TAX REVENUES IN ROMANIA SHOW IMPRESSIVE GROWTH IN

UNCLAS SECTION 01 OF 03 BUCHAREST 001035

SIPDIS

STATE FOR EUR/NCE - WSILKWORTH, EB/IFD, D STAFF - WILSON
STATE PASS USTR
USTR FOR LERRION
TREASURY FOR STUART
USDOC FOR 4232/ITA/MAC/EUR/OEERIS/CEEB/BURGESS/KIMBALL
STATE PASS USAID

SENSITIVE

E.O. 12958: N/A
TAGS: ECON ETRD EIND EFIN RO
SUBJECT: TAX REVENUES IN ROMANIA SHOW IMPRESSIVE GROWTH IN
FIRST QUARTER OF 2005

REF: BUCHAREST 000130

SENSITIVE BUT UNCLASSIFIED

SUMMARY
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1. (SBU) Romania's budget revenues soared in the first three
months of 2005. Embassy attributes this to a variety of
factors, including unexpectedly high GDP growth in 2004,
wider general tax compliance (perhaps linked to the new flat
tax) and the threat of increased tax collection enforcement.
However, corrupt mid-level managers continue to compromise
tax collection efforts within the fiscal authority. End
Summary

Higher Tax Revenues.
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2. (U) According to preliminary data released in early April
by the Ministry of Finance (MOF),first quarter consolidated
budget revenues grew to nearly Romanian Lei (ROL) 177.9
trillion, or approximately $6.3 billion up from nearly ROL
153.2 trillion, the equivalent of $4.7 billion, during the
same period in 2004. The MOF stated that revenues increased
more than ROL 8.38 trillion in January, ROL 5.39 trillion in
February, and ROL 10.94 trillion in the first 23 days of
March 2005 when compared with the same period in 2004. The
aggregate three-month increase over the same period in 2004
amounted to ROL 24.7 trillion, the equivalent of $1.5
billion. The MOF believes in the sustainability of these
trends, and points to the elimination of tax relief and tax
rescheduling options as one reason for optimism. The GOR
also claims to see an overall widening of the tax base due
to a mix of economic growth and conversion of grey market
revenue to the legitimate economy.

.Above Budget Forecasts
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3. (U) These higher revenues came in above the previous
government's planning targets for 1Q 2005, in spite of the
flat tax. Forecasts made in 2004 predicted consolidated
budget revenues for the first quarter 2.6 percent lower than
actual results. Corporate profit tax collection was up 13.9
percent from projected, although the lower tax on personal
income resulted in numbers 7.1 percent lower than initially
expected. The increase in revenues from corporations was
likely due both to greater enforcement and unexpectedly high
growth. Other areas that benefited from tighter policing
include customs, with revenues up 16.1 percent from
projected, and VAT collections, up 5.0 percent. Revenues
from excise taxes were lower than planned, mainly due to the
GOR's January 1 elimination of excises on certain categories
of electronic goods, such as digital cameras. This decision
was later repealed in March after conversations with the
IMF. Municipal contributions to the GOR budget also
exceeded projections by 9.4 percent.


4. (U) The previous government based its 2005 tax revenue
projections on an estimated GDP growth rate of 5.3%.
However, the Ministry of Finance has not yet calculated
growth for the first quarter to determine how it compares
with projected. Without this statistic, it is not possible
to determine to what extent increased tax revenue is a
result of unexpectedly fast economic growth versus greater
tax collection efforts.

Flat Tax Starting to Show its Effects?
--------------

5. (U) Another factor contributing to increased tax revenues
may be the "flat tax" that is now in effect. On December
29, 2004, the new Romanian coalition government passed an
emergency ordinance fulfilling its campaign promise to
implement flat personal and corporate tax rates effective
January 1, 2005. The new government hailed this 16 percent
tax as a method of attracting foreign investment, boosting
job growth and remaining competitive as Romania approaches
EU membership in 2007. Excluding Georgia (12 percent),the
flat tax on corporate profits is the region's lowest.


