## 1albea2022001

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### PREFACE — mission, purpose, and fiscal gap
- IMF Fiscal Affairs Department (FAD) mission advising on tax policy for a Medium-Term Revenue Strategy (MTRS) visited Tirana during November 1–12, 2019.
- Mission members: Ms. Dora Benedek (head), Mr. Aqib Aslam, Ms. Nariné Nersesyan. Partly overlapped with a revenue administration mission led by Mr. Stephen Vesperman.
- Purpose: present tax policy reform options to raise at least an additional 1.34 percent of GDP in revenues over five years to finance estimated development spending of 2.2–3.0 percent of GDP over five years, and to improve tax system quality and efficiency.

### Executive-summary diagnostic findings
- Albania’s tax-to-GDP ratio lags regional peers despite tax rates for major taxes being broadly in line with regional peers.
- High reliance on indirect taxes (especially VAT); social security contribution revenues are lower than the regional average.
- Tax system characterized as complex, fragmented, and frequently changed, undermining stability and transparency.
- Narrow tax bases and/or inefficient enforcement and collection contribute to lower revenue performance.
- High informality reinforced by complexity and compliance costs.

### Consumption taxes (VAT, excises, national taxes) — findings and selected recommendations
- VAT: standard rate 20 percent; contributes about half of tax revenues; VAT efficiency low compared with regional peers.
- Authorities estimate revenue forgone through indirect tax exemptions, reduced rates, and other beneficial treatments at around 5.5 percent of GDP (comprising both policy and compliance gaps).
- Large VAT exemptions: education, health, medicines, sale of new property (first sale), and financial services.
- Selected recommendations (timing indicated in source):
  - Tax private health and education services under the VAT (timing: 3 years).
  - Tax non-prescription drugs, medicines and related products under the VAT, preferably at the standard rate (timing: 3 years).
  - Tax fee-based financial services under the VAT; consider in the long term unifying tax treatment of financial services and insurance under the VAT (timing: 3 years).
  - Tax the first sale of new residential property under the VAT; subsequent sales and long-term rentals/leases remain exempt (timing: 2 years).
  - Eliminate the 6 percent reduced VAT rate and tax accommodation and other services at the standard rate (timing: 2 years).
  - Carefully review and eliminate non-standard VAT exemptions; eliminate zero-rating on inward processing arrangements (timing: 1–3 years).
  - Raise the VAT threshold to ALL 8 million; allow voluntary registration for taxpayers with turnover between ALL 5–8 million, but not below (timing: 2 years).
  - Apply VAT threshold consistently across all taxpayers (timing: 2 years).
  - Phase out the 6 percent compensation scheme for farmers; replace with targeted benefits (timing: 3 years+).
  - Eliminate exemptions from fuel excises (Immediate).
  - Introduce automatic indexation of specific excise rates (Immediate+).
  - Increase specific charges payable on plastic bags, packaging, plastic bottles (to EUR 5-10/kg), and aluminum cans and encourage recycling through refund mechanisms (timing: 2 years).
- Expected revenue and quality effects:
  - Eliminating non-standard exemptions, reduced rates and beneficial treatments across VAT, excises and national taxes would increase indirect tax revenues by at least 0.2 percent of GDP and substantially improve tax system quality and efficiency.
  - Increasing plastic/environmental charges could raise 0.25 (2022), 0.25 (2023), 0.25 (2024) percent of GDP per year according to the reform schedule shown.

### VAT specifics, exemptions, threshold, and tourism (evidence and proposals)
- VAT C-efficiency ratio: 0.54 (authorities collect 54 percent of total VAT revenue compared with a perfectly enforced VAT at the standard rate).
- VAT registration threshold was lowered to ALL 2 million (previous threshold ALL 5 million); proposed threshold ALL 8 million with voluntary registration between ALL 5 million and ALL 8 million.
- Empirical outcomes:
  - VAT threshold reduction increased VAT taxpayers from 38,000 to 53,000.
  - About 94 percent of VAT collections come from about 33 percent of businesses.
- Authorities estimate revenue loss due to VAT exemptions around 5.4 percent of GDP (estimate includes non-compliance and evasion).
- Sectors with largest revenue forgone (percent of GDP):
  - Public administration: 0.84 percent of GDP
  - Real estate services: 0.74 percent of GDP
  - Education services: 0.71 percent of GDP
  - Human health services: 0.64 percent of GDP
- Sector-specific VAT proposals:
  - Tax private health and education services; compensate poor households with targeted benefits if needed.
  - Tax non-prescription drugs, over-the-counter drugs, online-ordered drugs, and related products such as food supplements and vitamins at the standard rate; maintain exemption only for drugs prescribed by a licensed healthcare professional and not available over-the-counter.
  - Tax fee-based financial services at the standard VAT rate; in the longer term unify tax treatment of financial services and insurance under VAT.
  - Tax first sale of new residential property; ensure inputs and services used in construction are taxable so inputs are creditable.
  - Eliminate the 6 percent reduced VAT rate on tourism-related activities and tax accommodation at the standard rate (raising the reduced rate to the standard rate would increase revenues by about 0.1 percent of GDP).
- Administrative and policy cautions:
  - Multiple VAT rates complicate administration and create opportunities for abuse.
  - Registering micro and small businesses for VAT imposes large burdens and may not raise much revenue when compliance is low.
  - Voluntary registration between ALL 5–8 million limited to avoid fraudulent refund claims.

### Income taxes and social contributions — structure, distortions, and reforms
- Direct income taxes contribute around 20 percent of total tax revenues, increasing from 3.7 to 4.4 percent of GDP between 2014 and 2018.
- Income-based social contributions add an additional 6 percent of GDP; combined social contributions and tax revenues were about 26 percent of GDP as of 2018.
- Current design (progressive PIT, graduated general business profits tax, simplified profits tax, and social security contributions) creates complexity, distortions, and non-neutrality; multiple thresholds fragment tax bases and rates.
- System incentivizes self-employment under the business profits tax over employment under the PIT for identical economic activities.
- Revenue administration lacks complete taxpayer information; not all required to file declarations; limited third-party data access.

- Recommended structural reforms (selected):
  - Convert the simplified profits regime for smaller businesses (below ALL 8 million) into a simplified presumptive regime with a turnover threshold and a lower tax rate of 3 percent on turnover (timing: 2 years).
  - For the smallest taxpayers, below ALL 1 million turnover, introduce a flat presumptive fee of around ALL 50,000 per year.
  - Unify the tax rate in the general business profits tax regime to 15 percent (timing: 3 years+).
  - Remove reduced business profits tax rates and exemptions for priority sectors; switch from profit-based incentives to cost-based incentives for priority sectors (timing: 3 years / 3 years+).
  - Bring self-employed professional individuals into the personal income tax system (timing: 2 years).
  - Remove the ALL 2 million individual personal income declaration threshold (timing: 2 years).
  - Consider improving progressivity within the PIT regime (timing: 3 years).
  - Align social security contribution caps with the upper threshold of personal income tax (timing: 3 years).

- Expected revenue impacts (as shown in reform schedule Table 1 entries):
  - Income taxation reforms contribute 0 (2020), 0.62 (2021), 0.62 (2022), 0.62 (2023), 0.62 (2024) percent of GDP cumulatively.

