4th December 2022, Skopje –
Tax reform concept, presented at the last week’s joint press conference with the Prime Minister, is part of an extensive process aimed at creating an optimal tax system that will be fair, while underpinning the economic growth at the same time. Tax reform fundamentals were laid under the 2021-2025 Tax Reform Strategy, adopted by the Government at the end of 2020, as part of the Government’s Work Program. Its main objective is to ensure fair, efficient, transparent and modern tax system based on state-of-the art digital technologies and innovations, all to the end of attaining an accelerated, inclusive and sustainable economic growth.
Under the Strategy, five priorities have been defined for the tax policy makers and the bodies responsible for administering the public revenues, such as greater fairness of taxation, in order to ensure that everyone pays its fair share of tax. The second priority is attaining more efficient and effective revenue collection, via analysis and finalization of the tax base, strengthening the capacities of the institutions, modernizing and automating the respective processes, as well as stronger institutional coordination. In addition, increased tax transparency is also one of the set priorities, all to the end of enhancing the legal framework for transparency and exchange of information, cooperation between the financial institutions and the tax administration in the Republic of North Macedonia and the financial institutions and the tax administrations from the other countries, as well as greater stimulus for taxpayers to report all relevant information. The fourth priority includes better-quality services, i.e. simplifying and speeding up the procedures and reducing the administrative burden, while the last one is introduction of environmental (“green”) taxation, aimed at encouraging the taxpayers to reduce the activities, which cause environmental pollution, as well as stimulating taxpayers to use renewable energy sources, protect the natural resources, sustainable economic development and improved quality of life.
Optimal Tax System
As per the economic theory, the principles of an optimal tax system are fairness and equality; stability, predictability and legal certainty; neutrality; financial coverage of the needs for performing the public functions and rendering the services; convenience and clarity of the rules and cost-effectiveness, i.e. a positive ratio between the collected public duties and the administrative costs for their collection. In his book “The Wealth of Nations”, Adam Smith identified four principles of taxation: fairness, certainty, convenience and efficiency. According to the world-renown economists Mankiw, Ramsey and Mirrlees, the optimal tax system should be chosen to maximize a social welfare function subject to a set of constraints.
At the beginning of the nineties, by introducing the new social system in our country, a new fiscal system was also put into place, based upon the principle of allocative neutrality of the taxes and the budget, as per which, fiscal policy instruments will not favor certain sectors. Since then onwards, few major tax reforms have been implemented, among which the introduction of the Value Added Tax, which replaced the previous sales tax on goods and services. Income tax rate was also changed at several occasions, turning from progressive into proportional tax rate, and vice versa.
Tax system is a dynamic matter, which ensures the efficacy of the state apparatus and the public services, also playing a role in allocating the funds, all to the end of encouraging the economic growth and development. Accordingly, it should change over time so as to be able to keep pace with the contemporary setting and needs. For instance, new technologies and digitization fundamentally change all social and economic processes, also including the tax system in terms of taxes and incentives, as well as from the aspect of simplifying the administrative processes and saving money and time.
Higher Revenues than Taxes in Support of Better-Quality Public Services
Data show that tax collection as a percentage of GDP in our country is below the percentage in the countries in the region, being, at the same, far below the average of the 27 EU countries, as well as the developed countries. The need for changes is evident if historical data on the quantitative indicators of the tax system efficiency are considered. Gap between the share of revenues generated from taxes and contributions in GDP in the EU-27 and North Macedonia, is significant, i.e. in 2008, total tax revenues and social contributions accounted for 38.4% of GDP on average in the EU-27, while accounting for 27.7% in our country, or by 10.7 percentage points less. The gap during the analyzed period 2008 – 2020 deepened, reaching 13.9% in 2020. Compared to Western Balkan countries, by only analyzing the tax revenues without the social contributions, share of tax revenues in GDP is convincingly the lowest in our country, accounting for 16.1% in 2020, 23% in Montenegro, 22.3% in Kosovo, 20.1% in Serbia and 17.3% in Albania. If analyzed for a longer period of time, a negative gap is constantly recorded in our country compared to the region. This is a result of several factors such as lower tax rates, higher tax exemptions, as well as coping with the informal economy, coupled by the respective efficient collection.
