## 1. Allowances Arising from Employment

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---

### Overview and context
- The tax wedge in Bosnia and Herzegovina (BiH) drives labor market outcomes and requires entity-level analysis because legislation differs between the Federation of BiH (FBiH) and Republika Srpska (RS).
- Recent developments and context:
  - Unemployment declined from 18 to 13 percent over the past four years.
  - World Bank estimate: 30 percent of workers are employed in the informal sector.
  - Revenue-to-GDP (2021): 40.5 percent in BiH; Western Balkans average 35.3 percent; EU average 42.2 percent.
  - Labor taxes (PIT and SSCs) generated about 40 percent of total revenue in BiH.

### Labor taxation structure and rates (entity differences)
- Personal Income Tax (PIT):
  - FBiH and Brcko District (BD): flat 10 percent for all types of income; base = gross salary reduced by calculated SSCs.
  - RS: flat 8 percent for employment income, 10 percent for self-employment income, and 13 percent for other income; base = gross salary minus the prescribed PIT deduction (for employment).
- Social Security Contributions (SSC):
  - Total SSC rate: 41.5 percent of gross wages in FBiH; 31 percent in RS; 32 percent or 36.5 percent in BD (depending on pension fund payments).
  - In FBiH, SSC burden is divided between employers and employees; in RS and BD, contributions are borne entirely by workers.
- PIT revenue shares (2024 context):
  - Share of PIT in total revenues: 5.9 percent in FBiH; 5.7 percent in RS.
  - Regional comparisons: Western Balkans average 8.6; EU 22.6.

### Recent policy changes and fiscal impact (FBiH, 2025)
- Minimum wage and SSC law amendments in FBiH:
  - Minimum wage increased by 61.6 percent (from KM 619 to KM 1,000).
  - Employer SSC reduced by 5.5 percentage points, lowering overall SSC from 41.5 percent to 36 percent (effective July 1, 2025).
  - Specific contribution rate changes from July 2025: pension insurance contribution reduced by 6 to 2.5 percentage points of gross wages; health contribution reduced from 4 to 2 percentage points.
  - For workers working 4 hours a day or less, the SSC calculation basis is salary or 50 percent of minimum wage, whichever is greater.
- Estimated fiscal effects (staff calculations using 2024 wage distribution data):
  - Minimum wage increase alone: generates an 8 percent increase in revenue from PIT, SSC and other wage-related revenue.
  - After SSC rate reductions: net increase in revenues of 1.5 percent relative to 2024, or 0.3 percent of FBiH GDP for the full year.
  - The SSC rate cut largely affects pension contributions which finance the central government budget.

### Measurement and methodological adjustments to tax wedge
- Two methods used to calculate the tax wedge in BiH:
  - Method 1 (simplified, cross-country comparable): accounts for statutory PIT allowance and rate, and SSC.
  - Method 2 (entity-specific, detailed): includes non-taxable employment benefits (e.g., meal, transportation, vacation allowances), other tax deductions for dependent family members, and mandatory fees linked to salaries (e.g., contribution for natural disaster protection, water protection, fire protection).
- Rationale for Method 2 and entity differences:
  - In FBiH, non-taxable benefits can account for over 30 percent of average take-home pay.
  - In RS, most allowances (except transportation) are treated as part of overall remuneration and taxed; in FBiH they are generally tax-free and must be reflected in calculations assuming they are provided and used under labor contracts.
  - Method 2 in FBiH includes mandatory fees for water protection, rehabilitation of the disabled (0.5 percent of gross salary), and contribution for protection against natural disasters.

### Allowances arising from employment (incidence and practice)
- Statutory and contractual allowances:
  - Employers are obliged to increase income for difficult working conditions, overtime, night work, work during weekly rest, or holidays; allowance range typically 15 percent (weekly holiday work) to 50 percent (holiday work) of net hourly wage per hour.
  - Annual salary increase rights: at least 0.3 percent per year in RS; 0.4 percent per year in FBiH.
  - Branch collective agreements can define larger allowances.
  - These allowances (overtime, night work, etc.) are taxed in both entities.
- Common non-taxable benefits in FBiH (prevalence and treatment):
  - Hot meal compensation: about 70 percent of workers receive it.
  - Transportation compensation: about 40 percent receive it.
  - Regress (vacation allowance): about 45 percent receive it.
  - Example accounting practice in FBiH: an agreed income of KM 1,000 may be shown as taxable salary KM 700 plus allowances KM 300; only the KM 700 is subject to taxation.
- Other employer-paid benefits:
  - Severance pay, per diems, car-use compensation, jubilee awards, one-off cash assistance, death/illness assistance — generally tax-free only up to certain amounts in both entities.

