## 1. The EU Growth Plan: A Catalyst for Structural Reform

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### Growth drivers and performance
- Average real GDP growth in North Macedonia:
  - about 2.6 percent annually since 2001.
  - other Western Balkan countries: 3.5 percent.
- Historical patterns:
  - Pre-Global Financial Crisis (GFC): growth exceeded 5 percent in several years.
  - 2009–2019: growth moderated to about 2.4 percent.
  - 2021–25: growth averaged about 3 percent.
- Demand-side contributions:
  - Private consumption: contributed between 3.0 and 3.4 percentage points to GDP growth across periods.
  - Private investment: contributed 1.4–1.7 percentage points.
  - Public consumption: modest contribution.
  - External sector: mostly negative contribution.
- Production-side dynamics:
  - 2001–2008: balanced gains from labor, capital, and TFP.
  - 2009–2019: TFP contribution turned negative; capital accumulation more prominent.
  - 2021–2025: productivity accounted for the majority of output gains; labor contribution weakened and turned negative.
- Convergence and labor supply pressures:
  - GDP per capita (PPP) in 2024: 43 percent of the EU average.
  - Output per capita growth: ~3.0 percent per year versus 3.7 percent for other Western Balkan countries.
  - “Half-life” of the income gap at current rates: almost 20 years.
  - UN projections: continued emigration will shrink the working-age population, leading to a 0.5 percentage point decline in employment by 2030.

### Potential output estimates
- Methods:
  - Univariate filters (dual Hodrick–Prescott on annual and quarterly GDP from 2001).
  - Two semi-structural multivariate models estimated with a Kalman filter (annual model with Okun’s law; quarterly QPM-like model).
- Key estimates:
  - Potential output growth averaged around 2.6–2.8 percent over 2001–2025 using HP and multivariate filters.
  - Potential growth slowed from 3.4–4.0 percent before the GFC to 2.3–2.4 percent post-GFC (excluding 2020).
  - Both annual and quarterly models indicate a pickup in potential growth in 2025 to about 2.6–2.7 percent.
  - Estimated positive output gap in the range of 0.7–1.0 percent (2025, HP-based).
  - Multivariate models and HP filter together suggest potential output growth in 2025 of about 2.9 percent.

### Medium-term GDP impact of structural reforms (methodology and magnitudes)
- Framework:
  - Six policy areas: governance; labor and human capital; business regulation; R&D and digitalization; credit and capital markets; external sector.
  - Frontier defined as average of two best-performing European economies and the United States, normalized to 100.
  - Scenario: North Macedonia closes 50 percent of its gap relative to the CESEE frontier.
  - Output Gains = Closed Policy Gaps * Output Elasticities (elasticities from IMF and OECD studies; impacts measured over a five-year horizon).
- Country positioning:
  - North Macedonia ranks below the 25th percentile and below the CESEE average in most areas except business regulation.
- Reform-specific medium-term GDP gains (closing 50% of gap):
  - Labor market and human capital: 6.6 percent total gain.
    - Closing gaps in labor force participation: 5.5 percent.
    - Closing gaps in UN Human Capital Index: 1.1 percent.
  - Business environment (combined): 4.6 percent total gain.
    - Lower external trade restrictions (MATR): 2.5 percent.
    - Improvements in product market regulations (PMR): 1.0 percent.
    - Deeper financial markets: 0.6 percent.
    - Higher business R&D spending: 0.5 percent.
  - Governance (control of corruption proxy): 2.7 percent.
- Combined impact:
  - Cumulative medium-term output gains from combined reforms: about 14 percent (roughly 2–3 percent additional annual growth, nearly doubling current potential growth estimates).
  - Caveats: aggregation assumes additivity and abstracts from interactions and general equilibrium effects; estimates could both over- and under-state true gains depending on complementarities and overlaps.

### The EU Reform and Growth Facility (RGF) as a catalyst
- RGF potential and targets:
  - World Bank estimates: full implementation of RGF reforms (closing 70 percent of critical gaps with the EU in five key areas over 20 years) could boost baseline annual GDP per capita growth in the Western Balkan countries by up to 3 percentage points.
  - Five priority areas under RGF: (i) digital infrastructure; (ii) regulatory quality; (iii) government effectiveness; (iv) financial development; (v) female labor force participation.
  - Largest projected dividends per World Bank: regulatory quality (1.13 pp), government effectiveness (0.95 pp), digitalization (0.63 pp); female LFP (0.35 pp); financial sector development (0.03 pp).
- Financing and conditionality for North Macedonia:
  - Eligibility: up to €750 million in grants and favorably priced loans over 2024–2027, conditional on meeting reform milestones.
  - As of latest assessment: completed 6 of the 50 steps (12 percent) and received €76 million, including €52.5 million in pre-financing.
  - Progress concentrated in: digital transition legislation; strengthening financial controls; SOE management (requirements for independent board members); labor and market inspections.
  - Outstanding milestones: optimizing para-fiscal charges; establishing a comprehensive SOE register; advancing railways restructuring.
- Implementation monitoring:
  - Figures reflect the December 2024 and June 2025 assessments and prefinancing; the December 2025 assessment is pending.

