14th August 2022, Skopje – Since last week, tax reform concept is an ongoing topic of discussions. Consultations commenced in 2020 already in parallel with the analyses of the performance of the tax system and its strengthening. Tax reform concept actually refers to increased collection of tax revenues, mainly by expanding the scope of taxable revenues, i.e. reassessing the preferential treatment of certain categories, as well as by including more taxpayers in the system, i.e. by reducing the informal economy.
Essential analysis and broad public debate comprise significant part of the reform
Public revenue collection in our country is far below the EU average, also lagging behind the countries in the region. I have elaborated on this issue in my previous column, however, it is important to mention it again since it indicates that systemic changes should and have to take place. In the period 2008-2020, there was a significant gap between the share of tax and contribution revenues in GDP in EU 27 and North Macedonia. In 2008, total revenues from tax and social contributions accounted for 38.4% of GDP in EU 27, while in North Macedonia they accounted for 27.7%. Over the years, this gap has been widened. Compared to the Western Balkan countries, tax revenues in our country are undoubtedly the lowest. Share of tax revenues alone in GDP is even lower in our country, accounting for 16.1% in 2020. According to World Bank experts, share of tax revenues in GDP is crucial for both economic growth and poverty reduction, as it ensures that countries have the necessary funds at their disposal to invest in the future and achieve sustainable economic growth. Share of tax revenues in GDP in the developed countries is usually higher, while the average at Organization for Economic Co-operation and Development (OECD) countries accounted for 33.8% in 2019, being twice the average in our country.
According to these data, the need for changes in the system is obvious. Tax reform is not an ad hoc solution for instant increase of budget revenues amid crisis. Budget revenue collection is as per the projections, constantly being revised upwards under the Supplementary Budgets. The reform is essential for the future economic growth and fairness of the tax system. In order to be sustainable, the reform is to undergo an inclusive process of a broad debate, in addition to the thorough analysis. As French essayist and moralist Joseph Joubert would say: “It is better to debate a question without settling it than to settle it without debating it”.
Rightfully, the tax reform concept has attracted a lot of public attention. Still, conflicts of opinions exists – some believe a progressive tax is to be introduced, others are against it, some believe banks’ profit is to be taxed rather than banks’ deposits, others are in favour of taxing the “extra” profits of companies, with some even proposing for alcohol and tobacco excise duties to increase so as to collect more revenues for the health and the sports sectors. The list of proposals is long, “temporary” tax being among them, as well as other similar proposals pertaining to VAT and other taxes. Discussions are therefore a good thing, with all opinions and arguments presented.
Broadening the tax base includes, above all, formalization of the informal sector
All those debating publicly the pros and the cons as regards the need for tax reform have also taken informal economy into account. I would like to make it quite plain, although already indicated in the previous column, emphasizing that combat against informal economy is part of the reform, i.e. systemic changes will entail series of measures aimed at formalizing the informal sector. When I say broadening the tax base, I mean including the entities from the informal sector therein as well.
For the purpose of being transparent and accountable to the public, I will fully dedicate this column to policies, measures and activities we will undertake to the end of eradicating the informal economy.
Informal economy as a constant phenomenon
Despite all challenges the world and we as an economy and a society face in this period – the pandemic, the price and energy crisis – informal economy remains to be an “evergreen” problem. Informal economy is one of the biggest problems many developing economies, including ours, face. In a nutshell, informal economy involves tax evasion, market distortion, unfair competition and inefficient distribution of resources. It undermines competitiveness of both the companies and the individuals and it brings an unfair and illegal “advantage” to those not adhering to the legal requirements. Tax avoidance tears down the system of equalities and causes shortfalls to all.
Informal economy is detrimental to all citizens. Therefore, it is essential that we are all self-aware and contribute individually in solving this challenge. Let’s take a look at the electricity and the energy efficiency, for instance. If we are all together more electricity conscious, we will all together pay cheaper price.
Looking at the big picture and taking into account the goal we want our economy to reach, despite the many challenges in the past two years since the outbreak of the pandemic, we undertook measures and prepared plans aimed at combating this pressing issue for our economy. They include the MoF’s Action Plan on Eradication of Informal Economy, which is part of the Government’s Action Plan and Strategy for Fomalization of Informal Economy. It is a comprehensive and consistent system for efficient reduction of informally employed, unregistered business entities and informal activities within the formal economy.
A phenomenon present in every society
Informal economy is a global phenomenon. Its level and form are different and are related to the level of development of the country itself. Level of incidence of informal economy is very difficult to measure due to its character. However, several methods are developed to estimate its size. Direct methods are based on direct data collected on the basis of surveys, observations and interviews with economic operators, while indirect methods determine the level of informal economy by applying macroeconomic indicators, such as the ratio between cash and deposits, physical output, etc.