### Key analytical insights
- Conventional tax-wedge measures likely overstate the effective labor tax wedge in FBiH because they omit widespread non-taxable allowances and preferential treatments that lower taxable income.
- Accurate, granular measurement across the income distribution and contract types (self-employment, full employment, temporary) is necessary to assess progressivity and behavioral incentives.
- Differences in statutory bases and rates between FBiH and RS require entity-level tax wedge calculations.

### Policy implications and recommended reform directions
- Reform objectives:
  - Create a more efficient, progressive, and transparent labor tax system to support fiscal and growth outcomes.
- Scope for reforms:
  - Simplification of the tax system.
  - Broadening of the tax base (reducing opportunities for tax-saving arbitrage via non-taxable allowances).
  - Increasing progressivity of the PIT/SSC system.
  - These reforms could pave the way for future headline SSC rate cuts while maintaining revenue adequacy.
- Additional recommendations (from the source):
  - Simplify the system and remove preferential treatment for certain categories of work.
  - Broaden the tax base to include currently untaxed compensation (noting that non-wage benefits appear to increase with income levels, so expanding the tax base to all labor income would increase overall progressivity).
  - Combine reductions in tax rates with offsetting revenue measures to sustain financing of social benefits.
  - Avoid relying on minimum wage hikes (such as the January 2025 increase) as a substitute for tax wedge reductions.
  - Harmonize tax treatment of labor taxation across entities to reduce distortions and compliance costs.
  - Review the link between SSC contributions and benefits to strengthen incentives to contribute.
  - Once compliance improves, consider introducing a second marginal PIT tax bracket at a higher rate to enhance progressivity and revenue from higher earners.

*Source: 2024 IMF Selected Issues Paper (section "1. Allowances Arising from Employment")*

### 14. Using the detailed methodology, tax wedges in both entities are found to be nearly

### Tax wedge estimates (methods and levels)
- Using the detailed methodology (method 2 inclusive of non-taxable benefits), the tax wedge is estimated at 32.3 percent of the gross average wage in RS and 29.7 percent in FBiH.
- Under method 1 (simplified approach), FBiH tax wedge is significantly higher due to higher headline PIT rates, lower PIT allowances and a higher SSC rate; inclusion of large non-taxable benefits under method 2 reduces the effective tax burden in FBiH by 13 ppts.
- In RS, method 2 yields a slightly lower tax wedge than method 1 because of a reduced tax base for dependent family members and included non-taxable transportation allowance.

### Time variation, allowances, and 2024–2025 changes
- Tax wedge has varied over time in both entities: RS changes reflect frequent legal changes; FBiH changes reflect allowance and base adjustments.
- Historical and recent movements:
  - In 2008 (FBiH, method 2) there was a decrease due to introduction of tax deduction for dependent family members; an increase from 2017 reflected a reduced level of permitted non-taxable meal and vacation allowances.
  - In 2024, FBiH permitted employers to pay each worker monthly non-taxable cash assistance in the amount of up to KM 461 to mitigate purchasing-power effects of price increases.
- Amendments to the law on contributions in FBiH effective July 1, 2025:
  - Headline SSC rate reduction will reduce the tax wedge under both calculation methodologies.
  - SSC tax base for employees earning below the minimum wage will be amended to 50 percent of MW for those who work less than four hours per day, or personal gross income for those who work more than four hours per day, reducing the tax wedge for those workers.
  - Under method 2, distributional impacts may arise because the regulation that enabled the payment of tax-free compensation of KM 450 per month ceases to be valid in July 2025; that compensation was mainly paid to workers whose salary in 2024 was KM 1,000 or more.

### Composition and regional comparison
- The standard tax wedge in BiH—driven primarily by SSC—is among the highest in Europe but falls significantly when non-taxable allowances are considered.
- The average share of SSC in the tax wedge in BiH is 89 percent, higher than the average share in the region.
- For OECD countries, the share of PIT is on average 38 percent; in the EU the share of PIT in total tax wedge is 35.2 percent.
- According to both methodologies, RS is in the middle in comparison with the region and has a lower tax wedge than the EU average.
- For comparator countries, both methods likely yield similar results because non-taxable allowances are not typical in most labor tax regimes; tax wedge for other countries is calculated using only method 1.

