The new fiscal code – economic context andimpact on the budget

Ionut DumitruPresident of the Fiscal Council

June 2015

A booming economy before the crisis

Source: Eurostat

BG

CZ

EE

LVLT

HU

PL

RO

SI

SKHR

2

3

4

5

6

7

8

9

10

2 4 6 8 10

An

nu

al g

row

th r

ate

fo

r d

om

esti

c d

ema

nd

(ave

rag

e 2

00

1-2

00

8)

Annual growth rate for real GDP (average2001-2008)

GDP growth drivenby domesticdemand

GDP growth drivenby exports

1.82.1

3.3

4.04.3 4.3

5.76.0 6.2

6.5

7.4 7.5

EA

EU 2

7

HU PL

HR

CZ

BG EE SK RO LV LT

Annual average GDP growth(2001-2008)

Scarce net inflows of foreign capital toprivate sector, slow recovery pace

Source: National Bank of Romania, National Institute of Statistics

Note: net inflows of foreign capital in the private sector; portfolio inflows excluded

-9

-6

-3

0

3

6

9

12

01Q

1

02Q

1

03Q

1

04Q

1

05Q

1

06Q

1

07Q

1

08Q

1

09Q

1

10Q

1

11Q

1

12Q

1

13Q

1

14Q

1

15Q

1e

Real GDP excluding agriculture (% yoy)

6.9% per year

2.6% per year

-10

-5

0

5

10

15

20

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Jan

-Ma

r 2

01

5

Net FDIs (% of GDP)

Net loans, deposits (% of GDP)

Total inflows of foreign capital in private sector (% of GDP)

Economic growth is strengthening

Source: National Institute of Statistics, Eurostat

Economic activity re-entered on an upward trend in 2011, but GDP growth rates weremuch below pre-crisis’ levels.

Pace of economic growth strengthened in 2014 and GDP dynamics in Q1 2015 (1.6%qoq, 4.3% yoy) came in much above our expectations and analysts’ consensus.

-9

-6

-3

0

3

6

9

12

01Q

1

02Q

1

03Q

1

04Q

1

05Q

1

06Q

1

07Q

1

08Q

1

09Q

1

10Q

1

11Q

1

12Q

1

13Q

1

14Q

1

15Q

1e

Real GDP excluding agriculture (% yoy)

6.9% per year

2.6% per year

-2

-1

0

1

2

3

4

5

6

7

8

EA HU PL HR CZ BG RS EE SK RO LV LT HR EA RS CZ BG HU SK PL RO EE LT LV

Annual GDP growth rate,average 2001-2008

Annual GDP growth rate,average 2012-2014

Improving consumption drives GDP

Note: Net wage fund = (number of employees * net wage ) in private companies with at least four employees and in the public sectorSource: National Institute of Statistics, European Commission, GfK

In 2014, households started to show an increasing appetite for consumption after several years in which they were quiteprudent in spending.

Improving labor market conditions (lower unemployment rate, decent growth of real wages and of real disposableincome) fuelled a rapid increase in the consumer confidence index starting Q4 2014.

Fast increase of private consumption (4.9%) was the key driver of GDP growth in 2014. Private consumption shouldremain the major driver of GDP growth in 2015 as well.

-70

-60

-50

-40

-30

-20

-10

0

10

May-05 May-07 May-09 May-11 May-13 May-15

Consumer confidence indicator

Savings over next 12 monthsFinancial situation over next 12 monthsGeneral economic situation over next 12 monthsUnemployment expectations over next 12 monthsConsumer confidence

-15

-10

-5

0

5

10

15

20

Apr-05

Apr-07

Apr-09

Apr-11

Apr-13

Apr-15

Net wages fund(real terms, % yoy)

Private sector Total economy

90

100

110

120

130

140

11Q1 12Q1 13Q1 14Q1 15Q1

Households' spending(11Q1=100)

Nominal sales of durable consumer goods

Real retail sales

Real private consumption

Investments are lagging behind

12

18

24

30

36

42

48

12

16

20

24

28

32

36

04Q4 06Q4 08Q4 10Q4 12Q4 14Q4

Gross fixed capital formationin the private sector

As % of GDP Current RON bn

0

2

4

6

8

10

0

2

4

6

8

10

04Q4 06Q4 08Q4 10Q4 12Q4 14Q4

Gross fixed capital formationin the public sector

As % of GDP Current RON bn

Note: In-house seasonally adjusted data for gross fixed capital formation in the private sector and in thepublic sectorSource: Eurostat, National Institute of Statistics, Ministry of Finance

Private fixed capital formation had a very poor performance starting mid-2012, while the government has also restrainedinvestment spending as to keep the public budget deficit at a low level.

