World Bank: Romania’s tax system increases poverty, especially for rural households and families with children

Sorin Melenciuc 05/08/2019 | 12:17

Romania’s tax system increases poverty especially for rural households and for families with children, as direct cash transfers to poor households are not large enough to compensate them for the burden of indirect taxes, according to a recent World Bank study.

The results of the study, called “The Distributional Impact of Taxes and Social Spending in Romania”, suggest that the combined effect of taxes and social spending in Romania help to reduce inequality, although less so than in other EU countries.

“However, the combination of direct and indirect taxes and transfers leads to an increase in poverty, as direct cash transfers to poor households are not large enough to compensate them for the burden of indirect taxes. This is especially important for rural households and for families with children,” the study says.

The government has recently reduced the rates for personal income and value added taxes with the objective of encouraging private investment and reducing the tax burden on citizens, and consequently, to contribute to the improvement of living standards.

The combined fiscal effect of these changes is estimated to lead to a 5.4 percent reduction in total revenue and a substantial increase in the primary deficit, holding all other economic variables constant.

“On the distributional side, our simulations show that these changes have likely led to an increase in inequality, as most of the tax relief accrued to the top of the income distribution. Moreover, the reform was a very expensive way to achieve what is actually a very small decline in the poverty rate,” World Bank experts indicate.

“In fact, our simulations show that higher and better targeted social assistance spending could have achieved much better distributional results at a much lower fiscal cost,” they added.

Experts warn that these results are problematic, not only because Romania engaged in procyclical policies that could put is sustainability at risk, but also because much of this fiscal effort was not used to efficiently reduce poverty.

According to the study, once indirect taxes and in-kind transfers are considered, Romania is less redistributive than other countries with similar levels of GDP per capita (in purchasing power parity – PPP – terms) such as Croatia and Chile, but also less distributive than some countries with lower levels of GDP per capita, such as Brazil, Costa Rica, Mexico and Tunisia.

“The impact of indirect taxes is relatively important in all cases. Once indirect taxes are taken into account, the redistributive effort is somewhat reversed as the Gini coefficient for consumable income is slightly higher than what is observed for disposable income as indirect taxes tend to be regressive and unequalizing,” the study points out.

In the case of Romania, the effect of indirect taxes is less severe than in Poland and Croatia, according to the experts. Spending on education and health further reduce inequality, however, the redistributive effect is much lower than in other countries.

Beyond the impact on inequality, which measures the relative position of households across the distribution, the study measures the impact on poverty, which depends on the absolute level of income of a household with respect to a poverty threshold. The results of the study suggest that the combination of taxes and social spending “was poverty increasing in 2016.”

“The share of the population whose market income (including pensions) was below the per capita USD 5.50 PPP-a-day poverty line was 13.9 percent. Once the burdens of direct and indirect taxes are considered, these are larger than the direct benefits received from transfers, so that the share of the population whose consumable income is below the USD 5.50 PPP-a-day poverty line increases to 15.4 percent,” the experts calculated.

Similarly, if one were to use Eurostat’s relative poverty line of 60 percent of the median equivalized disposable income, the headcount poverty rate increases from 21.8 percent for disposable income to 27.5 percent for consumable income.

Most of the increase in poverty is due to the burden of indirect taxes, as households are not being compensated for this burden through direct transfers, according to the study.

“Even for extreme levels of poverty (such as those captured by the USD 3.20-a-day poverty line), social transfers are insufficient to mitigate the burden of taxes so that the level of extreme poverty after taxes and transfers is higher than before taxes and transfers are considered,” the study indicate.

The poverty gap and the severity of poverty decline when going from market to disposable income for the absolute poverty lines, but once indirect taxes are incorporated into the analysis, part of this effect is reversed, researchers found out.

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