### Income source, reclassification incentives, and scenarios
- Fragmentation of the tax system creates incentives to reclassify employment income to income from other sources (temporary service contracts, royalties, self-employment).
- The tax wedge based on income from employment is the highest and the only one that tends to increase at higher income levels.
- Reclassification can reduce the tax wedge as much as 24 percent at higher income levels in FBiH and 18 percent in RS.
- Examples of differential treatment:
  - In FBiH: additional self-employment income is taxable for PIT but not for SSC; temporary service contract and copyright contributions are 10 percent, tax base reduced by 30 and 20 percent respectively, plus reduction by the amount of calculated contribution for healthcare.
  - In RS: self-employment income (if already employed elsewhere) is taxed at 10 percent, contributions are 18.5 percent on a base that is 30 percent of the average salary in RS; temporary service contract and copyright tax rate is 13 percent, reduced by calculated contributions; copyright recognized costs reduce tax base by 40 to 60 percent; of the contributions only pension insurance contribution (18.5 percent) is paid.

### Progressivity across income distribution and minimum wage effects
- PIT and SSC rates in both entities are flat; progressivity comes from PIT deduction which is proportionally larger for lower incomes.
- PIT deduction in RS is 3.3 times higher than in FBiH, so progressivity is more pronounced in RS.
- RS increased progressivity over time via increases in the personal deduction (from KM 200 to KM 500 and later to KM 1,000); FBiH progressivity remained unchanged absent reforms.
- Progressivity of the tax wedge in BiH is lower compared with both the regional and the EU average.
- Increases in minimum wages and average wages lead to more workers facing a higher tax wedge, but rates increase only marginally, by up to 1 percentage point.
- Employees with a salary below the minimum wage (mainly part-time workers) face the largest tax wedge because the legal basis for contributions in those cases is the minimum wage.

### Conclusions and policy considerations (recommendations)
- Identified inefficiencies:
  - Complexity, opacity, non-wage benefits, and differential treatment of labor income create avoidance/evasion opportunities, undermine revenue collection, and sustain high statutory SSC rates on formal employment income.
  - Differences in tax treatment between the entities (and BD) increase administrative burden for multi-entity businesses and create tax-arbitrage opportunities.
- Recommended reform objectives and measures:
  - Simplify the system and remove preferential treatment for certain categories of work.
  - Broaden the tax base to include currently untaxed compensation.
  - Combine reductions in tax rates with offsetting revenue measures to sustain financing of social benefits.
  - Avoid relying on minimum wage hikes (such as the January 2025 increase) as a substitute for tax wedge reductions.
  - Harmonize tax treatment of labor taxation across entities to reduce distortions and compliance costs.
  - Review the link between SSC contributions and benefits to strengthen incentives to contribute.
  - Once compliance improves, consider introducing a second marginal PIT tax bracket at a higher rate to enhance progressivity and revenue from higher earners.

*Source: IMF staff calculations and analysis as presented in the provided content unit.*

### 3. Macroprudential policy plays a key role in managing housing sector risks

### Role and instrument categories
- Macroprudential tools mitigate systemic risks from housing market overheating.
- Two broad categories:
  - Containing the build-up of risk (borrower-based measures).
  - Enhancing resilience (capital buffers).
- Borrower-based measures:
  - Limits on household borrowing capacity reduce excessive leverage and enhance resilience.
  - Loan-to-Value (LTV) limits: most EU countries have some LTV limits lower than 100 percent; the average LTV limit in Europe is 80  percent.
  - Debt-Service-to-Income (DSTI) or Loan-to-Income (LTI) limits cap the share of income servicing debt and can act as automatic stabilizers.
- Capital-based measures:
  - Sectoral capital requirements (e.g., higher risk weights for mortgage loans with high LTVs).
  - Countercyclical capital buffers (CCyB) activated depending on the financial cycle and mortgage credit cycles.

### Indicators for policy intervention
- Recommended indicators:
  - House price indicators: House Price Index (HPI), House Price-to-Income Ratio, Price-to-Rent Ratio.
  - Credit indicators: Household Debt-to-GDP, Mortgage Debt-to-Income Ratio, average Loan-to Value Ratios, average Debt-Service-to-Income Ratio, mortgage credit growth, lending rates.
  - Banking sector exposure: share of mortgage loans to total loans, share of NPLs in mortgage loans, level of loan loss provisions, real estate assets as percentage of total assets.
  - Market activity indicators: transaction volumes, building permits, housing starts, vacancy rates, real estate valuation gaps.
- Filtering techniques (e.g., Hodrick-Prescott (HP) filter) can calculate position in the financial cycle.
- IMF Integrated Macroprudential Policy Database (iMaPP) used for data reference.