Private investments have a large potential to rebound if the investors’ confidence would improve, due to: their current lowbase, low interest rates, and favorable taxation conditions (profits reinvested in equipments are tax exempted, socialcontributions paid by employers were reduced in Q4 2014).

Public authorities should increase the use of EU Funds, as 2015 is the last year to use 2007-2013 allocations.

5.2%

6.3%

6.7%

6.0%5.7%

5.4%

4.8%4.5%

4.3%

3%

4%

5%

6%

7%

2006 2007 2008 2009 2010 2011 2012 2013 2014

Public sector investments (% of GDP)

20

30

40

50

60

70

80

90

100

110

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Gross fixed capital formation at 2010 prices

Consumption at 2010 prices

GDP at 2010 prices

Very week performance of investment activity (2008=100)

Source: EUROSTAT

Contribution to GDP growth by uses (pp)

Source: EUROSTAT

Cut of taxes to help domestic demand,but likely to increase macro imbalances Measures aimed to cut taxes that were already enforced in 2014-2015:

Profits reinvested in equipments are tax exempted Social contributions paid by employers were reduced by five percentage points Tax on special constructions was reduced from 1.5% to 1.0% VAT rate for food products was cut to 9%

The new Fiscal Code that is under debate in Parliament aims for broad based cut of taxesduring 2016-2019: Among the measures planned to be implemented in 2016 there are:

• Cut of standard VAT rate from 24% to 20%• Removal of tax on special constructions• Cut of tax on dividends from 16% to 5%• Adjustment of excises for fuels and alcoholic beverages• Change in taxation of microenterprises (as to take into account the number of

employees)• Adjustment of local taxes (increase)• Enlargement of taxation base in case of social contributions, while capping the

payments (the maximum level of contributions will be determined based on amountof five gross wages in the economy)

Among the measures planned to be implemented in 2017-2019 there are:• Cut of social contributions in 2018• Cut of VAT rate from 20% to 18% in 2018• Cut of flat tax on profit and income from 16% to 14% in 2019

Full enforcement of the draft of the new Fiscal Code should generate upward pressures on thepublic budget deficit, reversing the consolidation trend from the past years

Source: Fiscal Council

The impact of the new fiscal code on budget deficit (% of GDP)

-1.9

-2.9-2.6

-4.6

-5.3

-8.6 -8.8

-5.9

-3.3

-2.1

-1.5

-1.0-1.3

-3.2 -3.3

-4.7

-5.5

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

Effective Deficit (ESA 2010)

Structural balance

Medium term objective (MTO)

Maastricht criteria

Unrealistic assumptions of the Government on second– round effects

Medium term objective is very challenging for Romania

Source: AMECO, Fiscal Council* For 2015-2016 – European Commission** Fiscal Council calculation (average economic growth at 4% during 2015-2020, potential growth at 3%)

-4.7

-3.5

-2.0-1.5 -1.2 -1.2

-2.2-2.9

-5.6

-8.9

-6.6

-5.3

-2.9-2.2

-1.5 -1.6

-3.5-3.0

-2.0-1.2

-0.6

0.6 0.41.2 1.3

2.0

-1.1

-1.8 -1.9

-2.3 -1.7 -1.4-0.9 -0.4 -0.1

0.20.6 0.9

-10

-8

-6

-4

-2

0

2

4

6

8

10

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

e

2016

p

2017

p

2018

p

2019

p

2020

p

output gapHeadline deficit*Headline deficit requered for structural deficit of 1% of GDP**Maastricht criterion

Low level of competitiveness

Source: The Global Competitiveness report, World Economic Forum, 2014-2015

Note: Red lines denote scores for Romania

World Economic Forum World Competitiveness Report – Ranking(out of 144 countries)