### Business tax regime, SPT, and behavioral effects
- SPT modifications in 2016 and general regime changes effective January 1, 2019:
  - SPT 2016: turnovers below ALL 5 million: 0 percent; turnover ALL 5–8 million: 5 percent.
  - General regime from Jan 1, 2019: turnover ALL 5–14 million: reduced rate 5 percent; turnover > ALL 14 million: profits taxed at 15 percent.
  - Dividends or profit distributions taxed at 8 percent as of January 1, 2019 (previously 15 percent) with specified payment timing conditions.
- SPT outcomes (2018):
  - Tax revenues from SPT: less than 0.03 percent of GDP despite declared turnover totaling 8.4 percent of GDP.
  - Over 90 percent of taxpayers are physical persons accounting for about 90 percent of turnover reported under SPT.
  - 95 percent of taxpayers under SPT file revenues less than ALL 5 million.
- Distortions:
  - Example: an individual earning ALL 5 million annual (net) income can face an effective income tax rate of 0 percent in self-employment under the SPT, instead of 18.5 percent as an employee under the PIT.
  - Social contributions narrow the gap but a sizeable differential remains (averaging around 15 percentage points for incomes between ALL 5 million and ALL 14 million).
- Recommendations and estimated fiscal effects:
  - Limit special treatments within the general business profits tax regime; maintain a single uniform rate of 15 percent for all businesses.
  - Removing the 5 percent reduced rate: suggested increase in revenues about 0.03 percent of GDP (based on 2018 data).
  - Consider maintaining some small firms in general regime where compliance burdens are low; moving SPT firms into a 3 percent turnover tax could yield up to an additional 0.22 percent of GDP (if applied to activity declared under SPT below ALL 8 million), but specific outcomes depend on margins and compliance.

### Labor tax wedge, labor market outcomes, and specific adjustments
- High labor tax wedge combined with structural rigidities associated with:
  - high youth and female unemployment,
  - low labor force participation,
  - high informality.
- Informality in non-agricultural employment (ILO data):
  - Albania: 31.9 percent
  - North Macedonia: 9.0 percent
  - Serbia: 13.8 percent
- Proposed adjustments and preliminary revenue estimates:
  - Align minimum social contribution base (currently ALL 26,000 per month) with PIT personal income exemption of ALL 30,000: preliminary estimate could generate an additional 0.08 percent of GDP of contributions (with an unchanged cap).
  - Raise earnings cap for employee and employer social contributions from ALL 114,670 per month and align with upper PIT threshold of ALL 150,000 per month: preliminary estimate could generate an additional 0.1 percent of GDP of contributions (with an unchanged minimum).
  - Introduce an additional PIT band between 13 and 23 percent for middle incomes (example: income between ALL 100,000 and ALL 150,000 per month taxed at 18 percent): preliminary estimate could raise additional 0.04 percent of GDP in PIT revenues.
  - Unify special (lower) contribution rate for self-employed persons in agriculture with the general scheme for the self-employed, to the extent social contributions are insurance-based.

### Property and environmental taxes — current state and potential
- Current property tax revenue: 0.3 percent of GDP.
- Comparable countries average property tax revenue: around 0.8 percent of GDP.
- Authorities expect around ALL 3.2 billion revenues from the recurrent property tax this year, and some ALL 1 billion more next year.
- Several groups are exempt from property tax: pensioners living alone, state and local government buildings, public properties transferred to public enterprises, buildings used for social services and social housing, and 4-/5-star hotels.
- Recommendations:
  - Finalize fiscal cadaster on schedule and transition property tax valuation to the cadaster.
  - Eliminate property tax exemptions for several taxpayer groups; provide relief for vulnerable groups through targeted measures rather than blanket exemptions.
  - Gradually raise property tax rates as the system and cadaster mature to approach the regional average of 0.8 percent of GDP in the medium term.
- Environmental taxes:
  - Simplifying rules and raising plastic waste charges and environmental levies could raise an additional 0.2–0.5 percent of GDP.
  - Specific proposal: increase plastic/environmental charges to EUR 5-10/kg for plastic bottles/packaging and aluminum cans (timing: 2 years); expected incremental revenue schedule: 0.25 (2022), 0.25 (2023), 0.25 (2024) percent of GDP per year according to reform schedule shown.

### Tax incentives: principles and calibration
- Key principles:
  - Prefer cost-based incentives (e.g., accelerated depreciation, deductions) over profit-based incentives (tax holidays, reduced rates).
  - Target incentives to marginal investors who would not invest otherwise to minimize revenue loss.
  - Design incentives with clearly prescribed, verifiable eligibility criteria and consolidate them in tax law.
- Numerical guidance and calibration presented:
  - Optimal threshold (Wei and Wen (2019) estimate): between about US$100,000 and US$150,000 (corresponds to between ALL 11 million and ALL 16 million).
  - Current SPT threshold: ALL 8 million.
  - Suggested optimal turnover tax rate if single rate applied: close to 3 percent.
  - Fixed tax regime example for smallest businesses with turnover less than ALL 1 million: fixed annual payment of ALL 50,000.
  - At a rate of 3 percent, potential yield from a turnover tax on activity currently declared under the SPT (below ALL 8 million): up to an additional 0.22 percent of GDP.
- Treatment of self-employed professionals:
  - Carve out self-employed professional individuals from simplified presumptive regime and bring them into PIT; allow a maximum deemed expense deduction (for example, 10–20 percent of income).
  - Identified categories: lawyers, notaries, specialized doctors, dentists, chemists, nurses, vets, architects, engineers, approved accountants and estate appraisers, and hospitality economic activities.
  - Current counts and potential: over 8,000 physical persons in professional services generate up to 1 percent of GDP in turnover and pay 0.1 percent of GDP under the VAT; preliminary estimate if shifted to PIT: could generate around 0.4 percent of GDP under the PIT and over 2 percent of GDP of social contributions.

### Institutional and design recommendations
- Strengthen tax policy capacity:
  - Ministry of Finance requires a dedicated tax policy function to collect data and develop expertise to assess taxes and tax expenditures in terms of revenues and economic costs/benefits; staff appropriately.
  - Strengthen capacity of the General Directorate of Fiscal Policy in the Ministry of Finance to manage MTRS implementation (Immediate).
- Increase tax system stability by minimizing frequent changes (Immediate).
- Replace tax-based support and exemptions with direct subsidies that are easier to monitor, control, and contain.
- Improve tax administration data capabilities (require filing and access to third-party data) to build a comprehensive picture of taxpayers.
- The mission handed over three models to MoF staff:
  - A VAT model calculating revenue forgone from exemptions and reduced rates.
  - A PIT microsimulation model, incorporating social security contributions.
  - A tax model analyzing reform proposals regarding small enterprises.

### Consolidated revenue trajectory (selected totals from Table 1)
- Revenue impact totals by year (percent of GDP) as shown:
  - 2020: 0.07
  - 2021: 0.94
  - 2022: 1.04
  - 2023: 1.34
  - 2024: 1.34

*Source: IMF staff mission report for Albania (PREFACE and EXECUTIVE SUMMARY, November 1–12, 2019). Canonical URL: https://www.imf.org/-/media/files/publications/cr/2022/english/1albea2022001.pdf*

### PREFACE ___________________________________________________________________________________________________ 6

### PREFACE

### Mission and acknowledgements
- An IMF Fiscal Affairs Department (FAD) mission advising on tax policy for a Medium-Term Revenue Strategy (MTRS) visited Tirana during November 1–12, 2019.
- Mission members: Ms. Dora Benedek (head), Mr. Aqib Aslam, Ms. Nariné Nersesyan. The mission partly overlapped with a revenue administration mission led by Mr. Stephen Vesperman.
- The mission held multiple discussions with Albanian officials, including Mr. Elton Haxhi (Deputy Minister of Finance); Mr. Ylber Karanxha (Director of GDC); Ms. Arjana Dyrmishi (Advisor to the Minister); Mr. Nikolla Lera (Director, General Directorate of Macroeconomics and Fiscal Policy); Ms. Enkeleida Pipa (Director, Fiscal Harmonization Directorate); and Mr. Artan Gjoka (Director of Fiscal Cadaster).
- Coordination with World Bank colleagues and support from Ms. Linda Spahia (IMF Resident Representative office) were noted. Interpretation provided by Ms. Arlinda Gjebrea and Ms. Engjellushe Shqarri.

