HUP: The Decline of Public Debt Opens Space for Strong Tax Relief

The decline in the share of GDP and favorable forecasts for the further movement of public debt open space for strong tax relief, it is assessed in the weekly analytical contribution of the Croatian Employers’ Association Focus of the Week, signed by the chief HUP economist Hrvoje Stojić.

Stojić reminds that the European Commission has significantly reduced its estimate of the Croatian budget deficit in 2023 to just -0.5% of GDP, down from -2.4% of GDP in November last year, while the deficit estimate for 2024 has been halved to 1.3% of GDP. This places Croatia among the top three EU member states in terms of expected improvement in the balance compared to the autumn forecasts and ranks it among the six EU member states with the most orderly public finances.

Of all member states, projections for public debt have improved the most for Croatia in both years, allowing it to fall slightly below 62 percent of GDP by the end of next year, or below the Maastricht threshold of 60 percent, after adjusting for a significant budget reserve (around five percent of GDP). In addition, Stojić notes, Croatia has reduced the cost of interest on public debt to just 1.2 percent of GDP in the next two years, which is 0.5 percentage points below the euro area average. Finally, in 2023, the gross financing needs of the state are falling to 12 percent of GDP, the lowest level in 15 years.

Thus, the picture of public finances is significantly better than many expectations, and this is one of the key prerequisites for comprehensive tax relief, which, along with strong labor productivity growth (+2.7% annually over the last three years or 2 percentage points above the euro area average), would further strengthen the competitive position of Croatian companies, says the chief HUP economist.

He adds that due to one of the lowest activity and employment rates, Croatia should opt for a bolder reduction of the tax burden compared to the reference averages of EU member states or CEE countries, according to OECD recommendations for creating sustainable and quality jobs.

HUP Welcomes the Contribution of Local Government to Tax Changes

In this regard, HUP welcomes the announced new round of tax relief for labor, among other things, through a certain contribution from local government. Stojić reminds of last year’s surplus in the local government budget balance of 0.6 percent of GDP.

– A stronger than expected positive balance of local government as the owner of income tax in an environment of accelerating wage and employment growth is a welcome opportunity for local government to contribute to the price competitiveness of labor costs in Croatia – concludes Stojić and recalls HUP’s proposals for tax changes.

These include increasing the personal deduction by 25 percent from 530.89 euros (4,000 kuna) to 663.61 euros (5,000 kuna), reducing the lower income tax rate by five percentage points from 20 percent to 15 percent, and increasing the nominal threshold for applying the higher income tax rate (30%), i.e., the amount to which this rate applies above the gross amount of 3,981.68 euros (formerly 30,000 kuna).

– Croatia taxes above-average income from work of highly qualified individuals more progressively than is the case in most transitional countries in the CEE region, which are our fiercest competitors in attracting investments in sectors with higher added value. Among other things, this is why we have seen an increase in the number of highly qualified employees who are abandoning traditional employment contracts in favor of alternative forms of income that contribute significantly less to solidarity health and pension systems (so-called flat-rate taxpayers), which ultimately burdens the state budget – says Stojić.

He reminds that HUP also advocates limiting the maximum amount of contributions for pension and health insurance to four average salaries for all payments to employees under employment contracts.