Impact of fiscal policies changes on the budgetary revenues and sustainable economic growth

1
Impact of fiscal policies changes on the
budgetary revenues and sustainable economic growth

• Cristian Nicolae Stanica
• Institute for Economic Forecasting, Romanian
  Academy, Romania

2
Objectives

• The estimation of the GDP dynamics, employment
  and wages as a response to the fiscal policies
  changes
• The presentation of the particular features of
  the model used for fiscal policy simulation
  analysis
• The investigation of the impact on the budgetary
  revenues and expenditures by the direct effects
  of the fiscal policies and by the indirect
  effects of the economic growth changes using a
  baseline scenario and two alternative scenarios
• The presentation of the scenarios results.

3
Models used in Romania

• Macro Models
• Dobrescu Macro Model of the Romanian weakly
  structured economy
• Link-Dobrescu Model
• Hermin Model
• SAM-MEGA Model
• RMSM-X Model
• Other specific models
• Determination of the potential output
• Long-term growth models, especially developed by
  the experts of the National Commission for
  Forecasting

4
Some features of the model used for budgetary
forecasts

• SAM-MEGA model is built on the relationships
  across macroeconomic indicators of the IMF
  financial modules and the modules of the
  institutional sectors (public, private and
  foreign sector)
• National Accounts Indicators (GDP and the
  aggregate incomes) NatAcc
• Public Accounts (General Consolidated Budget)
  GovAcc
• Labor Force Indicators (Unit labor cost,
  Compensation of employees) Labor
• Foreign Sector (Exchange Rates, Balance of
  Payments, Romanias International Investment
  Position) Foreign
• Monetary Sector (Monetary Survey) MoneyAcc
• Private Sector, as a residual for the overall
  model PrivSect

5
The transmission of the influence from the
governmental policies to primary blocks
GDP
Aggregate Demand
transmission
transmission
transmission
Gross added value
Market Private Consumption Investments
transmission
transmission
Gross salary earnings
Social security contributions, Taxes on income
Taxes on profit
Government Policies
transmission
Gross profit
transmission
VAT, Excise duties, Custom taxes
6
The transmission of the influence from the
governmental policies to primary blocks

• Any shock in the fiscal policy, particularly
  related to a fiscal relaxation, would entail a
  surplus of factors incomes which, at their turn,
  would generate a surplus of aggregate demand
  (consumption and investments) and supply (GDP)
• During the forecasted period, aggregate demand
  and supply determines, at their term, the
  comportment of taxation bases. The budget
  revenues are estimated in relation with the
  taxation bases and the empirical collection
  rates.
• On the demand side, from the national account
  module it results the taxation bases for indirect
  taxes
• Market private consumption for value added tax
• Import for Customs taxes.
• On the supply side, from the national account
  module it results the taxation bases for direct
  taxes
• Official gross wages for Social contributions and
  Taxes on income
• Gross profit (and other incomes) for Taxes on
  profits.

7
Fiscal policies changes and the budget scenarios

• The presentation of two practical applications of
  the model to evaluate the impact of the fiscal
  policies on the evolution of the budgetary
  revenues and on the economic growth
• The quantification of both the direct (budgetary)
  effects of the fiscal policy and the indirect
  effects were quantified for every alternative
  scenario variants if the direct effects are
  accounting results of the new tax rates, the
  indirect effects consist in the influences of the
  new fiscal policy on the macroeconomic indicators
  and the impact of their changes upon the
  budgetary revenues)

8
Fiscal policies changes and the budget scenarios

• The definition of a baseline scenario in order to
  forecast the budgetary revenue, respecting the
  following requirements the update of the
  macroeconomic indicator forecast in relation with
  the first part of 2011 and the maintenance of the
  same fiscal policy in 2011-2012 as the one from
  2010

9
BASELINE SCENARIO
2010 2011 2012
Economic growth GDP () -1.3 1.5 3.9
Final consumption -2.1 1.3 3.4
Private consumption -1.7 1.9 3.9
Public consumption -3.6 -1.1 1.4
Gross capital formation 2.7 2.8 5.1
Gross average earnings (RON) 1910 2026 2125
Average number of employees (thou. pers.) 4570 4610 4655
Budget deficit ( GDP) -6.5 -4.4 -3.0
10
The baseline scenario

• The baseline scenario for 2011-2012 foresees the
  continuation of positive effects of economic
  growth recovery recorded in the first quarter of
  2011. Industry and exports would be further the
  main catalyst elements of economic growth.
• On the labor market, in the private sector, over
  80 thousand employees are to be hired in 2011,
  after losing 160 thousand employees during the
  crisis year 2010. As for the governmental sector,
  the employees number would decrease with 40
  thousand persons in 2011, the same with 2010, due
  to the measures meant to restructuring government
  expenses negotiated with IMF.

11
The baseline scenario

• The main targets of the forecasting in the
  baseline scenario concerning the economic growth,
  for the 2011-2012, are
• GDP will accelerate the growth from 1.5 in 2011
  to 3.9 in 2012
• Gross fixed capital formation (investments) will
  be the most dynamic component of the domestic
  demand
• The government consumption will decrease with
  1.1 in 2011 and will have a moderate growth of
  1.4 in 2012, as a consequence of the restrictive
  budgetary expenditures, planned according to the
  fiscal reform in the Government Program.

