## _cr15299

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---

### General recommendations on revenue mobilization — overview and objectives
- Revenue mobilization should be guided by three principles: efficiency, fairness, and transparency.
- Objectives:
  - Mobilize revenue in a growth-friendly way to provide space for social assistance and infrastructure improvement.
  - Use simple and broad-based taxes and strengthen tax compliance in a globalized economy.
- Box — General recommended measures (as presented):
  - Building administrations that limit incentives and opportunities for rent seeking and are capable of implementing the voluntary compliance needed to extend the tax base;
  - Adopting and making readily available clear laws and regulations embodying strong taxpayer protection;
  - Eliminating exemptions that forgo revenue to little useful end;
  - Implementing a broad-based VAT with a fairly high threshold;
  - Establishing a broad-based corporate income tax, at rates competitive by international standards;
  - Extending the PIT base, and ensuring a coherent treatment of alternative forms of capital income;
  - Levying excises on a few key items that address revenue needs and wider social concerns;
  - Implementing simple but coherent regimes for taxing smaller businesses;
  - Strengthening real estate taxes; and
  - Developing capacity for tax expenditure and wider policy analysis.

### Level of government spending and fiscal context
- Fiscal consolidation after the global financial crisis narrowed the overall budget deficit from a peak deficit of around 6 percent of GDP in 2009 to 2 percent of GDP in 2013.
- A major natural disaster caused an increase in the deficit to 3 percent of GDP in 2014.
- Central governments achieved budget surpluses in recent years, but lower levels of government and social funds, and foreign-financed investment projects, generated persistent deficits and contributed to increasing public debt levels.
- General government current expenditures:
  - Rose from an average of around 38.5 percent of GDP over 2000–05 to around 41.5 percent thereafter.
  - Public current expenditures increased mainly through higher public sector wages; increased, and poorly targeted, social benefits; and higher spending on goods and services.
- Public sector size:
  - At over 41 percent of GDP, BiH’s public sector size ranks second in the region (behind Croatia) and is substantially larger than that of more advanced Emerging Europe economies.
- Public capital spending:
  - Average capital expenditures were 8.0 percent of GDP for 2003–2008 and 6.8 percent of GDP for 2009–2014.
  - Financing shifted from own resources to debt-generating foreign financing.
- Policy implication:
  - BiH needs more investment in human and physical capital to accelerate real GDP growth; higher capital investment requires reducing current spending given limited fiscal space.

### Structure and efficiency of government spending — key findings
- Composition of general government current expenditures (2013):
  - Compensation: 31%
  - Use of goods and services: 26%
  - Interest: 2%
  - Subsidies: 4%
  - Social benefits: 37%
- Western Balkans ex BiH (2013) current expenditure composition:
  - Compensation: 25%
  - Use of goods and services: 13%
  - Interest: 7%
  - Subsidies: 7%
  - Social benefits: 48%
- Public sector wages and employment:
  - BiH spends over 12 percent of GDP on public sector wages in 2013.
  - Two factors driving high wage spending: continued increases in public sector payrolls; public sector wages—particularly in public administration—are very high compared to average pay levels in the economy.
  - Number of public administration and defense jobs increased by nearly 13 percent over the past decade; employment in education and health increased by over 22 percent over the past decade.
- Health sector:
  - Public health spending is over 7 percent of GDP, the highest in the region.
  - The health system is highly fragmented: 13 ministries of health and 13 health insurance funds operate independently across entities and cantons.
  - Health financing is mostly from social security contributions; contribution rates in both entities are the highest in the region.
  - Health outcomes and capacity indicators show inefficiency despite high spending: hospital beds (per 1,000 people), life expectancy at birth, infant mortality, and physicians (per 1,000 people) indicate BiH lags behind regional peers and Emerging Europe; number of non-medical staff in health care facilities is on the high end relative to peers.
- Education:
  - Education spending is about 5 percent of GDP.
  - Governance is fragmented with 14 ministries of education (11 in the FBiH, 1 at state level, 1 in RS, 1 in Brcko District).
  - Around 80 percent of the education budget is spent on wages rather than system development or material resources.
  - Enrollment: relatively high for primary and lower secondary, substantially below regional averages at upper secondary and tertiary levels; vocational and technical training are declining.
- Social assistance:
  - Spending on non-contributory social assistance is close to 4 percent of GDP (largest in the region and in Emerging Europe); World Bank analysis suggests this amount could be as high as 7 percent of GDP if canton and municipal programs are included.
  - The bulk of social assistance transfers are for war veterans and disability benefits; civilian programs are small and underfunded.
  - Targeting of social assistance is poor:
    - The poorest 20 percent receive only 36.8 percent of total social assistance budget.
    - Regional peers (Albania, Kosovo, Montenegro) show much better targeting, with the poorest quintile receiving over 60 percent of social assistance in some cases.
    - The richest quintile in BiH receives a disproportionately high share of social assistance benefits.
  - Aging veteran liabilities pose significant fiscal risk.