### Priority reform areas and policy implications
- Highest-return reform clusters (aligned with RGF priorities):
  - Labor market and human capital: raise labor force participation and human capital accumulation.
  - Business environment: reduce trade restrictions, ease product market regulation, deepen financial markets, and raise business R&D.
  - Governance: control of corruption to amplify payoffs and improve implementation.
- Sequencing and complementarities:
  - Governance improvements can boost effectiveness of labor and business reforms.
  - Delivering RGF-linked reforms supports EU accession objectives and unlocks financing that reinforces implementation.

### Labor market: supply-side constraints
- Key facts:
  - Female labor force participation remains approximately 20 percentage points below the EU average.
  - Youth unemployment: about 29 percent for those aged 15–24; persistently elevated NEET rates.
  - Emigration projected to reduce employment by around 0.5 percentage points by 2030.
  - Skills mismatches: low adult participation in learning and training; vocational programs insufficiently aligned with employer needs.
- Recommendations:
  - Expand affordable childcare.
  - Wider use of flexible work arrangements.
  - Strengthen activation and re‑skilling programs (aligns with RGF 2024–27 and Government’s Strategic Priorities for 2026).
  - Increase adult-learning participation; strengthen vocational education and training; enhance recognition of non-formal and informal learning.
  - Gradual increase in the statutory retirement age for women to mitigate workforce losses from emigration and aging.

### Labor market: demand-side constraints and productivity
- Productivity and wages:
  - Labor productivity: cumulative rise of 15 percent since 2019.
  - Post-pandemic annual productivity growth: around 5 percent.
  - Real wage–productivity ratio: up by around 18 percent, eroding external competitiveness.
- Policy levers:
  - Lowering the labor tax wedge to boost participation and reduce barriers to formal employment.
- Structural impediments:
  - High informality, concentration in low‑productivity sectors, limited quality entry-level positions for youth.
- Implication:
  - Closing supply and demand-side gaps could significantly improve labor market outcomes and generate sustained productivity gains.

### Governance, rule of law, and anticorruption reforms
- Governance impacts:
  - Governance weaknesses materially affect macro‑financial stability, investment, human capital accumulation, and TFP.
- Progress since 2000:
  - Over 24 years, North Macedonia has almost halved its WGI‑based governance gaps relative to economies that joined the EU since 2004; progress uneven, especially on rule of law and corruption.
- Priority actions:
  - Strengthen judicial independence and integrity: transparent, merit-based appointments; enhanced accountability; adequate staffing and resources; full operationalization of case management systems; effective implementation of the 2024–2028 Judicial Reform Strategy.
  - Adopt a new Criminal Code aligned with EU and international standards; strengthen financial investigation and confiscation tools to improve high-level corruption case outcomes.
  - Reinforce the State Commission for the Prevention of Corruption: capacity, independence, credibility; improve asset and conflict-of-interest declarations.
  - Accelerate national anti-corruption strategy implementation; prepare a prioritized 2026–2030 strategy with clear responsibilities, sequencing, and resourcing.
  - Strengthen coordination, data exchange and integrity systems across prevention, detection, investigation, and prosecution institutions.
- Rationale:
  - Prioritizing governance reforms amplifies the impact of labor market, business environment, and digital reforms by improving policy credibility and reducing implementation risks.

### Business environment, informality, and investment policy
- Constraints:
  - Transparency and digitalization gaps; regulatory and financial constraints on SMEs; complex licensing and permit procedures; inconsistent fees impede formalization.
  - Prior investment model: generous tax incentives and export‑oriented FDI in a narrow set of industries produced limited domestic spillovers, high export concentration, and sizable fiscal costs.
- Policy priorities:
  - Strengthen transparency and digitalization; ease regulatory and financial constraints on SMEs; simplify licensing and permit procedures; streamline fees.
  - Foster entrepreneurship and innovation; enhance EU internal market integration and alignment with EU legislation; improve connectivity, competition, consumer protection and legal certainty.
  - Shift investment policy toward a competitiveness agenda with performance-based and EU-consistent state aid that strengthens linkages with domestic firms and productivity.
  - Further tariff alignment with the EU and enhance customs efficiency.

### Digitalization: public and private sector
- Public sector digitalization:
  - SIGMA indicators: overall strong performance vs. Western Balkan and EU Enlargement countries, but weaknesses in e-government strategy and coordination, architecture and infrastructure maturity, digital identity, signature and trust services.
  - Priorities: integrated e-government services; interoperability and data sharing; expanded digital tools for efficient and transparent service delivery.
  - Specific tools: E‑PRO and mandatory e‑invoicing (e‑Faktura) to streamline procedures, enhance compliance, and increase revenues.
  - Digitalizing public financial management through IFMIS: enhance transparency, strengthen budget execution and capital projects oversight, improve compliance, lower costs and improve revenue mobilization.
- Private sector digitalization and skills:
  - Connectivity and usage: 91.2 percent of households have internet access and 89.2 percent are daily users.
  - Digital skills gap: 28.5 percent of the population possess basic or average digital skills compared to the EU's 60.4 percent.
  - Priorities: national digital skills framework; targeted reskilling programs; strengthen private sector digital capacities; promote digital adoption for SMEs and startups; improve access to finance; public–private partnerships; coordination of donor support; transparent management of digital transformation funds.
  - AI governance: establish a flexible and robust legal and institutional framework for safe and ethical AI use, supported by long‑term investment in talent attraction, research centers and laboratories.