Source: The Global Competitiveness report, World Economic Forum, 2014-2015

Romania Bulgaria Czech Republic Hungary Poland Slovak Republic 7.05 Effect of taxation on incentives to work, 1-7 (best) 140 91 110 128 88 119 6.04 Effect of taxation on incentives to invest, 1-7 (best) 128 81 107 133 102 114 7.08 Country capacity to retain talent, 1-7 (best) 128 142 80 122 117 130 7.07 Reliance on professional management, 1-7 (best) 126 113 47 114 71 74 7.01 Cooperation in labor-employer relations, 1-7 (best) 125 111 52 71 100 105 2.02 Quality of roads, 1-7 (best) 121 106 81 58 89 82 6.01 Intensity of local competition, 1-7 (best) 120 75 17 47 51 32 6.09 Prevalence of trade barriers, 1-7 (best) 117 99 72 30 66 38 1.08 Wastefulness of government spending, 1-7 (best) 116 98 7 96 85 126 7.09 Country capacity to attract talent, 1-7 (best) 115 142 93 118 124 117 1.07 Favoritism in decisions of government officials, 1-7 (best) 114 134 106 122 67 141 4.10 Primary education enrollment, net %* 114 66 55 95 49 n/a 1.17 Ethical behavior of firms, 1-7 (best) 112 101 94 96 57 123 1. Corporate ethics 112 101 94 96 57 123

…. 5.06 Internet access in schools, 1-7 (best) 53 45 27 35 50 31 2.09 Fixed telephone lines/100 pop.* 52 42 63 37 78 68 9.03 FDI and technology transfer, 1-7 (best) 49 91 36 19 68 18 6.07 No. days to start a business* 48 84 92 14 111 87 1.21 Strength of investor protection, 0–10 (best)* 45 45 83 105 45 98 10.01 Domestic market size index, 1–7 (best)* 44 66 48 56 20 61 9.05 Fixed broadband Internet subscriptions/100 pop.* 40 39 41 31 46 47 6.06 No. procedures to start a business* 32 22 106 22 22 78 5.04 Quality of math and science education, 1-7 (best) 31 54 74 60 50 75 9.06 Int’l Internet bandwidth, kb/s per user* 19 27 25 75 37 93 8.08 Legal rights index, 0–10 (best)* 11 11 63 43 11 29 7.04 Redundancy costs, weeks of salary* 7 21 95 61 89 89

WOR

STBE

ST

Very low public revenues. . .

Source: EUROSTAT

Public revenues and fiscal revenues (% of GDP, ESA 2010, 2014)

33,4

45,2

27.6

39,9

202530354045505560

Dane

mar

caFr

anța

Belg

iaSu

edia

Finl

anda

Aust

riaIta

liaLu

xem

burg

Ger

man

iaU

ngar

iaG

reci

aO

land

aPo

rtug

alia

Slov

enia

Croa

țiaM

alta

Mar

ea B

ritan

ieCi

pru

R. C

ehă

Span

iaEs

toni

aPo

loni

aSl

ovac

iaIrl

anda

Leto

nia

Bulg

aria

Litu

ania

Rom

ânia

UE

28Zo

na e

uro

Venituri bugetare Venituri fiscale

… and very poor tax collection

7.9%8.0%

7.8%

6.5%

7.5%

8.6%8.4%

8.3%

7.8%

6%

7%

8%

9%

2006 2007 2008 2009 2010 2011 2012 2013 2014

VAT revenues (% of GDP)19% VAT rate 24% VAT rate

VAT rate (2015)

17

18 18

19 19

20 20 20 20 20 20

21 21 21 21 21 21

22 22

23 23 23 23

24 24

25 25 25

27

15

17

19

21

23

25

27

29

Luxe

mbo

urg

Rom

ania

201

7

Mal

ta

Germ

any

Cypr

us

Bulg

aria

Esto

nia

Fran

ce

Aust

ria

Slov

akia

Unite

d Ki

ngdo

m

Belg

ium

Czec

h Re

publ

ic

Spai

n

Latv

ia

Lithu

ania

Neth

erla

nds

Italy

Slov

enia

Gree

ce

Irela

nd

Pola

nd

Port

ugal

Rom

ania

Finl

and

Denm

ark

Croa

tia

Swed

en

Hung

ary

EU average: 21.5

Source: European Commission

Top corporate income tax (2014)