### Real estate developments in BiH — key findings
- House price dynamics:
  - Year-on-year real house price growth in BiH was over 13 percent at the end of 2023, the highest price growth peak since the onset of the GFC (38 percent y-o-y at end 2007).
  - HPI increased by 55 percent between 2019 and 2023.
- Affordability:
  - Housing affordability index has declined since the pandemic.
  - With an average monthly net wage in 2024, a person could afford 0.6 and 0.5 square meters of an apartment in RS and FBiH respectively, 13 percent less than in 2018.
  - Authorities amended VAT law to allow VAT refunds on newly built units for first-time homebuyers; amendment in force since mid-April, but implementing bylaws still under discussion.
- Spatial and demographic patterns:
  - Apartment prices show upward pressure in Sarajevo since 2022; less pronounced capital drift in RS (Banja Luka and other areas co-move).
- Supply trends:
  - Number of completed new flats trended upward over the last decade with a notable peak in 2024.
  - Ongoing projects increased significantly; planned new apartments stabilized in 2024.
  - Average size of built flats marginally declined.
  - Built area shows an overall increasing trend, highest value recorded in 2024.
  - Number of buying transactions decreased in recent years, mainly fewer transactions of existing homes.
- Construction costs and supply constraints:
  - Construction costs show notable upward trend since end-2021, peaking in mid-2024.
  - Contributing factors: inflationary pressures, supply chain disruptions, anecdotal shortage of construction labor, burdensome regulatory framework in large urban areas.
  - Significant minimum wage increase in FBiH in 2025 may put further upward pressure on construction costs.

### Demand, credit, and financial stability indicators
- Mortgage credit growth and bank portfolios:
  - Credit growth in mortgage segment increased in recent years but remains a small part of banks’ total loan portfolios.
  - Private credit growth: 9.3 percent yoy at end 2024.
  - Credit for home purchase grew by 7.6 percent in the same period.
  - Mortgage lending represented only 24 percent of bank loans to households as of end-2024.
  - Share of total home purchase transaction volumes financed by mortgages: 36.5 percent in 2022 to 53.8 percent in 2024.
  - Banks generally finance around 80 percent of the home value when granting mortgages; a share of volumes financed with mortgages below 60 percent suggests a significant proportion conducted in cash.
  - Authorities set limits on general purpose consumer loans: KM 50,000 and 10 year maturity; higher risk weights for general purpose loans with remaining maturity above 5 years.
  - Banking agencies initiated mandatory reporting of LTV and DSTI ratios.
- Interest rates and investment incentives:
  - Deposit rates close to zero; deposit rates at banks below 1 percent.
  - Interest rates on mortgages around 4 percent on average as of December 2024.
  - Fixed-rate loans increased from less than 20 percent of loans in 2012 to over 90 percent in 2024 for overall household loans.
    - For housing loans, share increased from 35 percent to 87 percent.
  - Interest rates have not co-moved with euro area rates despite a currency board arrangement pegged to the euro.
  - RS retail government bonds issued with yield of 4.38 percent at issuance; total amount issued KM 5 million.
  - Price-to-rent ratio is 15 percent.
- Household indebtedness and asset quality:
  - Household-debt-to-GDP ratio in BiH: 23.7 percent in 2023.
  - Euro area household debt: 52.8 percent of GDP.
  - NPLs in the mortgage segment: 0.7 percent as of end 2024.

### Conclusion, risks, and policy recommendations
- Overall assessment:
  - Housing prices have risen rapidly in BiH; HPI and private credit growth increased, but risks remain contained given low household indebtedness and limited mortgage share in bank portfolios.
- Key risks:
  - Continued strong price growth combined with rising construction costs and limited alternative investment channels could exacerbate overheating.
  - Fixed-rate mortgages originated at historically low interest rates may pose future risk to lenders.
  - Potential circumvention of mortgage LTV via topping-up with consumer loans.
- Policy recommendations (priorities and measures):
  - Systematically collect and analyze housing market indicators:
    - Monitor HPI, price-to-income ratio, price-to-rent ratio, household debt as share of GDP, LTV and DSTI ratios, mortgage growth, lending rates, and employ filtering tools to identify cyclical risks.
    - Collect data on purchase purpose (primary residence vs. investment) and bank real estate exposures (mortgage shares, NPLs, direct holdings).
    - Track market activity indicators: number of transactions, building permits, housing starts, vacancy rates, and valuation gaps.
  - Speed up implementation of borrower- and capital-based measures:
    - Authorities plan to collect LTV and DSTI data for monitoring; no current plans to impose limits.
    - Authorities are considering implementing CCyB, but coordination challenges remain.
  - Enhance coordination among the Central Bank and financial stability agencies:
    - For a well-functioning macroprudential framework, coordination and cooperation among agencies in charge of financial stability are essential.

