Liberal tax reforms in Croatia

Croatian Prime Minister Andrej Plenković (Croatia’s State Chancellery, CC BY-NC-ND)

Two main objectives of the reform of Croatian tax system are increase of the sustainability of the public debt and promotion of the economic growth and employment.

The new government of Croatia spend most of the autumn on consultations and preparations of the tax reform that would enter into force in January 1st, 2017. Expert group responsible for preparation of the amendment found that the tax system created too high burden in relation to the neighboring countries on the one hand, and introduced too many allowances, exemptions and exceptions on the other hand. As emphasized in the bill proposal, effects of the current legislation were questioned by both: the European Commission and the International Monetary Fund. Forty four amendments to the law introduced between 2012 and 2015 have deepen instability of the tax system. This resulted in turn in legislative, judiciary and administrative uncertainty, and as such constituted one of the main obstacles to the development of entrepreneurship, as well as explanation of low domestic and foreign investments in Croatia.

According to the authors of the bill the government ought to address these problems by decreasing overall tax burden, increasing competitiveness of economy, building a socially equitable tax system, stable, sustainable and simple tax system simpler and cheaper tax administration and providing a greater degree of legal certainty to the taxpayers.

Current income tax is set at 20 per cent, and exceeds those in neighboring countries ( Hungary 19 per cent, Slovenia 17 per cent, Serbia 15 per cent, BiH 10 per cent)  Subsequently, the bill reduces the basic tax rate for entrepreneurs to 18 per cent, and for the entrepreneurs with annual income up to EUR400 thousand even to 12 per cent. This group would have possibility of determining the profit tax base according to the cash principle.

Personal income tax have been set up at level of 24 per cent if annual income does not exceed EUR27.8 thousand and 36 per cent for those with income above this rate. Previously the tax level was at 25 per cent when income did not exceeded EUR21 thousand, and 40 per cent for those earning more. 

The government has introduced amendments to the personal allowance rate (tax threshold) and child benefits. The amount of the personal allowance should be increased from the current EUR345 to EUR497 monthly (from EUR4140 to EUR5725 annually). The amount of tax benefits for children in absolute terms remains the same as before: EUR172 for the first child, EUR241 for the second child, EUR345 for the third child, EUR483 for the fourth and subsequent child. However, it will not depend on the level of parents’ income, as it does now.

Income taxes have been reduced also in several other areas. In parallel with the reduction of tax rates, due to the need to preserve fiscal sustainability and a certain level of revenues arising from income tax, experts propose expansion of the tax base by abolishing tax exemptions for reinvested profit and amending regional tax incentives.

Ljubo Jurčić explains in Croatian weekly Lider, that these changes provide Croatian citizens with additional EUR265m. It remains unclear how the consumers will behave, although the government hope that this money will stimulate domestic consumption and production. Miodrag Šajatović is more skeptical and indicates that the increase of the consumption and the GDP growth is questionable.   

The government has also declared a will to increase VAT in catering industry from 13 to 25 per cent. It may hit local, tourist-oriented facilities. On the other hand, it supposes to bump up trade in supermarkets. It will be much cheaper to buy in local market than to produce “home-made” food products. The Prime Minister Andrej Plenković will have to explain how these changes will promote local economy and small family owned enterprises living from eco-tourism.    

This is not the end of news. Institutions carrying out activities that meet certain social and spiritual needs, as well as the implementation of activities of public interest or certain public duties are exempted from the income tax. The list of institutions is relatively long and includes state institutions and agencies, institutions of local and regional self-government, political parties, trade unions, commerce and trade chambers, associations including art and sport associations, volunteer fire departments, communities of technical culture, religious communities, tourist boards, sports clubs, sports clubs, foundations and trusts. However, the mentioned above organizations will pay the income tax if engaged in profit generation activity not linked to their statutory tasks and obligations.

Authors admit that the amendments will results in initial decrease in tax revenues on an annual basis, since there is an abolition of certain tax benefits and reduction in income tax rates. It is estimated that due to the reform reduction in the tax revenues in 2017 will amount to almost EUR50m. However, the hopes has been expressed that the changes will improve investment climate and economic growth.

Taking into account the observed trend of revenues increase from income tax in the previous periods, it is expected that the negative impact on budget revenues in future tax periods will be reduced. The government calculated that the tax reform will result in the GDP growth of 0.5 per cent, which increases the tax base. Juričić in interview for Lider accounts that this will result in additional EUR225m budget revenues.

The new government made a complicated move. The timing is right, if citizens are to enjoy benefits of the reform before the next elections in 4 years. Reforms have been welcomed by the President of the Croatian Economic Chamber Luka Burilović in an interview for Privredni Dnevnik. According to his view it should unburden the economy, improve the business climate and create greater tax fairness. Further, he expressed contentment that this tax reform will be beneficial for micro and small enterprises, constituting 98 per cent of entrepreneurship in Croatia, and that the additional funds will be used for future investments.

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