IREF Yearbook Taxation 2011

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Taxation in Europe 2011The yearly report on the evolution of European tax systems

a publication from theInstitute for Research on Economic and Fiscal Issues

Edited by Pierre Garello


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About IREF

IREF is a private institute founded in 2002 by representatives of the civil so-

ciety coming from the academic as well as business worlds. It is designed to be an

efcient platform for the investigation of scal and taxation policies. Taxation is

a many-faceted issue and existing studies are mostly incomplete if not biased. It

is the aim of IREF to explore systematically and completely questions related to

taxation and public nance.

IREF has a strong European dimension. Tax studies can no longer ignore theprocess of globalisation and its consequences in terms of tax competition. In

particular, tax authorities are currently under the strain of two opposing forces:

centralisation and harmonization on one hand, devolution and competition on

the other. It is IREFs intention to reintroduce in this debate the essential links

between tax competition and individual freedom.

In order to achieve its goals, IREF relies on a network of specialists. Today, a

team of over 25 scholars or professionals--economists and lawyers--report regu-

larly on the quantitative as well as qualitative evolution of the scal systems of

their respective countries or regions.

Besides its Yearbook on Taxation in Europe, IREF is editing books, reports,

briefs and academic studies on topics related to taxation and public nance.Those studies together with general information on taxation in Europe can be

found on IREF website at: http://www.irefeurope.org


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Taxation in Europe 2011The yearly report on the evolution of European tax

systems

a publication from theInstitute for Research on Economic and Fiscal Issues

Edited by Pierre Garello

IREF 2011


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A short presentation ofIREF Yearbook on taxation in Europe

Series

Among the many ways to understand the climate of opinion and the culture

of a country, looking at its scal system is one of the most rewarding. Sure, scal

systems almost always rhyme with complexity; each system bearing the weight of

its history. But the attempts to change the system, to give it a new direction, are

highly instructive.

To observe changes, debates and new directions in tax systems is preciselywhat IREF yearbook is all about. In that sense, the yearbook is not in direct com-

petition with other yearly reports on taxation that typically focus on numbers

rather than on the philosophy behind them.

Another unique trait of this yearbook is to provide the latest information

on the topic. What is presented here are the last known gures (this year, data

for 2010) and the on-going debates. This approach allows the reader to judge

whether public decision makers have been keeping their promises or have been

victims of inter-temporal inconsistency; drawing plans that they are later unable

or unwilling to maintain.

The yearbook is conceived for all those who look for a dynamic understand-

ing of tax and budgetary policies. This includes scholars and students, of course,

but also journalists, businessmen and public decision makers. While avoiding

technical jargon, authors do not hesitate to enter the details of a mechanism

whenever it is necessary. For we all know that there is sometimes a world between

notional and real taxation.

Those reports can be used all along the year for quick reference whenever

mention is made of one of the twenty countries presented here. The country

prole cards, that have been added this year for the rst time, should further

facilitate such use of the yearbook.


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Table of contentsMain findings for 2010 11 Austria

Belgium 21Bulgaria 31Croatia 39Czech Republic 44Denmark 53

France 66Germany 73Italy 80

Lithuania 86Luxembourg 95 The Netherlands

Norway 106Poland 118Portugal 126Slovakia 140Romania 147Spain 157Sweden 166Switzerland 173United Kingdom 179Country Profiles 189

Austria 2010 Belgium 2010 191Bulgaria 2010 192Croatia 193Czech Republic 194Denmark 195France 197Germany 198Italy 199Lithuania 200Luxembourg 201Netherlands 203

Norway 204Poland 205Portugal 206


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Romania 208Slovakia 2010 209Spain 210Sweden 211Switzerland 212

United Kingdom 213


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10 Taxation in Europe 2011


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11Main findings for 2010 Pierre Garello

Main findings for 2010

Pierre Garello

IREF

Balancing between constraints rather than reforming

Once again, IREFs yearbook on taxation conrms that in Europe, includingwithin the European Union, scal policies are far from homogeneous.

One obvious reason for this is that countries are not confronted with similar

situations. While some, such as the Netherlands, Norway, Slovakia, Luxembourg,

Germany, Sweden or Switzerland, are close to a balanced budget, others are more

or less - and sometimes badly - in need for scal consolidation. The latter group

of countriesthose that must urgently reduce public decit and public debt,

forms a large majority.

But divergences between scal policies can also be traced back to ideolo-

gies. If today almost no one suggests that decit and debt could safely be in-

creased (a good point at last after many stimulus packages had to be swallowed

in 2009!), only few believe that the present situation calls for a deep rethinking

of the welfare state. Almost nowhere politicians behave as if the sovereign debt

crisis was calling for a fundamental reorientation of economic policies.

As a result, in most countries 2010 was a year of mildbut sometimes pain-

fulreforms aimed at balancing the budget or at least at getting the budget

closer to balance. Surely, many governments hope that a strong economic recov-

ery will allow for a progressive reduction of the share of the state in the economy

and, more importantly in their opinion, to the much-desired scal consolida-

tion. This scenario is, however, very unlikely. For one thing, the general level oftaxation remains much too high to be compatible with strong growth. But also,

the social acquis that make the welfare state require expenses that are likely


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to grow at least as fast as the economy. Such is the case with unemployment

benets, free access to schooling and university, health care benets, etc. As an

illustration, end of 2010, hundreds of doctors in Czech Republic threatened to

quit their jobs and leave for countries with more doctor-friendly environment.

What they must understand, however, is that no real improvement for them will

be taking place unless deep reforms are implemented.

What needs to be done is to demystify the notion of social acquis, and, as

all the signals of public nances are turning red, it could be the right time to do

so. It could be the right time to explain that wealth and welfare cant be writtendone in the lawIf citizen have a right to the pursuit of happiness, one cant

guarantee a right to happiness! As a matter of fact, sound economic analysis

teaches us that state-run redistribution mechanisms are difcult to sustain in the

long run and that a much safer and fruitful mechanism for development is to

make individuals responsible for their future. Pooling of risks being of course

welcome.

Trends in taxation

Having made the choice to balance the budget and to restore growth by all

means without introducing structural changes, we observe almost everywhere a

mix of various, predictable policies. More precisely, the trends are:

to lower ormore oftento leave unchanged rates related to direct taxation

(corporate and personal income taxation), but often with a broadening of the

basis (getting rid of exemptions, tax-credits and the like)

to increase indirect taxes, starting with VAT and continuing with excises

to increase top marginal income rate (because, it has argued, an increase of

VAT harms more the low than the highest incomes)to increase international co-

operation between tax authorities.But these are just trends. In reality, everywhere the making of a scal law re-

mains, as Bismark used to say, like the making of sausage - you dont want to see


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13Main findings for 2010 Pierre Garello

how it is produced! To illustrate, IREF fellow in Sweden reports that the Swedish

income tax system has become so complicated that the most reliable source of

information is a privately owned and operated website (www.jobbskatteavdrag.

se).