World Bank experts point out that the share of tax revenues in GDP is significant for the economic growth and the poverty reduction, since it is necessary for the countries to have the required funds at their disposal, so as to be able to invest in the future and achieve sustainable economic growth. This is also a significant signal for investors in terms of the country’s capacity and its sustainability in servicing the liabilities. Developed countries usually have a higher share, with the average in OECD countries accounting for 33.8% in 2019, or twice the average in our country.
Analysis of the total tax collection as a percentage of GDP, as well as the separate taxes as a percentage of GDP, covering the period 2008 – 2020, demonstrates that a more comprehensive tax reform is needed, thus providing for having a more efficient tax system in place. Additionally, this need has been reinforced over the past three years, when our country, along with the whole world, faced the most serious economic challenges since the Great Depression onwards. Subsequent shocks and the Government’s response to their mitigation have provided for narrowing the fiscal space in our country, as in most of the developing countries. Following the pandemic-induced crisis, fiscal consolidation became both a need and a priority as regards public finances. This means that it is necessary to streamline the expenditures, as well as optimize the revenue side.
Tax Expenditures and Economic Justification
Tax expenditures are the systemic difference in the tax treatment of certain categories of taxpayers or activities, at the expense of which, less taxes are collected in the Budget. Simply put, it is a matter of a financial support for certain categories of citizens and companies, through certain tax exemption or a lower tax rate than the regular one, so as to accomplish some social, economic or social purpose for a certain period of time. When determining these tax exemptions, greater economic benefit than the tax expenditures has always been the desired goal.
Over time, after these indirect budget transfers have served their purpose, they become an unnecessary burden to the budget, while making certain category of citizens and companies unnecessarily privileged over the other ones. In that case, the damage caused by these exceptions is double, both upon the budget and the other taxpayers, thus increasing the chances for unequal treatment of certain categories under the tax system.
Most of the Organization for Economic Co-operation (OECD) and the European Union (EU) countries, as part of the budget process, require preparation of reports on tax expenditures on annual basis and cost-benefit analysis thereof. This is aimed at ensuring greater transparency for the policy makers, the MPs and the general public by disclosing data on the foregone revenues resulting from the tax relief.
Under the IFIs’ reports on our country, high tax expenditures are indicated. In addition, when analyzing our tax system, huge amount of tax exemptions can be noticed, as well as a long list of goods and services being taxed with preferential tax rates, the most extensive one compared to all countries in the region. Some of the exemptions date back to a long period of time ago, which, over time, served its purpose, and became ineffective. Nowadays, they are only additional costs for the Budget and an unjustified privilege for certain taxpayers, thus creating a market distortion.
By being committed to building a just tax system, which will be fair for all taxpayers, as well as efficient, by playing its redistribution role and underpinning the economic growth, we took the tax expenditures as a starting point. Primary objective of the new tax concept, being part of the broader tax reform, is broadening the tax base. Broadened tax base implies increased number of taxpayers. This will be attained by reviewing the tax expenditures having already served their purpose, as well as by incorporating some of the entities from the informal economy into the formal economy through the uncompromising fight against the informal economy.
Under the new Organic Budget Law, and by following the suit of the OECD and the EU, systemic solution was introduced, i.e. an obligation to prepare annual reports on tax expenditures and their revision as per the impact thereof.
Inclusive Process for Optimal Tax Concept
On the basis of the Tax Reform Strategy, draft concept was prepared, being part of the overall tax reform. Draft concept was aimed at laying a foundation – an idea as a starting point in the communication process with all stakeholders. Tax reform concept was based upon fairness, i.e. broadening the tax base by: 1) revising the tax exemptions and the preferential rates and 2) fight against the informal economy. Draft concept contained measures with total estimated fiscal implications of Denar 6.1 billion, being based upon prior research and analyses, comparisons with other countries, as well as reports and recommendations by the international financial institutions.
