Lovrinčević on Tax Reform: Entrepreneurs Have Been Given Space, It Is Up to Them to Utilize It

Renowned economist Željko Lovrinčević, also one of the creators of the comprehensive tax reform presented today in an interview for Lider comments on its fundamental features.

– This is a package of tax relief with the greatest effect in the income tax system, which has been extremely complex, with many exceptions, numerous and different personal deductions, special areas, and so on. It has therefore been punctured in many places and in many ways, and now it has been significantly simplified. The concept of synthetic taxation of dependent and independent work has been introduced, and for income from property, final payment has been established, which reduces uncertainty. Looking at the general effect in the system, income is essentially increasing for everyone, although depending on status and modalities – for example, the number of members or children in a particular household. This also applies to people with the lowest incomes, as the non-taxable portion has increased to 3,800 kuna. This part of the tax reform is good and is not questionable because the overall tax burden in Croatia is reduced to 6.3 percent, thus entering the category of countries with low effective tax burdens.

The proposals suggest social awareness; the minister said today that they are, as much as they can be, aimed at demographic renewal.

– I think that this, in my opinion, could have been resolved more effectively in the part related to dependent family members and the treatment of children. The proposal still retains different, progressive coefficients for the number of dependent children or household members, with the flaw that it cannot actually help poor citizens who have children. These are people who cannot utilize the tax shield because they have no income. I believe that the entire system, when we talk about child care, should have equal coefficients in the lower part, and to assist demographic trends, we should resort to other instruments, namely through another ministry responsible for child allowances and pro-natal benefits. In other words, you cannot help the demographic segment except at levels starting from 8 or 9 thousand kuna. Those who are lower simply have nothing to deduct, and that is my biggest complaint. People with lower incomes simply cannot benefit from tax progression based on the number of dependent children and members. We should model the entire system according to, conditionally speaking, the Austrian model, that is, through the system of child allowances and child care that does not finance parents, but rather children. Let’s call it per capita financing of children. This, in my opinion, is the weakest link in the changes to income tax; the rest is OK.

OK, what do you say about the changes in corporate tax?

– In corporate tax, the main intention is to shift part of the tax burden onto non-residents or tourists, or to return it to where it was before Linić’s experiments with rates that showed that lowering rates for hospitality, drinks, and similar did not result in lower prices. The idea is to pull some money and income from that segment so that the other two segments can be relieved. One is inputs for agriculture to encourage competitiveness, and the other relates to alleviating municipal and other expenses for the most socially vulnerable. This includes electricity consumption, waste disposal, and other significant expenses for the poorest. The goal is to relieve them and partially mitigate the impact of VAT, which is very regressive for the poor. Of course, there will be much discussion about this, as everyone has their own linguistic story. However, we must know that if we do not shift part of the burden towards the tourism sector, we cannot achieve actual relief for Croatian citizens, agriculture, energy, and the poorest. The regressive effect of VAT is terrible; at this moment, the bottom 20 percent of the poorest in Croatia pay a higher VAT than the wealthiest tourists.

What changes would you highlight as interesting for entrepreneurs?

– There are quite a few changes in the work and organization of the tax administration; for example, the possibility of recognizing part of uncollected receivables as tax deductions is being opened. These parts are interesting to entrepreneurs but are relatively technical in nature and less interesting to citizens. There will be more discussion about this when the details are released; the minister has only presented a small part, and this is a large area with many changes.

How do you comment on the changes in property taxation?

– In the property transfer tax system, the rate is reduced from five to four percent, but the exemptions for the first property are abolished. The intention here is to stimulate the real estate market and facilitate the transfer of ownership. I believe that this rate will continue to fall and could be around two percent. When you introduce a tax on classic property, you apply it either to ownership or transaction. You cannot tax both.

The reform also raises the question of sustainable financing of local self-government. The minister has insisted in recent days that he will compensate for potential losses in local budgets.

– Local self-government must undoubtedly retain part of the revenue they have, and losses should be compensated through the budget. This has not been the case so far, and they have always lost. Units should be financed through property tax; this is their natural, original, own income, and it is actually the only long-term solution for financing local self-government. Everything else implies a transfer of money.

Is this reform heading towards fiscal or internal devaluation?

– It is, in principle, on that track. It is primarily aimed at reducing costs for entrepreneurs; you can now nominally have wage growth through reduced tax pressure. For the private sector, there is also room through the reduction of some input costs, through lower rates for agriculture and other inputs. The sector should feel relief regarding liquidity and costs. Looking at the whole, the reform leaves the private sector room to make a new, its own calculation.

In theory, there is room for encouraging more competitive exports?

It should be so; what the private sector will specifically do with that space is now hard to say. The question is whether this will result in higher net wages, higher net profits, or somewhere in between. That is up to employers and employees, but the space is open. The cost of labor has been significantly reduced, from 7.5 to 6.3 percent, thus opening up one percentage point. Whether you will transfer this to wages, profits, or depreciation as a cost for technological renewal, these are questions for each private entrepreneur. Finally, one of the intentions of the changes was also to open this space for growth in competitiveness.

We hear a lot about revenues and little about expenditures; is the reform fiscally sustainable?

– Here, we need to answer numerous questions; first of all, local self-government, the long-term sustainability of so many units. This is only the revenue side of the budget; it can be covered, but the expenditure side needs to be kept under control. I assume that for this year there is an intention to keep expenditures at nominal levels from last year. It should be noted that these are only proposals and that lobbying and phone calls will now begin. Politicians have a tendency to puncture zero proposals, and I hope that they will not do too much of that this time. The income and profit tax system has so far been very, terribly punctured with that complex system of exemptions that were no longer clear to anyone, and in the end, only one percent of entrepreneurs used them.