### Executive summary: purpose and fiscal gap
- Albania plans a Medium-Term Revenue Strategy (MTRS) to finance estimated development spending of 2.2–3.0 percent of GDP over five years.
- The report presents tax policy reform options to raise at least an additional 1.34 percent of GDP in revenues over five years and to improve tax system quality and efficiency.

### Key diagnostic findings
- Overall tax-to-GDP ratio lags regional peers despite tax rates for major taxes being broadly in line with regional peers.
- High reliance on indirect taxes, especially VAT; social security contribution revenues are lower than the regional average.
- The tax system is complex, fragmented, and frequently changed, undermining stability and transparency.
- Narrow tax bases and/or inefficient enforcement and collection contribute to lower revenue performance.
- Informality is high and is reinforced by complexity and compliance costs.

### Consumption taxes (VAT, excises, national taxes)
- VAT contributes about half of tax revenues; standard VAT rate is 20 percent.
- VAT efficiency is low compared with regional peers.
- The authorities estimate revenue forgone through indirect tax exemptions, reduced rates, and other beneficial treatments at around 5.5 percent of GDP (comprising both policy and compliance gaps).
- Large VAT exemptions: education, health, medicines, sale of new property (first sale), and financial services.
- Recommendations (selected):
  - Tax private health and education services under the VAT (timing: 3 years).
  - Tax non-prescription drugs, medicines and related products under the VAT, preferably at the standard rate (timing: 3 years).
  - Tax fee-based financial services under the VAT; consider in the long term unifying tax treatment of financial services and insurance under the VAT (timing: 3 years).
  - Tax the first sale of new residential property under the VAT; subsequent sales and long-term rentals/leases remain exempt (timing: 2 years).
  - Eliminate the 6 percent reduced VAT rate and tax accommodation and other services at the standard rate (timing: 2 years).
  - Carefully review and eliminate non-standard VAT exemptions; eliminate zero-rating on inward processing arrangements (timing: 1–3 years).
  - Raise the VAT threshold to ALL 8 million; allow voluntary registration for taxpayers with turnover between ALL 5–8 million, but not below (timing: 2 years).
  - Apply VAT threshold consistently across all taxpayers (timing: 2 years).
  - Phase out the 6 percent compensation scheme for farmers; replace with targeted benefits (timing: 3 years+).
  - Eliminate exemptions from fuel excises (Immediate).
  - Introduce automatic indexation of specific excise rates (Immediate+).
  - Increase specific charges payable on plastic bags, packaging, plastic bottles (to EUR 5-10/kg), and aluminum cans and encourage recycling through refund mechanisms (timing: 2 years).

- Expected revenue and quality effects:
  - Eliminating non-standard exemptions, reduced rates and beneficial treatments across VAT, excises and national taxes would increase indirect tax revenues by at least 0.2 percent of GDP and substantially improve tax system quality and efficiency.
  - Increasing plastic/environmental charges could raise 0.25 (2022), 0.25 (2023), 0.25 (2024) percent of GDP per year according to the reform schedule shown.

### Income taxes and social contributions
- Direct income taxes contribute around 20 percent of total tax revenues, increasing from 3.7 to 4.4 percent of GDP between 2014 and 2018.
- Income-based social contributions add an additional 6 percent of GDP; combined social contributions and tax revenues were about 26 percent of GDP as of 2018.
- The current design (progressive PIT, graduated general business profits tax, simplified profits tax, and social security contributions) and their interaction generate complexity, distortions, and non-neutrality.
- Multiple thresholds fragment tax bases and rates, incentivizing tax minimization and avoidance.
- The system incentivizes self-employment under the business profits tax over employment under the PIT for identical economic activities.
- Revenue administration lacks complete taxpayer information (not all required to file declarations; limited third-party data access).

- Recommended structural reforms (selected):
  - Convert the simplified profits regime for smaller businesses (below ALL 8 million) into a simplified presumptive regime with a turnover threshold and a lower tax rate of 3 percent on turnover (timing: 2 years).
  - For the smallest taxpayers, below ALL 1 million turnover, introduce a flat presumptive fee of around ALL 50,000 per year.
  - Unify the tax rate in the general business profits tax regime to 15 percent (timing: 3 years+).
  - Remove reduced business profits tax rates and exemptions for priority sectors; switch from profit-based incentives to cost-based incentives for priority sectors (timing: 3 years / 3 years+).
  - Bring self-employed professional individuals into the personal income tax system (timing: 2 years).
  - Remove the ALL 2 million individual personal income declaration threshold (timing: 2 years).
  - Consider improving progressivity within the PIT regime (timing: 3 years).
  - Align social security contribution caps with the upper threshold of personal income tax (timing: 3 years).

- Expected revenue impacts shown in the reform schedule:
  - Income taxation reforms contribute 0 (2020), 0.62 (2021), 0.62 (2022), 0.62 (2023), 0.62 (2024) percent of GDP cumulatively as indicated in Table 1 entries.

### Property and environmental taxes
- Property and environmental taxes are underutilized.
- Plastic waste charge and environmental levies: simplifying rules and raising rates could raise an additional 0.2–0.5 percent of GDP.
- Raising property tax rates, after the fiscal cadaster is fully developed and eliminating exemptions, could provide an additional 0.3–0.5 percent of GDP.

### Institutional and design recommendations
- Strengthen tax policy capacity:
  - The Ministry of Finance requires a dedicated tax policy function to collect data and develop expertise to assess taxes and tax expenditures in terms of revenues and economic costs/benefits; staff appropriately.
  - Strengthen capacity of the General Directorate of Fiscal Policy in the Ministry of Finance to manage MTRS implementation (Immediate).
- Increase tax system stability by minimizing frequent changes (Immediate).
- Replace tax-based support and exemptions with direct subsidies that are easier to monitor, control, and contain.
- Improve tax administration data capabilities (require filing and access to third-party data) to build a comprehensive picture of taxpayers.

### Summary of timing and revenue trajectory (selected totals from Table 1)
- Revenue impact totals by year (percent of GDP) as shown:
  - 2020: 0.07
  - 2021: 0.94
  - 2022: 1.04
  - 2023: 1.34
  - 2024: 1.34
- Table 1 presents a consolidated schedule of reforms, timing (Immediate, 1–3 years, 3 years+, etc.), and estimated revenue impacts for individual measures across 2020–2024.