### Expenditure and structural policy recommendations
- Rationalize the institutional setting to reverse excessive growth of the public sector caused by high fiscal decentralization and proliferation of institutions at entity, canton, and municipal levels; aim to reduce current spending and increase efficiency.
- Implement expenditure consolidation measures together with structural reforms in the pension and health sectors to create fiscal space for reducing social security contributions while improving targeting to support the most vulnerable.
- Streamline education spending and reallocate greater resources to active labor market programs to reduce skills mismatches and contribute to lowering unemployment.
- Reduce high and poorly targeted non-contributory social assistance spending through additional reductions in veterans’ benefits; improvements in the audit process; measures to remove labor market disincentives and bring social assistance spending to sustainable levels.
- Shift public expenditures away from the present high share of non-productive current spending toward more productive capital expenditures to enhance economic growth.

### Toward a more balanced tax system — key findings and challenges
- Key macro challenges: high unemployment and a large informal sector.
- Total tax and social security contribution (SSC) revenues in BiH are 38 percent of GDP, one of the highest in the region and slightly above the average of EU member countries.
- The share of total taxes to GDP has been increasing; other revenues (e.g., dividends from state-owned enterprises) have been declining.
- Revenue composition shifts:
  - Share of SSC within total tax and SSC revenues in BiH: over 40 percent.
  - Regional average share of SSC: 31 percent.
  - EU average share of SSC: 30.5 percent.
  - Direct taxes in BiH provide 8 percent of revenues (out of which the PIT brings in about two-thirds).
  - Regional average of direct taxes: 17.5 percent of revenues, with PIT at 11 percent.
  - Indirect taxes provide about half of tax and SSC revenues both in BiH and in the region (EU average of indirect taxes: 38 percent).
  - Revenues from property taxes in BiH: 1 percent of total tax revenues.
- Policy implication:
  - Given limited fiscal space to reduce overall revenues, consider shifting the tax mix away from labor (high SSC) toward less distortionary bases; lowering SSC rates would need offsetting revenue measures and spending cuts—including better targeting of social assistance.

### Tax rate structure and VAT regime
- Standard statutory rates:
  - PIT rate: 10 percent in both the FBiH and the RS.
  - CIT rate: 10 percent in both entities.
- VAT:
  - Single standard rate with no reduced rates (no reduced rates enhances VAT efficiency).
  - VAT threshold is one of the lowest in the region, placing a larger burden on tax administration by keeping many small and medium-sized taxpayers in the VAT net.
- SSC rates are high compared to neighboring countries, especially in the FBiH.
- SSC structure differs by entity: the RS collects all contributions from employees, while the FBiH collects some contributions from employers as well.

### Tax efficiency, policy gap, and compliance gap
- VAT efficiency in BiH is very high due to a low policy gap: few exemptions, no reduced rate, and a narrowly used zero rate (exports and diplomats).
- CIT efficiency in BiH is around the regional average.
- Two components for improving tax efficiency:
  - Policy gap: difference between collections under current law and those under best-practice law — can be reduced by broadening tax bases and eliminating exemptions.
  - Compliance gap: difference between current collections and those if existing law were perfectly enforced — can be reduced by revenue administration reforms.
- Recommendations:
  - Review and consider eliminating tax incentives and exemptions that forgo revenue to little useful end.
  - Pursue tax administration reforms to improve compliance, recognizing administration measures usually take time to show significant results.
  - Strengthen property taxation (recurrent property taxes, cadastral systems) to increase local revenue take.

### Total tax wedge and labor-tax burden — detailed figures and implications
- Tax wedge (PIT plus SSC) differs between entities due to decentralization.
- For a single average wage earner:
  - Tax wedge in the Federation of BiH (FBiH): 42 percent of the gross wage.
  - Tax wedge in the Republika Srpska (RS): slightly over 39 percent of the gross wage.
  - Most of the burden arises from SSC.
- Selected detailed figures (Labor Income Taxation, percent of November 2014 gross wage):
  - Gross wage (A): 100.0 (FBiH), 100.0 (RS)
  - Income tax (B): 4.5 (FBiH), 5.2 (RS)
  - Contributions (C): 41.5 (FBiH), 33.9 (RS)
    - Pension: 23.0 (FBiH), 18.0 (RS)
      - Employee pension: 17.0 (FBiH), 18.0 (RS)
      - Employer pension: 6.0 (FBiH), ...
    - Health: 16.5 (FBiH), 12.5 (RS)
      - Employee health: 12.5 (FBiH), 12.5 (RS)
      - Employer health: 4.0 (FBiH), ...
    - Unemployment: 2.0 (FBiH), 1.0 (RS)
      - Employee unemployment: 1.5 (FBiH), 1.0 (RS)
      - Employer unemployment: 0.5 (FBiH), ...
    - Child protection: ... (FBiH), 1.5 (RS)
      - Employee child protection: ... (FBiH), 1.5 (RS)
    - Floods (temporary in RS): ... (FBiH), 0.9 (RS)
  - Net wage (J = A – B – D – E – F – G – H): 64.5 (FBiH), 60.9 (RS)
  - Labor cost to employer (K = J + B + C + I): 111.1 (FBiH), 100.0 (RS)
  - Tax wedge (percent of labor cost) (L = (1 - J / K) * 100): 41.9 (FBiH), 39.1 (RS)
- Policy implications:
  - Consider shifting tax mix away from labor toward less distortionary bases.
  - Broaden tax bases (reduce exemptions and reduced rates) to close policy gaps.
  - Consider raising VAT threshold prudently or simplifying VAT registration rules to reduce administrative burden from many small taxpayers.

