The Anti-Competitive Objective of the Romtelecom/Astra Agreement: a Letter to Romania's Competition Council

Dear competition inspectors,

I would like to inquire the council regarding the recent set of events surrounding a controversial arrangement between the telecommunications company Romtelecom and the insurance company Astra Asigurari.

Specifically, in April 2010 the Romanian media unveiled that Romtelecom was forcefully enrolling their existing phone service customers into property insurance plans provided by Astra, while charging for the insurance premium directly through the telephone bills.  It is further well known that Romtelecom engaged in this practice without the customer's permission or request for such services, and in fact, a number of complaints to the Autoritatea Nationala pentru Protectia Consumatorilor (ANPC) reveal that customers inquiring and requesting termination of the insurance policy faced a great deal of resistance and even outright refusal from the Romtelecom staff.

An Economic Perspective of a VAT Increase, Part 2: Effects on Tax Revenues and Welfare

Last week's (Part 1) discussion regarding the effect of the VAT rate increase on prices illustrated that from a basic supply-demand perspective, ceteris paribus, base prices (those collected by the producers) and equilibrium quantities should both fall, following the VAT hike.  It was, moreover, briefly mentioned that one immediate side effect of this is a direct loss in social welfare, commonly referred to as deadweight loss.  Indeed, any increase in the tax rate, in this sense, always embodies a certain degree of inefficiency.  This is why economists constantly argue that tax rates adjustments should be approached with extreme caution and utmost consideration to intended goals and potential effects.

What are the chances that the decision of raising Romania's VAT rate from 19% to 24% within one week was preceded by a comprehensive methodological analysis of its consequences?  For the majority of Romanians, the answer comes in the form of either laughter or tears (sometimes both).  Yet, criticism of this decision is not, by any means, new; the common media has exploited the opportunity to denounce the policy move to maximum extent.  Sometimes, the government officials themselves, either as a paradoxical phenomenon or arrogant sarcasm, publicly proclaim the counterproductive nature of this initiative.  However, most such discussions appear to be narrowly cast in terms of poorly understood concepts: usually limited to effects on consumption and encouragement of tax evasion.  On the other hand, certain obvious outcomes -- such as, for example, the fact that a higher VAT rate implies lower profits which immediately leads to lower income tax revenues -- receive remarkably little attention.

Indeed, many questions and details remain unaddressed.  For those wishing to grasp a better understanding of the economic effects of VAT-type (e.g. consumption) taxation, the present discussion once again offers a fairly simple explanation grounded in fundamentals of economic theory.  What exactly drives the inefficiency of a consumption tax?  How does an increase in the VAT rate translate into overall tax revenues, both from VAT and income based collections?  How may a benevolent policy maker (i.e. one who is concerned only with the well-being of the public) approach the decision of a VAT rate increase?  These are just a minor subset of questions requiring methodological answers in order to attempt to understand the misalignment between the motivation driving the current government's decision and the consequences that may be expected.  Unfortunately, one clear conclusion supported by the ensuing analysis is that bankruptcy has now materialized as a rather genuine possibility for Romania in the near future.

Commentary: A Few Initial Observations on Producer Reactions to the VAT Increase

As an interesting follow-up to the discussion of last week, here are some passing observations on the immediate responses in price setting behavior.  This is by no means a scientific investigation -- just some prices I happened to notice in my personal routine.  As anecdotal and limited as this evidence is, however, it nevertheless appears quite to be illustrative.

For example, out of pure personal interest, I have been tracking the prices of several models of mobile phones offered by Vodafone and Orange at the end of June 2010.  Both offer phones for purchase, with prices depending strongly on whether or not you agree to a service contract (or extension) at the time of the purchase.   Obviously, agreeing to a contract (typically two years in length, for both companies) entitles the purchaser to a rather hefty discount on the price of the phone.

An Economic Perspective of a VAT Increase, Part 1: Effects on Market Prices

The announcement of a planned 5 basis points increase in Romania's VAT rate, effective 1 July 2010, has sparked (as usual) a wide spectrum of frantic analyses and predictions in the past week. A brief read of the Romanian print media produces a tsunami of awe-striking figures: 10-12% growth in prices, devaluation of the currency to 6 RON/EUR, additional tax revenues of RON 3-4 billion, etc. Likewise as typical, the numbers are accompanied by little to no justification, neither empirical nor hypothetical in nature. In the context of the foreseen inflation, for example, it is not even clear weather the proclaimed dramatic growth in prices refers to the prices charged by producers (i.e. before applying the VAT) or the prices paid by the consumers (i.e. after applying the VAT), nor what currency they are being assessed in (e.g. RON, EUR, USD, etc.).

In this sense, while the predictions are certainly sensational and undoubtedly entertaining, they offer admittedly little to those looking for information upon which to base a serious business management of investment decision. For the latter purpose, it may be worthwhile to consider more bland but methodological explanations of what might be possibly expected in a market following a VAT rate increase. This is the point of the discussion found here -- to provide some insight using several fundamental concepts offered by economic theory. We proceed in two parts. Presently, the analysis focuses on the effect of a VAT rate increases on market prices (both base prices and final prices) as may be pertinent to business managers and investors; subsequently, Part 2 will explore the merits of a VAT increase from a social planning perspective.