10

12.512.5

1415 15

1617

19 1920 20 20

20.6 21 2122 22

24.5 25 2526

27

29.230 30.2

31.431.5

3435

38

10

15

20

25

30

35

40

Bulg

aria

Irela

nd

Cypr

us

Rom

ania

201

9

Latv

ia

Lithu

ania

Rom

ania

Slov

enia

Czec

h Re

publ

ic

Pola

nd

Croa

tia

Finl

and

Icela

nd

Hung

ary

Esto

nia

Unite

d Ki

ngdo

m

Slov

akia

Swed

en

Denm

ark

Neth

erla

nds

Aust

ria

Gree

ce

Norw

ay

Luxe

mbo

urg

Spai

n

Germ

any

Italy

Port

ugal

Belg

ium

Mal

ta

Fran

ce

EU average: 21.3

Source: KPMG

Top personal income tax (2014)

10

1415

16 16

2122

2425

32

35 35

39

43.645

46 46.247.247.547.9 48

50 50 50.351.5 52 52

53.755.656.556.9

10

15

20

25

30

35

40

45

50

55

60

Bulg

aria

Rom

ania

201

9

Lithu

ania

Hung

ary

Rom

ania

Esto

nia

Czec

h Re

publ

ic

Latv

ia

Slov

akia

Pola

nd

Cypr

us

Mal

ta

Norw

ay

Luxe

mbo

urg

Unite

d Ki

ngdo

m

Gree

ce

Icela

nd

Croa

tia

Germ

any

Italy

Irela

nd

Aust

ria

Slov

enia

Fran

ce

Finl

and

Spai

n

Neth

erla

nds

Belg

ium

Denm

ark

Port

ugal

Swed

en

EU average: 37.9

Source: KPMG

Top social security contributions (2014)

14.7515.819.3 20

22.3

27.34

31 32.0234.0934.4534.6534.75 36 36.2537.2 38.238.4239.7139.940.4940.98

43.9644.95 4547 48.0748.649.96

68

10

20

30

40

50

60

70

80

Irela

nd

Unite

d Ki

ngdo

m

Cypr

us

Mal

ta

Norw

ay

Luxe

mbo

urg

Bulg

aria

Finl

and

Latv

ia

Pola

nd

Rom

ania

201

7

Port

ugal

Esto

nia

Spai

n

Croa

tia

Slov

enia

Swed

en

Germ

any

Aust

ria

Italy

Lithu

ania

Gree

ce

Rom

ania

Czec

h Re

publ

ic

Hung

ary

Belg

ium

Slov

akia

Neth

erla

nds

Fran

ce

EU average: 36.6

Source: KPMG

Unsustainable deficit in the social protection sector

Public deficit in the social protection sector (pension, healthcare and unemployment) - ESA2010 (% din PIB)

1.45 1.34 1.49 1.07

-0.08

0.34 0.69 0.42

-1.12

-3.12

-4.46-4.15 -3.30 -3.01 -3.28

-10.00

-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.0020

00

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Deficit sisteme de asigurări sociale (% din PIB)

Deficit bugetar (% din PIB)

Source: EUROSTAT, Ministry of Finance

Dividend tax (2014)

0 0 0 0 0 0 0

5

12

15 15 15 15 1516

1920 20

21

25 25 25 25 25 2526

27

30 30

0

5

10

15

20

25

30

35

Cypr

us

Esto

nia

Hung

ary

Latv

ia

Slov

akia

Unite

d Ki

ngdo

m

Rom

ania

201

6

Bulg

aria

Croa

tia

Czec

h Re

publ

ic

Lithu

ania

Luxe

mbo

urg

Neth

erla

nds

Slov

enia

Rom

ania

Pola

nd

Finl

and

Irela

nd

Spai

n

Aust

ria

Belg

ium

Germ

any

Gree

ce

Norw

ay

Port

ugal

Italy

Denm

ark

Fran

ce

Swed

en

EU average: 16.1

Source: Deloitte