In general, less developed countries have higher informal economy, mainly as a result of the inability of the formal sector to create enough jobs. However, practice in the EU countries also shows that the informal sector exists even in more developed countries. According to IMF, on average, informal economy represents 35% of GDP in low- and middle- income countries versus 15% in advanced economies. For instance, informal economy in Austria is around 9%, with 15% in Germany, 26% in Greece, etc. As regards countries in the region, informal economy represents around 30%. For example, Kosovo has informal economy with around 39%, Montenegro with 38%, Serbia with 34%, Bosnia and Herzegovina with 34.4% and Albania with 28.3%. Simply put, there is no economy in which informality is not present.
There are several key factors affecting its incidence, such as: level of economic development of the country, level of digitalization, tax burden, parafiscal charges, high level of regulation of the formal economy, especially on the labour market, use of cash payments, level of corruption, trust in the government administration and tax morale.
Strengthening the tax morale – as basis for the Strategy for Eradication of Informal Economy
No universal model for reduction of informal economy exists. OECD proposes a three-pillar model, the implementation of which can provide for reducing this general economic problem. First, education of taxpayers and simple regulations. Second, reducing the possibilities for inclusion of informal economy in the activities and third, strengthening the social norms. These three pillars are good basis to design national strategies.
In the region, strategies for eradication of informal economy are mainly based on raising the awareness about the importance of formalizing the economic activities. Moreover, in addition to the campaign, Albania has undertaken measures to strengthen both the inspection and the oversight, streamline the administrative procedure, as well as enhance fiscalization. Serbia, in addition to the intensive campaign for increasing the “tax morale”, has introduced measures to strengthen the supervision, tax and fiscal measures to stimulate formalization of economic activities and reduce administrative and parafiscal burden.
Therefore, awareness raising activities for the citizens about the negative effects of the informal economy are necessary to be undertaken, through the education system and the media, thus providing for higher tax morale and improved quality of public goods and services provided by the country.
Last year, Ministry of Finance, supported by UNDP, launched “Add Color” campaign, going by the maxim “Less Informal Economy, Better Quality of Life”. Symbolically, by drawing a grey-colored circle, we marked the start of the activities aimed at reducing the informal economy by raising citizens’ awareness.
Informal economy is a pressing challenge for our economy as well
As I have mentioned above, although the focus in the past years was put on resolving and adopting measures regarding the constant economic crisis the world faced in the past two years, our economy not being an exception therefrom, informal economy remains to be one of our biggest challenges. Reducing the informal economy is crucial in the context of creating possibilities for growth, planning and implementing strategies for sustainable and inclusive development.
Companies operating in the informal economy have fewer opportunities for growth and less, even lacking, access to finances, which is a key element for their development. They cannot attract quality and professional personnel, resulting in lower performance than their true potential. Moreover, informal economy is especially present among the vulnerable categories and increases their inequality and poverty, while the informal workers earn less than those in the formal sector. The government, on the other hand, has narrower tax base and accordingly less funds for quality public services.
Assessments are that informal economy in the Republic of North Macedonia represents around 33%. If we want a country with a better infrastructure, quality education, better health and social protection, we are all to put efforts and contribute individually. Transition from the informal to the formal sector will provide for establishing a predictable and stable business environment, equal working conditions and a sound competition. In addition, it will also contribute to creating conditions for equal competition among the businesses, strengthening the tax morale, as well as increasing the GDP.
This speaks in favour of the importance of taking urgent measures to combat the informal economy.
Activities envisaged in the MoF’s Action Plan are based on support and encouragement of formalization of the informal activities by promoting the advantages when entering the formal economy. Activities that are part of the Plan are based on the positive experience of the EU Member States. They cover both sides of the informal market – supply and demand. As regards the demand side, stimulations and preventive measures are envisaged for transition to formal products and services by reducing the costs therefore and providing equal conditions for all companies. With respect to the supply, formality is and will be encouraged within the whole supply chain, by stimulating measures (and tax exemptions) for the fully formal companies. Thereby, special focus is put on enhancing the efficiency of inspections and oversight in order to ensure greater equality of all market participants.
The measures also pertain to modernization of the processes, for instance e-commerce, which gains momentum and creates unfair competition for the small- and medium-sized enterprises as the main driving force of economic development. Following are the priorities: improving the process of measuring, monitoring and detecting the informal economy, stimulating activities for formalization of the informal economy, raising the awareness about the informal economy and strengthening the tax morale, enhancing the inspection services, strengthening the legislation, as well as implementing measures as regards the Customs Administration, which will also include e-commerce products. Initiatives, also expected to contribute significantly to the combat against informal economy, include reduction of cash payments under the new payment system and payment services reforms by liberalizing the payment operations and introducing FinTech solutions, in addition to the banking sector solutions, at the beginning of 2023, introduction of e-invoice system and e-fiscalization by the PRO, as well as introduction of track and trace system for the excise goods (in particular tobacco and alcohol beverages) by the Customs Administration, and other digitalization processes in these two institutions.
