Controversy over proposed income tax reform

In September 2003, the Romanian government announced plans to abolish the current system of progressive income tax and replace it with a fixed-rate tax of 23%, as part of a new Fiscal Code. The proposals met with major opposition from three of the largest trade union organisations, which organised protests, adding a number of other demands, such as increases in the national minimum wage. Parliament is now to decide on the government's plans, and it seems likely that it will at least postpone the new fixed-rate tax until 2005.

The Romanian government has recently been drafting a proposal for a new Fiscal Code, with the aim of simplifying and putting in order the taxation system, which has become very complicated, with hundreds of laws and ordinances added in the past decade. The social partners were much in favour of this move, and especially employers, which have often criticised not only the overall tax burden but the system's complexity and instability as a major restraint on development. In September 2003, the debate moved onto a new stage when the government turned its attention to personal income tax and proposed the abolition of the current progressive income tax (whereby the rate of taxation increases with income) and the introduction of a fixed- or flat-rate income tax of 23%.

This proposal was opposed by the President of Romania, who had on many previous occasions declared his support for an even more progressive income tax regime than at present. However, the main opponents were three of the most important trade union organisations (RO0307101F) - the National Trade Union Bloc (Blocul Naţional Sindical, BNS), the Confederation of Democratic Trade Unions of Romania (Confederaţia Sindicatelor Democratice din România, CSDR) and Cartel Alfa. In their opinion, a fixed-rate income tax is unacceptable of grounds of equity, as only a small proportion of employees – the highly paid ones - will benefit from its introduction, while the majority will have to pay more taxes.

The government reacted promptly in an attempt to dispel fears of losses in net pay and stated that no employee will have to pay more income tax overall. For those on low wages, for whom the income tax rate is currently 18%, tax deduction schemes will ensure that the actual net wage will be higher in all cases. Moreover, members of the government proclaimed their unanimous support for a fixed income tax rate, stating that this will continue to be a proportional tax, so social equity will not be damaged. They also asserted that such a scheme had the following advantages:

  • the 'tax wedge'- ie the difference between workers' take-home pay and the cost of employing them (made up of income tax and social security contributions) - will be reduced, which will stimulate employment by lowering costs without affecting the take-home pay of employees;
  • it will provide an incentive to reduce the clandestine economy, as wages are often underdeclared because of high taxation;
  • it will provide a simpler and less costly tax mechanism; and
  • it will strengthen the process of forming a 'middle class', by supporting adequately paid work, private savings and investment.

Trade union opposition

When income tax reform was debated in the Economic and Social Council (Consiliul Economic si Social, CES), the national tripartite body for social dialogue, trade unions expressed their support for a different type of change. They called for the lowest rate of income tax to be cut from 18% to 14%, whilst lowering the highest rate from 40% to 25% - the same rate as the tax on company profits.

Consequently, the government launched a wide-ranging public consultation, including through the media, and commissioned an opinion poll. However, this found that 45% of respondents preferred the present progressive income tax, while 25% were in favour of the introduction of a fixed rate, and 30% did not know which would be better.

Meanwhile, trade unions increased their opposition, anticipating that at least some employers' organisations would join them, as well as students’ and pensioners’ associations. Their protests went further by integrating many other previous claims which have remained unsolved since spring 2003. The unions announced a three-stage programme of protests, as follows:

  1. pickets in front of prefectures in Romania’s main cities (Bucharest, Iasi, Brasov and Timisoara) on 2 October 2003. These were particularly well attended in Brasov, where the current privatisation of two major public companies is regarded with distrust, as mass redundancies are to be made;
  2. a five-minute work stoppage in all companies in which BNS, Cartel Alfa and CSDR are represented on 9 October; and
  3. a major national demonstration in Bucharest, if the first two steps do not achieve progress over the unions' demands.

The trade unions’ claims now cover more than 20 issues, of which the most important are:

  • the withdrawal of the fixed-rate income tax;
  • the introduction of tax allowances for items such as private pension schemes, private health insurance schemes, housing repair and insurance, and mortgage interest relief, which are not consistent with a fixed-rate income tax;
  • a cut in prices for public utilities - electricity, heating and especially natural gas - that have recently been raised;
  • an increase in the national minimum wage to EUR 100 per month from January 2004, and to EUR 150 in 2005 and EUR 500 in 2007. This would not only increase wages across the economy, but also lift benefits and social assistance (eg students’ scholarships);
  • a reduction of the retirement age by at least two years; and
  • a recalculation of all pensions awarded under to Law 19/2001, as previously agreed, in order to eliminate, step by step, the inequalities that had been created over time by successive changes to the pensions legislation.

Parliament to take final decision

Against the background of resistance to its proposals (considered undesirable in a pre-election year), on 2 October the government finalised its Fiscal Code reform plans and submitted them to parliament for its decision. As regards income tax, the proposed changes involve:

  • maintaining the current progressive income tax regime in 2004, while introducing additional tax allowances. These deductions will cut the annual tax base for individuals by EUR 200 for contributions to private pension funds, private health insurance funds and housing insurance, EUR 380 for housing renovations and repairs and EUR 500 for mortgage interest; and
  • introducing the fixed-rate income tax of 23% from 2005.

Parliament's final decision on whether or not to accept the government's proposals should be taken under a fast-track procedure since the government needs the issue to be decided in order to draw up the state budget proposal for 2004.

Commentary

The chances are that parliament will be cautious in this matter and at least postpone the abolition of the progressive income tax until 2005, well after the elections in 2004. The idea of a fixed-rate income tax has proved to be unpopular, for at least two reasons:

  • leaving aside the issue of informal payments which avoid taxation, most people currently pay income tax at a rate below the proposed 23% fixed. A rate that was fixed but at a lower level (for example, 14%-18%) would have received more support;
  • the fixed-rate tax implies the abolition of tax allowances, which would harm the interests of better paid employees and some service sector employers (eg in construction or insurance).

Generally, employers have not shown the expected enthusiasm for the reform because they regard payroll taxes and not income tax as a major restraint on their development

Probably the most important aspect of this issue is that it reopens debate on pay, a critical issue in Romanian industrial relations. Regardless of their likely short-term success in preventing the introduction of the fixed-rate income tax, trade unions will continue their protests over their other demands, both old and new, but the government and employers might turn out to be less flexible on these claims, as they include increases in the minimum wage. (Diana Preda, Institute of National Economy, Romanian Academy)

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