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Tax burden in business climate.


The intensity with which revenues are taken from individuals and legal entities, or the whole society through taxation, is tax burden and indicates the extent to which the nominal incomes of the population are adjusted through taxation, and show the extent or degree to which the state budget procure their income through taxes. We established that fiscal pressure represents a part of the taxpayers' income that they compulsorily give up in favour of the sate. These mandatory taxes established and collected through legal coercion by the state finance the state budget, social insurance, local budgets and public funds.


Tax burden, made visible by the fiscal rate, is calculated as a "ratio between the fiscal returns, including social insurance contribution, over a certain period, usually a year, AND the value of gross domestic product (GDP), achieved in the same period by a national economy" (Hoanta, 2000), and shows the share of GDP taken from the public budget to cover public expenditure.

For legal persons, the tax burden will be determined as a ratio between the total of tax payments supported by the firm and the value added obtained by the legal person' (Lepadatu, 2007).

Each tax can modify the taxpayers' economic and social behavior because the tax will have an impact on his/her expenditures or savings. Reducing the available income as a result of paying the tax the taxpayers' ability to obtain savings will be automatically reduced, and implicitly its consumption. However, this influence manifests itself differently according to the social category involved.

Apart form the fiscal rate at the state or legal person level, specialists in the field see as relevant in explaining the growth of tax evasion as a result of tax burden the psychological tax burden which represents the psychological tolerance threshold acceptable to the taxpayer. This tolerance to payment represents the individual tax burden, calculated as ratio between total levy and the total income obtained before tax payments (Buziernescu, 2001). This ratio expresses the "sacrifice" approved by law which has to be made by the taxpayers from the income over a period, usually a year. Thus, this indicator allows for the subjective elements of social life to enter economic calculus. The higher this pressure the higher the tendency toward tax evasion. However, it is difficult to determine which is the ideal level of individual tax burden to which taxpayers can be submitted to because it is influenced by random elements which depend on the taxpayers' education, their mentality, but also by the diversity of the levy, the volume of state supported social services, taxpayer's fiscal subjectivity (direct tax payments are visible and their amount can be easily determined, while the indirect tax payments included in the price of products and services are not that obvious to the taxpayers).

Given the fact that analysts dealing with problems (Basiat, Keynes) related to tax burden assessed the influence of the taxes on the taxpayers' behaviour these have always tried to establish an optimal tax system to minimalize financial pressure. In our opinion, of all the researches in the field, the American Arthur Laffer's work is the most relevant.

The Laffer curve (Laffer, 2004) illustrates the basic idea that changes applied to tax rates have two effects on taxes: the arithmetic effect and the economic effect. The arithmetic effect refers to the fact that if tax rates are lowered, taxes will be lowered by the amount of the decrease in the rate. The reverse is true for an increase in tax rates. The economic effect, however, recognizes the positive impact that lower tax rates have on work, output, and employment--and thereby the tax base--by providing incentives to increase these activities. Raising tax rates has the opposite economic effect by penalizing participation in the taxed activities. The arithmetic effect always works in the opposite direction from the economic effect.

According to Laffer's theory, a rise of tax burden does not necessarily determine the rise of the taxes, but on the other hand, a lowering of fiscal pressure creates favorable conditions to increase fiscal incomes. This increase of fiscal incomes as a consequence of tax rate cut, even by only one percent, determines, at least psychologically, a lowering tendency of tax evasion from the taxpayer's side. But a reduction of tax burden can be difficult because, a sudden tax cut by a significant percent can lead to a budgetary deadlock, while a timely moderate reduction of tax burden is sensed later and the tax payers' behaviour remains relatively unaffected.

If the existing tax rate is too high, then a tax-rate cut would result in increased taxes. The economic effect of the tax cut would outweigh the arithmetic effect of the tax cut.

A moderate tax burden will maintain the taxpayers' interest in working or extending the business and the attraction to tax evasion is diminished. At the other end an unbearable high tax burden will discourage supplementary work, will discourage the legal person and will encourage tax evasion.

In this paper, we want to use Laffer's curve as a tool to analyze the economic effect of tax rates cut, because this theory shows the complexity of the economic effect of taxation by analyzing the ways in which different factors interact.

To try to demonstrate the usefulness of Arthur Laffer's theory, we'll analyze on the tax due for individual and legal entities income in Romania. Thus, in the year 2004, profits made by a company is taxable with a fixed percentage rate of 25% and earnings of employees are taxable by progressive tax rate, respectively from 18% to maximum 40% for revenue higher than 13 million ROL, which represented approximately 325 Euros. Also wages generate employer contributions of 33.25% and employee contributions of 17%. In the year 2005 a single tax rate of 16% was introduced both for legal entities profits and for individuals, without affecting other contributions generated by the salaries. What was the impact of this tax diminishing?

In order to answer the question we determined the net salary obtained from an average salary of 10 million ROL (approx. 250 euros) in 2005 compared with 2004.

In 2004 when the progressive tax rate was applied the tax on salary was of 21.92%, which exceeds by 5.92% the unique tax rate. As a result of introducing the unique tax rate, the tax burden of the employees lowered from 30.15% to 26.28%, which represents a decrease of 3.87%. In all, the tax burden generated by the salary has decreased by almost 3% in 2005 as compared to 2004. In 2004, in the case of a 20 million ROL salary the tax on salary reached a maximum of 40%. In 2005, this tax rate cut to the unique tax rate of 16% determined a reduction of the tax on salary by 13.1% and the tax burden decreased by 7.53% for the employee. Finally, the entire tax burden from a 20 million salary decreased by 5.64%. It can be noticed that in the case of a double salary the tax burden decreases by almost double. Thus, the higher the incomes the lower the tax burden is. In other words, a cut of the tax on salaries from the progressive tax rates--that reached the maximum tax rate of 40%--to the unique tax rate of 16% favored the ones with higher incomes.

