Budapest Business Journal (BBJ) reports that Romania's state budget deficit widened to 1.7% of GDP last year from 0.8% in 2005 as spending increased before the country joined the European Union. In 2006, the country was forced, by the EU, to launch an expansionairy fiscal and budget policy, closely related to Keynesian economic doctrine based on consumption and spending (instead of incentives) stimulations. Tight EU regulations forced the country to widen the budget gap as the policymakers in Brussels set several requirements which Romania probably had to adjust. Among them, spending on pensions several other areas, including infrastructure, was introduced. The government plans to raise spending more this year, widening the budget deficit to 2.8 percent of the GDP. As late as November, Romania posted a budget surplus of 1.2% of GDP. Budget balance should be narrowed in order to avoid long-term accelerating inflation from a 16-year low of 4,7 percent. It is highly recommendable for the Central Bank to follow the rules instead of discretion. It could set the inflation targeting framework and thus make a commitment and minimize the inflation risk which is a first-degree priority for further price stability. Transparent and non-complex tax code, instituted by a 16 percent flat tax, did not cause the instability of public finance as policymakers in Paris and Brussels have predicted. Instead, the flat tax generated more revenue, from 30,3 percent in the previous year to 31,8 percent in the last year.
EU Monetary Affairs Commissioner Joaquin Almunia said last year that "budget revenue as a proportion of GDP was lower than in any EU nation and recommended the country increase it." Following the empirical evidence, raising tax rates and penalties on productive behavior will not result in higher revenue. High taxes, instead of revenue-neutral tax rate, cause high administration costs. Numerous loopholes, deductions and exemptions stimulate individuals to search devices of how to avoid paying taxes. Tax collection thus becomes very costly while at the same time, tax revenue can hardly reach higher levels.
Laffer Curve shows this particular aggregate relationship between tax rates and the height of tax revenue. Laffer Curve in the case of Romania goes following:
"Romania has said income tax revenue has consistently increased since January 1, 2005, when it introduced a flat tax of 16% on corporate and personal income, the lowest in eastern Europe. It replaced a corporate tax rate of 25% and a personal income tax rate of as high as 40%. The Finance Ministry said revenue from the 19% value added tax increased 23% last year and totaled 8.3% of GDP and customs tax collection rose 19%."
The surest way to increase the revenue is to lower tax rates on corporate and individual income and set them flat. Another very important way to raise the revenue is to work on monetary stabilization and price stability. Cutting penalities on productive behavior is of the utmost importance as well. There is no such thing as a static feedback between productive behavior and tax system. Expansionairy spending could strongly boost the public consumption in the long-run when the stability of the public finance could pose serious risk if policymakers pursued a spiral of spending mechanism with high public debt and structural weakness.