Some of the most original and diverging moves

Reading the twenty reports published in IREF 2010 yearbook, one will get a

taste of the various sausages put together by each government and realize thateach one is somehow unique; some, like the Portuguese one, being particularly

spicy in 2010.

Interestingly, one also notices conicts between recipes. For instance, at the

very moment where France is painfully getting out of its local business tax (a tax

that used to be based on payroll), the Germans are thinking to introduce one!

Germany also got a new trick: Taxpayers have a right to receive interest pay-

ments by the tax administration if refunds take more than 15 months. From 2011

on, these interest payments themselves will count as taxable income.

Lithuania has learned a good lesson in economic theory and mechanism de-

sign: The state having decided to pay mandatory health insurance contributions

for the unemployed, a surge in unemployment gure followed as a number of

individuals ofcially registered unemployed in order to avoid having to pay con-

tributions. The mechanism was then amended.

Romania also received a good lesson. The making of the Romanian sau-

sage was made of an increase of VAT by 5 points (from 19% to 24%) and a

shortening of the list of goods beneting from a preferential rate. The result of

this double increase of rate and base was a disappointing increase of VAT rev-

enues of only 10%. At the opposite, Sweden that consistently lowered taxes for

the past four years was rewarded with higher revenuesGovernments also adopt different recipes to ght fraud and tax evasion.

Hence, in late November 2010 the German Constitutional Court has ruled that


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the fact that data on clients of foreign banks had been collected illegally does

not protect tax evaders from prosecution, even if the accusations rely entirely on

illegal sources of information. But in the same time, the Belgian court took the

opposite direction.The Brussels Court of Appeal has conrmed the judgment

of the Court of First Instance rejecting the claims of the Treasury based on list-

ings that came into the possession of the Treasury through the commission of a

crime, namely theft by dishonest employees

Many lost opportunities

Reading last years reports we had the feeling that something was cooking but

it wasnt clear yet what direction the various governments would take. For once,

everyone shared the view that changes had to be implemented, that the bill was

no longer affordable. The title of the preface for the 2009 yearbook was: 2009,

A transition towards what? One year later, one must sadly observe that little has

happened. The goal was survival, not the setting of a new dynamics. As our UK

report puts it, 2010 was a year of lost opportunities in the midst of scal panic.

As always in Europe, and fortunately, this is not everywhere the case.

One of the best moves in our opinion took place in Slovakia where employ-

ees will from now on be paid a super-gross wage (superhrub mzda in Slovak).

This means that each employee will receive on his bank account not only his

regular wage but also the social and health contributions that used to be paidby his employers. Hence the wage received will express the total labor cost. This

is in stark contrast with rules prevailing almost everywhere in Europe. More

importantly, it constitutes the best way to prepare the ground for true reforms;

making taxpayers aware of the costs and benets of the prevailing systems.

2011 is again a year full of uncertainty due, in particular, to the crisis of the

euro-zone that is far from being over. Nonetheless, for decision makers that areconvinced that further postponing reforms is unwise, interesting ideas such as

the one just mentioned can be drawn from those reports.


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15Austria Stefan Buczolich

Austria

Stefan Buczolich

The Hayek Institute, Vienna

Current situation

Austria is currently one of the countries with the highest tax burdens in Eu-rope with a progressive personal income tax system with top marginal rate at

50%, a corporate tax rate at 25% (lowered from 34% in 2005) and, as will be

explained, a new at capital gains tax rate which is independent from individual

income and amounts to 25% for both short and long-term investments.

Notwithstanding this heavy scal burden, public debt in Austria was approach-

ing 200 billion on 31st of December, that is, about 68.6% of GDP (Source: CIA

World Factbook). This places Austria at the 25 th place globally. Compared to oth-

er Western European countries such as Germany and France with a percentage

of public debt of GDP of 74.85 and 83.5% respectively, and amid rising decits

all over Europe, the short-term risks in Austria still seems to be moderate.

Development of Public Debt since 2006 in absolute numbers and as a per-

centage of GDP

2006 2007 2008 2009 2010 2011Debt ( billion) 145.265 147.376 161.715 168.715 179.1 78 186.903

Debt (% GDP) 56.53 54.18 57.22 61.50 63.42 63.82

Source: Statistik Austria (2010, 2011 estimates)

Because efforts to reform the costly and inefcient administration were omit-ted in the 2011 Budget, the increase of public debt is expected to continue, al-

though its pace should decrease. The 2011 Budget is expected to lead to a Budget


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decit of 3.2%. The WIFO institute, founded by Friedrich A. Hayek and Ludwig

v. Mises in 1927, recently presented its concept for an administrative reform

yielding cost reductions of up to 5 billion per year.

A long-awaited coalition budget

In 2010, the political agenda was heavily dictated by the budget negotiation

between the coalition partners SP (Social Democratic Party) and the VP

(Peoples Party). Rising costs resulting from still high unemployment and bankbail-outs along with a substantial decrease in tax revenues urged the coalition

to take measures against a further increase of public decit, although the Social

Democrats and the Peoples Party did certainly not agree on how this problem

should be addressed.

The nal presentation of the budget was postponed as the coalition intended

to wait for updated information to be offered by research organizations that

would enable them to adapt the budget to the most recent forecasts of economic

growth and predicted budget decit. According to the constitution the budget

has to be presented in the Parliament ten weeks before the end of the year, on 22

October. Nevertheless, Finance Minister Josef Prll held his rst speech on 30

November. When both parties reached an agreement about the key measures at

a meeting at the end of October, the elections in Vienna were already past. Both

SP and VP had suffered heavy losses, whereas the right-wing populist party

FP could increase its result by almost 11 percentage points to 25.77%. Stress-

ing the importance of savings in order to consolidate the Budget, the coalition

agreed on a ratio of 60:40 of savings and new sources of tax income. In 2010

the SP proposed an Eight-Point plan unexceptionally consisting of propos-

als ranging from new and higher taxes on wealth and capital gains to a bank tax

based on the banks assets. Finance Minister Josef Prll, member of the VP,repeatedly stated that there were no plans to introduce new taxes in order not to

harm the middle class and small to medium sized enterprises.


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The nal budget was announced to be one of the most ambitious in the last

decades. Critics however said that the budget lacked necessary broad structural

reforms.