### Reform sequencing, complementarities, and expected gains
- Complementarities:
  - Reform bundles outperform isolated actions; examples: judicial efficiency improvements boost contract enforcement, reduce corruption, increase returns to human capital investment and improve business environment.
  - Digitalization raises productivity and reduces administrative burden, strengthening business climate and fiscal management.
  - IMF literature: non-linear rising returns when labor, product, and financial market reforms are implemented simultaneously.
- Timing:
  - Reforms implemented in good times generate larger and faster output gains; political mandate and fiscal space improve implementation and compensation options.
- Quantified medium-term impacts:
  - Closing half the distance to the CESEE frontier—particularly in governance, labor and human capital, and the business environment—could raise GDP by up to 14 percent over the medium term.
  - Decisive, integrated implementation aligned with RGF milestones could sustain annual growth up to 2–3 percent higher than current potential.

### Modeling framework (Annex I)
- Two structural models for filtering output:
  - Annual reduced‑form New Keynesian model with unemployment and Okun’s law (based on Alichi et al. (2015)); potential output treated as latent trend and cyclical components; estimation via Kalman filter in a Bayesian framework; includes Phillips Curve and NAIRU dynamics and Okun’s law link.
  - Quarterly reduced‑form New Keynesian model with monetary policy; semi-structural QPM linking aggregate demand, sectoral inflation (core, food, energy), monetary policy under a fixed peg, risk premium dynamics, and consistency identities for projections.
- Purpose: produce coherent medium-term projections and assess policy scenarios, ensuring internal consistency across national accounts, prices, and financial variables.

### Annex I. Figure 1 — data and presentation notes
- Sources: Haver Analytics and IMF staff estimates.
- Units: Mil. Chn. 2005 Denars, percent.
- Quarterly and annual panels show Actual GDP; Potential GDP; Output Gap (RHS, percent).
- Reference/projection marker shown: 2025Q3 (in quarterly models).

### Tax policy and administration — key findings and priorities
- Revenue framework:
  - Headline tax rates:
    - Standard VAT rate: 18
    - Headline PIT rate: 10
    - Headline CIT rate: 10
  - VAT C‑efficiency remains below several regional peers.
  - PIT and CIT productivity indicators modest; PIT and CIT buoyancy estimates above 1.5.
- Informality and tax potential:
  - Informal economy estimate: approximately 33 percent of GDP.
  - World Bank CESEE average (excluding Western Balkans): 26 percent of GDP.
  - Estimated tax gap for North Macedonia: 3½ percent of GDP.
  - Estimated tax potential: 21 percent of GDP.
- VAT recommendations:
  - Rationalize poorly targeted and costly VAT expenditures.
  - Phase out reduced VAT rate of 5 percent for accommodation services and meals provided by hotels, hostels, and motels.
  - Phase out reduced VAT rate of 10 percent for restaurants.
  - Remove VAT exemption for use of toll roads.
  - Review the MY VAT Program; reduce complex schemes incentivizing fiscal receipts.
  - Pursue a broad‑based VAT with limited exemptions and a single rate.
- CIT recommendations:
  - Scale back open‑ended and weakly targeted incentives to broaden the base and contain fiscal costs.
  - Ten‑year profit tax holiday for firms in Technological‑Industrial Development Zones (TIDZs): significant revenue losses of around 20 percent of CIT revenue.
  - Subject incentives not linked to performance to periodic review and sunset provisions.
  - Curtail reinvented profits deduction that disproportionately benefits established profitable firms.
  - Given statutory CIT rate of 10 percent, base broadening should precede any rate increase; over the medium term consider closer alignment with the 15 percent global minimum.
- PIT recommendations:
  - Introduce greater progressivity to support equity and revenue; move toward a more neutral PIT structure to reduce reliance on high social security contributions.
- Excises and environmental/health taxes:
  - Most excise rates (petrol, diesel, LPG, cigarettes) remain below EU minimum thresholds.
  - Absence of an excise on sugar‑sweetened beverages noted.
  - Strengthen environmental and health‑related excises once inflationary pressures subside.
- Property taxation:
  - Recurrent property taxation underutilized; low yields reflect low statutory rates, exemptions, and weak valuation.
  - Recommended municipal property tax statutory rate path: gradual increase toward 0.3–0.6 percent.
  - Current municipal property tax statutory rate: 0.10% – 0.20% (up to 3× for unused agricultural land).
  - Support reforms with market‑value assessments, improved transaction recording, automated mass appraisal techniques, and some centralization of expertise.
- Tax administration and digitalization:
  - PRO needs strengthened staffing, analytical, and technical capacity.
  - IT infrastructure outdated; adopt a COTS solution to avoid bottlenecks when deploying e‑invoicing.
  - IMF capacity building priorities for PRO:
    - (i) Improving Compliance Risk Management;
    - (ii) Strengthening audit and verification approaches and methods;
    - (iii) Modernizing organizational structure and improving collection and debt management functions;
    - (iv) Accelerating digitalization and business process reengineering.
  - E‑invoicing evidence:
    - Peru: e‑invoice adoption increased reported sales, purchases, and value‑added by over 5 percent in the first year.
    - Cross‑country evidence: e‑invoicing and electronic fiscal devices can improve revenue mobilization by 0.7 percent and 0.5 percent of GDP, respectively.
    - Effectiveness depends on tax type, complementary resources, analytical tools, digital connectivity, and adequate staffing.
- Selected quantitative points:
  - Informal economy: approximately 33 percent of GDP.
  - CESEE average (excl. Western Balkans) informal economy: 26 percent of GDP.
  - Estimated tax gap (2023): 3½ percent of GDP.
  - Estimated tax potential: 21 percent of GDP.
  - TIDZ profit tax holiday revenue loss: around 20 percent of CIT revenue.
  - Recommended municipal property tax statutory rate range: 0.3–0.6 percent.
  - Current municipal property tax statutory rate: 0.10% – 0.20%.
  - Cross‑country revenue gains from digital tools: e‑invoicing +0.7 percent of GDP; electronic fiscal devices +0.5 percent of GDP.
  - Peru case: over 5 percent increase in reported sales, purchases, and value‑added in first year after e‑invoice adoption.

