When Consumption Does Not Tell the Full Fiscal Story: Macroeconomic and Financial Drivers of the VAT-to-Consumption Ratio in Romania

This study investigates the annual evolution of the VAT-to-consumption ratio in Romania to explore if household consumption alone determines this evolution or if other macroeconomic and financial factors contribute to it. At the intersection of fiscal analysis and applied macroeconomics, this research assumes that how consumption translates into VAT-related outcomes is not a constant mechanical function but rather may be influenced by persistence effects, labor market conditions and other costs associated with various forms of consumption. According to the empirical evidence, the VAT to consumption ratio for Romania has a high level of temporal persistence which implies that the evolution of this variable is related to current as well as historical conditions. Similarly, the findings show that labor market conditions significantly correlate with changes in this ratio, thereby indicating the value of employment-based demand structures for understanding the fiscal performance of the country. Financial conditions also have high significance since higher interest rates are associated with lower fiscal conversion from consumption into corresponding VAT results. Conversely, broad income growth dynamics seem to offer limited explanations once these other variables have been included in the analysis. This paper adds to the body of work in the literature by demonstrating that it is inappropriate to use only household consumption when trying to determine VAT-associated fiscal performance. The findings for the country of Romania indicate that macroeconomic conditions and financial conditions are necessary to consider when evaluating how household consumption translates into fiscal outcomes, allowing for a more comprehensive interpretation of indirect taxes and their appropriate use as policies.