Child Support and tuition fees

Austria is currently one of the countries with the longest child support in the

European Union. The coalition decided to reduce the maximum age for students

to qualify for child support from the 26th to the 24th birthday and also to cut the13th child support to 100 and limit it to scholars (child support is usually paid

13 times per year, 12 payments for each month of the year and one additional

payment in September, when school starts in most of the states as compensation

for the costs of books, etc.) The expected savings amount to 270 million per

year. Tuition fees, that were abolished in 2001 for students who manage to com-

plete their studies within a certain time span (usually the minimum time plus one

semester), are once more considered by the conservative VP, citing the lack of

capacity and deteriorating conditions for students at universities.

Capital Gains Tax

So far prots from security investments are exempt from taxation if the as -

set is not disposed of within one year, whereas the individuals personal income

tax rate is levied on speculative earnings. A at 25% tax rate is applicable on

dividends and interest income regardless of the source and regardless of the in-

dividuals income. As of 1 January 2011 a at tax rate of 25% is applicable on all

capital gains from stocks and mutual funds, regardless of the individuals income

and the time the asset has been held. Any short-term capital gains from invest-

ments purchased in 2011 and sold before 1st

of October will be subject to theindividual marginal tax rate and have to be declared separately. Income from de-

rivative instruments and bonds (excluding interest payments) will be tax-exempt


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after one year. Beginning October 1, any realized prot from assets purchased

after 2010 taxes will be withheld automatically, causing considerable discomfort

since in case of losses in the same period taxes will not be refunded before dec-

laration after the end of the year. The new at tax is no longer dependent on

neither personal income nor on the time horizon of the investment; it is there-

fore questionable whether the new solution will particularly target speculative

earnings as most individuals with medium to high incomes will pay less taxes on

their short term capital gains, whereas long-term investments aiming to insure a

certain standard of living during retirement will be affected by the discontinua-tion of the speculative period. One might think the introduced capital gains tax

is similar to that imposed in Germany in 2009, in-depth scrutiny reveals a few

details that differ signicantly from the German model.

Losses from nancial transactions may not be carried forward in order to

reduce taxable capital gains in the future.

Capital gains from the sale of stocks, bonds or derivatives may not be con-

solidated with other forms of income including interest payments of savings

accounts.

Transaction costs or other brokerage fees such as escrow costs are not tax

deductible.

In contrast to German law that offers a 801 tax allowance for individuals,

such an allowance is not implemented in the current law.

A few other aspects of the new rules will hopefully give rise to further dis-

cussion, in particular the fact that a major discrimination has been introduced,

between asset classes. Prots from life insurance will be exempt as well as long-

term capital gains from real estate, while gains realized within 10 years will be

taxable. If an apartment has been used by the owner, prots from its sale are tax

exempt after two years.

Parallel to the introduction of the capital gains tax, the tax levied on incomeof private (for-prot) foundations has been increased from 12.5 to 25%.

As of January 2011 many banks have already voiced their concerns about


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the costs related to the new capital gains tax and claim that the short time span

provided to implement the new legislation would cause overall costs higher than

the expected tax revenues. On February 1st 14 Austrian Banks led suit against

the newly implemented capital gains tax, complaining about the short period for

banks to implement necessary new technologies and high overall cost that are

expected to surmount future tax revenues in the next years to come.

Bank Tax

The Bankenabgabe is a Bank Tax with estimated revenues of 500 million

consisting of 340 million from taxing total assets only targeting larger banks

and an additional 160million of higher taxation on derivative transactions. Total

assets of banks will be taxed at a rate of 0.04% if above 1 billion Euros, while a

tax rate of 0,08% will be applicable if the banks assets exceed 20 billion Euros.

Tobacco Tax

Taxes on one pack of cigarettes will rise by 15 to 25 cents yielding 100-

150million.

Fuel Tax

Fuel Tax on gas and diesel will increase by 4 cents and 5 cents respectively.

In order to protect commuters from additional expenditures they will be given

additional compensation. The increase of the fuel tax, along with other measures

as the ight tax, is part of a somewhat opaque ambition of the coalition that is

praised to combine tax increases with desired aspects of environmental policy.


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Flight Tax

A ight tax of 8 for continental ights with European destinations and a of

up to 35 for international ights will be effective on January 1st and is expected to

yield 60 million in 2011 and 90 million per year in the next years. Since both

national and international airlines have to charge the fuel tax for every ight tak-

ing off from Austria, shifts to airports like Bratislava, only one hour away from

Vienna by train, are expected to increase as the tax may make up a substantial

amount of the total price when consumers choose to book a ight with a lowcost carrier. A similar tax was abolished in the Netherlands after having been in

effect for just one year.

Wealth Tax

The last years debate ahead of the nal agreement on the 2011 Budget was

dominated by the calls for a wealth tax, a (preferably international) nancial trans-

action tax, higher taxes for private foundations and a capital gains tax. Although

a wealth tax has not been included in the current Budget, many politicians of

the SP and members of the the Austrian Chamber of Labour have repeatedly

stressed their continuing efforts to introduce a wealth tax. Chancellor Faymann

said he was in favour of a wealth tax applied on net assets above 1 million with

the tax rate in a range between 0.3 and 0.7%. Supporters of the wealth tax namehigh taxes on labour income and comparably low taxes on capitals gains and

wealth in Austria as their main arguments.


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21Belgium Thierry Afschrift

Belgium

Thierry AFSCHRIFTProfessor at the Free University of Brussels

Lawyer

www.afschrift.com

The Belgian paradox

One could obviously not talk about Belgium without tackling its political cri-

sis. Belgium holds a sad record for facing the longest political crisis in Europe:

being without any government for more than 249 days. Should Belgium fail to

get a new government by March 30 it would beat Iraqs world record of 289

days in 2009.

This political crisis has of course enormous consequences on what happened

- or did not happen - last year but could also deeply impact our economic future.

In December 2010, the rating agency Standard & Poor lowered to negative its

perspective on the Belgian nancial rating, due notably to the legislative paralysis

and the lack of a credible budget policy for 2011.

However, economically, Belgium works relatively well. The growth rate is not

bad. Belgium nished 2010 with a public decit of 4.6 % of its GDP. This is

better than the 4.8 % decit determined by the Belgian stability program. In ad-dition, public debt reached 97.2 % of GDP and it is also less than the forecast.

This is the Belgian paradox. One can nevertheless fear that the caretaker cabinet

will not be able to deal with the economic issues of the future.