*Source: IMF staff background paper, “Unleashing Potential: Structural Reforms for Boosting Long-Term Growth,” Republic of North Macedonia, May 12, 2026.*

### 1. The EU Growth Plan: A Catalyst for Structural Reform ________________________________ 9

### 1. The EU Growth Plan: A Catalyst for Structural Reform

### Growth drivers and performance
- Average real GDP growth in North Macedonia:
  - about 2.6 percent annually since 2001.
  - other Western Balkan countries: 3.5 percent.
- Historical growth patterns:
  - Pre-Global Financial Crisis (GFC): growth exceeded 5 percent in several years.
  - 2009–2019: growth moderated to about 2.4 percent.
  - 2021–25: growth averaged about 3 percent.
- Demand-side contributions:
  - Private consumption contributed between 3.0 and 3.4 percentage points to GDP growth across periods.
  - Private investment contributed 1.4–1.7 percentage points.
  - Public consumption made only a modest contribution.
  - External sector contribution has been mostly negative.
- Production-side dynamics:
  - 2001–2008: balanced gains from labor, capital, and TFP.
  - 2009–2019: TFP contribution turned negative; capital accumulation became more prominent.
  - 2021–2025: productivity accounted for the majority of output gains; labor contribution weakened and turned negative.
- Convergence and labor supply pressures:
  - GDP per capita (PPP) in 2024 stood at 43 percent of the EU average.
  - Output per capita growth ~3.0 percent per year versus 3.7 percent for other Western Balkan countries.
  - “Half-life” of the income gap at current rates is almost 20 years.
  - UN projections: continued emigration will shrink the working-age population, leading to a 0.5 percentage point decline in employment by 2030.

### Potential output estimates
- Methods used:
  - Univariate filters (dual Hodrick–Prescott on annual and quarterly GDP from 2001).
  - Two semi-structural multivariate models estimated with a Kalman filter (annual model with Okun’s law; quarterly QPM-like model).
- Key estimates:
  - Potential output growth averaged around 2.6–2.8 percent over 2001–2025 using HP and multivariate filters.
  - Potential growth slowed from 3.4–4.0 percent before the GFC to 2.3–2.4 percent post-GFC (excluding 2020).
  - Both annual and quarterly models indicate a pickup in potential growth in 2025 to about 2.6–2.7 percent.
  - Estimated positive output gap in the range of 0.7–1.0 percent (2025, HP-based).
  - Multivariate models and HP filter together suggest potential output growth in 2025 of about 2.9 percent.

### Medium-term GDP impact of structural reforms (methodology and magnitudes)
- Benchmark and methodology:
  - Structural policy indicators grouped into six areas: governance; labor and human capital; business regulation; R&D and digitalization; credit and capital markets; external sector.
  - Frontier defined as average of two best-performing European economies and the United States, normalized to 100.
  - Assumed scenario: North Macedonia closes 50 percent of its gap relative to the CESEE frontier.
  - Output Gains = Closed Policy Gaps * Output Elasticities (elasticities drawn from IMF and OECD studies; impacts measured over a five-year horizon).
- Country positioning:
  - North Macedonia ranks below the 25th percentile of the cross-country distribution and below the CESEE average in most areas except business regulation.
- Reform-specific estimated medium-term GDP gains (closing 50% of gap):
  - Labor market and human capital: 6.6 percent total gain.
    - Closing gaps in labor force participation: 5.5 percent.
    - Closing gaps in UN Human Capital Index: 1.1 percent.
  - Business environment (combined category): 4.6 percent total gain.
    - Lower external trade restrictions (MATR): 2.5 percent.
    - Improvements in product market regulations (PMR): 1.0 percent.
    - Deeper financial markets: 0.6 percent.
    - Higher business R&D spending: 0.5 percent.
  - Governance (control of corruption proxy): 2.7 percent.
- Combined impact:
  - Cumulative medium-term output gains from the combined reforms: about 14 percent (roughly 2–3 percent additional annual growth, nearly doubling current potential growth estimates).
  - Caveats: aggregation assumes additivity and abstracts from interactions and general equilibrium effects; estimates could both over- and under-state true gains depending on complementarities and overlaps.