### Tax treatment of allowances and harmonization issues
- Allowances:
  - Employees often receive meal, holiday, and transportation allowances.
  - In the RS, these allowances are treated as part of overall compensation and subject to taxation.
  - In the FBiH, these allowances are tax-free.
- Consequences:
  - The effective labor tax wedge in the FBiH is lower if these allowances are included in calculations.
  - Tax-free allowances act as an increase in tax deduction for PIT purposes.
  - Lack of harmonization creates distortions and adds administrative burden for businesses operating in both entities.
- Recommendation:
  - Capture tax-free allowances in efforts to broaden tax bases; harmonize treatment across entities.

### Labor market context, diagnostics, and structural impediments
- Labor market outcomes are among the worst in emerging Europe, driven predominantly by structural reasons.
- Unemployment and employment statistics:
  - 2013 unemployment rate in BiH: 27½ percent.
  - Western Balkan average: 23 percent.
  - Central European average: about 11 percent.
  - CIS average: about 5 percent.
- Youth and long-term unemployment:
  - Youth (aged 15–24 years) unemployment rate exceeded 59 percent in 2013.
  - Unemployment rate for ages 24–34 years: over 34 percent.
  - Over 80 percent of unemployed have not been able to find a job for more than 12 months.
- Public sector and wages:
  - Public sector jobs enjoy high wage premium relative to private sector; BiH spends a greater share of GDP on compensation of public sector employees than peers.
  - Average gross wages are somewhat higher than labor productivity; labor productivity amounts to just over 25 percent of average productivity in EU countries.
  - Minimum wages are significantly higher in BiH than elsewhere in the region.
- Informal employment:
  - Nearly 15 percent of the country’s employment (or about 10 percent of the labor force) in 2014 is estimated to be engaged in activities in the informal economy.
  - Informal employment implies tax evasion, unpaid social contributions, and lack of employment protection for affected workers.
- Institutional and regulatory rigidity:
  - Up to 40 percent of younger/newer firms considered existing labor market regulations a major or very severe impediment (business surveys).
  - More than ¾ of companies (per FBIH employers association, 2015) are dissatisfied with current labor legislation.
  - About ⅓ of companies are unable to comply with provisions from the general collective agreements.
  - In 2013, and only in FBIH, the total value of all lodged legal challenges was over KM 500 million (about 2 percent of GDP).

### Decentralization, legal fragmentation, and labor-law reform priorities
- Challenges from decentralization:
  - Differences in labor regulations across entities and inconsistent court interpretations add administrative hurdles and costs for companies operating across the country.
  - Common problems: calculating past service, sick leave payment, compensation and refunds by health insurance funds, and maternity leave payments.
- Overarching goal:
  - Make BiH more conducive to job creation by maintaining macro-financial and political stability; cultivating competitive product and factor markets; deepening trade integration; and improving business and investment climate.
- Labor market legal and institutional reform priorities:
  - Update labor market legal framework to reduce duality between “insiders” and “outsiders” and make it more conducive to job creation.
  - Limit indefinite collective agreements so they can be adjusted regularly; consider making collective agreements limited in duration and applicable only to participating enterprises and workers.
  - Enhance flexibility of wage determination and promote differentiated wage setting based on skills, qualifications, experience, and performance.
  - Update civil service employment framework to facilitate public administration reform and reallocate labor market resources to the private sector.
  - Review minimum wages and redundancy costs; consider a separate minimum wage for young workers.
  - Strengthen unemployment insurance and active labor market programs (job matching, career counseling, training, employer subsidies for disadvantaged job seekers, self-employment support).
  - Introduce legal framework for temporary employment agencies; allow longer fixed-term contracts (up to five years) with safeguards; increase flexibility on overtime and probationary periods.
  - Harmonize family-related and maternity leave provisions across entities and cantons where warranted.
  - Ensure penalties for labor law violations are sufficiently high to protect workers’ rights and reduce the informal economy.
- Regional lessons cited:
  - Serbia (2014), Croatia (2014), and Macedonia (over 2007–12) implemented reforms to increase flexibility, clarify contracts, and improve job-support measures.

