Isa Mulaj: Proposed and approved tax rate changes
E diele, 25.01.2009, 10:58 AM
Senior researcher and coordinator for Kosova of the Institute for Economic Policy Research and Analyses, Prishtina, Kosova
Tax reform in small emerging democracies is difficult to measure what effects is likely to produce due to countries’ aggregate political and economic vulnerabilities. If both are taken as remaining relatively stable, then it is easier to discuss what impact the reform introduced may have in the economy and her stakeholders. In absence of a monetary policy, the Government of Kosova in mid-2008 adopted the changes in tax rates taking effect from January 2009, with the aim to foster economic growth and improve business competitiveness at least in the regional market of the Balkans. This article critically assesses the proposed and approved changes by the Government that were in line with the proposals made by business community Non-governmental Organizations (NGOs), and concludes that this tax reform is not well thought-out and properly analyzed to expect the benefits for which it was too optimistically hoped for, especially in relation to key stakeholders such as the Government’s budget, business development, and consumers.
Keywords: Kosova, Ministry of Economy and Finance, tax reform, business associations, value added tax.
JEL Classification: D31, H21, J31, P46.
By Isa Mulaj
By Isa Mulaj
For a long time, a number of NGOs and the overwhelming majority of businesses had identified tax rates in place as the main barrier to Kosova’s economic growth. They considered lowering of tax rates as indispensable towards business development and improving competitiveness. Many proposals by individual NGOs, namely by the organizations defending the interests of business community, were addressed to the United Nations Interim Administration in Kosova (UNMIK) and the Government of Kosova. After remarks by the UNMIK that the NGOs should speak with one voice or have their demands jointly addressed, a more unified proposal was made. A document by Investment Promotion Agency of Kosova (IPAK) entitled “A Proposal for Changing of Fiscal Policies: Investment Incentives” of July 04, 2008 proposed the following tax rate changes: Corporate Income Tax (CIT) to be halved from 20% to 10%, Personal Income Tax (PIT) with a progressive rate to be also halved from 20% to 10% for monthly incomes of over €450, Value Added Tax (VAT) to remain unchanged at a flat rate of 15%. The same document contained the proposals of main NGOs that represent and defend the interests of business community. The Alliance of Kosovan Businesses (AKB) had the following proposals for tax rates: CIT 8%, PIT 8%, VAT 3% and 17%; American Chamber of Commerce (AMCHAM) CIT 7%, PIT 7%, VAT 16%; and, Kosova Chamber of Commerce (OEK) CIT 7%, PIT 7% and 12%, and VAT 15%.[i] All these three business associations were trying to justify that a sharp decline in the CIT rate would provide greater opportunities for investment in production sector, generate employment, increase tax revenues and the demand for consumption goods, shift away a large proportion of the population from social assistance, and substantially lower fiscal evasion. The NGOs came to a conclusion that such a tax reform would lead to a better general economic welfare.
Before discussing on potential impact and effects of all proposed changes in tax rates, it is worth referring to a report by the International Monetary Fund (IMF) about Kosova prepared during
What the proposed and approved changes aim to achieve and where they can lead?
It is not difficult to discuss about economics and make good proposals on how to achieve certain goals. Jokes about studying economics at the
Sharp decrease in the CIT rate without more detailed analysis is another mistake and hurried decision of the Government having potential implications for budget revenue sustainability. Corporations are entities that have more resources and incomes than the poor and the unemployed. It was constantly overemphasized that the CIT at 20% is very high, and as such, it puts Kosova in a disadvantageous competitive position against neighboring countries to attract foreign investment. As a matter of fact, the CIT rate in
The Government takes the problem of reforming the tax system as a basic concept from the textbooks of economics and thinks it can work as it is written there. In the Government’s view, a decline in the CIT rate should encourage or bring foreign investors in who would invest and employ more people, then reinvest the profit, employ additional people, and pay more taxes to the state that would subsequently cause budget revenues to rise. All these were probably to result in higher economic growth rate and better welfare. This chain effect may only work under the assumption if other factors are taken as constant, which in Kosova, more than in any other European country, are less likely to remain.
