IMF Survey: Macedonia Makes Early Headway After Flat Tax Debut
IMF News, April 30, 2008
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- Authors: Pablo Lopez-Murphy IMF European Department April
- Published: April 30, 2008
Overview
- Macedonia's government reports early evidence of positive results from tax reforms intended to help lower unemployment and boost investment.
- Total income tax revenue has risen after a drive to achieve a more efficient tax system with transparent, simple, and lower taxes.
- Government objectives included reducing an unemployment rate of close to 40 percent and increasing foreign direct investment (FDI) from very low levels.
Assessment of tax reforms
- Unification of personal income tax (PIT) and corporate income tax (CIT) at flat and lower rates:
- Objective: simplify the tax system and encourage beneficial supply-side effects and better compliance.
- Context: 98 percent of taxpayers were paying the lowest PIT rate of 15 percent prior to reform; with this rate the same as the CIT rate, Macedonia already had, in substance, a flat tax before the reform.
- The pre-reform rate was already quite low compared to other countries in the region.
- Zero taxation of reinvested profits:
- Goal: foster corporate investment by allowing reinvested profits to be deducted from the CIT but with no further deductions for depreciation allowances.
- Concerns: threatens the base of the CIT and creates a "lock-in" effect so that profits are left in the company even if more profitable investments are available elsewhere.
- Mitigant: elimination of the double deduction protected revenues and removed a significant tax distortion.
- Increase tax concessions in free economic zones:
- Motivation: provide tax incentives for investment in Macedonia.
- Evidence: tax incentives are only one factor investors consider; many concessions may be incompatible with EU regulations, complicating eventual accession.
- Simplified CIT regime for small enterprises:
- Aim: reduce compliance costs for taxpayers and collection costs for the tax authority.
- Design: use of a flat rate of 1.5 percent of the turnover, described as in line with best practices in tax design.
- Harmonization of minimum social insurance contribution (SIC) bases:
- Previous system: minimum pension and unemployment contributions bases at least equal to 65 percent of the average wage of the economy; health contribution bases were sector and skill specific.
- New system: brings health contribution bases in line with the other social funds to reduce computational work for employers and scope for evasion.
- Lower VAT for selected items:
- Change: reduction of value-added tax (VAT) from 18 percent to 5 percent on computers, medicines, and public transportation.
- Note: international experience suggests administrative and compliance difficulties weaken the case for multiple VAT rates.
Recent tax policy reforms (enumerated)
- Unification of personal income tax (PIT) and corporate income tax (CIT) rates at a flat 12 percent rate from 2007, falling to 10 percent from 2008
- Zero taxation of reinvested profits with no further deduction for depreciation allowances from 2007
- Increasing tax concessions in free economic zones from 2007
- Harmonizing minimum social insurance contribution (SIC) bases from July 1, 2007
- Reduction of value-added tax (VAT) from 18 percent to 5 percent on computers, medicines, and public transportation from October 1, 2007
- Introduction of a presumptive tax for small enterprises from 2008
Preliminary outcomes and key statistics
- Despite rate cuts, income tax revenue increased during 2007.
- PIT revenues fell slightly as a fraction of GDP.
- CIT revenues increased, driven in part by a substantial 30 percent increase in reported profits.
- Unemployment rate: fell from 36 percent to 35 percent during 2007.
- Green field FDI: increased from 1.2 percent of GDP in 2006 to a projected 4.1 percent in 2007.
- Comparative observations: similar patterns observed in Estonia, Georgia, Ukraine, the Slovak Republic, Lithuania, Latvia, Russia, Georgia, and Estonia for various revenue effects.
Labor taxes and policy recommendations
- Issue: The labor tax wedge—the tax share of labor costs—remains high and likely contributes to high unemployment and a large informal sector.
- Main cause: social insurance contributions account for more than two-thirds of the wedge.
- Example: health care contributions of part time workers are calculated assuming a full time workweek, making formal part-time employment extremely expensive for the employer.
- Distributional effect: the size of the labor tax wedge grows exponentially for lower wages because of high minimum contributions.
- Recommendation: use any fiscal margin to link social contributions for low wage workers to their actual earnings.
- Expected effects: encourage formality and reduce unemployment for workers with less marketable skills.
Source: IMF Survey by Pablo Lopez-Murphy, April 30, 2008.