*Source: Excerpt from IMF staff analysis on Bosnia and Herzegovina housing market and macroprudential policy.*

### 1. Allowances Arising from Employment _______________________________________________ 8

### 1. Allowances Arising from Employment

### Overview and context
- The tax wedge in Bosnia and Herzegovina (BiH) is a key driver of labor market outcomes and needs entity-level analysis due to differing legislation in the Federation of BiH (FBiH) and Republika Srpska (RS).
- Recent developments:
  - Unemployment declined from 18 to 13 percent over the past four years.
  - World Bank estimate: 30 percent of workers are employed in the informal sector.
  - Revenue-to-GDP (2021): 40.5 percent in BiH; Western Balkans average 35.3 percent; EU average 42.2 percent.
  - Labor taxes (PIT and SSCs) generated about 40 percent of total revenue in BiH.

### Labor taxation structure and rates (entity differences)
- Personal Income Tax (PIT):
  - FBiH and Brcko District (BD): flat 10 percent for all types of income; base = gross salary reduced by calculated SSCs.
  - RS: flat 8 percent for employment income, 10 percent for self-employment income, and 13 percent for other income; base = gross salary minus the prescribed PIT deduction (for employment).
- Social Security Contributions (SSC):
  - Total SSC rate: 41.5 percent of gross wages in FBiH; 31 percent in RS; 32 percent or 36.5 percent in BD (depending on pension fund payments).
  - In FBiH, SSC burden is divided between employers and employees; in RS and BD, contributions are borne entirely by workers.
- PIT revenue shares (2024 context):
  - Share of PIT in total revenues: 5.9 percent in FBiH; 5.7 percent in RS.
  - Regional comparisons: Western Balkans average 8.6; EU 22.6.

### Recent policy changes and fiscal impact (FBiH, 2025)
- Minimum wage and SSC law amendments in FBiH:
  - Minimum wage increased by 61.6 percent (from KM 619 to KM 1,000).
  - Employer SSC reduced by 5.5 percentage points, lowering overall SSC from 41.5 percent to 36 percent (effective July 1, 2025).
  - Specific contribution rate changes from July 2025: pension insurance contribution reduced by 6 to 2.5 percentage points of gross wages; health contribution reduced from 4 to 2 percentage points.
  - For workers working 4 hours a day or less, the SSC calculation basis is salary or 50 percent of minimum wage, whichever is greater.
- Estimated fiscal effects (staff calculations using 2024 wage distribution data):
  - Minimum wage increase alone: generates an 8 percent increase in revenue from PIT, SSC and other wage-related revenue.
  - After SSC rate reductions: net increase in revenues of 1.5 percent relative to 2024, or 0.3 percent of FBiH GDP for the full year.
  - The SSC rate cut largely affects pension contributions which finance the central government budget.

### Measurement and methodological adjustments to tax wedge
- Two methods used to calculate the tax wedge in BiH:
  - Method 1 (simplified, cross-country comparable): accounts for statutory PIT allowance and rate, and SSC.
  - Method 2 (entity-specific, detailed): includes non-taxable employment benefits (e.g., meal, transportation, vacation allowances), other tax deductions for dependent family members, and mandatory fees linked to salaries (e.g., contribution for natural disaster protection, water protection, fire protection).
- Rationale for Method 2:
  - In FBiH, non-taxable benefits can account for over 30 percent of average take-home pay.
  - In RS, most allowances (except transportation) are treated as part of overall remuneration and taxed; in FBiH they are generally tax-free and must be reflected in calculations assuming they are provided and used under labor contracts.
  - Method 2 in FBiH includes mandatory fees for water protection, rehabilitation of the disabled (0.5 percent of gross salary), and contribution for protection against natural disasters.

### Allowances arising from employment (Box findings and incidence)
- Statutory and contractual allowances:
  - Employers are obliged to increase income for difficult working conditions, overtime, night work, work during weekly rest, or holidays; allowance range typically 15 percent (weekly holiday work) to 50 percent (holiday work) of net hourly wage per hour.
  - Annual salary increase rights: at least 0.3 percent per year in RS; 0.4 percent per year in FBiH.
  - Branch collective agreements can define larger allowances.
  - These allowances (overtime, night work, etc.) are taxed in both entities.
- Common non-taxable benefits (FBiH prevalence and treatment):
  - Hot meal compensation: about 70 percent of workers receive it.
  - Transportation compensation: about 40 percent receive it.
  - Regress (vacation allowance): about 45 percent receive it.
  - Example accounting practice in FBiH: an agreed income of KM 1,000 may be shown as taxable salary KM 700 plus allowances KM 300; only the KM 700 is subject to taxation.
- Other employer-paid benefits:
  - Severance pay, per diems, car-use compensation, jubilee awards, one-off cash assistance, death/illness assistance — generally tax-free only up to certain amounts in both entities.

