IME

At the end of April 2005 the Institute for Market Economics published White Paper on Achievements and Challenges of Business Environment Reforms (with an Exclusive Focus on SME). It was prepared with the support of USAID Enterprise Growth and Investment Project, MSI—Bulgaria. We will present the paper in the Economic Policy Review. In the current issue we publish the chapter Fiscal Environment and Taxes.

4.2. Fiscal Environment and Taxes

In 1997 the corporate tax rate was above 40% and the top marginal individual income tax rate was 40%. In most of the years since 1997 these direct taxes were lowered and this happened under the rule of two different governments. In 2005 the corporate income tax is 15% - one of the lowest in Europe [1] . In 2005 the dividend tax was reduced from 15% to 7%. Therefore, the corporate profit taxation is significantly reduced.

In 2005 the individual income tax is between 10 and 24% depending on the income. However, the social security tax is unchanged at the level of 42.7% (35% for sole proprietors), which is one of the highest in Europe. Taking into account both social security tax and income tax, the conclusion is that the total tax burden on individual income for most of the people is only a little lower.

The value-added tax is constant at 20%, but the other indirect taxes are increased every year. The reason is that Bulgarian government must impose the European Union minimum rates on excise duties before 2007 (2010 for cigarettes) when Bulgaria will become member of the union. In the next years the excise taxes will continue to rise. As a whole, the consumption taxes are increased substantially, both as rates and revenues generated.

4.2.2. Fiscal redistribution

Between 2001 and 2003, the consolidated government budget expenditures are maintained at a level of about 40% of the gross domestic product with a low level of 39.4% in 2002. The revenues are increasing, reaching a 41.7% of GDP – the highest level since the middle 1990s.

According to Eurostat, in 2002 Bulgaria's fiscal burden was higher than any of the new member states with the exception of Slovenia. But, as we mentioned above, 2002 was an exception with cyclically low fiscal burden. If we take data for a different year, Bulgaria has the highest tax burden among all the new member states. And it is quite higher than the average fiscal burden in the new member states – about 40% in Bulgaria compared to below 35% average in the region. What is more, there is one country with lower than 30% overall fiscal burden.

The consolidated expenditures in 2005 budget are less than 40%, but usually in the end of the year they are higher. There are many expenditures in the budget that are not efficient and can be optimized. The subsidies for loss-making activities and similar budget expenditures account for about 2% of GDP. The salaries of the budget employees are about 6% of GDP because the number of employees is much bigger than needed. Maintenance expenditures are more than 6% of GDP and they are rising rapidly. Bulgaria has one of the highest defense expenditures in Europe etc.

If the share of inefficient expenditures is decreased, Bulgarian fiscal burden can become much lower – in line with the low tax countries.

2005 Consolidated Budget Expenditures

4.2.3. Tax burden on sole proprietors and companies

Sole proprietors pay social security tax and income tax on their income. During the last several years the income tax was reduced. However, the social security tax rate remains the same and the maximum and minimum threshold for it was increased every year. Thus, it is not surprising, that for most of the sole proprietors with income between BGN 1,000 and 1,800, the tax burden actually increased.

Source: Authors' calculations based on the Law on Taxation of the Incomes of the Physical Persons

Although the tax burden for the sole proprietors increased, they can reduce their tax obligations by reregistering as a Limited Liability Company, which pays a corporate tax. If they do that, they can save more than one third of the tax obligation.

4.3. Taxes: public governance issues

Since 2001 roughly 50% of publications and communications to the government by major business associations like BCCI, BIA and BIBA were dedicated to taxes, social welfare contributions and related procedures. [2] In this paragraph we try to explain why, irrespectively of tax reforms, the tax issue still deserves more profound attention, including from the point of view of the public governance.

4.3.1. Who pays taxes?

1. Bulgarian citizens who produce income number 2.2 million (employed in public and private enterprises) or 33% of those above 15 years of age. The remaining 67% are net beneficiaries of redistribution and include pensioners, state and local administration and all employees paid by the budget (excluding non-subsidized SOEs), the unemployed, and those who receive government stipends.

A Bulgarian, 30-40, working on a contract or as sole proprietor, who receives a gross monthly income of BGN 1,000, would encounter the following situation. He/she should pay 29% (compulsory) pension insurance and 6% (mandatory) health insurance on BGN 850; in other terms he/she contributes to quasi-government funds BGN 297.5. The income tax on the remaining BGN 702.5 is BGN 149. The remaining BGN 553.5 is for consumption. According to the MOF and NSI assumptions, he/she will spend 80% of this amount on VAT-taxed products and services, i.e. another BGN 74 would go to the treasury. If he/she drives a car and consumes 50 liters a month, excise duties would be BGN 22 and if he/she smokes and drinks as the “average” Bulgarian, duties are BGN 12. What remains is BGN 445. The calculation is not complete but choices must obviously be difficult since there are other options to invest, consume, and redistribute within the family, etc.

Assuming that forecasted average wage for the year end is BGN 307, an ideal worker would pay (compulsory) BGN 32.77 insurance contributions; the employer – BGN 98.32. On the remaining BGN 274.23 the employee owes income tax of BGN 34.30; his/her net wage is BGN239.93. Employer's costs are: BGN 405.32.