What is expected to happen from the Government’s new tax rates or castling between the VAT and the CIT is more or less known. This system aims at further increasing of income differences between the very few rich by making them richer, and the very large proportion or almost half of the population in poverty even poorer. The rise in income differences is a significant limitation factor in economic growth and development in transition economies.[viii] The problem becomes more severe for those economies facing massive unemployment rate and widespread poverty such as Kosova. The Government seems not to have properly calculated as what it wants to achieve in a nascent independent country at the time when it needs more resources to finance her expenditures, provide a better environment for businesses and cope with ongoing deterioration of economic conditions of the population, whose very low purchasing power constrains business development and growth. Economic growth rate estimated at 3% in 2008 was generally considered too small for inroads to change the current socio-economic situation. The Government’s projected economic growth rate with unreliable data at 6% for 2009 has been moderately called by many economists as too optimistic, and in extreme form as a political propaganda. The politicians too often fail to understand that economy is the biggest politics for the state. It appears that the Government is not interested to make the state stronger with the tax changes it made. These changes to some extent are not castling but twaddling scheme.
MEF and the TAK continue to misinform taxpayers
The MEF and its department of tax revenue collection – the TAK never wanted to correct a technical error and wrong information they were and still are transmitting to businesses and the population on the VAT rate of change. This (on purpose or who knows for what reason) mistake has persisted from the day when the MEF proposed the change and the Government approved it on July 28, then on December when the Assembly of Kosova voted the changes in tax rates. The government authorities and high ranking officials reported and the media broadcasted the rise of VAT from 15% to 16% as an increase of only 1%. The same belief is present among them even today and may be in the future. As such, it was not correct then, neither is today nor it will ever be in the future. Here is a simple argument with elementary school mathematics that an increase in the rate of VAT from 15% to 16% or by one percentage point, is an increase precisely by 6.67%: 1/15 x 100 = 6.67. If an item before tax has a price of €100 and the consumer buys it in the shop increased by VAT at 15% or with a total price of €115, the buyer pays the seller and this one to the TAK the sum of €15 as VAT. From January 2009, the same item will cost: €100+16% VAT = €116. Instead of €15 that the buyer has been paying by the end of 2008, s/he will pay €16 or €1 more, which is 6.67% more.[ix]
If a book has a price of €20 and the reader buys it with VAT included at a rate of 15% or €3, then total price of the book is €23. The price of the same book from
Following the new VAT rate, a likely immediate increase in prices by 0.87% may force businesses to price their products higher because they will now pay an increased taxed by 6.67% to the state. Apart from this burden which will fall on consumers, businesses have two alternatives to cover the loss. One is to increase sales and reduce costs. The other would be to partially go in informal sector in order to survive competition in the market. Businesses typically strive to avoid paying or hide taxes, whereas the duty of tax authorities is to keep them in check and bring into formal sector. Kosova has the highest share of informal sector in Europe. Given the “expertise” of the TAK, the MEF, their local advisors paid by USAID/Bearingpoint as contractors with no accountability whatsoever, it can be argued that in Kosova there are more businesses paying taxes than the TAK deserves to be paid.
A logical question arises: why all these concerns for a technical error in calculation that the TAK continuously, on purpose or accidently, is selling to the media, businesses and the citizens? There is only one simple answer – the VAT is the main tax revenue for Kosova’s budget. In 2007, VAT accounted for 35% of all budget revenues. Yet, for 2009 it is projected to rise to 44%. The share of excise taxes in total budget revenues in 2007 was 21%. Although the MEF maintained that this indirect tax along with the VAT will cover the difference in revenues lost by lower rates of CIT and PIT, the contribution of the tax in question – the excise tax is projected to increase by only four percentage points to represent 25% of the 2009 Kosova’s budget revenues.[x] Since the VAT is the largest contributor to the budget, it should be viewed from another perspective that deserves more attention. Kosova’s trade deficit is amazingly large where, the value of exports in 2007 covered only 10% of total imports, a figure projected to slightly improve to around 14% by the end of 2009. According to official data, foodstuffs and beverages dominate total value of imported goods, in the overwhelming majority of which VAT was collected. Taken the VAT revenues in total, over 85% of them were collected on imported with the rest on goods and services produced at home.[xi]
Last but not least remark. The Government after approving the rise of VAT, signed the memorandum with the United Nations Development Programme (UNDP) to reach the Millennium Goals, an event which was given a great publicity in the media, in particular to one of the eight Millennium Goals – to halve the proportion of people living in poverty line by 2015. Despite the rhetoric by the Government itself to be deeply committed to this and the rest of the Goals, the new tax reform adopted involving the rise of VAT is the first step off the track or backwards in the short to medium term as the year 2015 is not far.