### Key analytical insights
- Conventional tax-wedge measures likely overstate the effective labor tax wedge in FBiH because they omit widespread non-taxable allowances and preferential treatments that lower taxable income.
- Accurate, granular measurement across the income distribution and contract types (self-employment, full employment, temporary) is necessary to assess progressivity and behavioral incentives.
- Differences in statutory bases and rates between FBiH and RS require entity-level tax wedge calculations.

### Policy implications and recommended reform directions (from the source)
- Reforms are necessary to create a more efficient, progressive, and transparent labor tax system to support fiscal and growth outcomes.
- There is significant scope for:
  - Simplification of the tax system.
  - Broadening of the tax base (reducing opportunities for tax-saving arbitrage via non-taxable allowances).
  - Increasing progressivity of the PIT/SSC system.
  - These reforms could pave the way for future headline SSC rate cuts while maintaining revenue adequacy.

*Source: 2024 IMF Selected Issues Paper (section "1. Allowances Arising from Employment")*

### 14.      Using the detailed methodology, tax wedges in both entities are found to be nearly

### 14.      Using the detailed methodology, tax wedges in both entities are found to be nearly 

### Tax wedge estimates (methods and levels)
- Using the detailed methodology (method 2 inclusive of non-taxable benefits), the tax wedge is estimated at 32.3 percent of the gross average wage in RS and 29.7 percent in FBiH.
- Under method 1 (simplified approach), FBiH tax wedge is significantly higher due to higher headline PIT rates, lower PIT allowances and a higher SSC rate; inclusion of large non-taxable benefits under method 2 reduces the effective tax burden in FBiH by 13 ppts.
- In RS, method 2 yields a slightly lower tax wedge than method 1 because of a reduced tax base for dependent family members and included non-taxable transportation allowance.

### Time variation, allowances, and 2024–2025 changes
- Tax wedge has varied over time in both entities: RS changes reflect frequent legal changes; FBiH changes reflect allowance and base adjustments.
- In 2008 (FBiH, method 2) there was a decrease due to introduction of tax deduction for dependent family members; an increase from 2017 reflected a reduced level of permitted non-taxable meal and vacation allowances.
- In 2024, FBiH permitted employers to pay each worker monthly non-taxable cash assistance in the amount of up to KM 461 to mitigate purchasing-power effects of price increases.
- Amendments to the law on contributions in FBiH effective July 1, 2025:
  - Headline SSC rate reduction will reduce the tax wedge under both calculation methodologies.
  - SSC tax base for employees earning below the minimum wage will be amended to 50 percent of MW for those who work less than four hours per day, or personal gross income for those who work more than four hours per day, reducing the tax wedge for those workers.
  - Under method 2, distributional impacts may arise because the regulation that enabled the payment of tax-free compensation of KM 450 per month ceases to be valid in July 2025; that compensation was mainly paid to workers whose salary in 2024 was KM 1,000 or more.

### Composition and regional comparison
- The standard tax wedge in BiH—driven primarily by SSC—is among the highest in Europe but falls significantly when non-taxable allowances are considered.
- The average share of SSC in the tax wedge in BiH is 89 percent, higher than the average share in the region.
- For OECD countries, the share of PIT is on average 38 percent; in the EU the share of PIT in total tax wedge is 35.2 percent.
- According to both methodologies, RS is in the middle in comparison with the region and has a lower tax wedge than the EU average.
- For comparator countries, both methods likely yield similar results because non-taxable allowances are not typical in most labor tax regimes; tax wedge for other countries is calculated using only method 1.

### Income source, reclassification incentives, and scenarios
- Fragmentation of the tax system creates incentives to reclassify employment income to income from other sources (temporary service contracts, royalties, self-employment).
- The tax wedge based on income from employment is the highest and the only one that tends to increase at higher income levels.
- Reclassification can reduce the tax wedge as much as 24 percent at higher income levels in FBiH and 18 percent in RS.
- Examples of differential treatment (as described in the source):
  - In FBiH: additional self-employment income is taxable for PIT but not for SSC; temporary service contract and copyright contributions are 10 percent, tax base reduced by 30 and 20 percent respectively, plus reduction by the amount of calculated contribution for healthcare.
  - In RS: self-employment income (if already employed elsewhere) is taxed at 10 percent, contributions are 18.5 percent on a base that is 30 percent of the average salary in RS; temporary service contract and copyright tax rate is 13 percent, reduced by calculated contributions; copyright recognized costs reduce tax base by 40 to 60 percent; of the contributions only pension insurance contribution (18.5 percent) is paid.