While most European countries have adopted various measures to reduce

their decit for years to come, Belgium has not yet a real budgetary policy or

a concrete tax policy. No-one can predict what will be the scal or budgetaryorientations of the future government. However, in order to reduce its astro-

nomical public debt and to avoid its debt reaching more than 100 % of GDP,


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the future government - whatever its composition - will inevitably have to cut

spending. It will have to struggle with structural decits. Far from expecting a

corresponding reduction of taxes, it will be essential to boost investment and

enhanced Belgian competitiveness and attractiveness. The decit struggle will

certainly involve some scal effort. Where the Belgian State already takes 46%

of what its inhabitants produce and spends 53% of it, tax competition might be

the only thing which can still moderate the governments temptation to always

prefer an increase in receipts to a reduction of expenditure in order to balance

the budget.Despites the Belgian political and legislative apathy of the last months, few

measures were adopted at the beginning of 2010, and one can underline the case

law relating to privacy, European freedoms, etc. One can also draw an outline of

what could happen in a near future.

Fight against tax fraud and banking secrecy

In accordance with most European countries policies on this issue, the Bel-

gian state gives itself more and more means to ght tax fraud and to reduce

banking secrecy to nil. Its interventions are however prejudicial to the right to

privacy.

The new article 335 of the Belgian Tax Code (BTC) gives tax authorities

wider investigative powers: any ofcer is entitled to collect any information re-lated to any tax, even one for which the ofcer has absolutely no jurisdiction,

and can convey this information to other tax administrations. It seems at least

doubtful that the new version of this disposition complies with article 8 of the

European Convention on Human Rights, with article 22 of the Constitution and

with the law of 8 December 1992 on the protection of privacy with regard to the

processing of personal data. It creates indeed systematic and spontaneous trans-mission of information between tax administrations without any preconditions.

In 2010, the ght against banking secrecy continues as it began in the wake


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of the economic crisis. Different double tax treaties have been modied in order

to insert on demand data information exchange clauses. Many vague proposals

have also been made by different members of Parliament in order to abolish the

last rampart of the Belgian banking secrecy, article 318 BTC. On that subject, the

current political crisis gives this secrecy a few moments grace. However, if the

proposals are adopted without being modied the new law will be prejudicial to

the right of privacy. In this regard it is symptomatic that, in Belgium, the right of

privacy and the right of ownership are most of the time sacriced in favour of

an always more powerful State.To strengthen the scal anti-evasion policy, a new reporting obligation has

been introduced. The new measure concerns legal persons who make payments

to persons established in a tax haven as soon as the total amount of 100,000 is

exceeded. Consequently these payments should be included in a separate declara-

tion.

In May 2010, the Belgian government published a royal decree updating the

list of the tax havens, and the non-existent or low taxation countries. The list

covers countries where certain companies are not or slightly taxed (a nominal

tax rate lower than 10%). This is used to require that any payment to a company

established in a listed country is only deductible if this company is the subject

of a special declaration, and the payment corresponds to industrial and com-

mercial considerations and not an articial construction. We observe that the

Belgian tax authorities do not consider as tax havens: Liechtenstein, Gibraltar,

Hong Kong, Macau or Panama, for example. Therefore payments made to com-

panies established in these countries do not fall within the scope of the new legal

provisions.

A law of 18 January 2010, published in the Moniteur belge of 26 January

2010, overloads the legal provisions on the prevention of money laundering, dat-

ing from 1993, which have been reinforced many times since then. Among themultiple obligations it prescribes, this law states that, from now on, any person

or entity who acquires securities representing capital or otherwise conferring the


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right to vote in stock companies ... and has issued bearer or dematerialized shares,

must declare to the company, not later than the 5th business day following the

date of acquisition, how many securities it owns when the voting rights attached

to those securities achieve a proportion of 25% or more of the total voting rights

... . The text aims at preventing companies, with bearer or dematerialized shares,

from being able to declare that they are unaware of their shareholders identity

when a bank account is opened or during a tax audit. These obligations do not

exist for shareholders holding less than 25% of voting rights in a company, even

if the companies in question are controlled by the same person, by spouses orrelatives. Shareholders wishing to keep their anonymity - which can be for very

good reasons - should place themselves in a situation where they hold less than

25% of the shares. This new measure against shareholders anonymity--that the

law justies by the ght against money laundering--might have consequences in

terms of inheritance. At the time of death, in order to tax the value of the shares,

tax authorities will only have to ask the company who are the shareholders (if the

shares were to be owned by an individual).

Notwithstanding the legislative will to ght tax fraud, tax evasion and tax

havens, the Belgian Courts rightly pointed out that this battle and the repression

of this fraud cannot be conducted at any price or on any conditions. In the tax

component of the KB Lux case, the tax authorities have nothing to be delighted

about because almost all judgments pronounced by our Courts are favourable

to taxpayers challenging tax assessments after the discovery of the famouslistings coming allegedly from the Luxembourg bank. One of the arguments

for rejecting the claims of the Treasury was that the listings on the basis of

which the disputed taxes were established are not conclusive: they are mere cop-

ies of microches containing no reference to their author, signature, stamp or

other evidence to identify their origin. Another argument has been advanced to

challenge these tax assessments: the listings concerned came into the possessionof the Treasury through the commission of a crime, namely theft by dishonest

employees. As far as the criminal aspect of this case is concerned, the Brussels


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Court of Appeal has conrmed the judgment of the Court of First Instance

that relied on this second argument to declare the prosecution inadmissible. One

can only welcome this brave decision which will remind the Public Prosecutors

ofce that, under the rule of law, the end does not justify the means and it is not

possible to prosecute someone for an offence on the basis of the commission of

another. This will give some food for thought in a setting that seems quite similar

to the LGT case in Liechtenstein and the HSBC case in Switzerland.

Corporate Tax

In the wake of the recession, corporate tax receipts have fallen and in order

to boost economic activity, this tax rate could be reduced. With a corporate tax

rate of 34 %, Belgium has in fact one of the highest in Europe. But instead of

that, the maximum tax deduction for equity capital rate for the 2011 and 2012

assessment years is reduced from 6.5% to 3.8%. Admittedly the tax deduction

for equity capital has played a role in the tax income inexion, but according to

the National Bank this has been to a limited extent.

Since 1 January 2006, a Belgian company can benet from a tax deduction

for equity capital also known as a deduction for notional interest (Art. 205bis-

205novies, BTC). All companies are treated, from a tax point of view, as if they

had borrowed their own funds at an annual rate of interest equivalent to the rate

for ten years bonds issued by the Belgian state. The notional interest calculatedin this way is deductible from the taxable base for corporation tax purposes.

Since its coming into existence, this measure has been a disputed one. This de-

duction is presented as gifts to companies and one criticizes their cost for the

budget, as well as their social uselessness. It is not impossible that the deduction

will be soon linked to an employment condition. Proposals have been raised in

this direction.


