IMF and Romania tackle flat tax failure
At the time of its introduction the flat tax was supposed to deliver sustained economic growth in Romania. This did not happen. The onset of recession in Europe in 2008 impacted heavily on employment and public finances, and after national income declined by 7.1 percent in 2009, exposing a yawning budget deficit, the government had no option other than to call in the IMF. Since 2009 the country's problems have deepened as a result of the crisis in Greece: an estimated 15 percent of the assets held by Romanian banks belong to Greek parent companies.
As part of a reform package IMF officials are discussing tax reform. This is likely to include hiking VAT rates, which will have a regressive impact on growth and social equality, and raising the 16 percent flat tax rate on personal incomes and corporate profits to 20 percent. With unemployment at about 8 percent and inflation running way ahead of earnings growth, the finance minister is under pressure from employee representatives to abandon the flat tax and restore progressive income taxes.
Flat taxes have been enthusiastically promoted by a range of conservative think tanks. Proponents claim they attract inwards investment and deter tax evasion. In practice they have achieved neither, and the majority of Eastern European countries such as Romania have suffered mounting fiscal deficits and rising inequality since their introduction.
As analysts elsewhere have noted, the flat tax model involves significant tax hikes for lower income households and significant tax cuts for wealth holders and high income households. Claims that removing progressivity from the tax system will lead to its simplification have been exagerated since much of the complexity arises from the need to counter corporate tax avoidance.