### The EU Reform and Growth Facility (RGF) as a catalyst
- RGF potential and targets:
  - World Bank estimates: full implementation of RGF reforms (closing 70 percent of critical gaps with the EU in five key areas over 20 years) could boost baseline annual GDP per capita growth in the Western Balkan countries by up to 3 percentage points.
  - Five priority areas under RGF: (i) digital infrastructure; (ii) regulatory quality; (iii) government effectiveness; (iv) financial development; (v) female labor force participation.
  - Largest projected growth dividends per World Bank: regulatory quality (1.13 pp), government effectiveness (0.95 pp), digitalization (0.63 pp); female LFP (0.35 pp); financial sector development (0.03 pp).
- Financing and conditionality for North Macedonia:
  - Under RGF, North Macedonia is eligible for up to €750 million in grants and favorably priced loans over 2024–2027, conditional on meeting reform milestones.
  - As of the latest assessment, North Macedonia has completed 6 of the 50 steps (12 percent) and received €76 million, including €52.5 million in pre-financing.
  - Progress concentrated in: digital transition legislation; strengthening financial controls; SOE management (requirements for independent board members); labor and market inspections.
  - Important milestones not yet met include optimizing para-fiscal charges, establishing a comprehensive SOE register, and advancing railways restructuring.
- Implementation monitoring:
  - Figures referenced reflect the December 2024 and June 2025 assessments and prefinancing; the December 2025 assessment is pending.

### Priority reform areas and policy implications
- Highest-return reform clusters identified for North Macedonia (aligned with RGF priorities):
  - Labor market and human capital reforms to raise labor force participation and human capital accumulation.
  - Business environment reforms to reduce trade restrictions, ease product market regulation, deepen financial markets, and raise business R&D.
  - Governance reforms, particularly control of corruption, to amplify payoffs from other reforms and improve reform implementation.
- Sequencing and complementarities:
  - Reform packages and sequencing are important; governance improvements can boost the effectiveness of labor and business reforms.
  - Delivering RGF-linked reforms would support EU accession objectives and unlock financing that reinforces implementation.

*Source: IMF staff background paper, “Unleashing Potential: Structural Reforms for Boosting Long-Term Growth,” Republic of North Macedonia, May 12, 2026.*

### 13.  Labor market inefficiencies represent significant structural bottleneck to growth. On

### 13.  Labor market inefficiencies represent significant structural bottleneck to growth. On

### Labor market: supply-side constraints
- Female labor force participation remains approximately 20 percentage points below the EU average.
- Youth unemployment is about 29 percent for those aged 15–24, with persistently elevated NEET rates.
- Ongoing emigration is projected (Ayerst and Kovachevska Stefanova, 2025) to reduce employment by around 0.5 percentage points by 2030, eroding labor supply and growth potential.
- Skills mismatches constrain supply: despite improvements in educational attainment, the share of adults participating in learning and training remains low, and vocational programs are insufficiently aligned with employer needs.
- Recommendation highlights:
  - Expand affordable childcare.
  - Wider use of flexible work arrangements.
  - Strengthen activation and re‑skilling programs to facilitate participation and re-entry (aligns with RGF 2024–27 and Government’s Strategic Priorities for 2026).
  - Increase adult-learning participation, strengthen vocational education and training, and enhance recognition of non-formal and informal learning.
  - Gradual increase in the statutory retirement age for women to mitigate workforce losses from emigration and aging (Ayerst & Kovachevska Stefanova, 2025; IMF Article IV, 2025).

### Labor market: demand-side constraints and productivity
- Productivity performance:
  - Labor productivity has risen by a cumulative 15 percent since 2019.
  - Post-pandemic annual productivity growth accelerated to around 5 percent but remains insufficient to close gaps with regional peers or the EU.
- Real wages and competitiveness:
  - Real wages have outpaced productivity, pushing the real wage–productivity ratio up by around 18 percent and eroding external competitiveness.
  - Collective wage-setting mechanisms (prevalent in the public sector) are weakly linked to productivity.
- Labor code alignment and policy levers:
  - The labor code is broadly aligned with EU benchmarks (Annex II).
  - Lowering the labor tax wedge would boost participation by strengthening work incentives and reducing structural barriers to formal employment (IMF, European Department, 2024).
- Structural impediments:
  - High informality, concentration of employment in low‑productivity sectors, and limited availability of quality entry-level positions for young people reduce incentives and dampen wage growth potential.
- Policy implication:
  - Closing supply and demand-side gaps could significantly improve labor market outcomes and generate sustained productivity gains.