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Tax deduction for equity capital

There are three objectives behind this deduction scheme.

First, to establish equilibrium between the tax treatment of the equity capital

and the tax treatment of loans. Under the former system, it is scally more at-

tractive for a company to be funded by means of loans because the interest can

be deductible for tax purposes. The equity capital, on the other hand, gives rise

to non-deductible dividends. The new scheme remedies this situation partly by

decreasing the taxable base by an amount corresponding to the interest that thecompany would have paid if it had borrowed the same amount.

Second, the new measure offers an attractive alternative for coordination

centres whose present low tax regime should be withdrawn at some point be-

cause it is incompatible with EU states aid law.

Last, the new scal treatment allows Belgium to compete with the general

fall in the corporation tax rates throughout Europe. Although the nominal cor-

poration rate tax stays at 33, 99%, the new measure cuts the effective rate down

to 26 % on average, a little less than the European average.

Nevertheless, few modications occurred: a few explanations concerning the

basis for the calculation are inserted in the law and any deduction that is not used

during the taxable period can henceforth be consecutively transferred to the fol-

lowing seven taxable periods instead of during seven years, as previously.

In the context of tax neutral cross-border mergers, the notional amount of

interest deductible and the tax credits for research and development may now be

fully transferred as if the merger or de-merger had not taken place. Moreover,

the parts taken over or acquired that are located in Belgium must no longer nec-essarily be used in a Belgian establishment (of the acquired foreign company),

but these can also be used in the Belgian acquiring company.


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The Belgian Tax Code provides that, under certain conditions, dividends

from stocks and shares held by a Belgian company are deductible from the prof-

its of this Belgian company as denitively taxed income. This deduction is

allowed up to a limit of 95 % of the gross amount paid. One of the conditions

concerns a minimum participation of 10% in the capital of the paying company

or a minimum participation of at least 1,200,000 (purchase value). As of as-

sessment 2010 year, this condition also applies to dividends acquired by credit

institutions, insurance companies and listed companies. Once again, this comes

with the proviso that any amendment made after 1 January 2009 to the closingdate of the annual accounts is without effect. Moreover, the minimum participa-

tion is raised to 2,500,000 (or still a minimum of 10%). This applies to income

that is allocated or made payable as of 10 January 2010.

Finally, amendments have been made to the favourable so-called tax shelter

system. Under certain conditions, this system provides exemption from corpo-

rate tax for investments in recognized audio-visual works. Those amendments

enlarge the scope of the tax shelter system. For example, it is no longer necessary

for the production company to be a domestic company, but from now on

it may also be the Belgian establishment of a foreign company. The notion of

ction lms replaces that of long-play lms and thus includes lms not only

of long, but also of medium and short duration.

Personal Income tax

As in 2009, the year was poor in interesting measures. No fundamental modi-

cation occurred at a legislative level. In Belgium, whatever the composition of

the government is going to be, one should fear, in the short or medium term, an

increase in the rate of withholding tax on interest, the imposition of a tax on the

capital gains on shares, and perhaps an increase in the marginal income tax ratefor high incomes.

Its is however interesting to mention that, on 1 July 2010, the European Court


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of Justice judged that Belgian legislation imposing an additional local tax on in-

come from capital where the income is received by a Belgian resident without

the intervention of a Belgian nancial institution, violates EU laws on the free

movement of capital. Under Belgian tax law, foreign interest and/or dividends

received without the intervention of a Belgian nancial institution have to be

reported in ones Belgian income tax return and an additional local tax (varying

from 0% to 9,5%) is levied. However, in the case of interest and/or dividends

received via a Belgian nancial institution, a withholding tax of 15% is deducted

and there is no obligation to report this income in ones Belgian income tax re-turn, so that no additional local tax is due. The Belgian Tax Authority conrmed

in its circular letter dated 19 October 2010, that it would abide by the decision

handed down by the European Court of Justice on 1 July 2010.

Moreover one can welcome the setting up of a tax conciliation service, intro-

duced by the Program Law of 25 April 2007. This service is operational since

1 June 2010.

The new service, working independently from the Federal Finance Depart-

ment, has the purpose of assisting the taxpayer to nd possibilities for an agree-

ment rather than going to court according to the Minister of Finance.

Green tax legislation

For many years Belgian tax policy has been inuenced by environmental con-siderations. Energy-saving measures tend to be encouraged by the granting of

tax advantages. The crisis and the budgetary constraints imply nevertheless that

those advantages are tending to be reduced or limited.

As of 1 January 2010, the calculation of the benet in kind for the free private

use of company cars by employees or company directors depends on the CO2

emissions of the car and is no longer based on the scal horsepower.


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VAT

Belgium is being found at odds with the interpretation of the Court of Justice

developed in the Breitsohl case for nearly ten years since in Belgium real estate

transactions remained excluded from the application of VAT. However, from

1 January 2011, Belgium complies with the European requirements. From now

on, the simultaneous sale of land and a new building will be subject to VAT. The

new regulation replaces the former registration tax. This measure is favourable

to VAT taxable persons. Indeed, enjoying full right of deduction, they can fullydeduct input VAT in their VAT account. Moreover, they will no longer pay a reg-

istration fee on the land value. Other purchasers of land will bear a heavier tax

burden. Indeed, they will have to pay 21% VAT on the value of the land adjacent

to the building instead of registration tax of 12.5% or 10% and the VAT will not

be recoverable.

Until recently, in order to benet from the reduced VAT rate in the real estate

sector, construction works on land needed to be executed by a registered building

contractor. This requirement for the application of the 6% VAT rate applicable

in such situations has now been abolished by means of Royal Decree dated 2

June 2010.

Since the 1 January 2010, VAT in the catering industry has been reduced from

21% to 12 %. The measure should have been analyzed and the results submitted

to the Government in late October at the latest. The political crisis postponed

this analysis. This reduction should be maintained if it does not lead to a reduc-

tion in tax revenue.

Conclusion

While a caretaker cabinet is at the helm of a boat without captain, and tryingto keep the trains running on time, fears are growing of threatening economic

troubles. Rating agencies and the nations Central Bank have warned of a poten-


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tial threat from nancial markets if politicians fail to strike a deal soon. This

chaotic situation could have long-lasting effects on the Belgian economy

The markets will be merciless if the country does not emerge promptly from this

unprecedented hell said billionaire investor Albert Frre, a leading shareholder

in energy groups Total and GDF Suez.