*Prepared by Dora Benedek and Ricardo Llaudes; Ruben Atoyan, Dora Benedek, and Irena Jankulov; IMF staff analysis as presented in the supplied chapter content.*

### 1. General Recommendations on Revenue Mobilization __________________________________ 11

### 1. General Recommendations on Revenue Mobilization

### Level of Government Spending
- Fiscal consolidation after the global financial crisis was largely accomplished through efforts at the central government level; IMF-supported policies narrowed the overall budget deficit from a peak deficit of around 6 percent of GDP in 2009 to 2 percent of GDP in 2013.
- A major natural disaster caused an increase in the deficit to 3 percent of GDP in 2014.
- While central governments achieved budget surpluses in recent years, spending by lower levels of government and social funds, and on foreign-financed investment projects, have persistently generated deficits and contributed to increasing public debt levels.
- General government current expenditures rose from an average of around 38.5 percent of GDP over 2000–05 to around 41.5 percent thereafter.
- Public current expenditures increased mainly through:
  - higher public sector wages;
  - increased, and poorly targeted, social benefits;
  - higher spending on goods and services.
- At over 41 percent of GDP, BiH’s public sector size ranks second in the region (behind Croatia) and is substantially larger than that of more advanced Emerging Europe economies.
- Public capital spending has been decreasing: average capital expenditures were 8.0 percent of GDP for 2003–2008 and 6.8 percent of GDP for 2009–2014.
- Financing of public investment has shifted from own resources to debt-generating foreign financing.
- BiH needs more investment in human and physical capital to accelerate real GDP growth; higher capital investment requires reducing current spending given limited fiscal space.

### Structure and Efficiency of Government Spending
- Public spending composition (2013, general government current expenditures):
  - Compensation: 31%
  - Use of goods and services: 26%
  - Interest: 2%
  - Subsidies: 4%
  - Social benefits: 37%
- By contrast, Western Balkans ex BiH (2013) current expenditure composition:
  - Compensation: 25%
  - Use of goods and services: 13%
  - Interest: 7%
  - Subsidies: 7%
  - Social benefits: 48%
- BiH spends over 12 percent of GDP on public sector wages in 2013, substantially greater than countries such as Macedonia and Albania which spent around 5 percent of GDP in the same year.
- Two factors driving high wage spending:
  - continued increases in public sector payrolls;
  - public sector wages, particularly in public administration, are very high compared to average pay levels in the economy.
- Public-sector employment attractiveness has created economic distortions and stifled private sector development.
- Capital spending is relatively high compared to peers but has been declining; reversing the decline and boosting resources for infrastructure would support long-term growth and job creation.
- Social benefits spending is low relative to peers overall, but with significant internal differences: health care and non-contributory social assistance stand out, while education, old-age pensions, and active labor market programs are at or below regional averages.
- Public health spending is over 7 percent of GDP, the highest in the region; expenditures have continued to increase while elsewhere they have remained flat or declined.
- The health system is highly fragmented: 13 ministries of health and 13 health insurance funds operate independently across entities and cantons, producing duplication and inefficiencies.
- Health financing is mostly from social security contributions; contribution rates in both entities are the highest in the region.
- Health outcomes and capacity indicators show inefficiency despite high spending:
  - hospital beds (per 1,000 people), life expectancy at birth, infant mortality, and physicians (per 1,000 people) indicate BiH lags behind regional peers and Emerging Europe.
  - number of non-medical staff in health care facilities is on the high end relative to peers.
- Education spending is about 5 percent of GDP, in line with comparable countries, but governance is fragmented with 14 ministries of education (11 in the FBiH, 1 at state level, 1 in RS, 1 in Brcko District), causing duplication and inefficiencies.
- Around 80 percent of the education budget is spent on wages rather than system development or material resources.
- Enrollment: relatively high for primary and lower secondary, substantially below regional averages at upper secondary and tertiary levels; vocational and technical training are declining, widening the skills mismatch.
- Active labor market programs are severely underfunded; BiH allocates very little to these programs compared with regional peers such as Serbia, Croatia, Montenegro, and Macedonia.
- Spending on non-contributory social assistance is the largest in the region and in Emerging Europe at close to 4 percent of GDP; World Bank analysis suggests this amount could be as high as 7 percent of GDP if canton and municipal programs are included.
- The bulk of social assistance transfers are for war veterans and disability benefits; civilian programs are small and underfunded. Aging veteran liabilities pose significant fiscal risk.
- Targeting of social assistance is poor:
  - The poorest 20 percent receive only 36.8 percent of total social assistance budget.
  - Regional peers (Albania, Kosovo, Montenegro) show much better targeting, with the poorest quintile receiving over 60 percent of social assistance in some cases.
  - The richest quintile in BiH receives a disproportionately high share of social assistance benefits.