### Progressivity across income distribution and minimum wage effects
- The PIT and SSC rates in both entities are flat; progressivity comes from PIT deduction which is proportionally larger for lower incomes.
- PIT deduction in RS is 3.3 times higher than in FBiH, so progressivity is more pronounced in RS.
- RS increased progressivity over time via increases in the personal deduction (from KM 200 to KM 500 and later to KM 1,000); FBiH progressivity remained unchanged absent reforms.
- Progressivity of the tax wedge in BiH is lower compared with both the regional and the EU average.
- Increases in minimum wages and average wages lead to more workers facing a higher tax wedge, but rates increase only marginally, by up to 1 percentage point.
- Employees with a salary below the minimum wage (mainly part-time workers) face the largest tax wedge because the legal basis for contributions in those cases is the minimum wage.

### Conclusions and policy considerations (recommendations)
- The labor tax system in BiH exhibits several inefficiencies: complexity, opacity, non-wage benefits, and differential treatment of labor income create avoidance/evasion opportunities, undermine revenue collection, and sustain high statutory SSC rates on formal employment income.
- Differences in tax treatment between the entities (and BD) increase administrative burden for multi-entity businesses and create tax-arbitrage opportunities.
- Recommended reform objectives and measures:
  - Simplify the system and remove preferential treatment for certain categories of work.
  - Broaden the tax base to include currently untaxed compensation (noting that non-wage benefits appear to increase with income levels, so expanding the tax base to all labor income would increase overall progressivity).
  - Combine reductions in tax rates with offsetting revenue measures to sustain financing of social benefits.
  - Avoid relying on minimum wage hikes (such as the January 2025 increase) as a substitute for tax wedge reductions.
  - Harmonize tax treatment of labor taxation across entities to reduce distortions and compliance costs.
  - Review the link between SSC contributions and benefits to strengthen incentives to contribute.
  - Once compliance improves, consider introducing a second marginal PIT tax bracket at a higher rate to enhance progressivity and revenue from higher earners.

*Source: IMF staff calculations and analysis as presented in the provided content unit.*

### 3.      Macroprudential policy plays a key role in managing housing sector risks. The strategic

### 3.      Macroprudential policy plays a key role in managing housing sector risks

### Role and types of macroprudential instruments
- Macroprudential tools mitigate the accumulation of systemic risks from housing market overheating.
- Two broad categories:
  - Containing the build-up of risk (borrower-based measures).
  - Enhancing resilience (capital buffers).

- Borrower-based measures:
  - Place limits on household borrowing capacity to reduce excessive leverage and enhance resilience.
  - Loan-to-Value (LTV) limits impose restrictions on credit relative to appraised property value.
    - Most EU countries have some LTV limits lower than 100 percent, and the average LTV limit in Europe is 80  percent.
  - Debt-Service-to-Income (DSTI) or Loan-to-Income (LTI) limits cap the share of income servicing debt, can act as automatic stabilizers when house prices outpace disposable income growth.

- Capital-based measures:
  - Sectoral capital requirements can target exposures (e.g., higher risk weights for mortgage loans with high LTVs).
  - Countercyclical capital buffers can be activated depending on the financial cycle and mortgage credit cycles.

### Indicators for policy intervention
- A comprehensive set of indicators should be employed, with emphasis on mortgage expansion and house price fluctuations:
  - House price indicators: House Price Index (HPI), House Price-to-Income Ratio, Price-to-Rent Ratio.
  - Credit indicators: Household Debt-to-GDP, Mortgage Debt-to-Income Ratio, average Loan-to Value Ratios, average Debt-Service-to-Income Ratio, mortgage credit growth, lending rates. Filtering techniques (e.g., Hodrick-Prescott (HP) filter) can calculate position in the financial cycle.
  - Banking sector exposure: share of mortgage loans to total loans, share of NPLs in mortgage loans, level of loan loss provisions, real estate assets as percentage of total assets.
  - Market activity indicators: transaction volumes, building permits, housing starts, vacancy rates, real estate valuation gaps.

*IMF Integrated Macroprudential Policy Database (iMaPP) used for data reference.*

### (Residential) Real Estate Developments in BiH and the region — key findings
- House price dynamics:
  - Year-on-year real house price growth in BiH was over 13 percent at the end of 2023, the highest price growth peak since the onset of the GFC (38 percent y-o-y at end 2007).
  - HPI increased by 55 percent between 2019 and 2023.

