25.8% (currently 30. 8%).

Objectives of the legislative change

According to the Explanatory Memorandum, the purpose of this law is to:

  • prevent and combat undeclared work and/or sub-declared work;
  • support fair competition in business;
  • protect workers by increasing the level of social security.

Decreased social insurance contributions will reduce the tax burden on workers by 1.6% (compared with 2013). According to Romania’s Business Magazine, the average worker’s tax burden will thus become 42.6% (in Romanian), a level that will still mean Romania has one of the highest tax rates in Europe.

Views on the usefulness of the measure

According to online newspaper Objectiv.Info, the Minister of Finance, who initiated the measure, says that social security contributions have been reduced before (in Romanian) and analysis of the results shows that this has had a positive effect in the medium term by:

  • reducing undeclared work and tax evasion;
  • increasing employment rates;
  • improving external competitiveness;
  • attracting foreign direct investment.

The minister says that reducing social security contributions by five percentage points could lead to an increase in GDP of 0.1%–0.2%, which could lead to the creation of 70,000 new jobs.

However, the President of Romania has opposed the measure and sent it back to parliament to review, stating in the online newspaper Ziare.com that reducing the rates for employers will increase pressure (in Romanian) on the current national budget deficit.

The Fiscal Council also opposed the measure, saying on its website that it would hamper compliance with the medium-term deficit targets (in Romanian). The council added that any reduction in social security contributions should be accompanied by a reform of the whole system of social contributions, because of the principle of equal treatment of taxpayers, regardless of their income. Instead, it suggested, transparency in budget spending would stimulate people to pay their taxes.

The Labour Minister stated in Income Magazine (in Romanian) that reducing social security contributions by five percentage points would increase funds available to the employer (in Romanian). The minister said the money can be used to create new jobs, and will also stimulate business, reduce undeclared work and thus increase the number of taxpayers, which will improve the ratio of contributions to beneficiaries.

Social partners’ reaction

Bogdan Hossu, President of the National Trade Union Confederation, Cartel Alfa, told Monitorul Expres that he believes that if social security contributions are reduced, 90% of the money saved will go to well corporate profit (in Romanian) and that only a small part will be used to create incentives for employees.

Gheorghe Naghiu, President of the Romanian Owners Association, considers that a five percentage point reduction is not significant enough for Romanian employers. He told online magazine Economica.net that, at best, most employers will slightly increase workers’ wages (in Romanian) but, at worst, the money saved from reducing the contributions will get lost through accounting.

Alternative solutions

Some analysts estimate that reducing VAT would have been a better alternative (in Romanian), a view backed by René Schöb, Country Managing Partner of audit and consultancy firm Mazars Romania.

Commentary

Many analysts are sceptical that reductions in social security contributions will generate jobs and reduce undeclared work. Small businesses in sectors with a high incidence of tax evasion (such as restaurants, hotels, car servicing and laundries) might not be particularly affected by this reduction, which is small compared to the total labour cost.

The level of social security contributions is not the only element that matters in this case – also important is the overall economic climate (in Romanian). It might be better to bring in measures offering stability and predictability to the business environment, which – in turn – will stimulate domestic and foreign investment.

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