### Policy Recommendations
- Rationalize the institutional setting to reverse excessive growth of the public sector caused by high fiscal decentralization and proliferation of institutions at entity, canton, and municipal levels; aim to reduce current spending and increase efficiency.
- Implement expenditure consolidation measures together with structural reforms in the pension and health sectors to create fiscal space for reducing social security contributions while improving targeting to support the most vulnerable.
- Streamline education spending and reallocate greater resources to active labor market programs to reduce skills mismatches and contribute to lowering unemployment.
- Reduce high and poorly targeted non-contributory social assistance spending through:
  - additional reductions in veterans’ benefits;
  - improvements in the audit process;
  - measures to remove labor market disincentives and bring social assistance spending to sustainable levels.
- Shift public expenditures away from the present high share of non-productive current spending toward more productive capital expenditures to enhance economic growth.

### Toward a More Balanced Tax System in Bosnia and Herzegovina
- Key challenges include high unemployment and a large informal sector.
- A high tax burden on labor provides disincentives for people to move from informal to formal employment and may deter labor force entry.
- An aging population and shrinking labor force strain the social security system.
- Lowering social security contribution rates would need to be accompanied by offsetting revenue measures and spending cuts—including better targeting of social assistance—given the limited fiscal space.

*Prepared by Dora Benedek and Ricardo Llaudes; October 9, 2015 — Bosnia and Herzegovina, International Monetary Fund.*

### 1.      Many economies face the challenge of mobilizing revenue in a growth-friendly way,

### Many economies face the challenge of mobilizing revenue in a growth-friendly way

### A. Overview and objectives
- Many economies need to mobilize revenue in a growth-friendly way to provide space for social assistance and infrastructure improvement.
- Revenue mobilization in an increasingly globalized economy requires simple and broad-based taxes and strong tax compliance.
- Revenue mobilization efforts should be guided by three principles: efficiency, fairness, and transparency.

### B. Level and structure of tax revenues in Bosnia and Herzegovina (BiH)
Findings:
- Total tax and social security contribution (SSC) revenues in BiH are 38 percent of GDP, one of the highest in the region and slightly above the average of EU member countries.
- The share of total taxes to GDP has been increasing, while other revenues (e.g., dividends from state-owned enterprises) have been declining.
- The composition of revenues has shifted toward an increasing share of social security contributions, while the contribution of indirect taxes has been decreasing.
Key comparative shares:
- Share of SSC within total tax and SSC revenues in BiH: over 40 percent.
- Regional average share of SSC: 31 percent.
- EU average share of SSC: 30.5 percent.
- Direct taxes in BiH provide 8 percent of revenues (out of which the PIT brings in about two-thirds).
- Regional average of direct taxes: 17.5 percent of revenues, with PIT at 11 percent.
- Indirect taxes provide about half of tax and SSC revenues both in BiH and in the region (EU average of indirect taxes: 38 percent).
- Revenues from property taxes in BiH: 1 percent of total tax revenues (below regional average).
Additional note:
- Overall revenue-to-GDP ratio has been rather stable in recent years.

Box — General recommendations on revenue mobilization (as presented)
- Building administrations that limit incentives and opportunities for rent seeking and are capable of implementing the voluntary compliance needed to extend the tax base;
- Adopting and making readily available clear laws and regulations embodying strong taxpayer protection;
- Eliminating exemptions that forgo revenue to little useful end;
- Implementing a broad-based VAT with a fairly high threshold;
- Establishing a broad-based corporate income tax, at rates competitive by international standards;
- Extending the PIT base, and ensuring a coherent treatment of alternative forms of capital income;
- Levying excises on a few key items that address revenue needs and wider social concerns;
- Implementing simple but coherent regimes for taxing smaller businesses;
- Strengthening real estate taxes; and
- Developing capacity for tax expenditure and wider policy analysis.

### C. Tax rate structure
Findings:
- Standard statutory rates of PIT and CIT in BiH are low compared to many SEE countries: PIT rate of 10 percent in both the FBiH and the RS; CIT rate of 10 percent in both entities.
- VAT in BiH has a single standard rate with no reduced rates (no reduced rates enhances VAT efficiency), but the VAT threshold is one of the lowest in the region, placing a larger burden on tax administration by keeping many small and medium-sized taxpayers in the VAT net.
- SSC rates are high compared to neighboring countries, especially in the FBiH.
- SSC structure differs by entity: the RS collects all contributions from employees, while the FBiH collects some contributions from employers as well.

Selected comparative indicators from Table 3 (as presented):
- VAT threshold (US dollars) and tax rate context for selected countries are provided in the source (table values preserved in the original).

### D. Tax efficiency
Concepts:
- Tax efficiency measures the share of tax revenue in percent of GDP relative to the statutory tax rate.
- Two components for improving tax efficiency:
  - Policy gap: difference between collections under current law and those under best-practice law (can be reduced by broadening tax bases).
  - Compliance gap: difference between current collections and those if existing law were perfectly enforced (can be reduced by revenue administration reforms).
Findings:
- VAT efficiency in BiH is very high due to a low policy gap: few exemptions, no reduced rate, and a narrowly used zero rate (exports and diplomats).
- CIT efficiency in BiH is around the regional average.
Recommendations to improve CIT efficiency:
- Review and consider eliminating tax incentives and exemptions that forgo revenue to little useful end.
- Pursue tax administration reforms to improve compliance (noting that administration measures usually take time to show significant results).