Despite the current political crisis being the biggest challenge Belgium has

to deal with, the country should not delay important long-term economic deci-

sions that will end not only by delaying or avoiding investment projects but also

by corporate expatriation. Measures have to be taken soon in order notably toreinforce the competitiveness of Belgian companies.


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31Bulgaria Petar Ganev

Bulgaria

Petar Ganev

Institute for Market Economy, Soa

2010 was a controversial year for the Bulgarian scal policy the common

use phrase in the recent years balanced budget was replaced by excessive

decit; the budget was revised in the middle of the year, even though no ma -jor changes took place in the tax policy; the health and pension reforms were

debated all through the year; some partial nationalization of private pension ac-

counts for early retirement took place; the shadow economy was once again an

issue. Along with all these, the government started a campaign towards the rich

with helicopters ying over some big estates taking pictures and also a proposal

for introducing a luxury tax.

In 2011 Bulgaria will struggle to achieve a reasonable decit below 3 per-

cent of GDP. No major taxes are changed, except for the slightly higher so-

cial contributions and some excise duties. There are, however, concerns that the

budged would have to be revised throughout the year, as happened in 2010.

Fiscal Issues

Bulgarian economy did not improve much in 2010 the economy grew less

than 1%, employment is source of worries and foreign investments are not com-

ing back. Expectations are now that the recovery will nally happen in 2011,

with an economic growth of 3,6%. The scal stability of the country depends

on that growth.

2010 was a bad year for Bulgarian scal policy. Throughout the middle ofthe year the revenues were far from their expected levels and this led to a severe

revision of the budget from almost balanced to one with excessive decit.


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Moreover, the decit for 2009 was also revised upwards, which gave an entirely

new look to Bulgarian scal stability. If, consequently, tons of measures were dis-

cussed through the year to get the budget back on track, only a few of them have

been implemented. The revision of the budget didnt affect the tax policy.

In 2011 Bulgaria is expected to recover partly from the crisis, which means

more revenues and less pressure for the budget. The decit is projected to be

just below the 3% line, which will be a success after two consecutive years with

excessive decits. More revenues are expected mainly from VAT and corporate

taxation, thus depending on the recovery of the economy.In 2011 the government is supposed to redistribute around 36,5% of GDP,

which is slightly less than the previous years some cuts in the administration

took place and the pensions were frozen. Nevertheless, the pressure on the

government and the budget will remain high, as all sectors are asking for more

money and opposing all unpopular measures. The scal debate promised to be

intense in 2011.

Direct Taxation (Corporate Tax & Income Tax)

In 2007 the corporate tax rate in Bulgaria was reduced to 10% (down from

15%). The following year the income tax was also reformed replacing the pro-

gressive scale (20%, 22% and 24%) with one singe at rate of 10%. Those tax

cuts made Bulgaria the country with the lowest direct taxes in the EU, excluding

the social contributions off course. Both tax cuts brought about positive effects

for the economy and the state budget that were clearly visible prior to the crisis.

The revenue from corporate taxation went straight up after the reform both

in 2007 (up almost 40%) and in 2008 (an additional 20%). Nevertheless, the crisis

had a severe impact on corporate tax revenues that felt by almost 20% both in

2009 and 2010, going back almost to their level before the reform. In 2011 thecorporate tax will still be at 10% with projection to stay at that level for the years

to come. The ofcial projections for 2011 are that the revenues from corporate


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taxation will start to recover (up 17%) and will reach 1.7 billion levs (870 mil-

lion) which represents more or less 2.2% of the GDP.

The at tax story is somewhat different. Since the introduction of the single

at rate in 2008 the revenues also went up, but also prove to be stable during the

crisis. The positive budgetary effect of the at tax is indisputable with a single

tax rate two times lower than the lowest marginal rate of the previous progres-

sive scale, the revenues went up and stayed stable during the crisis. In 2011 the

revenues from income taxation are projected to reach BGN 2.1 billion (1,1

billion), which is around 2.7% of the GDP. Despite the purely ideological debateover the at tax in Bulgaria, the ofcial projection is that the at tax will stay

unchanged 10% at rate and no tax-exempt minimum.

Tax exemptions continue to be an issue. Since the beginning of 2010 some

tax exemptions for farmers were removed--they were not supposed to pay any

income tax in the previous years. Earlier, beginning of 2009, a tax exemptions for

young families with mortgage loans was introduceddeduction of interest pay-

ments. This exemption was highly disputed in the recent years and the object of

several votes in the Parliament. Nevertheless, it will be upheld in 2011. The data

shows that in 2009 more than 5 thousand families beneted from it; a shortfall

in tax revenues of around BGN 2 million (1 million).

Indirect Taxation (VAT & Excise Duties)

Indirect taxes include VAT and excise duties on special goods such as ciga-

rettes and alcohol beverages. The VAT in Bulgaria is set at 20% and, despite the

various discussions that took place during the year, it is supposed to stay at that

level for the years to come. The budget revenues from VAT are expected to reach

BGN 6.5 billion (3.3 billion) or 8.4% of GDP in 2011. This is above their 2010

level and back to the revenues of 2009.Some changes in the preferential VAT for tourism were made effective 1

April 2011 a single reduced VAT rate of 9% will apply to hotel accommodation


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services regardless of whether they are a part of a tourist package or bought

individually. Until now the reduced VAT rate of 7% applied only to hotel accom-

modation if it is a part of a tourist package.

Bulgaria has to harmonize its tax regime with that of the European Union

by introducing the minimum excise duties of the European Community on to-

bacco, alcoholic beverages, and fuels. Started in 2002, the harmonization process

is scheduled to be completed by the end of 2013.

In 2010 excise duties on kerosene, electricity for industrial purposes and ciga-

rettes increased, while on gasoline and diesel, as well as on liquor there were nochanges. The scal effect of the higher excise duties on the budget was expected

to reach BGN 300 million (150 million), mostly due to the higher excise duties

on cigarettes. But in fact, the revenues collapsed even below their 2009 level the

additional revenue from excise duties on cigarettes never materialized as con-

sumption felt and smuggling went up. Once again the Laffer curve prove to be

right in this case higher taxes on consumption led to lower revenues, as trade

shifted to the shadow economy.

In 2011 excise duties on tobacco and some fuels have been increased, but still

the budgetary effect of this is expected to be remote. Overall the revenues from

excise duties in 2011 are supposed to reach BGN 3.8 billion (1.9 billion) or 4.9%

of GDP, which would be more than 2010, but less than 2009.

