Further Strong Decline in Public Debt. Will There Be Tax Relief?

Croatia records the fifth largest decline in public debt among EU member states. Namely, the share of Croatia’s public debt in GDP fell in the second quarter by almost six percentage points to 66.5 percent of GDP, compared to the same period in 2022.

This is contributed by a strong nominal GDP growth (around 13.5 percent), resulting from high inflation, a tax-generous recovery in tourism, and a strong influx of EU funds, despite a significant increase in wage mass, indexing of pensions and social benefits, and increased interest costs, states the weekly macroeconomic analysis of the Croatian Employers’ Association signed by their chief economist Hrvoje Stojić.

On a cumulative level over the last four quarters, Croatia is at the end of the second quarter of this year in a zone of very low budget deficit (-0.4 percent of GDP), ranking among the seven best EU member states.

Last year, Croatia recorded a surplus of 0.4 percent of GDP, while this year we expect a slight deficit of 0.5 percent of GDP due to the effects of full implementation of collective agreements and new anti-inflation transfers to the population. In 2024, the deficit will rise to two percent of GDP due to the waning strong growth of tax revenues and the impact of a super-election year on budget expenditure trends.

The good news is that public debt remains on a downward trajectory towards a share of 60 percent of GDP in 2024. For the record, compared to the pandemic ‘maximum’, our public debt will be reduced by almost a third in 2024, which is one of the best results among all EU member states.

Croatia is one of the few countries in the CEE region that are improving indicators in public finances and one of only three that will not face entry into excessive deficit procedures in the coming year.

Trends in Public Finances ‘to be Desired’

The decline in the share of public debt and the low budget deficit may be slowed or threatened by weaker economic growth compared to expectations. Namely, in addition to the vulnerability of commodity exports due to recession in the euro area, further growth in tourism is limited by the restraint of investments compared to pre-pandemic years and restrained demand for travel in an uncertain environment.

Additional expenditures in healthcare, defense, and within the framework of common EU policies for subsidies for active industrial and climate policies, as well as increased expenditures for interest on public debt, may also negatively affect the budget balance.

Along with the trends in public finances ‘to be desired’, the decline in gross financing needs to the lowest level in 15 years (11 percent of GDP), as well as a series of positive ratings from rating agencies leading towards achieving an ‘A-‘ rating level in 2024, the question of tax relief in the economy aimed at strengthening the Croatian economy in the single market is once again brought to the forefront.

As gross wage growth accelerates to 15 percent from eight percent last year, along with employment growth above 2.5 percent, the local government surplus will be above plans, opening up space for stronger wage relief through lower tax rates – along with a more agile (completely unutilized) tax treatment of tourist rentals.

Actively utilizing the fiscal space of local government units encourages competition in the business climate, price competitiveness of labor in Croatia, and dynamism in entrepreneurship. It is extremely important to relieve the income of highly qualified labor and promote its employment to raise the level of productivity per working hour from just 68.4 percent of the EU average.

To this end, Croatia could, as part of an ambitious relief for highly qualified incomes, lower the average tax wedge by almost ten percentage points from 42.5 percent in 2022, concludes Stojić in the analysis.