### E. Total tax wedge and labor tax burden
Findings:
- The tax wedge (PIT plus SSC) differs between entities due to decentralization.
- For a single average wage earner:
  - Tax wedge in the Federation of BiH (FBiH): 42 percent of the gross wage.
  - Tax wedge in the Republika Srpska (RS): slightly over 39 percent of the gross wage.
  - Most of the burden arises from SSC.
- Comparative position:
  - The labor tax wedge in BiH is relatively high compared with other countries; current BiH rates are more in line with advanced EU countries than many emerging economies.
  - In 2013 the tax wedge in both entities was notably higher than the EU or Euro Area averages.

Selected detailed figures from Table 4 (Labor Income Taxation, percent of November 2014 gross wage):
- Gross wage (A): 100.0 (FBiH), 100.0 (RS)
- Income tax (B): 4.5 (FBiH), 5.2 (RS)
- Contributions (C): 41.5 (FBiH), 33.9 (RS)
  - Pension: 23.0 (FBiH), 18.0 (RS)
    - Employee pension: 17.0 (FBiH), 18.0 (RS)
    - Employer pension: 6.0 (FBiH), ...
  - Health: 16.5 (FBiH), 12.5 (RS)
    - Employee health: 12.5 (FBiH), 12.5 (RS)
    - Employer health: 4.0 (FBiH), ...
  - Unemployment: 2.0 (FBiH), 1.0 (RS)
    - Employee unemployment: 1.5 (FBiH), 1.0 (RS)
    - Employer unemployment: 0.5 (FBiH), ...
  - Child protection: ... (FBiH), 1.5 (RS)
    - Employee child protection: ... (FBiH), 1.5 (RS)
  - Floods (temporary in RS): ... (FBiH), 0.9 (RS)
- Net wage (J = A – B – D – E – F – G – H): 64.5 (FBiH), 60.9 (RS)
- Labor cost to employer (K = J + B + C + I): 111.1 (FBiH), 100.0 (RS)
- Tax wedge (percent of labor cost) (L = (1 - J / K) * 100): 41.9 (FBiH), 39.1 (RS)

Policy implications highlighted across sections:
- Given limited fiscal space to reduce overall revenues, consider shifting the tax mix away from labor (high SSC) toward less distortionary bases.
- Broaden tax bases (reduce exemptions and reduced rates) to close policy gaps.
- Strengthen tax administration and compliance measures to reduce the compliance gap, recognizing these measures take time.
- Consider raising VAT threshold prudently or simplifying VAT registration rules to reduce administrative burden from many small taxpayers.
- Strengthen property taxation (recurrent property taxes, cadastral systems) to increase local revenue take, noting divergence in property tax systems between the FBiH and RS.

*Prepared by Ruben Atoyan, Dora Benedek, and Irena Jankulov; source: IMF staff analysis as presented in the supplied content.*

### 13.      The tax treatment of allowances is

### _cr15299 - 13.      The tax treatment of allowances is

### Tax treatment of allowances across entities
- Employees in BiH often receive meal, holiday, and transportation allowances as part of their remuneration.
- In the RS, these allowances are treated as part of the overall compensation and subject to taxation.
- In the FBiH, these allowances are tax-free.
- Consequences:
  - The effective labor tax wedge in the FBiH is lower if these allowances are included in the calculations.
  - The tax-free allowances can be viewed as an increase in tax deduction for PIT purposes.
  - Lack of harmonization creates distortions and adds administrative burden for businesses operating in both entities.

### Impact of labor taxation on competitiveness and formality
- High labor taxation undermines cost competitiveness and contributes to the high share of informal employment in BiH.
- Policy intent stated: To increase overall employment—and employment in the formal sector in particular—and to improve competitiveness to attract foreign investment, the labor tax wedge will need to be reduced.

### Conclusions and policy recommendations
- Lowering SSC rates is necessary to improve labor market incentives.
  - Any reduction will need to be accompanied by offsetting revenue measures, including base broadening and improving compliance, and/or spending cuts.
- A review of the tax system is necessary to identify measures to broaden the tax base of all major taxes by:
  - Capturing tax-free allowances.
  - Curtailing tax exemptions and incentives.
- Tax rates need to be reviewed to identify options to mobilize revenues from other taxes than SSC.
- Property taxes could be expanded, notably in the FBiH.

