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Taxation of Wage Earnings for Pension Purposes in Romania, since 1950

Taxation of Wage Earnings for Pension Purposes in Romania, since 1950 Some implications at present

The income tax has increased about four times in Romania since 1950, according to data published by the National Institute of Statistics (INS). The evolution of gross and net earnings shows that we have reached a doubling compared to the period before the political regime change, which occurred in 1989 (see data presented in extenso and centralized by decades in the table below).

The statistical series of the INS covers practically all the periods worked by the current retirees. Therefore, it is as relevant as possible for the assertions regarding the contributions made by each individual during his work life, through the taxes levied by the state – taxes deducted from the gross income to reach the net income, more popularly known as “money in hand” (in the socialist period, starting from 1978, the term “retribution” was adopted, representing the equivalent of the net salary). 

 

An initial period of 20 years can be observed when the relatively high ratio between taxpayers and retirees led to very low contributions by current standards. That is, a ten-year average of 7.7% gross wage income taxation. The 10% threshold was passed, for the first time, only in 1970, and since then there was a gradual levelling of the rate of tax increases devoted to the payment of pensions, with the stabilized level of around 14% from 1978 to 1989.

Thus, during the socialist period, there was a gradual recognition of the need to double the taxes applied on gross wages, mainly to cope with the aging process of the population and to ensure a decent ratio between the pension received and the pensioner’s former wage (“the replacement rate”). It should be noted that in “communism” there was no concern whatsoever for progressive taxation involving differentiated rates for smaller salaries and higher salaries.

The massive retirement wave, along with the early retirement incentive for certain occupations, combined with the sharp decrease of the labor force subject to fiscal duties, determined, immediately after 1989, a rapid increase of the labor taxation. The level of 25% taxation on gross salary has been reached since 1997 and the year 2002 marked the maximum value of this indicator, of 28.8%. Interestingly, the decrease from 1998 to 1999, somewhat more consistent than the one caused by the modification of the taxation paradigm from progressive to fixed, passed almost unnoticed.

The introduction of the single tax rate for taxable income brought the net/gross ratio to 77% in the first year of implementation (2005). Afterwards, the systematically delayed indexation of personal deductions and those for dependents, however insufficient in relation to the advances in price levels, was followed by the bizarre-liberal idea of ​​the progressive diminution of personal deductions after income.

That led to the return to a downward trend of the ratio between net salary and gross salary. This fact, combined with the convenient “forgetfulness” of the indexation after inflation of the amounts exempted from taxation, led, for the total economy, to the restoration of the level of labor taxation, paradoxically, almost exactly at the level before the introduction of the single tax rate.

When applying the system based on “pension-points” for calculating the pension rights based on “defined contribution”, introduced since 2001, the pension score was calculated only by reference to the average level of pay and not by correlating with the amount of taxes paid, respectively with the actual coverage of a number of pension beneficiaries from that time.

This was an approach close to the principle of the distribution of heating costs in condominiums, which did not take into account the actual consumption of different winter months and gathered scores from years when the tax rate was very different. Technically, strictly based on real contribution, a year of contribution from the present is felt much more intensely as a financial effort at individual level, without taking into account the subsidization of the pension budget from the state budget, a situation that has only appeared since 1995.

Otherwise, if it were according to the actual contribution of each individual out of the agreed gross salary (pure contribution from the perspective of intergenerational solidarity), one year of contribution after 1990 would have been equivalent to about three years before 1970 or one year from now, about double that of any of the years before 1989.

Translated into normative acts, the most favored classes by this approach were those who paid relatively low taxes at a young age and benefited from the possibility of retiring immediately after 1990 five years before retirement compared to the standard age. A measure taken, at that time, in order to avoid a massive increase in unemployment.

The most disadvantaged category would have been that of those employed only in the post-1989 period, who need work five more years (compared to the previous legislation) so as to meet the age required by law and for which there will be no sustainable sources in the decades to come for the payment of pensions at the same rate of replacement as at present. I wrote “would have been” because the contributiveness tableau, based on fair principles, has been complicated by the emergence of different correction coefficients for different retirement years since 2013. That created the situation of the significantly different amounts received by people who accumulated identical scores.

All in all, the system built at a declarative level on contribution was strongly distorted by the initial paradigm itself and ended up being adjusted successively until it came to resemble the Leaning Tower of Pisa. That symbolic building, although corrected during times by various craftsmen, still looks crooked. Keep in mind that it has not crashed yet or, more precisely, it has not been allowed to fall down. Therefore, a rethinking of the fundamentals for ensuring a truly equitable basis of taxation would be urgently required, even if the legal obstacles may prove difficult to overcome.

 
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OEconomica No. 1, 2016