Social Security Contributions

Social contributions are still the most disputable tax in Bulgaria. In 2005 the

contributions were above 40% of the gross wage, but following a 6 percentage

points cut in 2006 and a 3 percentage points cut in late 2007, they felt to 33.5% of

the gross wage. At the start of 2009 a further reduction of 2.4 percentage points

was enacted, followed by another 2 percentage points cut in 2010, bringing thecontributions bellow 30% of gross wage. The cuts did not reached uniformly all

the contributions: if the pension contributions were reduced, along with those


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for unemployment, the healthcare contributions were increased.

Also, starting in 2009 and along with social contributions paid by the em-

ployee and the employer (as in most European countries), the State itself started

to pay social contributions for every worker 12% of the gross wage. Those

new State contributions, however, are more of an accountants trick than a real

reform. Actually, the State had always made payments from the budget to the

Pension Fund the difference is that those payments were called transfers (or

subsidies) and now they are called contributions. Even with these state contribu-

tions, the state pension fund is far from balanced and need further governmentsubsidies (transfers).

Throughout 2010, the crisis put additional pressure to the pension system

and the government was forced to take action. The negotiations with the so-

called social partners, namely the trade unions and the business organizations,

were intense and lasted months. The result was a long term reform plan, which

includes frozen pensions, higher social contributions, higher retirement age for

both men and women (starting 10 years from now), and also some measures to

reduce a wide spread strategy of early retirement. Still, the pension plan was not

welcome and there is a probability that the long term measures would not be

enforced as written.

One of the most heated controversies in the country was the partial nation-

alization of the private professional pension funds the idea was to transfer

the money from the early retirement accounts in private funds to a newly set-up

state early retirement fund. The goal was not so much to reform the pension

system, but mainly to indirectly support the budget. At the end, the government

stepped back and transferred into the National Social Security Institute only the

money of those to retire in the next 3 years thus, not establishing a new state

early retirement fund and not shutting down the private professional funds.

Still, partial nationalization did take place and some private accounts were shiftedto the solidarity system. This action is now supposed to be reviewed by the Con-

stitutional Court.


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At the end of 2010 the healthcare system in Bulgaria went through a deep

crisis, pushing for the second time in just one year the minister of healthcare to

leave ofce. The state of the system was chaos bad organization and articial

pricing, lack of nancing, perverse incentives and fraud, and absence of agree-

ment on the expected reform. Nevertheless, by the end of the year some changes

did take place the most important change is that the health contributions (8%

of the gross wage) will henceforth go entirely and directly into the system, while

until now 25% of the money (2 percentage points) was going to the health

reserve held at the Bulgarian National Bank. Meanwhile, the money that wasaccumulated in the health reserve around BGN 1.5 billion (800 million),

is now considered to be part of the scal reserve. Meaning, it can be spend on

everything, not necessarily health.

In 2011, another 1.8 percentage points will increase social contributions: 1

percentage point increase in pension contribution for the employer and 0.8 per-

centage points for the employee. Thus, the social contributions as a whole will

again be over 30% of gross wage. Again, the employer contributions are higher

than those of the employee, but that is not so important as both of these pay-

ments lay, one way or another, on the shoulders of the employee (as they are

taxes on labour).

Moreover, the 0.1% employers contribution to the Salary Guarantee Fund

is abolished for several years, as the amount of money accumulated in the fund

is sufcient. There is also an increase in the amounts of the minimum socialsecurity thresholds for the main economic activities and groups of professions

by 5.6% average. Also the minimum social security thresholds for self-employed

individuals in 2011 will be determined, based on their taxable income received

in 2009.

As administrative measures, the period for calculation of the compensations

for unemployment, pregnancy and birth is increased to 18 months and the periodfor calculation of the compensations for temporary disability is increased to 12

months. The current regulation for payment of monetary compensations for


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temporary disability by the insurer for the rst three days of the disability will be

extended until the end of 2011.

Social Security Contributions in Bulgaria (% of the gross wage)

SocialContributions

(2011)State Fund Private Fund

Total Employer Employee Employer EmployeePension 17.80% 7.10% 5.70% 2.80% 2.20%

Illness & Maternity 3.50% 2.10% 1.40% X X

Unemployment 1.00% 0.60% 0.40% X X

Labour Accidents& Professional

Illness*0.50% 0.50% 0.00% X X

Health 8.00% 4.80% 3.20% X XOverall 30.80% 15.10% 10.70% 2.80% 2.20%

(*) The rate for Labour Accidents and Professional Illness is averaged there are severalrates depending on the labour category varying from 0.4 to 1.1 percent.

Further changes in the social security contributions are to be expected in the

forthcoming years. Either the pension plan will be enforced as written or a new

plan will be developed in both cases changes in contributions and retirement

age are coming. The healthcare system has proven to be highly vulnerable in the

recent years and it is expected to remain so in the years to come changes in

health contributions are also possible.

Local Taxes and Issues

The local taxes were also an issue and recently some changes took place: In 2011 Bulgarian municipalities will be allowed to set the annual real estate

tax rate within the range between 0.01% and 0.45% on the highest of the gross


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book value and the tax value of the immovable property. Before that the maxi-

mum rate was 0.25%.

A new tourist tax has been introduced replacing the tourist fee. As of 1

February 2011 the rates determined by municipalities should be in the range of

BGN 0.2 to BGN 3. The tax is due per night and is payable by the property own-

ers providing lodging.

Along with these, the debate focused around the government campaign to-

wards the rich helicopters were sent to y over some large estates to take pic-

tures while a proposal for introducing a luxury tax was made. Those actions(and pictures) were all over the media, triggering vivid discussions, but achieving

nothing substantial.

Conclusions

Fiscal policy in Bulgaria has played a crucial role for the development of the

economy in the recent years. Balanced budgets and low taxes proved to be a

success prior to the crisis, while the excessive budget decits in 2009 and 2010

did not strengthen the economy. 2011 will be a tough scal year, as the decit is

supposed to stay below 3% of GDP.

As for the taxes, the 10% at income tax, the 10% corporate tax and the 20%

VAT should remain untouched in the years to come. Social contributions will

once again drag attention, as further reforms in pension system and healthcare

are inevitable.


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39Croatia Giorgio Brosio

Croatia

Giorgio Brosio

University of Torino

A delayed economic recovery

A very few substantial tax measures have been introduced in Croatia in 2010.The most important of which, the earlier repeal of the special tax on salary in-

come introduced in 2009, has been due to the necessity of sustaining household

consumption in the face of the persisting slow-down of the economy. The sec-

ond measure, consisting in a restructuring of the tax rate schedule applying to the

personal income tax, has a more structural character and it is also oriented to re-

align the Croatian tax system to the structure prevailing in most EU countries.

Tax measures have clearly to be inserted in the evolution of Croatias econ-

omy that continued to be affected, even in 2010, by the global economic crisis.

