Existing analysis finds that the redistributive impact of direct taxes and transfers is relatively low compared to the EU average.<sup>7</sup> Focusing on direct taxes and transfers alone, there is evidence that after some improvements in 2016 (Stroe et al, 2017), changes in direct tax and transfers led to a 0.7 percent decline in the disposable income of the poorest deciles in 2017 (Militaru and Tammik, 2017). This was mainly due to increases in health insurance contributions, as the minimum base for contributions increased with the statutory minimum wage. Some of this effect was counterbalanced by the fact that pension income became exempt from health insurance contributions starting in 2017, and the guaranteed minimum social pension increased thanks to a 30 percent increase in its threshold, however the overall effect was negative. Increases in non-means tested child benefits seem to have contributed to income gains for the upper income deciles. For 2018, recent simulations focused on direct taxes and transfers find that the reduction in the PIT rate is likely to increase the degree of redistribution (EC, 2018). The 2017 Emergency Ordinance is expected to increase the degree of redistribution, largely thanks to the increase in the PIT-free allowance and a reduced PIT rate, although there will likely be some losers.<sup>8</sup> Although this work has been very useful, it has not consistently included the impact of indirect taxes, despite recent important changes.<sup>9</sup> VAT, excises and customs duties amounted to over 10 percent of GDP in Romania in 2016, making up more than 40 percent of total tax and social contributions.<sup>10</sup> The government has since reduced VAT rates in several steps since 2015, reducing the standard rate from 24 percent to 20 percent in 2016, further to 19 percent in 2017, and there are plans to further reduce it to 18 percent in 2018, but it is unclear how these changes affect the overall impact of policies. These changes were no doubt also over distributional concerns. For instance, De Agostini et al (2017) found that Value Added Taxes were strongly regressive in 2011, but not so for excise taxes. Despite the very useful work on direct taxes and transfers, analysis using more recent data to comprehensively include indirect taxes is not regularly done. Similarly, the impact of in-kind transfers in the form of public education, health and other services on the welfare distribution have not been typically included. Education and health expenditures make up the largest share of social spending after social protection, amounting to about 2.8 and 4 percent of GDP respectively in 2016. Without empirical analysis of the impact of these policies it is difficult to assess the likely impacts of these reforms in combination with other initiatives taken by the government.

This paper aims to fill this knowledge gap through a more comprehensive analysis of the impact of fiscal policy on inequality and poverty in Romania. Building on existing work, the analysis covers the impact of the contributory pension system, direct taxes and transfers, value added and excise taxes, as well as the 7 See EUROMOD Statistics on the Distribution and Decomposition of Disposable Income. Version H1.0+. Available at: <u>https://www.euromod.ac.uk/using-euromod/statistics.</u> 8 Some people will be net losers because they will face an increased burden of social contributions which will not be compensated by the benefits they receive from a higher minimum gross wage, or a higher PIT allowance. Part-time workers are also likely to lose due to the introduction of a minimum contributory base for their social contributions.

9 Incorporating indirect taxes into the analysis is not consistently done, although there have been recent advances in this regard. For instance, existing EUROMOD analysis typically uses EU-SILC data which do not have information on household spending. Recent work by De Agostini et al (2017) has tried to use survey-to-survey imputations to combine EU-SILC data with household budget survey data, however this is not regularly done.

10 Total tax and social contributions amounted to 24.8 percent of GDP in 2017, of which VAT collection amounted to 6.3 percent of GDP, while excise taxes and customs duties amounted to 3.1 and 0.1 percent of GDP, respectively (General Consolidated Budget, Ministry of Public Finance).

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