*Source: IMF staff mission report for Albania (PREFACE and EXECUTIVE SUMMARY, November 1–12, 2019). Canonical URL: https://www.imf.org/-/media/files/publications/cr/2022/english/1albea2022001.pdf*

### 2.      International and regional comparison suggests that there is room for additional

### 1albea2022001 - 2.      International and regional comparison suggests that there is room for additional

### International and regional comparison — headline findings
- Albania’s overall tax-to-GDP ratio lags behind comparative countries despite tax rates for all major taxes being in line with regional peers.
- Potential causes for weaker outcomes:
  - Narrow tax bases.
  - Inefficient enforcement and collection.
- Albania has a high reliance on indirect taxes, especially VAT.
- Social security contribution revenues are lower than the regional average.

### Domestic revenue composition and trends
- Tax revenues fell after the global financial crisis (2008–10), reaching a low of 17.5 percent of GDP in 2013.
- Indirect taxes provide up to two thirds of Albania’s tax revenues.
- VAT revenues have averaged just under 9 percent of GDP over the last 5 years, contributing around 45 percent of total tax revenues.
- Excise duties are derived almost entirely from fuel and tobacco products (54 and 36 percent of total excises, respectively).
- Direct income taxes (PIT, business income tax, simplified profits tax) contribute only around 20 percent of total tax revenues, gradually increasing from 3.7 to 4.4 percent of GDP between 2014 and 2018.
- Income-based social contributions make up 20.7 percent of overall domestic revenues.
- By adding 5.7 percent of GDP to total domestic revenues, social contributions and tax revenues together raise 25.8 percent of GDP as of 2018.
- Overall, 72.5 percent of domestic revenues come from the tax system.

### Quality of the tax system and MTRS objectives
- Domestic revenue mobilization is central to the Medium-Term Revenue Strategy (MTRS), alongside improving tax system quality and efficiency.
- The current system is described as complex and fragmented with proliferating exemptions and beneficial treatments that undermine stability and transparency.
- Objectives for reform include making the tax system fairer, more efficient, simpler, and more transparent to:
  - Make Albania more attractive for foreign investment.
  - Invigorate domestic economic activity.
  - Ease administration and enforcement.
  - Set appropriate economic incentives.
- Combined with planned increases in investment in human and physical capital (in line with the SDGs), tax reform is expected to support a higher, more sustainable growth path.

### Institutional recommendation: Tax Policy Unit
- Effective MTRS planning and sound tax policy assessment require a dedicated function in the Ministry of Finance (MoF).
- This unit should:
  - Collect data and develop expertise necessary for policy and cost-benefit analysis.
  - Be adequately staffed and ensure continuity in case of staff turnover.
- Reference: Grote (2017) “How to establish a Tax Policy Unit.”

### IMF technical assistance history and analytical tools provided
- Albania received several IMF Technical Assistance missions over the last decade; recent Technical Reports listed include:
  - Jensen et al: Causes of Tax Revenue Underperformance and Options for Corrective Measures, August 2015.
  - Caner et al: Guidance on Tax Expenditure Assessment and Advancing Property Tax Reform, February 2017.
  - Grote et al: A Value-Based Property Tax: Review of Policies, Draft Legislation and Implementation Steps, October 2017.
  - Nersesyan et al: Evaluation of Proposed Changes to Value-Added Tax and Income Taxation, December 2017.
  - Schatan et al: Tax Treaty Policy and BEPS Issues, November 2018.
  - Baunsgaard et al: Reforming the Petroleum Fiscal Regime, August 2018.
- This report focuses on developing a menu of options for the government’s MTRS covering the next five years, building on previous findings.

- The mission developed and handed over three models to the MoF staff:
  - A VAT model calculating revenue forgone from exemptions and reduced rates, used for scenario analysis for VAT changes.
  - A PIT microsimulation model, incorporating social security contributions, used for scenario analysis and calculations of labor tax wedge.
  - A tax model calculating and analyzing reform proposals regarding small enterprises.

### Principles of Sound Tax Policy (as stated)
- Tax policy must balance somewhat conflicting objectives:
  - Revenue mobilization: raise sufficient revenues to finance public spending and investment.
  - Efficiency: be transparent, simple, stable, minimize distortions, and be neutral between similar economic situations.
  - Equity: be just, inclusive, and contribute to distributional objectives; taxpayers should contribute according to ability to pay.
- Simplicity, inclusiveness, transparency, and equity establish legitimacy and anchor investors’ and taxpayers’ long-term expectations.
- In contexts of high informality, tax systems should be based on a relatively small number of taxes with a single or few rates on broad bases to facilitate assessment and administration.
- Exemptions create loopholes that can lead to tax arbitrage and undermine revenues; tax expenditures should be reviewed and assessed regularly for efficacy and revenue impact.

### Tax expenditures and special treatments
- The MoF has started calculating revenue forgone through tax expenditure and intends to publish a tax expenditure report.
- The estimated cost of tax expenditures in 2018 is 5.6 percent of GDP, most of which comes from the VAT; tax expenditures are also granted from customs duties, excises, business profits tax, and the PIT.
- Beneficiary groups often include small businesses, professionals, and farmers.
- Some tax expenditures exist in law but are not utilized (e.g., tax benefits for special economic zones; benefits for branded five-star hotels).

Box — Most important benefits provided through the tax system to priority sectors (selected items and exact treatments reproduced)
- 4-/5-star hotels (with internationally-recognized trademarks/brands):
  - CIT: exempt (0 percent rate)
  - VAT: 6 percent rate on all activities
  - Exemption from infrastructure impact tax
  - Exemption from property tax
- Agrotourism:
  - CIT: 5 percent rate
  - VAT: 6 percent on accommodation and restaurant services
  - Exemption from infrastructure impact tax
- Farmers, agrobusinesses:
  - CIT: agriculture cooperatives: 5 percent rate; farmers: exempt
  - PIT: farmers exempt
  - VAT: exempt inputs; 6 percent flat-rate compensation scheme; higher registration threshold (ALL 5 million)
  - Excises: exemption from vehicle tax for agricultural machines
  - Social security contributions: reduced fixed payment (determined by geographic location)

### Regional context and comparisons
- Comparator groups: CEE EU member countries (Czech Republic, Hungary, Poland, Slovakia, Slovenia); SEE EU members (Bulgaria, Croatia, Romania); SEE non-EU (Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, Serbia).
- Across the region (excluding Albania), tax revenues and social contributions contribute on average 21.8 and 12.2 percent of GDP, respectively.
- For the region, taxes on goods and services are the most significant component, bringing in two-thirds of the total on average.
- Direct income taxes contribute less than 6 percent of GDP on average across the region.

### VAT performance and C-efficiency
- Albania’s VAT C-efficiency ratio is 0.54 (authorities collect 54 percent of total VAT revenue compared with a perfectly enforced VAT at the standard rate).
- Albania’s standard VAT rate is 20 percent.
- The VAT registration threshold was recently lowered to ALL 2 million (previous threshold ALL 5 million).
- The combination of a reasonable rate and low threshold suggests design and implementation issues—breadth of base and compliance—undermining VAT performance.
- Exchange rate note: The ALL/USD exchange rate was around 110 ALL/USD at the time of writing.

### Direct taxation, rates, and progressivity
- Albania’s business profits tax rate is 15 percent.
- Albania stands out for both its progressive business profits and personal income taxes in the region.
- Albania operates an additional simplified regime for small businesses; similar schemes exist in Kosovo, North Macedonia, Hungary, and Romania.
- In the region, many countries apply relatively low flat rates on labor income (10 or 15 percent in several countries).
- Capital income is taxed at varying levels across the region; significant differentials can encourage incorporation or tax-motivated legal form choices.
- Revenues from labor income (PIT + social contributions) form about 30 percent of total domestic revenues in Albania; in the rest of the region they represent approximately 40 percent of domestic revenues, corresponding to an average of 16 percent of GDP.
- Albania has one of the most progressive income tax schedules in the region, but exclusions (e.g., self-employment income excluded from PIT and taxed under business profits tax) and high informality undermine effective progressivity.