Process of broad debate about the draft concept took place over two months. Meetings and discussions were held with the academicians, the business community, the NGOs, as well as the political parties. During this period, by hearing the individual arguments and analyzing them, some of the measures were withdrawn or postponed and some were revised, while also accepting certain new initiatives. Process of adopting this tax reform is the best illustration of a democratic and inclusive procedure. Reception of the news in the public, which was followed by approval, which is uncommon considering the specificity of the topic, i.e. the fact that someone will always be affected thereby, most accurately speaks in favor thereof.
It has to be underlined that the fiscal effect of this reform is expected to amount to around Denar 4.2 billion (EUR 70 million) which, in times of increased cost of capital on the financial markets, is significant for our commitment to fiscal consolidation.
Under the Revised Tax Reform Concept, which was submitted to and adopted by the Government, amendments to three laws are proposed – Profit Tax Law, Personal Income Tax Law and Value Added Tax Law.
Although considered previously, following the consultations with the business community, and taking into account the specific current economic conditions, we have decided not to tax reinvested profit applying for all types of investments, instead of the initial proposal for the exemption to cover only investments in digitalization and renewable energy source. Still, legal amendment will take place, setting the mechanisms preventing abuse of this exemption, i.e. in case the taxpayer improperly applies the provisions on reinvested profit, the taxpayer will be obliged to pay five-fold the tax amount the taxpayer would have paid when not applying the exemption. Thus, possibility to abuse the tax exemption and tax evasion will be prevented or reduced. Moreover, simplified tax model is envisaged for micro and small businesses with a possibility to choose to pay tax either on the total income or the generated profit. As regards sports donations, the voucher system will be changed, in particular assistance will be rather allocated through a Government program with a direct Budget support.
Exemptions on the basis of paid-in contributions for the workers in the voluntary pension fund remain, all to the end of supporting the human capital development.
Exemptions on the basis of paid-in life insurance for the workers is a measure adopted during the development of the insurance companies in the country. The respective exemptions served their purpose, and the development of the insurance companies should now be as per the market conditions. Should the employer have an intention to keep quality workers, this should not be an obstacle to continuing the payment of the life insurance premium.
Private health insurance premiums for the workers is yet another exemption we reviewed with the analysis and discussed it later on with the social stakeholders. Considering that we see health as one of the priorities from the point of view of human capital, as well as from the point of view of productivity, this exemption remains in force.
Interventions will also take place as regards the exemptions for the companies hiring disabled persons, thus continuing the support for employment of persons with special needs through a special law.
Personal Income Tax
Under the Tax Reform Concept, PIT Law provision stipulating progressive tax rate, which was to be applied starting 1st January 2023, is proposed to be abolished. From the fairness principle point of view, this solution opens a lot of dilemmas. For instance, under the previous solution, if a member in a multi-child family earns a higher wage and the rest of the members earns no income, that particular member would have had to pay higher tax than those members in households in which all members make earnings, although less individually, but much higher as a household. Hence, this context will be also reviewed and further analyses will be made. At the same time, other models of greater fairness as regards PIT will be considered.
In times of high inflation rates, it is important to encourage the citizens to save. Hence, application of the provision in the existing PIT Law prescribing for interest on time deposits to be taxed starting 1st January 2023 will be postponed until country’s accession to the EU.
On the other hand, the provision stipulating taxation of capital gains generated from sale of securities and units issued by investments funds acquired from 1st January 2023, alienated within two years from the acquisition, remains to be in effect, with the annual calculation and payment of tax being envisaged, on the basis of a decision of the PRO prepared according to the data report of the Central Securities Depositary, i.e. the data report of the investment fund management companies.