### Governance, rule of law, and anticorruption reforms
- Governance weaknesses, including corruption, materially affect macro‑financial stability, investment, human capital accumulation, and total factor productivity (IMF, 2016).
- Progress since 2000:
  - Over the past 24 years, North Macedonia has almost halved its WGI‑based governance gaps relative to economies that joined the EU since 2004, but progress is uneven, especially on rule of law and corruption.
- Priority governance reforms:
  - Strengthen judicial independence and integrity through transparent, merit-based appointments; enhanced accountability; adequate staffing and resources; full operationalization of case management systems; and effective implementation of the 2024–2028 Judicial Reform Strategy.
  - Adopt a new Criminal Code aligned with EU and international standards and improve the track record in high-level corruption cases via stronger financial investigation and confiscation tools.
  - Reinforce capacity, independence and credibility of the State Commission for the Prevention of Corruption and improve effectiveness of asset and conflict-of-interest declarations.
  - Accelerate implementation of the national anti-corruption strategy; prepare a credible, well-prioritized updated 2026–2030 strategy with clear institutional responsibilities, sequencing, and adequate resourcing.
  - Strengthen coordination, data exchange and integrity systems across institutions responsible for prevention, detection, investigation, and prosecution of corruption.
- Rationale: Prioritizing governance reforms amplifies the impact of labor market, business environment, and digital reforms by improving policy credibility and reducing implementation risks.

### Business environment, informality, and investment policy
- Key constraints:
  - Transparency and digitalization gaps, regulatory and financial constraints on SMEs, complex licensing and permit procedures, and inconsistent fees impede business activity and formalization.
  - The prior investment model centered on generous tax incentives and export‑oriented FDI concentrated in a narrow set of industries produced limited domestic spillovers, high export concentration, and sizable fiscal costs (World Bank, 2022).
- Policy priorities:
  - Strengthen transparency and digitalization; ease regulatory and financial constraints on SMEs; simplify licensing and permit procedures; streamline administrative, licensing, and registration fees.
  - Foster entrepreneurship and innovation; enhance integration in the EU internal market and alignment with EU legislation; improve connectivity, competition, consumer protection and legal certainty.
  - Shift investment policy toward a broader competitiveness agenda with performance-based and EU-consistent state aid schemes that strengthen linkages with domestic firms, support productivity gains, and facilitate deeper integration into EU and regional value chains.
  - Further tariff alignment with the EU and continued progress in enhancing efficiency of customs procedures.

### Digitalization: public and private sector
- Public sector digitalization:
  - SIGMA indicators show North Macedonia performs overall well compared with Western Balkan and EU Enlargement countries, but weaknesses remain in e-government strategy and coordination, architecture and infrastructure maturity, digital identity, signature and trust services.
  - Priorities: strengthen integrated e-government services and platforms; improve interoperability and data sharing across institutions; expand use of digital tools for efficient and transparent service delivery.
  - Specific digital tools mentioned: E‑PRO and mandatory e‑invoicing (e‑Faktura) can streamline procedures, enhance compliance, and increase revenues (Fan and others (2020), Bellon and others (2022)).
  - Digitalizing public financial management through IFMIS can enhance transparency, strengthen budget execution and capital projects oversight, improve compliance, lower costs and improve revenue mobilization.
- Private sector digitalization and skills:
  - Connectivity and usage: 91.2 percent of households have internet access and 89.2 percent are daily users.
  - Digital skills gap: only 28.5 percent of the population possess basic or average digital skills compared to the EU's 60.4 percent (Eurostat, 2026).
  - Priorities: national digital skills framework; targeted reskilling programs; strengthen digital capacities in the private sector; promote adoption of digital solutions and innovation for SMEs and startups; improve access to finance; public–private partnerships; coordination of donor support; transparent management of digital transformation funds.
  - AI governance: establish a flexible and robust legal and institutional framework for the safe and ethical use of AI, supported by long‑term investment in talent attraction, research centers and laboratories.

### Reform sequencing, complementarities, and expected gains
- Reform complementarities:
  - Reform bundles outperform isolated actions; examples include judicial efficiency improvements boosting contract enforcement, reducing corruption, increasing returns to human capital investment and improving the business environment.
  - Digitalization raises productivity and reduces administrative burden, strengthening the business climate and fiscal management.
  - IMF structural reform literature finds non-linear rising returns when labor, product, and financial market reforms are implemented simultaneously (IMF, 2019; Budina et al., 2023).
- Timing:
  - Reforms implemented in good times tend to generate larger and faster output gains; political mandate and fiscal space improve implementation and compensation options (IMF, 2019).
- Quantified medium-term impacts:
  - Closing half of the distance to the CESEE frontier—particularly in governance, labor and human capital, and the business environment—could raise GDP by up to 14 percent over the medium term.
  - With decisive, integrated implementation aligned with RGF milestones, the integrated approach would help sustain annual growth up to 2–3 percent higher than current potential, more rapidly narrowing the income gap with the EU.

### Modeling framework (Annex I): multivariate filter models for potential output
- Two structural models used for filtering output:
  - Annual reduced‑form New Keynesian model with unemployment and Okun’s law (based on Alichi et al. (2015)); treats potential output as latent, decomposed into trend and cyclical components; estimation via Kalman filter in a Bayesian framework; includes Phillips Curve and NAIRU dynamics and Okun’s law link.
  - Quarterly reduced‑form New Keynesian model with monetary policy; semi-structural QPM linking aggregate demand, sectoral inflation (core, food, energy), monetary policy under a fixed peg (exchange rate as nominal anchor), risk premium dynamics, and consistency identities for projections.
- Purpose: produce coherent medium-term projections and assess policy scenarios, with mechanisms to ensure internal consistency across national accounts, prices, and financial variables.