*IMF staff report excerpt.*

### 22.      More generally, the high labor tax wedge, when combined with other structural

### 1albea2022001 - 22.      More generally, the high labor tax wedge, when combined with other structural

### Labor market distortions and outcomes
- High labor tax wedge combined with structural rigidities has led to unsatisfactory economic outcomes across the region.
- Legacy of persistent high labor taxes and large social security programs contributed to:
  - high youth and female unemployment,
  - low labor force participation,
  - high levels of informality.
- Labor force participation rates are some 5–10 percentage points lower than EU-28 and OECD averages (Figure 6, panel 1).
- Informality in non-agricultural employment (International Labour Organization data):
  - Albania: 31.9 percent
  - North Macedonia: 9.0 percent
  - Serbia: 13.8 percent
- While the level of the tax wedge across SEE (non-EU) countries, including Albania, does not particularly stand out relative to EU and OECD countries, limited progressivity from the flatter PIT levied on wages does stand out (Figure 6, panel 2, from Jankulov Suljagic 2019).

### Effective tax burden and tax wedge observations
- Tax wedge measures cited:
  - Tax wedge defined as the ratio between the amount of taxes paid by an average single worker (a single person without children at 67, 100 and 167 percent of average earnings) and the corresponding total labor cost for the employer.
- Figures referenced compare Albania with:
  - SEE non-EU countries,
  - SEE EU members,
  - CEE EU members.
- Labor force participation data sources: International Labour Organization (ILO) and IMF staff calculations.
- Notes: Labor force participation rate defined as the sum of all persons of working age who are employed and those who are unemployed divided by the working age population.

### VAT: importance and current system
- VAT is the most important revenue source of Albania:
  - providing 8.8 percent of GDP,
  - and 47 percent of tax revenues,
  - and 37 percent of total tax and social security contribution revenues (Table 3).
- Current VAT law entered into force in 2015 and has been amended five times since then.
- General VAT registration threshold: annual turnover of ALL 2 million (before April 2018 it was ALL 5 million) with exceptions:
  - Professionals (lawyers, notaries, doctors, architects, auditors) required to register irrespective of threshold.
  - Agricultural producers that carry out activity as individual farmers required to register only if turnover is above ALL 5 million.
  - Voluntary registration of any taxpayer is possible.
- VAT rates:
  - Standard VAT rate: 20 percent.
  - Reduced rate: 6 percent (applies to accommodation services by hotels and similar establishments; accommodation and restaurant services by registered agrotourism providers; advertising in electronic media; and supply of books (previously exempt)).
- Zero rates apply to exports and a standard set of goods and services, and to temporary imports of certain goods; zero rates also apply to importation of goods to free zones and fiscal or customs warehouses and to “linked services” associated with free zones.

### VAT revenue statistics (2017–2019)
- Table 3 (ALL million; in % of Total tax revenues) excerpt:
  - Import VAT:
    - 2017: 104,586
    - 2018: 107,157
    - 2019 (9 month): 79,405
    - 2017: 35.6
    - 2018: 35.2
    - 2019 (9 month): 34.3
  - Gross domestic VAT:
    - 2017: 48,845
    - 2018: 50,763
    - 2019 (9 month): 35,815
    - 2017: 16.6
    - 2018: 16.7
    - 2019 (9 month): 15.5
  - Refunds:
    - 2017: 13,891
    - 2018: 14,394
    - 2019 (9 month): 14,502
    - 2017: 4.7
    - 2018: 4.7
    - 2019 (9 month): 6.3
  - Total net VAT Collection:
    - 2017: 139,540
    - 2018: 143,526
    - 2019 (9 month): 100,718
    - 2017: 47.6
    - 2018: 47.2
    - 2019 (9 month): 43.5

### Special regimes and tax-free zones
- Albania provisions exempt taxpayers operating in special zones from indirect taxes and/or customs duties (bonded warehouses, production warehouses, tax suspension regimes, special economic zones).
- There are a total of 670 entities with special provisions:
  - 13 bonded warehouses,
  - 27 production warehouses,
  - 183 fishing operators with suspension regimes.
- No company registered to operate in special economic zones so far.
- Risks and administrative concerns noted:
  - Incentives to allocate revenues inside zones and expenses outside to minimize tax burden.
  - Administrative difficulty in controlling interactions between firms inside and outside zones.
  - “Creep” of beneficial treatments radiating out along the value chain beyond special zones.
- Recommendations for limited use of special zones and strict limits if established:
  - free zone should be physically isolated and effectively controlled;
  - privileges strictly limited to trade tax regime (trade taxes) with no incentives for direct taxes or property taxes, and no benefit to taxpayers outside the zone.

### VAT exemptions: scope, impact, and reform proposals
- Authorities estimate revenue loss due to VAT exemptions around 5.4 percent of GDP. This estimate includes revenue loss due to non-compliance and tax evasion.
- Draft tax expenditure report prepared by authorities takes stock of VAT exemption costs.
- Sectors with largest revenue forgone (percent of GDP):
  - Public administration: 0.84 percent of GDP
  - Real estate services: 0.74 percent of GDP
  - Education services: 0.71 percent of GDP
  - Human health services: 0.64 percent of GDP
- Other sectors with substantial tax expenditures: food, beverage, and tobacco; textile, clothing, and leather; other household services; art, entertainment, and recreation.
- The eight sectors above account for about 4.5 percent of GDP loss in VAT revenues, indicating scope to improve collection via VAT policy and compliance improvements.

Proposals to enhance the VAT base (specific recommended eliminations of exemptions and changes):
- Health and education services provided by the private sector should be taxable by VAT.
  - Rationale: VAT exemptions and zero rating are poorly targeted and regressive; private sector customers tend to be better off.
  - If impact on poor households is a concern, compensate through targeted benefit systems.
- Non-prescription drugs, medicines, and related products should be taxable, preferably at the standard rate.
  - All non-prescription drugs, over-the-counter drugs, drugs ordered online, and related products such as food supplements and vitamins should be subject to VAT.
  - Only supplies of drugs prescribed by a licensed healthcare professional and not available over-the-counter should remain exempt.
  - Definitional issues require careful legislation.
- Fee-based financial services should be taxed at the standard VAT rate; insurance (other than life insurance) currently subject to a 10 percent premium tax.
  - In the longer term, tax treatment of these financial services and insurance can be unified under the VAT.
- The first sale of new residential property should be subject to VAT; subsequent sales and long-term rentals/leases should remain exempt.
  - Commercial transactions of property (sale, leasing or rental) should be subject to VAT that can be credited by businesses.
  - System works best if all construction inputs and services are taxable so inputs are creditable.
- The reduced VAT rate of 6 percent on tourism-related activities should be eliminated and accommodation services taxed at the standard rate.
  - Current reduced rate applies to all services offered by 5-star hotels and to accommodation services in case of other accommodation providers.
  - Raising the reduced rate to the standard rate would increase revenues by about 0.1 percent of GDP.
  - Reduced rates commonly ineffective at stimulating demand for tourism; operators tend to adjust pre-tax prices and not pass savings to consumers.