### Labor market context and structural diagnostics (key findings)
- Labor market outcomes in BiH are among the worst in emerging Europe, driven predominantly by structural reasons.
- Unemployment and employment statistics and comparisons:
  - 2013 unemployment rate in BiH reached 27½ percent.
  - Western Balkan average was 23 percent.
  - Central European average was about 11 percent.
  - CIS average was about 5 percent.
- Youth and long-term unemployment:
  - Youth (aged 15–24 years) unemployment rate exceeded 59 percent in 2013.
  - Unemployment rate for ages 24–34 years: over 34 percent.
  - Over 80 percent of unemployed have not been able to find a job for more than 12 months.
- Public sector employment trends:
  - Number of public administration and defense jobs increased by nearly 13 percent over the past decade.
  - Employment in education and health sectors increased by over 22 percent over the past decade.
  - Public sector jobs enjoy high wage premium relative to private sector employment; BiH spends a greater share of GDP on compensation of public sector employees than its peers.
- Labor market cyclicality:
  - Responses of labor market outcomes to swings in economic cycles are small and statistically insignificant, implying unemployment is unlikely to drop radically once economic growth recovers.
- Structural impediments:
  - Core structural reforms (enterprise restructuring, competition policy improvements, privatization) are less advanced in BiH than in peers.
  - Business environment indicators lag in ease of starting businesses, obtaining construction permits, connecting to electricity, paying taxes, and investor protection.
  - Large emigration and brain drain contribute to labor shortages among better-educated segments.
- Institutional and regulatory rigidity:
  - Up to 40 percent of younger/newer firms considered existing labor market regulations a major or very severe impediment (business surveys).
  - More than ¾ of companies (per FBIH employers association, 2015) are dissatisfied with current labor legislation.
  - About ⅓ of companies are unable to comply with provisions from the general collective agreements.
- Indefinite duration of collective bargaining agreements (unique in the region) poses risks:
  - Fosters job loss and higher occurrences of bankruptcies by limiting firms’ ability to renegotiate wages and benefits.
  - Fosters informal economy as employers favor more adjustable and cheaper illegal workers.
  - Leads to a higher wage premium in the public sector over the private sector.
  - Encourages lengthy and costly litigations and piles up fiscal costs.
  - In 2013, and only in FBIH, the total value of all lodged legal challenges was over KM 500 million (about 2 percent of GDP).
- Historical and institutional legacies:
  - Legacy of “self-management” system and social ownership contributed to high job protection for “insiders” and overall rigidity.
  - BIH characterized by extremely rigid wage determination by collective agreements and a feeble link between compensation and productivity.
- Wages, productivity, and minimum wages:
  - Average gross wages in BIH—while low in absolute level—are somewhat higher than labor productivity; labor productivity amounts to just over 25 percent of average productivity in EU countries.
  - Minimum wages are significantly higher in BIH than elsewhere in the region (whether expressed in US dollars or as a share of average value added per worker).
  - High minimum wages may depress formal employment, especially for youth and in low-paid sectors, although employer associations did not indicate it poses a significant impediment to job creation.
- Informal employment (shadow economy):
  - Nearly 15 percent of the country’s employment (or about 10 percent of the labor force) in 2014 is estimated to be engaged in activities in the informal economy.
  - Shadow employment was higher during the boom years preceding the global financial crisis and may increase again as growth picks up.
  - Informal employment implies tax evasion, unpaid social contributions, and lack of employment protection for affected workers.

*Source: IMF staff analysis as presented in the supplied chapter content.*

### 15.      The decentralized political structure of Bosnia and Herzegovina imposes additional

### _cr15299 - 15.      The decentralized political structure of Bosnia and Herzegovina imposes additional

### Challenges from decentralization and legal fragmentation
- Differences in labor regulations across the entities and inconsistent court interpretations of legal provisions add administrative hurdles and costs to companies operating across the country.
- Most common problems: calculating the past service, sick leave payment, compensation and refunds by health insurance funds, and maternity leave payments.
- Collision of collective agreements with the Law on Personal Income Tax and the Law on Social Security Contributions results in different court rulings related to the same legal mater, adding a high degree of uncertainty for both employers and employees.
- Businesses perceive the judiciary system as slow and inefficient, with a negative impact on the labor market and employer-workers relations.
- Source references in text: White Book 2012/13, Foreign Investors Council BiH; FBIH Employers Association, 2015.

### Overarching goal: make BiH more conducive to job creation
- To sustainably bring down unemployment and improve labor market participation, BiH needs to become a more attractive place to invest and create jobs.
- Key prerequisites: maintain macro-financial and political stability; cultivate more competitive product and factor markets; deepen trade integration regionally and globally.
- Improving the business and investment climate is essential to attract foreign investors, stimulate entrepreneurship, improve productivity, and create more and better jobs, including for younger workers and women.
- Specific labor-market reforms can contribute to stronger growth, especially in the formal sector.

### Labor market institutions and legal-framework reforms (priorities)
- Update labor market legal framework to address duality between “insiders” and “outsiders” and make it more conducive to job creation.
- Limit indefinite collective agreements so they can be adjusted regularly to reflect rapidly changing economic realities.
  - Collective agreements that are limited in duration and apply only to enterprises and workers that want to be part of the agreement will help ensure collective bargaining can function.
- Enhance flexibility of wage determination frameworks and promote differentiated wage setting based on skills, qualifications, experience, and performance to better link compensation to productivity.
- Update legal framework governing employment in the civil service to facilitate public administration reform, including increasing scope for reallocating staff within the administration and adjusting staffing and wage levels, and channel labor market resources to the private sector.