12
ALTERNATIVE SCENARIOS Influences on
macroeconomic indicators for the year
2012Variant I flat tax decrease by 4
Variant II security contribution decrease by
3 and minimum wage increase by 20, from 165
euro to 200 euro
Baseline Scenario Var. I Var. II
Economic growth GDP () 3.9 5.0 4.0
Final consumption 3.4 4.7 3.6
Gross capital formation 5.1 6.4 5.2
Number of employees (thou. pers.) 4655 4725 4655
Gross average earnings (RON) 2125 2146 2234
13
The alternative scenarioVariant 1 flat tax
(profits and personal incomes) decrease by 4

• The scenario of fiscal projections take into
  account the tax legislation reducing the legal
  rates of profit tax and income tax from an
  average of 16 in 2010 to 12 in 2012
• The multiplicative effect of the surplus of
  income and profits would entail the increase of
  domestic demand and supply which, at their turn,
  would lead to the increase, in average, of gross
  salary earnings and to the generation of new
  jobs. The GDP growth would change from 3.9
  (baseline scenario 2012) to 5 in 2012. The
  number of employees would rise by 60 thousand
  people in 2012, as against the level forecasted
  in the baseline scenario
• In spite of the fact that fiscal relaxation
  policies have positive effects, stimulating
  labor, investments and economic growth, however a
  decrease is expected for the overall budget
  revenues by 2.5 billion Lei in 2012 as compared
  with the baseline scenario

14
The alternative scenario Variant 2 security
contribution decrease by 3 percentage points and
minimum wage increase from 165 euro to 200 euro

• The proposal to increase minimum wage is
  imperatively necessary for Romanias economy, due
  to its low level and to employment concentration
  around low income. However, this measure alone
  would entail the inhibition of supply and the
  increase of labor cost on short term, as well as
  the fast increase of demand that could entail an
  inflationary shock.
• Minimum wages indexation by 20 would lead to the
  increase of average gross salary earnings by 2.5
  in 2011 and by 5 in 2012, since the only
  professional categories which are affected would
  be those with low salary earnings. In order to
  minimize the financial effort of salaries
  increases, the social contributions on the
  employers side must be diminished by 3
  percentage points, this being the optimal value
  resulting from the models simulations.

15
The alternative scenario Variant 2 security
contribution decrease by 3 percentage points and
minimum wage increase from 165 euro to 200 euro

• Moderate effect of this package of measures upon
  GDP growth, being only entailed by the positive
  effect of increasing salary earnings that would
  encourage consumption
• The fiscal relaxation of security contributions
  would not allow the companies to allot funds for
  investments, but to compensate the additional
  labor cost.
• The combined effects of both economic policy
  measures at budgetary level, allowing the
  revenues to remain unchanged
• Direct effects net impact upon revenues from the
  reduction of legal quota by 3 percentage points
  consists in the diminution of revenues with 0.6
  billion Lei in 2011, respectively with 1.2
  billion Lei in 2012
• Indirect effects additional revenues of 0.6
  billion Lei in 2011 and 1.2 billion Lei in 2012,
  resulting from consumption encouragement (VAT,
  excise duties) and the increase of salary
  earnings (taxes on income).

16
Conclusions

• After the end of recession, which lasted 2 years
  in Romania, the application of economic policy
  measures is imposed in order to ensure economic
  recovery and to consolidate sustainable economic
  growth
• One of the factors encouraging the economic
  growth and improving the employment by reducing
  the hidden economy is the fiscal relaxation.
• According to the model results, the best policy
  measure for Romania is the one consisting in the
  reduction of flat tax by, at least, 4 percentage
  points
• In these conditions, the medium term economic
  growth (2011-2012) will continue to have a high
  level - of more than 5 - and will continue to be
  sustainable, even if the public finance will be
  less balanced due to the fiscal relaxation

17
Conclusions

• The fiscal relaxation will affect the budgetary
  revenues (mainly the direct taxes) by 1
  percentage point as share in GDP on the short
  term
• On medium and long term, the economic growth
  would be able to ensure the surplus of revenues
  necessary to fill the gaps entailed by fiscal
  relaxation
• In order to preserve the target of budgetary
  deficit weight in GDP of 3 in 2012, other
  compensatory measures would be needed for
  supplementing budgetary revenues with, at least,
  2.5 billion lei

18
Conclusions

• The solutions to increase the budgetary revenues
  and to consolidate the public finance, on medium
  term, are the following
• Tax collection rate increase by fiscal control
  strengthening
• Tax base extension by the taxation of
  agricultural lands at market value. Since the
  price for a hectare of land outside localities
  should not fall below some hundreds of Euros, an
  average taxation with 20 euro per hectare per
  year would be entirely reasonable. The 15.7
  million hectares of agricultural land would thus
  entail about 215 million Euros (about 0.3 of
  GDP) net gain for the consolidated budget
• Increase of budget receipts from the
  privatization of the viable units from the
  portfolio of the Authority for State Assets
  Recovery and from the closure of those (consuming
  subventions) without survival chances.