### Revenue impact considerations and complexities of exemptions
- Sector-by-sector estimated forgone VAT (percent of GDP) cited:
  - Financial services: about 1.3 percent of GDP
  - Construction: about 0.4 percent of GDP
  - Health: about 0.2 percent of GDP
  - Education: about 0.1 percent of GDP
- Simulations using microdata show that eliminating all exemptions might not significantly raise VAT revenues due to complex interactions; however, indirect impacts would be important by making VAT more transparent and easier to administer and collect.
- Box 3: VAT exemptions effects and complexities:
  - Exemptions distort revenues via cascading on inputs, distort input choices, induce vertical integration, compromise destination principle, lead to “exemptions creep,” and encourage avoidance and misreporting.
  - Revenue impact of exemptions is complex: exemptions can lead to either a fall or increase in VAT revenues depending on where the break in the VAT chain occurs.

*Source: IMF staff and Albania Ministry of Finance material as presented in the supplied content.*

### Box 4. VAT and Tourism

### Box 4. VAT and Tourism

### Rationale and pass-through of reduced VAT for tourism
- Many countries provide reduced VAT rates or exemptions to the hotel and accommodation sector to facilitate tourism and high-end (elite) tourism.
- Efficacy depends on price-elasticity of tourist demand and VAT pass-through:
  - If tourist demand is price-elastic (e.g., locations in different countries are close substitutes), tax rates might matter through the impact on consumer prices.
  - Impact of VAT on consumer prices is also a function of pass-through: whether service providers pass on the lower VAT rate as lower prices or maintain prices and absorb tax savings as additional profits.
- High-end tourism is typically less price-elastic than other segments.
- VAT on hotel accommodation largely bears on foreigners, not citizens; the case for reduced VAT depends on the extent a country values the welfare of these foreigners.
- Country-specific factors matter: elasticity of demand; costs of administration and compliance; rate differentiation; opportunities for abuse; share of accommodations consumed by foreigners; relative prices compared to neighboring countries.
- In many cases, the balance will offer little grounds for applying a reduced VAT rate.

### Administrative costs, multiple rates, and opportunities for abuse
- Multiple VAT rates complicate administration and compliance and create opportunities for abuse.
- Exemptions on inputs break the VAT chain, make enforcement more difficult, and lead to cascading of the VAT burden if applied in the middle of the supply chain.
- Zero rating of certain activities was introduced to address tax administration issues but can be unnecessary (example: zero rating on linked services to warehouses) and should be eliminated.
- The number of fiscal warehouses and suspension regimes should be reduced to enable easier monitoring and enforcement.
- Benefits provided through VAT, income taxes, and other taxes to certain groups undermine efficiency and integrity; these benefits should be assessed, evaluated, and phased out. It is more transparent to provide direct subsidies to priority sectors.

### Empirical and distributional observations on VAT administration
- Albania reduced the VAT threshold from ALL 5 million to ALL 2 million last year, increasing the number of VAT taxpayers from 38,000 to 53,000.
- Reductions in informal activity and formalization do not arise from mandatory registration alone, but from economic development, administrative improvements, and greater trust in the tax system.
- Registering micro and small businesses for VAT imposes an enormous burden on the tax administration without raising much revenues when administrative capacity and compliance are low.
- Distributional regularities (Figure 7 referenced):
  - Strongly diminishing returns to collections when the threshold is reduced.
  - About 94 percent of VAT collections come from about 33 percent of businesses.
- Revenue from non-registered taxpayers through VAT on purchased inputs depends critically on making business inputs taxable rather than exempt or zero-rated; if inputs are exempt or zero-rated, the revenue from inputs of small suppliers is lost.
- Voluntary registration for the smallest taxpayers often leads to fraudulent VAT refund claims that are costly to monitor and audit.

### Specific reform proposals and recommendations
- Threshold and registration
  - The VAT threshold should be raised to ALL 8 million.
  - Voluntary registration allowed between ALL 5 million and ALL 8 million, but not below.
  - Voluntary registration can be useful for small businesses that expect to cross the threshold within a few years and wish to claim input VAT credit; however, prevalence of fraudulent invoices suggests voluntary registration could lead to overuse and should be limited.
  - The threshold should be applied consistently across all taxpayers, regardless of activity; professionals should be taxed on their income in the PIT.
  - Mandatory registration of professional service providers is inconsistent with proper application of the threshold and leads to tax avoidance; preferable to apply the threshold consistently to all businesses.
- Compensation scheme for agriculture
  - The compensation scheme (flat-rate compensation for input VAT) should be phased out over time and replaced with targeted benefits for the agriculture sector that are easier to control and monitor.
  - Farmers receive a flat-rate compensation for input VAT at 6 percent of sales (previously 20 percent) paid by the purchaser; the compensation is irrespective of actual input VAT and functions as a subsidy.
  - Most agricultural inputs are exempt from VAT and voluntary registration allows farmers whose actual input VAT is higher than 6 percent to register and claim refunds.
  - The compensation scheme is generous even at 6 percent and leads to high leakage through less-than-full pass-through by agricultural purchasers.
- General VAT governance
  - All exemptions and zero ratings introduced to address administration problems should be carefully reviewed and those without sound justification eliminated.
  - Tax administration problems should not be addressed by tax policy changes; the VAT system should be simple and transparent to ease compliance and enforcement.
  - Benefits to certain groups via the VAT system should be phased out in favor of direct subsidies where warranted.

### Key numeric and policy figures preserved from the source
- VAT threshold reduced from ALL 5 million to ALL 2 million (resulting VAT taxpayers increasing from 38,000 to 53,000).
- Proposed VAT threshold: ALL 8 million; voluntary registration between ALL 5 million and ALL 8 million.
- Compensation scheme: current rate 6 percent of sales (previously 20 percent).
- Empirical distribution: about 94 percent of VAT collections come from about 33 percent of businesses.

*Source: 1albea2022001 - Box 4. VAT and Tourism.*

### 58.      Changes to the business tax regime in 2016 and 2018 have seen even more

### 58.      Changes to the business tax regime in 2016 and 2018 have seen even more

### Overview of recent tax changes
- SPT modifications in 2016:
  - Turnovers below ALL 5 million: 0 percent rate.
  - Turnover between ALL 5–8 million: 5 percent rate.
- General regime changes from January 1, 2019:
  - Turnover between ALL 5–14 million: reduced rate of 5 percent.
  - Turnover greater than ALL 14 million: profits taxed at 15 percent.
  - Dividends or profit distributions taxed at 8 percent as of January 1, 2019 (previously 15 percent).
  - Note on the 8 percent rate: The rate of 8 percent will also apply for earnings realized in 2018 or retained earnings of prior periods, including the reserves and retained earnings transferred to registered capital, provided that: (i) the tax on dividends or profit distributions deriving from retained earnings of 2017 or earlier periods is paid before Sep 30, 2019; (ii) the tax on dividends or profit distributions deriving from earnings of 2018 is paid by Aug 20, 2019.

### Sector- and activity-specific incentives
- Reduced profit tax rate of 5 percent extended to:
  - IT software development businesses.
  - Agricultural cooperatives.
  - Businesses awarded agrotourism status (applicable for a 10-year period).
- Internationally-recognized 4-/5-star hotels (that qualify before Dec 2024) are fully exempted from business profits tax for up to 10 years.