- Affordability:
  - Housing affordability index has declined since the pandemic.
  - With an average monthly net wage in 2024, a person could afford 0.6 and 0.5 square meters of an apartment in RS and FBiH respectively, 13 percent less than in 2018.
  - Authorities amended VAT law to allow VAT refunds on newly built units for first-time homebuyers; amendment in force since mid-April, but implementing bylaws still under discussion.

- Spatial and demographic patterns:
  - Apartment prices show upward pressure in Sarajevo since 2022; less pronounced capital drift in RS (Banja Luka and other areas co-move).

- Supply trends:
  - Number of completed new flats trended upward over the last decade with a notable peak in 2024.
  - Ongoing projects increased significantly; planned new apartments stabilized in 2024.
  - Average size of built flats marginally declined.
  - Built area shows an overall increasing trend, highest value recorded in 2024.
  - Number of buying transactions decreased in recent years, mainly fewer transactions of existing homes.

- Construction costs and supply constraints:
  - Construction costs show notable upward trend since end-2021, peaking in mid-2024.
  - Contributing factors: inflationary pressures, supply chain disruptions, anecdotal shortage of construction labor, burdensome regulatory framework in large urban areas.
  - Significant minimum wage increase in FBiH in 2025 may put further upward pressure on construction costs.

### Demand, credit, and financial stability indicators
- Mortgage credit growth and bank portfolios:
  - Credit growth in mortgage segment increased in recent years but remains a small part of banks’ total loan portfolios.
  - Private credit growth: 9.3 percent yoy at end 2024.
  - Credit for home purchase grew by 7.6 percent in the same period.
  - Mortgage lending represented only 24 percent of bank loans to households as of end-2024.
  - Share of total home purchase transaction volumes financed by mortgages: 36.5 percent in 2022 to 53.8 percent in 2024.
  - Banks generally finance around 80 percent of the home value when granting mortgages; a share of volumes financed with mortgages below 60 percent suggests a significant proportion conducted in cash.
  - Authorities set limits on general purpose consumer loans: KM 50,000 and 10 year maturity; higher risk weights for general purpose loans with remaining maturity above 5 years.
  - Banking agencies initiated mandatory reporting of LTV and DSTI ratios.

- Interest rates and investment incentives:
  - Deposit rates close to zero; deposit rates at banks below 1 percent.
  - Interest rates on mortgages around 4 percent on average as of December 2024.
  - Fixed-rate loans increased from less than 20 percent of loans in 2012 to over 90 percent in 2024 for overall household loans.
    - For housing loans, share increased from 35 percent to 87 percent.
  - Interest rates have not co-moved with euro area rates despite a currency board arrangement pegged to the euro.
  - RS retail government bonds issued with yield of 4.38 percent at issuance; total amount issued KM 5 million.
  - Price-to-rent ratio is 15 percent.

- Household indebtedness and asset quality:
  - Household-debt-to-GDP ratio in BiH: 23.7 percent in 2023.
  - Euro area household debt: 52.8 percent of GDP.
  - NPLs in the mortgage segment: 0.7 percent as of end 2024.

### Conclusion, risks, and policy recommendations
- Overall assessment:
  - Housing prices have risen rapidly in BiH; HPI and private credit growth increased, but risks remain contained given low household indebtedness and limited mortgage share in bank portfolios.

- Key risks:
  - Continued strong price growth combined with rising construction costs and limited alternative investment channels could exacerbate overheating.
  - Fixed-rate mortgages originated at historically low interest rates may pose future risk to lenders.
  - Potential circumvention of mortgage LTV via topping-up with consumer loans.

- Policy recommendations (priorities and measures):
  - Systematically collect and analyze housing market indicators:
    - Monitor HPI, price-to-income ratio, price-to-rent ratio, household debt as share of GDP, LTV and DSTI ratios, mortgage growth, lending rates, and employ filtering tools to identify cyclical risks.
    - Collect data on purchase purpose (primary residence vs. investment) and bank real estate exposures (mortgage shares, NPLs, direct holdings).
    - Track market activity indicators: number of transactions, building permits, housing starts, vacancy rates, and valuation gaps.
  - Speed up implementation of borrower- and capital-based measures:
    - Authorities plan to collect LTV and DSTI data for monitoring; no current plans to impose limits.
    - Authorities are considering implementing CCyB, but coordination challenges remain.
  - Enhance coordination among the Central Bank and financial stability agencies:
    - For a well-functioning macroprudential framework, coordination and cooperation among agencies in charge of financial stability are essential.

*Source: Excerpt from IMF staff analysis on Bosnia and Herzegovina housing market and macroprudential policy.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2025/english/1bihea2025002-source-pdf.pdf_