*Source: INTERNATIONAL MONETARY FUND — Republic of North Macedonia (Content unit 13).*

### Annex I. Figure 1. North Macedonia: Output, Potential Growth and Output Gap

### Annex I. Figure 1. North Macedonia: Output, Potential Growth and Output Gap

### Data and Sources
- Sources: Haver Analytics and IMF staff estimates.
- Note: 100 time natural log of real GDP in Mil. Chn. 2005 Denars, seasonally adjusted.

### Panels and Models Presented
- HP Filter - Quarterly Model
  - Series shown: Output Gap (RHS, percent); Actual GDP; Potential GDP.
  - Time axis ticks: 2002Q1, 2005Q3, 2009Q1, 2012Q3, 2016Q1, 2019Q3, 2023Q1.
  - Vertical level markers for GDP series: 1,040; 1,060; 1,080; 1,100; 1,120; 1,140; 1,160; 1,180; 1,200.
  - Output gap axis tick labels: -14, -12, -10, -8, -6, -4, -2, 0, 2, 4, 6, 8.
  - Projection/reference point shown: 2025Q3.

- Multivariate Filter - Quarterly Model
  - Series shown: Output gap (RHS, percent); Actual GDP; Potential GDP.
  - Time axis ticks: 2002Q1, 2005Q3, 2009Q1, 2012Q3, 2016Q1, 2019Q3, 2023Q1.
  - Vertical level markers for GDP series: 1,040; 1,060; 1,080; 1,100; 1,120; 1,140; 1,160; 1,180; 1,200.
  - Output gap axis tick labels: -14, -12, -10, -8, -6, -4, -2, 0, 2, 4, 6, 8.
  - Projection/reference point shown: 2025Q3.

- HP Filter - Annual Model
  - Series shown: Output gap (RHS, percent); Actual GDP; Potential GDP.
  - Time axis ticks: 2001, 2004, 2007, 2010, 2013, 2016, 2019, 2022, 2025.
  - Vertical level markers for GDP series: 1,200; 1,220; 1,240; 1,260; 1,280; 1,300; 1,320; 1,340.
  - Output gap axis tick labels: -4, -3, -2, -1, 0, 1, 2, 3, 4, 5, 6.

- Multivariate Filter - Annual Model
  - Series shown: Output gap (RHS, percent); Actual GDP; Potential GDP.
  - Time axis ticks: 2001, 2004, 2007, 2010, 2013, 2016, 2019, 2022, 2025.
  - Vertical level markers for GDP series: 1,200; 1,220; 1,240; 1,260; 1,280; 1,300; 1,320; 1,340.
  - Output gap axis tick labels: -4, -2, 0, 2, 4, 6.

### Figure Elements and Labels (as presented)
- Units: Mil. Chn. 2005 Denars, percent.
- Right-hand-side (RHS) axes label: Output Gap (RHS, percent) or Output gap (RHS, percent) depending on panel.
- Series labels used consistently: Actual GDP; Potential GDP; Output Gap/Output gap.
- Reference year/quarter marker shown: 2025Q3 (in quarterly models).

*Source: Haver Analytics and IMF staff estimates.*

### 2.1 percent of GDP) are modest. Overall, the revenue structure highlights persistent gaps relative to

### Tax Policy and Administration in North Macedonia (excerpt)

### Revenue Structure and Efficiency
- Revenue structure highlights persistent gaps relative to peers and underscores the need to enhance compliance, reduce tax expenditures, and pursue further tax policy reforms.
- Headline tax rates for North Macedonia:
  - Standard VAT rate: 18
  - Headline PIT rate: 10
  - Headline CIT rate: 10
- VAT C‑efficiency remains below several regional peers, pointing to losses from base erosion.
- Productivity indicators for PIT and CIT are modest, reflecting low statutory rates, limited progressivity, extensive reliefs, and informality.
- Tax buoyancy indicators show a weaker long-run response of overall tax revenue to economic growth than in peer countries, particularly for VAT and excises.
- PIT and CIT exhibit buoyancy estimates above 1.5, implying a relatively strong revenue response to growth and suggesting that mobilization should focus on greater PIT progressivity and narrowing the CIT base.

### Informality, Compliance, and Government Commitments
- The informal economy in North Macedonia is estimated at approximately 33 percent of GDP.
- World Bank CESEE average (excluding Western Balkans) for the informal economy: 26 percent of GDP.
- The Government Program for 2024–28: maintain low tax rates while prioritizing enhanced domestic revenue mobilization, primarily through digitalization.
- PRO Strategic Plan for 2025–27 planned actions include:
  - improving early detection of incorrectly reported taxes;
  - conducting advanced risk analyses;
  - implementing targeted audits prioritizing informality‑prone sectors;
  - strengthening the tax audit program;
  - enhancing enforcement and sanctions;
  - upgrading PRO’s electronic tax system (E-PRO) and analytical capacity; and
  - reinforcing IT reliability, security, and sustainability.
- PRO progress: testing phase of the e‑invoicing project launched as of January 1, 2026.
- Ministry of Finance plans to review VAT, PIT, and CIT laws to streamline regulations and improve compliance.