Informal economy is dynamic and endures, but it can be reduced
Informal economy is an activity which quickly adjusts its forms to the new modes of operation and the continuous changes in the way economic activity operates and business models. Hence, combat against informal economy should be a dynamic process, attentively monitoring and creating strategies to efficiently address the inefficiencies of both the system and the institutions in combating this phenomenon. Trends of globalization, digitalization, cross-border informal economy and changes in the modes of operation and the business models remain to be a challenge, hence they should be included in the strategies for combating this phenomenon. Therefore, activities are continuously being implemented, aimed at reducing the informal economy and its further formalization, since it is the key step towards establishing a functioning market economy, equal working opportunities and sound competition. Formalization of the informal economy and eradicating tax evasion will provide for increased tax revenues, with a possibility for the government and the institutions to render better quality services and greater social security to the citizens.
Moreover, the goal is to also increase the fairness of the tax system, improve the trust among the economic agents, the government and the citizens, and strengthen the tax morale. Formalization of the informal economy is especially important for the vulnerable categories, providing for their better social protection and security, as well as access to other benefits arising from the employment.
I would single out the MyVAT Project as a success story, with thousands of citizens participating for almost four years, thus contributing to reducing the informal economy. Citizens’ tax morale is thus strengthened. All those scanning are inspectors in a way, and the compensation they receive on the basis of VAT refund is just symbolic compared to the benefits yielded later on through delivered public services. Monthly VAT refund will be increased starting next year, thus motivating the citizens even more to combat informal economy.
Reduction of informal economy requires involvement not only of the government, but also of the business entities and the citizens. Personal decision not to be part of the informal economy by requesting a fiscal receipt or an invoice for each payment made could contribute thereto.
“Not worthwhile to be part of the informal economy”
According to the economic logic, if we are to reduce the informal economy, we should make it economically “unattractive”. In other words, by making the informal economy unviable, interest in operating in this zone will be reduced. In economic terms, opportunity cost of informal economy should be increased, i.e. to increase the potential benefits foregone, the advantage they would have if operating in the formal sector. This can be achieved by increasing the costs of the informal sector or the risk of operating in the informal sector on one hand, and increasing the benefits in the formal sector on the other.
Reducing bureaucracy and strengthening the institutions
In addition to these financial benefits and costs, improved business climate, strengthened institutional capacities, reduced bureaucracy, increased efficiency of the institutions, including the inspection services, as well as streamlined procedures for registering and doing business, also play a significant part in reducing the informal economy. I would emphasized that strengthening the formal sector is a strong signal for the investors, both domestic and foreign. They should recognize a strong and reliable system, fair to all and protecting the entities therein. As an economy we can offer a lot, which is already recognized by the foreign investors having invested in our country even amid the most severe crisis. Clear example of this are two German investments in high-tech production capacities. The first investment, amounting to EUR 130 million, made in construction of a factory was launched yesterday, it will employ 900 workers and will produce electrical vehicles, and the second investment, amounting to EUR 126 million, is made in the pharmaceutical industry and was promoted in June this year. Combating informality is very important since it provides for additional security to the economy to remain as a desired destination of the foreign brands which, in turn, yield many economic benefits.
Simple and efficient tax system put in place is also important, as well as is the strengthening of the accounting standards (envisaged in the new Law adopted last month), innovation executive programs on leadership and entrepreneurship, which will contribute to enhancing the decision-making process and accordingly the competitiveness and performance at work. Needless to say, raising the tax morale and the public awareness about the implications of the informal economy will also play a key role, thus informing about the possibilities for each individual to personally contribute to the reduction of this phenomenon, thus providing for better quality of life.
Before I end up this column, I would like to once again emphasize what I wrote in the previous one, also reiterating it during the public debates, that being that tax reforms are not an end in itself or merely for fiscal purposes, but we rather tend to ensure greater transparency, efficiency and fairness of the tax system, in support of the economic growth and better quality of life. Coupled with the reforms on the budget expenditure side, the fiscal rules and the improved public finance management according to the SMART Finance concept, greater support to the economy and investment incentives will be provided, competition will be boosted by supporting R&D investments, green transformation, digitalization, as well as support to vulnerable groups, ensuring better quality health and education, human capital strengthening, infrastructure improvement. They will be all included, through a transparent and accountable process, in the Budget and the medium-term framework, to be designed on the basis of “value for money” concept and monitoring tools on the basis of so-called key performance indicators as regards the budget policies.
At the end I would like to point out that if everyone pays his fair share of public duties, not only we will all pay less, but we will also live better, together sharing the benefits of the improved system we will build together.
“Ask not what your country can do for you — ask what you can do for your country”. (J. Kennedy)
Fatmir Besimi, Minister of Finance