Economic analysts welcome the tax relief announced by technical Minister of Finance Zdravko Marić, but warn that it is just one cog in the entire chain of necessary measures for the Croatian economy to become more competitive.
“Tax relief is certainly welcome, especially considering that it is relatively higher in Croatia compared to comparable countries, so along with all other problems, it is not encouraging,” says Zrinka Živković-Matijević, director of the Economic Research Directorate at Raiffeisenbank Austria (RBA).
Technical Minister of Finance Marić announced that starting next year, there will be a relief on wages and an increase in the non-taxable portion of income to 3,700 kuna, as well as an expansion of tax brackets and a reduction of the highest income tax rate, which will apply to incomes above 20,000 kuna.
Marić also announced a reduction of the general corporate tax rate from 20% to 18%, while farmers, craftsmen, and small entrepreneurs whose annual income does not exceed 3 million kuna will pay corporate tax at a rate of 12%.
“Reducing the tax burden and increasing the disposable income of citizens would, in itself, positively affect consumption, and a lower corporate tax would ease the business environment for the private sector,” says Živković-Matijević.
Marić intends to also reduce the general VAT rate by 1 percentage point, but additionally, when conditions are met, that is, when the GDP growth rate is even higher. In doing so, he will redefine the goods and services to which the reduced VAT rate applies.
“However, tax reform alone will not solve the structural problems of the public sector and the weak investment climate and represents just one cog in the entire chain of necessary measures,” says Zrinka Živković-Matijević.
We Must Not Return to the Pre-Crisis Model of Stimulating Growth
Reducing the tax relief on wages would stimulate household consumption and contribute to strengthening the competitiveness of the domestic economy, believes Zdeslav Šantić, chief economist at Societe Generale Splitska banka.
As he points out, there has been a noticeable recovery in retail trade and personal consumption for some time now, which is a result of the increase in the real disposable income of the population due to previous tax changes and the effects of deflation and recovery in employment.
According to the latest data from the Croatian Bureau of Statistics (DZS), in July, retail trade turnover increased by 4.5% year-on-year, marking the 23rd consecutive month of rising consumption, while consumer prices fell by 1.5% year-on-year in August and July, entering the third year of deflation.
“However, we also see that citizens are borrowing much more cautiously than in the years before the crisis, so the future long-term movement of retail trade and personal consumption will largely depend on the real wage movements, as well as employment,” says Šantić.
According to the latest data from the Croatian National Bank (HNB), total loans to the population at the end of July this year amounted to 117.5 billion kuna, which is 9.3 billion less than in the same month last year, marking a decline for the 13th consecutive month on a year-on-year basis.
Šantić also welcomes the announcement of a potential reduction in the VAT rate, but notes that care must be taken, given the deflationary pressures, to ensure that the reduction in the VAT rate does not result in an even stronger drop in prices.
However, he emphasizes that Croatia must not return to the pre-crisis model of stimulating GDP growth solely through increased domestic consumption.
“Tax relief will certainly contribute to strengthening competitiveness, but if there is no increase in competitiveness through other economic policy measures, then the growth of the domestic economy will be fragile and threatened in the event of any disturbances,” says Šantić.
He generally believes that the direction of the announced tax reform is good, as it should aim to relieve the cost of labor, that is, to reduce it.
The relationship between labor costs and productivity is quite unfavorable, especially when compared to other economies in the region, and this, as he notes, affects the inflow of investments and the overall potential GDP growth.
“Although the high cost of labor in Croatia predominantly comes from contributions to the pension and health systems, the fact is that the high progressivity we had through income tax has discouraged the restructuring of the economy towards activities that create higher added value, as well as discouraged employers from raising wages and caused a certain degree of tax evasion, that is, undeclared work,” emphasizes Šantić.
For Croatia, he highlights that it is crucial that it is a small economy that has a clear shortage of labor in a quantitative sense and can no longer engage in labor-intensive activities of low complexity.
“The announced tax reform should reduce this progressivity and thus positively affect the overall restructuring of the Croatian economy,” says Šantić.
A reduced tax burden on labor could attract investments in key export-oriented activities, as well as more complex production, thereby creating greater potential for new employment, he says.
Necessary Compensatory Measures for Local Government Units
He notes, however, that revenue from income tax predominantly goes to local government units, so their budgets could face difficulties as there has been no reform of local self-government, and some compensatory measures will need to be introduced.
Likewise, he points out that care must be taken not to jeopardize their financial capacity to participate in co-financing EU projects, which are an important lever for Croatian economic development.
“It should be noted that in the upcoming period, it will be necessary to implement a property tax, which would allow local government units to compensate for part of the lost revenue. For now, this is not yet mentioned, however, this tax is necessary if Croatia wants to continue with the relief of labor costs, which it has also committed to the European Commission,” concludes Šantić.