As regards the PIT Law, non-monetary benefits of managers, i.e. use of official vehicles for personal needs, company’s real estate, as well as acquisition of shares, are more precisely regulated, as is the tax base therefore.
One of the most debated measures, payment of contributions for the freelancers, is set so that they are given the possibility, should they voluntarily choose themselves, to register on a platform and pay contributions depending on the earnings generated – minimum, average or up to Denar 2 million. Once the respective law is adopted, it will apply starting 2024.
Valued Added Tax
Goals which the VAT reform is based on are further strengthening of the principles of neutrality and competitiveness, by narrowing the list of goods and services to which a preferential rate is applied, as well as taxation of certain supply. Moreover, activities are being undertaken to precisely regulate the rights and obligations of taxpayers as regards their right to tax credit deduction, which will provide for greater legal certainty thereof, as well as greater efficiency in carrying out the control.
Considering the ongoing price crisis, and to the end of safeguarding the living standard of the citizens, preferential tax rate on basic food products for human consumption remains at 5%. As for the products other then basic products for basic food consumption, higher preferential tax rate of 10% will be applied.
Furthermore, taking into account the demands and the initiatives at the broad debate, we have reached a decision to introduce a preferential tax rate on menstrual hygiene products, i.e. reduction of VAT from 18% to 5%.
Uncompromising Combat against Informal Economy
Including the informal sector in the formal economy is of vital importance for the broadening the tax base and accordingly increasing the collection of public revenues, without thereby introducing any new taxes and increasing the existing one. This is the first postulate in achieving tax system fairness: “Each taxpayer pays the same tax for the same tax base, no exceptions”. There is no justification whatsoever for not paying the taxes. They should be paid.
Activities are being undertaken, and will be undertaken, to strengthen the capacities for more efficient collection of revenues and reduction of the informal economy, thus strengthening the tax system fairness. Special focus will be put of digitalization of the processes in both the tax and the customs administration, with the implementation dynamics already set, so they can be carried out simultaneously with the tax reform. Public Revenue Office works round to introducing e-fiscalization and e-invoice, with the Customs Administration preparing for the “track and trace” system for excise goods (in particular tobacco, alcohol beverages and oil derivatives), also paving the way for other digitalization processes in these two institutions.
Action Plan for Eradication of Informal Economy envisages a series of measures that will encourage the entities to formalize their business, since it will be more profitable for them and they will yield more benefits therefrom.
Extra Profit Tax as an Initiative from the Public Debate to be Additionally Discussed with the Chambers of Commerce
Extraordinary taxes are a practice many countries around the world apply by imposing temporary taxes amid exceptional circumstances so as to fix the market distortions. Logic behind such taxes in economic theory and policy is based on redistribution of part of the windfall gain certain companies generate as a result of the market conjuncture or other exceptional circumstances. Globally, there are many examples of such solutions throughout history. Similar initiatives exist even now amid energy crisis, whereby some countries propose so-called extra profit tax. New UK Government announced the increase of energy profits levy to 35% for the period 2023-2028 for the energy firms. In May 2022, Hungary announced extra profit tax in the energy sector, the financial sector, the commercial airlines and the retail trade in the period 2022-2023, with the tax rate in the energy sector reaching 65%. In November, Croatia announced extra profit tax for all companies generating revenues higher than EUR 40 million annually, on a profit increase higher than 20% of their annual average in the period 2018-2021. Last week, Italy announced extra profit tax of 50% on energy companies’ profit higher than 10% of the average income in the period 2018-2021, to be applied in 2023.
During the public debate about the draft Tax Policy Reform Concept, many social stakeholders put forwards proposals for imposing extra profit tax. Although many examples exist of countries having imposed extra profit tax, having the principle of inclusiveness as a starting point when defining the economic policies, as we have announced at the joint press conference on tax reforms with the Prime Minister, the respective proposal will be further discussed with the Chambers of Commerce. In the meantime, Ministry of Finance is doing in-depth analyses about the fiscal and the economic implications.