The Dilemma of Fiscal-Budgetary Consolidation: Recipe for Failure or Path to Real Balance?

Discussions regarding fiscal-budgetary consolidation and the necessary measures for this purpose intensify twice a year – before the budget for the following year is drafted and after a period of about six months of execution, when the results of the implemented policies become evident, and corrective measures are required. 

By Vlad Boeriu, Coordinating Partner for Tax and Legal Services, Deloitte Romania.

This year is no exception, as representatives of authorities, as well as financial institutions and the business environment, expose possible solutions to help balance the budget within the limits assumed for this year, at least. However, most of these solutions are based on quick, extreme measures, insufficiently analyzed, and with uncertain outcomes. To break free from this cycle of short-term solutions, the discussion should begin with how the state budget is constructed, which is the main cause of its permanent fragility.

In broad terms, the current dilemma seems to be related to which budget column should be adjusted in favor of the other – cutting expenses to match revenues or increasing revenues to cover the assumed expenses.

Read more about

Study: eight out of ten global leaders expect Gen AI to transform their organization within three years

read more

Traditionally, in Romania, when drafting the state budget, representatives of authorities consider overestimated revenues and lower expenses than projected, relying each time on exceptional events that could bring more money to the budget (higher-than-expected economic growth, favorable international financial developments, etc.) or that certain expenses can be sacrificed, such as investments. Budget revisions follow the same formula, and at the end of the year, the result, predictably, is made to look as good as possible, attributing any deviations to identified factors along the way. As a result, this fragile budget structure is perpetuated from year to year, and for this reason, every time, we find ourselves on the wrong foot when economic conditions become adverse (as happened at the outbreak of the pandemic, which “surprised” us with a budget deficit much higher than the EU’s allowable limit after several years of record economic growth, during the energy crisis, and the outbreak of the war in Ukraine, etc.).

The Chronicle of an Announced Failure

To have the necessary fiscal space in such situations and to ensure budget balance in the long term, the state budget must be built according to the principle that underpins good governance: conservative revenue estimates and maximum expenses. In this way, in predictable economic conditions, budget balance can be maintained or improved, and in an adverse context, there is the necessary fiscal space to support the economy (tax cuts, fiscal incentives, subsidies, etc.).

However, in practice, history repeats itself, even this year – the Fiscal Council warned from the beginning of the budget drafting process that the projected revenues were overestimated (by over 11 billion lei) and the expenses were underestimated (by nine billion lei), and the budget deficit at the end of the year is expected to reach 5.7% of GDP, instead of the 4.4% of GDP target set by the authorities. Thus, the construction had an unstable foundation from the start, and the budget deficit recorded after the first five months of the year, 2.32% of GDP (compared to 1.4% of GDP in the same period last year), clearly indicates that Romania this year is at risk not only of exceeding the deficit target but also of reaching a higher level than last year, thus violating its commitment to the European authorities to gradually reduce the budgetary imbalance so that it falls below the maximum allowable limit in the EU, 3% of GDP, by the end of 2024.

Consequently, only after restoring the budget based on realistic estimates of revenues and expenses should the necessary measures be taken on both budget columns.

Regarding expenses, it is evident that, in the current inflationary context, a reduction in salaries and pensions is undesirable, but there is ample room for improvement in the efficiency of budget allocations for certain projects, restructuring institutions with excess staff, and redirecting them to deficit areas.

Correct Tax Treatment, Essential for Increasing Revenues

On the revenue side, increased collection should be the main source of additional revenue for the budget and a constant concern for the authorities during this period, especially since, from 2022, the process of digitizing the tax administration has been accelerated through the implementation of complex reporting systems, such as SAF-T, RO e-Invoice, and RO e-Transport. These systems are designed to provide the authorities with the information needed to identify transactions with potential tax evasion as quickly as possible and take direct action against them, with much higher chances of success, including discouraging these practices and increasing budget revenues. At the same time, compliant taxpayers will be identified and spared burdensome controls. However, for this endeavor to generate the desired results, it must continue beyond the enrollment of taxpayers in the new reporting systems, with the authorities equipped with the necessary technical solutions for the collection, processing, and analysis of the obtained data to obtain the information needed to combat tax evasion and, consequently, increase revenues to the state budget.

Nevertheless, in practice, situations increasingly arise where, due to pressure to increase revenues at any cost, tax inspectors target compliant taxpayers, carry out insufficiently documented controls, issue tax assessment decisions without a solid legal basis, and bring substantial sums to the budget, without being concerned that these sums will most likely be refunded to the respective taxpayers in a few years (as a result of actions won in court), with interest and penalties. Therefore, these amounts that are initially reported as additional revenues to the budget constitute extremely expensive loans that the state will have to repay to taxpayers sooner or later, along with the associated costs. And at that moment, once again, there will be additional pressure to cover current expenses plus the amounts to be refunded to taxpayers (won in court). A vicious cycle from which there is no escape except through the complicated but inevitable path of fiscal correctness.

Of course, in the short term, it is much simpler and faster for the National Tax Administration Agency (ANAF) to bring additional revenue to the budget from taxpayers who are already compliant (even if, in a few years, the court will decide that the applied tax treatment was incorrect) than to concentrate collection efforts in the areas of the economy where there are clear signs of deficient collection and/or tax evasion. But the outcomes of the two approaches are completely different: the first generates repayable and expensive “loans” for the state, indirectly encourages non-compliance with tax payments, reduces taxpayers’ confidence in ANAF, etc.; the second has the potential to reduce tax evasion in areas where this phenomenon has a significant impact, to help formalize operations in the “gray” economy, improve the relationship between tax authorities and the business environment, and ultimately generate real additional revenue to the state budget, either through tax assessment decisions issued on legal grounds or through voluntary compliance.

It is indeed true that all this process requires time and resources, but the old recipe, which has proven to be inefficient over time, can no longer be applied here.

In conclusion, before talking about essential expense cuts or revenue increases through extreme measures such as tax hikes or questionable tax assessment decisions, fiscal-budgetary consolidation must start with the development of a realistic budget, followed by cost-efficiency measures, and in parallel, measures to reduce tax evasion and increase voluntary compliance, possible only within a fiscal framework based on principles of good intent. Otherwise, if we once again resort to measures that aim for quick effects in the short term, without impact assessments and without consulting all stakeholders, in half a year, we will find ourselves facing the same dilemma once again.