### Treatment of business forms and behavioral effects
- Business tax system does not distinguish between incorporated and unincorporated businesses.
  - Self-employed individuals register as individuals with the commercial register for tax purposes; registration does not create a separate legal entity.
  - Depending on declared turnover, they are taxed under the SPT or the general business profits tax regime, but not the personal income tax (PIT).
- Incentives to change mode of engagement:
  - Complex thresholds and rates create non-neutrality between self-employment and employment.
  - Example: An individual earning ALL 5 million annual (net) income can face an effective income tax rate of 0 percent in self-employment under the SPT, instead of 18.5 percent as an employee under the PIT (Figure 10).
  - Social contributions narrow the gap but it remains sizeable, averaging around 15 percentage points for incomes between ALL 5 million and ALL 14 million.

### Simplified Profits Tax (SPT): scale and composition
- 2018 SPT outcomes:
  - Tax revenues from the SPT amounted to less than 0.03 percent of GDP in 2018, despite declared turnover from businesses under the scheme totaling 8.4 percent of GDP.
  - Within the SPT:
    - Over 90 percent of taxpayers are physical persons accounting for about 90 percent of all turnover reported.
    - Of these physical persons: 50 percent are in the services sector and 35 percent in the trade sector.
    - Turnover from professional services (accountants, architects, business consultants, computer programmers, dentists, engineers, medical professionals, and lawyers) amounted to just under 10 percent of total declared turnover under the SPT (0.83 percent of GDP) and these individuals make up approximately 7 percent of the SPT taxpayer base.
    - Professional services account for over 25 percent of any revenues earned from the SPT (<0.01 percent of GDP).
    - 35 percent of recorded turnover comes from 40 percent of small businesses in the SPT operating in relatively low-skilled service sectors (auto-repair, beauty, catering, retail, transport, and hotel services).
    - 95 percent of taxpayers under the SPT file revenues less than ALL 5 million; it is unclear whether these incomes have been underreported.
- Table 4 highlights by legal form (excerpted categories and totals):
  - Total number of businesses across listed legal forms: 401,365 (physical persons: 100,528; limited liability companies: 91,711; joint stock companies: 7,851; branches of foreign companies: 57,300; others distributed across sectors).
  - Declared turnover (percent of GDP) total: 8.37 percent (breakdown across sectors shown in table).
  - Taxes paid (percent of GDP) total from SPT: 0.026 percent (sectoral breakdown shown in table).

### Compliance, administration, and documentation burdens
- Filing and record-keeping under SPT:
  - For every sale: (i) issue a simple tax invoice for every taxable buyer who receives the supply, and (ii) issue a tax voucher from the fiscal cash register for every buyer, individual final consumer.
  - For every purchase: (i) obtain the VAT tax invoice when purchase is from VAT-registered persons, and (ii) obtain the simplified tax bill when purchase is from persons registered under the SPT and not registered for VAT.
  - Obliged to maintain:
    - Register of sales (record of every sale using simplified and regular tax bill).
    - Register of purchases (record of every purchase with simplified and regular tax bill).
    - Register of expenditures and revenues.
    - Register of business assets.
- Revenue administration limitations:
  - Within the PIT, only resident individuals that realize taxable incomes above ALL 2 million (either within or outside Albania) must submit an annual individual declaration of income to the GDT.
  - Limited resources and minimal exchange of information hinder collection of third-party data (e.g., banks, property registers) to cross-check information and register individuals for tax purposes.

### Economic distortions and productivity effects
- Size-related tax and labor regulations risks:
  - Size-based tax preferences can create a “small business trap,” disincentivizing firms from reporting income correctly or growing beyond small business thresholds, preventing economies of scale and limiting future growth.
  - Tax preferences can divert resources toward less productive firms, increasing their aggregate share and reducing incentives for innovation and aggregate productivity growth.
  - High share of small and less productive firms benefiting from size-based preferences can result in unfair competition and lower aggregate productivity growth.

### Capital gains tax (CGT) treatment
- CGT in Albania:
  - Applied only to gains from the sale of property (“transfer tax”).
  - Rate: 15 percent on difference between purchase price and sale price of a property and on gains from sale of an individual’s principal private residence.
  - Regional comparator note: after Serbia (20 percent), Albania has one of the highest tax rates on gains from property among comparators. Regional CGT rates cited: 15 percent (Czech Republic); 10 percent (Bosnia and Herzegovina, Bulgaria, and North Macedonia); 9 percent (Montenegro); 0 percent (Poland, Romania, and Croatia).
  - Gains from disposals of assets other than property are unified with taxation of profit and treated like ordinary income in Albania.

### Reform proposals and revenue estimates
- Labor tax wedge adjustments (possible changes and preliminary revenue impacts):
  - Align minimum social contribution base (currently ALL 26,000 per month) with PIT personal income exemption of ALL 30,000:
    - Preliminary estimate: could generate an additional 0.08 percent of GDP of contributions (with an unchanged cap).
  - Raise earnings cap for employee and employer social contributions from ALL 114,670 per month and align with upper PIT threshold of ALL 150,000 per month:
    - Preliminary estimate: could generate an additional 0.1 percent of GDP of contributions (with an unchanged minimum).
  - Introduce an additional PIT band between 13 and 23 percent for middle incomes (example: income between ALL 100,000 and ALL 150,000 per month taxed at 18 percent):
    - Preliminary estimate: could raise additional 0.04 percent of GDP in PIT revenues.
  - Unify special (lower) contribution rate for self-employed persons in agriculture with the general scheme for the self-employed, to the extent social contributions are insurance-based.
- Business profits taxation principles and impacts:
  - Recommendation: limit special treatments within the general business profits tax regime and maintain a single uniform rate of 15 percent for all businesses with no sectoral differentiation to prevent distortions, arbitrage, avoidance, and revenue leakage.
  - Estimated revenue from removing the 5 percent reduced rate:
    - 2018 data: just over 7,800 businesses (out of around 22,800 in the whole regime) with turnover below ALL 14 million would qualify for the reduced rate.
    - Net taxable profits for these businesses: around 0.3 percent of GDP (from revenues of around 2.8 percent of GDP).
    - Suggested increase in revenues from raising the profits tax rate from 5 to 15 percent: about 0.03 percent of GDP.
- Tax incentives design guidance:
  - Prefer incentives that lower the cost of investment (e.g., tax measures reducing capital cost) over profit-based tax incentives (tax holidays and exemptions).
  - Any tax incentive should be clearly prescribed and consolidated in the tax law with clearly defined and verifiable eligibility criteria to support a rules-based approach.
- R&D tax incentives:
  - Rationale: address public good qualities of R&D, positive externalities, asymmetric information, uncertainty, access to finance issues, and indivisibility of large R&D projects.
  - Design elements that improve effectiveness include carry-forward provisions, cash refunds, or relief from labor taxes for the employer (payroll taxes or employer social contributions) paid by the budget to stimulate R&D, including in new companies with negative tax liability.
  - Evidence suggests stronger positive impact on business R&D for firms less than 5 years old and SMEs.

*Source: IMF staff calculations and text from the provided content.*

### Box 5. Choosing the Right Tax Incentives

### Box 5. Choosing the Right Tax Incentives

### Purpose and context
- Tax incentives are used to stimulate investment and attract foreign direct investment, especially in developing economies.
- Goals often include bringing capital and (high-wage) jobs, spurring competition, increasing market efficiency, promoting specific sectors or activities, and addressing regional development needs.
- High-income countries rely more on investment tax credits and favorable tax treatment of research and development (R&D); low-income countries more often offer tax holidays and reduced tax rates; middle-income countries most often have preferential tax zones (in which income can be tax exempt and other favorable treatments may apply).