BGN--165.39 would go to the government, the remainder is squeezed out between employee's actual work and what he/she gets from the employer. The amount squeezed out in value is BGN 40.8%, i.e. the worker gets less than 60% of what he/she contributes to the economy. Presumably, either side of the contract has significant incentives to select non-compliance tactics. [3] The FIAS 2004 survey of obstacles indicated just negligible improvement in the tax situation from 2002, as a result of the reduction of corporate tax rate, a reduction of the lower threshold for income tax and shortening of VAT refund deadlines by the time of the survey.

The explanation is, perhaps, in the fact that taxes are perceived as a combined burden, including corporate and income tax, and the employer/employee social welfare contributions. (FIAS 2004 did not ask about the latter.) The conventional wisdom is that it is very likely that social transfers to the budget hamper development of SMEs and individual entrepreneurs. Our respondents made a point that it is not exactly true, and that it is often the case that “big tax payers” (corporations) suffer as well. The mechanism they reveal is that they lose trained work force to competition

Comparisons with neighboring countries are disappointing, even in relation to Serbia – a late reformer with a background of trade union/workers ownership of enterprises. [4]

Latest surveys (including that of FIAS) fail to identify these problems because questions are not asked and because, when asked, the answers add the burden to costs of dealing with the government. Most of our respondents were on the opinion that legitimate, bigger and more competitive businesses suffer in the first place.

4.3.3. Procedures: how are taxes being paid?

C.1) Corporate tax

As mentioned, in 2005 the corporate income tax is reduced to 15% and is flat. The difference between corporate and personal income rates for high-end income group (successful managers, entrepreneurs, competitive workers, etc.) is significant. There are incentives to “corporatize” personal expenditure of those who control corporations.

C.2) VAT

1. Almost 90% of VAT revenue accrues at the time of import; it is common phenomenon that VAT is paid at import but Bulgaria is a rather extreme case. Accrued revenues from domestic sources have been negative in some months because of refund claims (both domestic and export). VAT revenues are currently about five percent (5.6%) of GDP and there are about 87,000 VAT taxpayers (about 1/3 of the so-called active firms)

2. As Bob Conrad of the Duke Center for International Development (Duke University) has discovered: “It appears that the tax administration sought to combat fly-by-night evasion by attempting to trace transactions down the chain of value added (almost on a transaction by transaction basis) to determine if appropriate VAT had been paid at each point in the process. A regulation, promulgated in 2000, allowed the tax administration to disallow credit claims for otherwise legitimate transactions if fraud was deemed to have occurred at a lower, or subsequent stage, in the production and distribution chain.” [5] .

C.3) Income tax reporting in 2004 and 2005 (SMEs)

Irrespective of tax obligations, the tax procedure burdens employers because they must fill out and submit annual tax declarations. The tax declarations are usually filled along with the reports to NSI, since for corporations they must be submitted by the same deadline. Sole proprietors are supposed do the same but by a different deadline.

Even if the declaration and the report are empty (the firm or the entrepreneur declare no activity), the operation is time consuming. It is difficult to calculate the time spent on filling the tax declarations, since it is different from taxpayer to taxpayer. Recently, we measured the time spent on signing the report to NSI.

The firm (sole proprietor) ID number must be filled in 33 times in the NSI form; the tree names of the owner (manager) and the person who filled the report (usually the accountant) 22 times each (irrespectively whether it is one and the same person), and the contact person's names – 22 times, although it is usually either the owner, the manager or the accountant. The manager and the accountant must sign 50 times. For the economy as a whole, this means 124,000 days spent annually on signing NSI forms.

[1] Only five European countries has lower corporate tax rate – Estonia (zero tax rate on reinvested profit), Montenegro (9%). Serbia (10%), Ireland (12.5%) and Cyprus (10% and 15%).

[2] See the respective sites of BCCI - http://www.bcci.bg/bulgarian/law/apendix.htm (in Bulgarian); of BIBA - http://www.biba.bg/Publications.asp (in Bulgarian and English), and of BIA – http://bia-bg.com (in Bulgarian). The growing public attention to taxes is linked to consolidation of revenues and tax reforms in the late 1990s. The incumbent government increased expenditures while claiming that it is going to introduce different tax incentive.

[3] Obviously, this is not a certain behaviour but only an indication that there is a systemic issue.

[4] IME, Study of Incentives, Characteristics and Strategies of Firms Operating ‘in the Shadows' (180 Firms Survey in Bulgaria, Romania and Serbia), Sofia, IME, p. 34, available at: http://www.ime.bg/pdf_docs/papers/_Toc71455348

[5] Robert Conrad, Trip Report Bulgaria. October 2003, p 1 (unpublished). In between other conclusions Dr. Conrad commented with a pinch of pessimism: “The legal basis for this regulation is not clear. Courts in most countries would restrain a tax administration from using such methods. If not the courts, then the taxpayers would make such a public outcry about the regulation, with justification I believe, that the legislature would likely nullify the tax administration's action.”