### Tax Potential and Tax Gap (Econometric Estimates)
- Methodology: stochastic frontier (True Random Effects, half‑normal) on panel data to separate inefficiency (u_it) from noise (v_it); tax effort = exp(−u_i).
- Panel of 154 countries results:
  - Estimated tax gap for North Macedonia: 3½ percent of GDP.
  - Estimated tax potential: 21 percent of GDP.
  - The estimated tax gap size is comparable to the Western Balkan region and the EU median.
- The tax gap has been persistent over time, indicating limited systematic measures to narrow it.

### Policy Recommendations — Tax Policy Priorities
- VAT:
  - Rationalize poorly targeted and costly VAT expenditures.
  - Phase out the reduced VAT rate of 5 percent for accommodation services and meals provided by hotels, hostels, and motels.
  - Phase out the reduced VAT rate of 10 percent for restaurants.
  - Remove the VAT exemption for use of toll roads as it undermines the user‑pays principle.
  - Review the MY VAT Program; schemes incentivizing fiscal receipts tend to be administratively complex and prone to leakage.
  - Pursue a broad‑based VAT with limited exemptions and a single rate as a reliable instrument for domestic revenue mobilization.
- CIT:
  - Scale back open‑ended and weakly targeted incentives to broaden the base and contain fiscal costs.
  - Ten‑year profit tax holiday for firms in Technological‑Industrial Development Zones (TIDZs) entails significant revenue losses of around 20 percent of CIT revenue and unclear benefits.
  - Subject incentives not linked to performance criteria to periodic review and sunset provisions.
  - Reinvented profits deduction: consider curtailing as it disproportionately benefits established profitable firms.
  - Given the statutory CIT rate is already low at 10 percent, base broadening should precede any rate increase; over the medium term, aligning more closely with the 15 percent global minimum could simplify the system.
- PIT:
  - Introduce greater progressivity to support equity and revenue objectives.
  - Current PIT largely flat with large differences in effective taxation across labor income, service contracts, and capital income.
  - Move toward a more neutral PIT structure to reduce reliance on high social security contributions.
- Excises and health/environmental taxes:
  - Most excise rates (petrol, diesel, LPG, cigarettes) remain below the minimum thresholds in the Energy Taxation and Tobacco Excise Directives.
  - Absence of an excise on sugar‑sweetened beverages is a missed opportunity to address diet‑related health risks.
  - Strengthen environmental and health‑related excises once inflationary pressures subside.
  - EU minimum rates should be viewed as a floor rather than a policy target.
- Property taxation:
  - Recurrent property taxation underutilized; low yields reflect low statutory rates, exemptions (notably owner‑occupied housing), and weak valuation practices.
  - Gradual reforms could support municipal finances and fiscal decentralization.
  - Recommended statutory rate path: gradual increase toward 0.3–0.6 percent.
  - Current North Macedonia municipal property tax statutory rate: 0.10% – 0.20% (up to 3× for unused agricultural land).
  - Support reforms with modernized valuation: market‑value assessments, improved transaction recording, automated mass appraisal techniques, and some centralization of expertise.

### Tax Administration Priorities and Digitalization
- PRO human resources: urgent need to strengthen staffing, analytical, and technical capacity.
- IT infrastructure for tax payments is outdated; adopting a COTS solution recommended to avoid bottlenecks when deploying digitalization (e.g., e‑invoicing).
- IMF capacity building priorities for PRO:
  - (i) Improving Compliance Risk Management;
  - (ii) Strengthening audit and verification approaches and methods;
  - (iii) Modernizing organizational structure and improving collection and debt management functions;
  - (iv) Accelerating digitalization and business process reengineering.
- E‑invoicing:
  - Peru evidence: e‑invoice adoption increased reported sales, purchases, and value‑added by over 5 percent in the first year.
  - Cross‑country evidence: adoption of e‑invoicing and electronic fiscal devices can improve revenue mobilization by 0.7 percent and 0.5 percent of GDP, respectively.
  - Effectiveness depends on tax type (more effective for VAT and corporate income tax), availability of complementary human and physical resources, analytical tools and skills for mass data, digital connectivity, and sufficient staffing.

### Selected Quantitative Points and Model Output
- Informal economy estimate for North Macedonia: approximately 33 percent of GDP.
- CESEE average (excl. Western Balkans) informal economy: 26 percent of GDP.
- Estimated tax gap (2023): 3½ percent of GDP.
- Estimated tax potential: 21 percent of GDP.
- TIDZ profit tax holiday revenue loss: around 20 percent of CIT revenue.
- Recommended municipal property tax statutory rate range (target): 0.3–0.6 percent.
- North Macedonia current municipal property tax statutory rate: 0.10% – 0.20%.
- Cross‑country revenue gains from digital tools: e‑invoicing +0.7 percent of GDP; electronic fiscal devices +0.5 percent of GDP.
- Peru case: over 5 percent increase in reported sales, purchases, and value‑added in first year after e‑invoice adoption.

*Source: International Monetary Fund — Republic of North Macedonia (selected chapter content).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2026/english/1mkdea2026002.pdf_