### Redundancy, revenue implications, and marginal targeting
- Tax incentives are often redundant in attracting investment in developing countries: the same investments would have been undertaken even without incentives, implying a cash transfer to the investor.
- For projects that would not have been undertaken without the incentive, there is no direct revenue loss—there may be a net revenue gain so long as taxation of the incentivized activity is not eliminated.
- To minimize revenue cost, incentives should be targeted to marginal investors who would not have invested otherwise.

### Types of incentives — cost-based versus profit-based
- Cost-based tax incentives:
  - Involve specific allowances linked to investment expenses, such as accelerated depreciation schemes and special tax deductions and credits.
  - Target lowering the cost of capital and make a greater number of investment projects more profitable at the margin—i.e., may generate investments that would not otherwise have been made.
- Profit-based tax incentives:
  - Generally reduce the tax rate applicable to taxable income. Examples: tax holidays, preferential tax rates, income exemptions.
  - Forego government revenue to make even more profitable projects (that would be undertaken without the incentive) cheaper, benefiting industries that start making profits soon in the holiday period.
  - Introduce a bias towards short-term projects with low upfront investment costs; such projects may “pack and go” when preferential treatment is removed.
  - For industries with significant long-term capital needs and potentially greater spillovers, tax holidays could actually discourage investment.
- Critical distinctions and international considerations:
  - Profit-based incentives are less effective when profitability is low; when profits arise from location-specific factors (natural resources, agglomerations, local markets), profit-based incentives tend to have high redundancy rates.
  - Profitable investments that are highly mobile across borders (e.g., rents associated with intangible assets) may be sensitive to both cost-based and profit-based incentives.

### Recommendations and design principles
- Prefer cost-based incentives that lower capital cost where the objective is to encourage marginal investment.
- Offer incentives only to investors who would not have invested otherwise to reduce revenue loss.
- Recognize mobility and international aspects when designing incentives for intangible-rich or highly mobile investments.

### Numerical findings and calibration guidance (as presented)
- Optimal threshold (Wei and Wen (2019) estimate): between about US$100,000 and US$150,000 (which corresponds to between ALL 11 million and ALL 16 million).
- Current SPT threshold: ALL 8 million.
- Reduced rate of the business profits tax applies for turnover below: ALL 14 million.
- Suggested optimal turnover tax rate if a single rate is applied to all sectors: close to 3 percent.
- Operational rule for turnover-rate equivalence: choose a turnover tax rate equivalent to applying the 15 percent standard business profits tax rate to the average margin for small businesses.
- Suggested voluntary registration band near the threshold: between ALL 5 million and ALL 8 million.
- Fixed tax regime (“patent system”) example for smallest businesses with turnover less than ALL 1 million: fixed annual payment of ALL 50,000.
- At a rate of 3 percent, potential yield from a turnover tax on activity currently declared under the SPT (below a threshold of ALL 8 million): up to an additional 0.22 percent of GDP.
- Using 2018 GDT data:
  - 35 percent of businesses in the general business profits tax regime have turnover below ALL 14 million.
  - Tax revenues from these businesses (at the reduced rate) were 0.05 percent of GDP from reported turnover of 2.8 percent of GDP.
  - If these businesses were moved into the new presumptive turnover-based regime, tax revenues would only increase by an additional 0.03 percent of GDP.
- Policy implication: assuming low compliance burdens, preferable to retain these businesses in the general regime and subject them to the standard profits tax rate of 15 percent.

### Empirical profit-margin and implied turnover tax rate indicators (table summary)
- Businesses under general BPT:
  - Profit margin: 10.51, 11.42, 12.1
  - Implied turnover tax rate: 1.58, 1.71, 1.81
- Businesses under SPT:
  - Profit margin: 32.93, 32.33, 5.7
  - Implied turnover tax rate: 4.94, 4.8, 5.4

### Treatment of self-employed (professional) individuals
- Recommendation: self-employed professional individuals operating within the “free professions” should be carved out of the simplified presumptive small business regime and brought into the personal income tax (PIT) regime to restore neutrality with employees.
- VAT registration: these professionals must register and charge VAT for their services if they are over the VAT threshold of ALL 8 million.
- For PIT taxable income, allow a maximum deemed expense deduction, for example, 10–20 percent of income.
- Identified professional categories (to be captured under PIT and VAT list): lawyers, notaries, specialized doctors, dentists, specialized dentists, chemists, nurses, vets, architects, engineers, approved accountants and estate appraisers, and individuals that conduct economic activity in the fields of hospitality.
- Current counts and revenue potential:
  - Over 8,000 physical persons operating in professional services.
  - These businesses generate up to 1 percent of GDP in turnover and pay 0.1 percent of GDP under the VAT.
  - Cross-check with SPT: approximately 7,000 physical persons from the same categories generate a similar amount of turnover and negligible taxes.
  - Preliminary estimate if shifted to PIT: could generate around 0.4 percent of GDP under the PIT and over 2 percent of GDP of social contributions.
- Longer-term: eventually bring all categories of self-employed individuals (i.e., other businesses with 0 employees) from the SPT into the PIT once controls and audit functions are in place.
- Administrative change: remove the ALL 2 million reporting threshold so self-employed professional individuals declare all income and ensure consistent treatment across all PIT taxpayers.

### Capital gains taxation observation
- With a high CGT on gains from property there is risk of under-reporting sale prices to avoid liability.
- Mitigations: subject gains made after a certain period to a lower CGT rate; partially adjust purchase price for inflation if inflation is high or persistent.
- Align changes to CGT base with ongoing cadaster changes in the property tax.

*Source: Box 5. Choosing the Right Tax Incentives (excerpt).*

### 88.      Several groups are exempt from the property tax, such as pensioners living alone, state

### 1albea2022001 - 88.

### Exemptions and current revenue expectations
- Several groups are exempt from the property tax: pensioners living alone, state and local government buildings, public properties transferred to public enterprises, buildings used for social services and social housing, and 4-/5-star hotels.
- The authorities expect around ALL 3.2 billion revenues from the recurrent property tax this year, and some ALL 1 billion more next year.
- The currently applied rates of the property tax are described as relatively low, characterized as a reasonable choice during the introduction period.

### Valuation system and cadaster
- The current system of the recurrent property tax is based on sound principles.
- Finalization of the fiscal cadaster will improve the valuation system.
- Recommendation: ensure the cadaster is developed on time and the property tax system transitions to use that as the basis of the valuation.

### Revenue potential and international comparison
- Current property tax revenue in Albania is described as 0.3 percent of GDP.
- The average revenue from property tax in comparable countries is around 0.8 percent of GDP.
- Policy implication: Albania could aspire to reach the 0.8 percent of GDP level in the medium term by raising property tax revenues.

### Recommendations on exemptions and relief design
- Eliminate property tax exemptions for several taxpayer groups; exemptions should be kept to the minimum so as not to undermine the revenue take of this source.
- Provide relief for vulnerable groups in other forms instead of blanket property tax exemptions.
- Maintain minimal exemptions to preserve property tax as an important own-source of revenue for local governments.

### Rate path and transition
- The property tax rate can be raised substantially over time to increase revenues from the property tax.
- The currently low rates are acceptable during introduction, but gradual increases are recommended as the system and cadaster mature.

*Source: 1albea2022001 - 88.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1albea2022001.pdf_