### Cost competitiveness, minimum wages, and redundancy costs
- Review legislations governing minimum wages and redundancy costs.
- Strengthen the general system for unemployment insurance to avoid disincentives for hiring and to avoid placing a sizable burden exclusively on enterprises when downsizing.
- Consider introducing a separate minimum wage for young workers to facilitate youth unemployment.
- Contain current government expenditure and broaden the tax base by addressing tax evasion to create fiscal space to lower the tax burden on labor and reduce the informal economy.

### Welfare, active labor market policies, and enforcement
- Welfare reforms needed to better target social assistance and incentivize labor market participation for all groups.
- Boost skills and adaptability of workers through improved training and education.
- Active labor market programs of critical importance: job matching services, career counseling and training for both pre-redundancy workers and the unemployed, employer subsidies targeting disadvantaged job seekers, and self-employment support.
- Support these efforts with stepped up labor inspections and increased penalties for labor law violations to protect workers’ rights—consistent with ILO labor standards and EC labor directives—and reduce the informal economy.

### Social cohesion and transition management
- Completing the labor market transition amid slow post-crisis recovery will have wide-ranging social consequences.
- Achieve social cohesion through extensive consultation between all social parties, including those currently out of work.
- Ensure the adjustment is seen as fair and involves labor not just in production but also in services and financial sectors.
- Maintain a well-targeted social safety net to protect the most vulnerable and make fiscal space for critical social and infrastructure spending.

### Regional experience and lessons (Box 1 summary)
- Serbia (2014): Amendments to labor law to remove hiring disincentives and increase flexibility—linked severance to service with current employer; extended maximum length of temporary contracts from one year to two years; clarified separation rules; tightened extensions of collective agreements; envisaged wider use of job-support programs.
- Croatia (2014): New labor code to increase employment, decrease informal employment, introduce more flexible business operations, safeguard workers’ rights; supported different labor contracts, relaxed working hours and part-time employment, simplified redundancy and lay-off procedures.
- Macedonia (over 2007–12): Reforms to clarify part- and fixed-term contracts, allow greater overtime flexibility, simplify redundancy procedures, revamp collective bargaining framework including limiting duration of collective agreements.

### Modernizing labor laws in BiH (Box 2 summary and specific recommendations)
- Labor laws are outdated (FBIH law approved in 1999 and amended in 2000 and 2003; RS law approved in 2000 and amended in 2000, 2002, 2003, and 2007).
- Align labor legislation with ILO labor standards and EC labor directives in areas of market flexibility, worker protection, and the role of governments.

Key reform recommendations and specifics:
- Duration of collective agreements:
  - General collective agreement is mandatory for all employers and regulates minimum wage, basic wage calculation, severance payment, meal, transportation, and vacation allowances.
  - In practice, general collective agreements date many years back, do not reflect economic realities, and have led to failed negotiations and numerous court proceedings.
  - Labor laws should set a limit on the duration of collective agreements.
- Fixed-term contracts:
  - Current framework sets an overly restrictive time limit (up to two years).
  - New laws should allow duration of fixed-term contracts, with or without renewals, for up to five years.
  - Careful attention needed to avoid substitution of short-term contracts for permanent ones, harming new labor market entrants and youth.
- Temporary employment agencies:
  - No legal framework exists; one needs to be established to bring temporary jobs into the official economy and protect worker rights.
- Overtime activities:
  - Current framework sets strict time limits on daily, weekly, and annual overtime hours; legislation should permit greater flexibility and allow negotiation of specific overtime terms in collective agreements or individual contracts.
- Probationary period:
  - Current fixed limit is six months; consider differentiation with longer trial periods for managerial positions and shorter periods for unskilled workers.
- Leave and maternity provisions:
  - Family-related and sick-leave arrangements are fairly generous by international standards; long maternity leave can reduce women’s labor attachment and encourage discrimination against women of child-bearing age.
  - These arrangements are particularly costly for small and medium enterprises; some flexibility may be warranted (e.g., covered by annual leave or unpaid leave).
  - Maternity leave arrangements differ between entities and cantons; greater harmonization may be warranted.
- Role of the Government:
  - Minimum wages are relatively high compared with average productivity per worker and neighboring countries; lack of a separate minimum wage for young workers may contribute to extremely high youth unemployment.
  - Governments should take a more active role in regulating levels and differentiation of minimum wage.
  - Severance entitlements overprotect insiders and place burden on employers; focus should shift from job protection to helping job transition via strengthening active labor market policies and an unemployment benefit system.
  - Ensure penalties for labor law violations are sufficiently high to protect worker’s rights and reduce informal economy.

*Source: IMF staff assessment in _cr15299 (PDF chapter) on Bosnia and Herzegovina labor-market and structural reform recommendations.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15299.pdf_