6. (U) According to common economic wisdom, the imposition
of a flat tax should cause a dip in income tax revenues for
a time before showing a rise. The data from the first
quarter of 2005 show glimmers of this. For example, an
expected decrease in revenues from individual tax payers was
evident, but much less severe than many analysts predicted,
considering the ten percentage-point average drop in
personal tax rates due to the flat tax. The possibility,
however, that 2004 taxes (at the higher tax rates) were
being paid into the GOR's coffers in 2005 make the picture
too uncertain to make any explicit linkages to the flat tax
at this point.

Government Clamp-Down on Tax Dodgers
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7. (U) A third element in increased 2005 revenues is
probably the "fear factor." President Basescu has made the
fight against corruption a matter of national security and
the GOR has initiated a flurry of investigations against
high-profile "businessmen." Pragmatism also drives the anti-
corruption strategy, since the GOR is faced with increased
spending requirements in preparation for EU membership in
2007 and lower tax rates must necessarily go hand-in-hand
with increased tax enforcement.


8. (U) To this end, on April 7, the GOR approved a draft law
making tax evasion equivalent to a felony crime. This
legislation, now being debated by the Senate Budget and
Legal Commissions, imposes jail sentences for tax evaders on
a clear sliding scale, leaving little room for creative
court interpretation. Penalties increase based upon the
amount owed. Three to ten years of prison is prescribed for
those owing at least EURO 10,000; four to 12 years for those
owing at least 100,000 Euros; five to 16 years for those
owning at least 500,000; between 10 and 20 years for those
at least EURO 1 million; and 3 to 15 years for those making
illegal VAT reimbursements. Persons barring fiscal
authorities from inspecting corporate property would be
punished though jail terms ranging from six months to three
years.


9. (U) When the Senate Commissions complete their debates,
the draft law will arrive in the two houses of Parliament
for further debates and revisions. Once the law is passed,
it would normally come into force within thirty days, unless
the Parliament decides upon a longer transition period.

U.S. Department of the Treasury Advisors Propose Changes
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10. (SBU) Romania welcomes USG ideas on how to move from the
theory of tax collection to practical methods of
enforcement. Members of the U.S. Department of the
Treasury's Office of Technical Assistance from March 28 to
April 8, traveled to Bucharest to review the MOF's methods
of collecting tax revenues. The team identified ways to
increase tax receipts quickly by improving the collection
process. Suggestions included sending letters to delinquent
tax payers threatening seizure of property for nonpayment,
focusing GOR resources on the highest monetary value cases,
expanding the use of installment agreements and ceasing to
waste efforts on unsalvageable cases. More ambitious ideas
include legislative changes to limit taxpayer ability to
contest minor government errors and the augmentation of MOF
authority to seize assets and proceed against managers
responsible for non-payment of taxes of a legal entity.


11. (SBU) MOF Secretary of State Sebastian Bodu who heads up
the Agency for Fiscal Administration (AFA) concluded that
the GOR could implement some of the recommendations,
although he rejects installment payments in a nod to the
IMF's more conservative fiscal policies. Mr. Bodu is most
concerned, however, about the corrupt mid-level managers
that persist throughout the fiscal administration agency,
and is frustrated with his inability to clean house due to
restrictions on firing civil servants. He hopes to create
an internal investigation unit, partially composed of law
enforcement officers, in an attempt to examine reports of
employee malfeasance. If created, this unit would have the
authority to arrest those suspected of corruption.

Comment
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12. (SBU) Post is encouraged by the preliminary three-month
tax collection data, although a longer time horizon is
necessary to formulate a solid opinion on sustainability and
the true full effect of the imposition of the flat tax. In
addition, the GOR made amendments to the fiscal code in
March which raised taxes on banking interest, capital gains,
and real estate gains beginning in the second quarter. A
number of excise taxes also increased on April first. Thus,
three to six months of additional data are needed to come to
meaningful conclusion. Nonetheless, Post is cautiously
optimistic that revenues will continue to climb since
Romania seems to be in a solid growth mode.


13. (SBU) An even larger problem looming for the GOR,
however, is the continuation of a high level of mid-manager
corruption within the AFA. This will continue to impede tax
collection efforts until Mr. Bodu is given the necessary
tools for reform. Post recently held an interagency brain
storming session to identify ways to assist the AFA and
offer training and suggestions; several ideas were proposed
and their feasibility is currently being investigated.

Delare