Conclusions and remarks
Tax reform in emerging democracies and transition economies often involves two scenarios preceding a faster consensus: first, poor expertise and practice in policy making characterized by knowledge constraints; and second, more professional and diversified thoughts enabling better decisions. The case of Kosova’s Government and the business community NGOs discussed in this article, is an example of the first scenario. When the thoughts are similar for complex issues such as tax reform without detailed analyses and profound justification for the final decision taken and put into operation, discrepancies emerging from actual results and those expected, to a large extent can be blamed on how policy reforms were prepared and adopted. Business associations do not seem to sufficiently defend the interests of the entities they represent, except talking about the problems and make superficial proposals instead of more active lobbying to exercise pressure to the Government for their demands. It is not quite clear whose interests the Government is defending in economic affairs when it has conflicting objectives in tax policy reform. As the decision to rise the VAT rate was centralized and ignored concerns of small businesses and the consumers, so is the determination of few larger businesses with direct ties to the Government to lower the rates of CIT and PIT – to centralize the power in the hands of the few or a tiny small group interest by marginalizing and pushing into deeper poverty the army of the unemployed and the poor.
Tax reform in Kosova is more difficult to be designed, implemented, monitored and measure their expected impacts. If the system has a limited number of taxes in place, a thorough and detailed investigation which tax rates to lower and/or increase is not an easy decision to be made when it requires a consensus between the players involved and affected. It is more preferable if the decision to reform is dependent on what attainable goals wants to reach with available resources. The goals should be distinguished from desires or emotional feelings and the likely effect what actual system in operation can have.
Changes in tax rates for a certain development direction are an easy task of the Government. However, there is one task still remaining a significant challenge for the Government itself and that is, improving the TAK’s performance. Kosova is in the process of becoming the newest member of the IMF and subsequently of the World Bank. The IMF’s remarks addressed to the Government about urgent improvements in the TAK’s efficiency were not ignored. And what improvements occurred since then until the tax reform entered into force nine months later? The TAK increased “efficiency” in another segments – it continued to misinform the taxpayers about the amount of money they have to pay after increasing the VAT rate from 15% to 16%. A change between percentages indicates ratios, not differences.
[i] IPAK (2008), A Proposal for Changing of Fiscal Policies: Investment Incentives, manuscript,
[ii] International Monetary Fund – IMF (2008), Aide Memories of the IMF Staff Mission to Kosova,
[iii] One of these is a fictional and bizarre one according to which: “a man was run over by the train, his body remained on the rail, whereas his head was sent to hospital. After two years, the body went to hospital, picked up the head and became more complete, then got the idea to go and finish his studies in economics!” in Western countries, it is a completely different perception about economics and society’s most important part – the economy.
[iv] World Bank (2007), Kosova Poverty Assessment: Accelerating Inclusive Growth to Reduce Widespread Poverty, Vol. 1, Report No. 39737, Poverty Reduction and Economic Management Unit of the World Bank,
[v] Castling is a term in the game of chess to denote a special move between the king and either of the original rooks of the same color. It can be castling short when it involves the rook on the right, and castling long that moves the rook on the left.
[vi] Available at: http://www.doingbusiness.org/exploretopics/payingtaxes/, accessed on
[vii] To name some of them: geographical proximity to developed countries, political and economic stability, the state of infrastructure, methods of privatization, purchasing power of the population, trade openness, accession to the EU, institutions, rule of law, low labor costs, abundance of natural resources, political risk and uncertainty, and many more. See among others,
[viii] The studies confirming this trade off include a long list, few of which are: Milanovic, B. (1995), Poverty, Inequality, and Social Policy in Transition Economies, Policy Research Working Paper No. 1530, Policy Research Department, Washington D.C.: The World Bank; Barro, R. J. (2000), “Inequality and growth in a panel of countries”, Journal of Economic Growth, Vol. 5, No.1, pp. 5–32; Byung- Yeon, K. and Pirttilä, J. (2006), “Political Constraints and Economic Reform: Empirical Evidence from the Post-communist Transition in the 1990s, Journal of Comparative Economics, Vol. 34, No. 3, pp. 446–466.; and Sukiassyan, G. (2007), “Inequality and Growth: what Does the Transition Economy Data Say?”, Journal of Comparative Economics, Vol. 35, No. 1, pp. 35-56.
[ix] The motivation to give publicity this real change never reported or ignored by the authorities, came after a question asked to the Author of this article by a sole proprietor after the Government approved the rise in the VAT rate. “I have a small shop and I pay €1,000 on average for VAT per month. By this increase of 1% I will be paying an extra €10 from January 2009. That is not much but it is still an extra burden given that I hardly manage to keep this shop in business. What is your opinion?”, asked the sole proprietor. “In addition to that €10, you must pay another extra €57 per month. Tax authorities and your accountant must tell you that now and they probably will”, was the answer of the Author.
[x] MEF (2008), Semiannual Macroeconomic Bulletin, Issue 1, Macroeconomic Department, MEF, Government of Kosova, Pristina.