On the basis of the official reports issued by the Ministry of Finance we noticed that with the setting of the unit tax rate of 16% on salaries had as a first effect the decreasing of the income receipts by the state budget from these taxes. Thus, the collected incomes receipts from the tax on salary, decreased by 5.27% in the first 8 months of 2005 as compared to the same period of the previous year. This can be seen as a result due to the fact that at the employer's level there were no cuts in taxation, the social contributions levied on them being 32.5%. If we add social contributions levied on the employees, a contribution of 17% we get 49.5% total contributions for social security only. Therefore, taxation of wages in Romania is among the highest in Europe. As a result, the legal entities still resort to the use of the "black labor", especially since the fines charged in the case of discovering the use of the undocumented labor are much smaller than "earnings" obtained from undeclared incomes from salaries.

Regarding the tax on profit, the budgetary income from the profit increased by 7.6% in 2005 as compared to 2004. Nevertheless, the 9% profit tax rate cut was not incentive enough for the legal entities. The fiscal relaxation for the economic entities is an illusion because the reduction of tax rate on profit did not counter-balance the raising of indirect taxes which determined an increase in raw materials, materials, goods and services and also a decrease in the gross profit. At the same time, the employer continues to pay the same high taxes to social insurances.

Nevertheless, after only 8 months since the introduction of the unique tax rate on income, the collected budgetary income increased by 15.2% as compared to the same period of the previous year.

The Romanian state, seeing that the tax burden for the legal entities regarding the social security contributions is too high, establishes a fiscal policy of reducing it. A first reduction of 2.75% is achieved in 2006, but the Romanian state establishes a new tax of 0.75% for leaves and medical allowance. Even in these conditions, in 2006 the collected fiscal revenues increased as compared to 2005 by 44.57% regarding the income tax and an increase of 21.71% in the case of profit tax. At the moment, the social contributions levied on the employer represent 27.6% a 5.63% decrease as compared to 2004. Social contributions levied on the employees represent 16.5% a 2.5% decrease as compared to 2004. Ideally, on the basis of the above presented pattern, we can state that the fiscal relaxation regarding social contributions will lead to an increase of revenues for the budget. We believe that this raising of the budgetary revenues from the income tax may also be a result of the newly gained visibility of a part of the underground economy, namely from the "black labour". This positive effect caused by the tax cut may be also noticed by the increasing number of documented work contracts which are registered at the territorial labour bureau.

These results demonstrate Laffer's theory according to which a reduction in tax rates may cause an increase in collected revenues. Although there were some opinions against the desirability of introducing the unique tax rate, we consider that this reform of the tax system was a positive one which did not affect the state budget


In conclusion, the introduction of the unique rate of taxation had a favorable effect; the fiscal reduction generated an economic effect and not an arithmetic one, as showed by Laffer's theory on collected budgetary revenues. The increasing of the collected budgetary revenues with 20-40% compared to the period previous to introducing the single tax rate, shows that this relaxation of fiscal policy was stimulated the taxpayers voluntary compliance and we can consider that the flat tax of 16% is approaching an optimal tax. Also it is proper for the Romanians mentality.

Even the unique tax rate to 16 % had as an effect the raising of fiscal revenues to the state budget we consider that tax burden levied on the natural and legal entities are still very high in Romania as compare to the tax burden in other EU countries Today in Romania is more than 300 duties, taxes and contributions which must pay by the legal and natural persons in order to undertake an economic activity. Of these, only five categories of taxes make more than 80% of state revenues. These are taxes on income and profit, social contributions, VAT, excise and customs duties. Because of these, we believe that the government must review the policy and tax system, reduce the number of duties, taxes and contributions because, as we saw from the undertaken analysis, tax cuts can lead to an increase of the state budget, by encouraging taxpayers to declare all taxable incomes and by not resorting to tax evasion.

In the future, this study can be developed through the creation of a mathematical model that determines the impact of the reduction with another one or two percent of this tax, currently 16%, on revenues collected to the budget. The outcome of such reductions will increase the revenue collected to the budget or, on the contrary, a decrease?


Balaban, C. (2003). Tax evasion, Theoretical and juridical practice controversial aspects, Rosetti Publising House, ISBN 973-8378-47-8, Bucuresti

Buziernescu, R. (2001). Tax evasion in Romania, Universitaria Publising House, ISBN 973-8043-50-6, Craiova

Hoanta, N. (2000). Economie and public finance, Polirom Publising House, ISBN 973-683-459-X, Bucharest

Laffer, A. (2004).The Laffer curve: Past, Present and Future, Available from: 765 Accessed: 2008-07-15

Lepadatu, G. (2007) Tax burden and their quantification indicators, The Economic Tribune, No.42, 5 pages (33-37), ISSN 1018-0451
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Author:Avram, Laura; Savu, Lucian; Vancea, Smaranda; Ignat, Andreea; Horja, Monica, Avram, Calin
Publication:Annals of DAAAM & Proceedings
Date:Jan 1, 2008
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