GDP continued to contract in 2010, although at a decelerated pace. The decrease

of 5.8 percent observed for 2009 was reduced to an estimated 1.6% in 2010.

While the drop in 2009 was due to a huge fall of exports of goods and services

(consisting mainly of tourism) and to a contraction of personal consumption-

-exacerbated by the tax measures--the surge in foreign demand that took place

in 2010 was not big enough to compensate for the sluggish trend of domestic

demand. Domestic consumers still felt the burn of the increases of VAT and of

special tax on salaries. Household consumption was also negatively affected by

repayment of personal loans to banks and by the reduced propensity of the lat-

ter to extend new loans to families. Domestic investment showed a further drop,

particularly in the construction sector, where the activity had reached a huge peakjust before the time of arrival of economic crisis. Projections for 2011 show the

return of the economy to positive although modest growth: GDP is expected to


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increase by 1.5 percent under the stimulus of personal consumption and recon-

struction of inventories in rms.

Tax measures

As mentioned above and in the previous report, to keep the public sector

decit under control the government introduced in July 2009 a special crisis tax.

This was a temporary levy to be applied until 31 December 2010 - on salaries,

pensions and other income with a tax rate of 2 percent on incomes exceedingHRK 3,000 (the equivalent of 409 per month) and with a tax rate of 4 percent

on incomes exceeding HRK 6,000 (818 per month).

This levy was rather substantial and was seated on top of an existing personal

income tax that, while not particularly productive, holds the top statutory tax

rates among Eastern European countries. (The same applies also to the corpora-

tion income tax).

The prolongation of the economic downturn brought to a sharp inversion of

the tax policy. On July 2010 the Croatian parliament decided to eliminate, starting

from July 1, the special tax of 2 per cent, and to eliminate the remaining special

tax of 4 per cent starting from November 2010. It has been calculated that some

1,254,000 taxpayers had been affected by the tax measure and that it has contrib-

uted about 400 million to the central government budget.

Moreover, signicant changes meant to slightly reduce the tax burden and torealign the tax rates applying to different categories of income have also been

introduced with an amendment to the personal income tax law approved by the

national parliament in 1 July 2010. They are detailed in the two following tables.


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Table 1. Croatia: changes in the personal income tax applying to

income from wages and salaries

New tax schedule from 2011 Tax schedule applying to 2010 lings

Tax rates Income brackets Tax rates Income brackets

Kunas Kunas

12% 43,200 13,50% 43,20025% 43,200 - 129,600 25% 43,201 - 108,000

40% 129,600 30% 108,000 - 129,600

37,50% 129,601 - 302,40042,50% 302,400

The changes in the tax rates schedules were accompanied by the elimination

of a number of tax relieves that have a considerable importance weight for tax-

payers. They are, more precisely, the deduction from income of expenses for:

health services;

voluntary and additional health insurance;

insurance premiums paid in respect of life insurance with a retirement sav-

ings component;

certain costs for the purchase or construction or maintenance of a rst

main (principal) residence, as well as interest expenses paid for these purposes;

and;

rental costs for a main (principal) residence.

On the other hand, it was also decided that employer payments to pension

funds payments by employers made to Croatian voluntary pension funds (pillar

III pension insurance) on behalf of employees up to a maximum of HRK 500

monthly per employee will be treated as non-taxable income for PIT purposes

(and as a corporate prots tax deductible expense for the employer).


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in 2010, up from the 2.9% of the previous year.

Table 3. Structure and recent evolution of tax revenue in Croatia

2007-2010 (millions of kunas)

2007%on

total2008

%on

total2009

% ontotal

2010%on

total

Personal

income Tax 1772.7 2.9 1687.0 2.5 1399.0 2.5 1200.8 1.9Prot tax 8816.3 14.5 10564.7 15.9 9439.8 15.9 6314.8 10.2

Taxes onProperty

578.6 1 635.9 0.9 532.2 0.9 491.2 0.8

VAT 37747.9 62 41308 62.2 37050.3 62.2 37884.9 61.1

Sales tax 168.5 0.3 166.5 0.25 123.5 0.2 122.1 0.2

Excises 9096.9 15 588.6 0.9 8205.1 0.8 11283.7 18.2

Taxes on

games andgambling

505.1 0.8 543.8 0.82 532.8 0.8 609.4 1.0

Taxes oninternationaltrade

1641.5 2.7 1900.80 2.8 1721.2 2.8 1658.1 2.7

Other taxes 509.6 0.8 0 0 1590.1 0 2436.3 3.9

Total taxrevenue

60837.1 100 66344.9 100 60594 100 62001.3 100

Source: Ministry of Finance of Croatia


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Czech Republic

Ji Schwarz jr.

Resident Research Fellow, Liberln Institut (Prague)

The year 2010 was an election year in the Czech Republic. The debates both

before and after the election were concerned mainly with growing decit. In

order to reverse the trend of recent years, the newly elected government imple-mented a number of measures on revenue and expenditure sides with a plan to

lower the decit under 3 % of GDP in 2013. However, no deeper reforms were

so far implemented, nor planned in greater detail. It is therefore not clear what

ways will the government use to further balance the budget. Without profound

reforms, there may be no other way to tame the decits than to increase the tax

burden.

PIGS effect and the decit

The year 2010 was markedly inuenced by the development of the so-called

PIGS, or southern-wing EU countries Portugal, Italy/Ireland, Spain, and espe-

cially Greece. Whilst during the previous years after the nancial crisis outbreak

the emphasis of scal and monetary policy was put on ght against the reces-sion and nancial system instability, in 2010 the sustainability of public nance

became one of the most important issues.

The Czech Republic was having decit problems already in 2007, that is, even

before the crisis hit its economy. Extraordinary and unexpected high tax revenues

in 2008 temporarily pushed the decit below the 3 % Maastricht criterion. How-

ever, the inability to seriously tackle the issues of budgetary imbalance resultedin a government decit of 6.1 % of GDP in 2009. According to the methodol-

ogy of the ESCB (European System of Central Banks), the cyclical part of the


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45Czech Republic Ji Schwarz jr.

decit was literally zero. In other words, even if we adjust for the impact of the

business cycle and one-off factors, the remaining structural decit of the Czech

Republic in 2009 was 6.1 %.

It became were soon clear that without restrictive measures the decit in

2010 was going to reach 8 % of GDP. The technical government, appointed

after the previous government fell due to a vote of no condence, was therefore

looking for ways to decrease the decit. Political pressures from both ends of

the political spectrum led however to such measures on both revenue and expen-

diture sides, that the resulting mix was more a tax increase than an expenditurecut. Still, the government managed to decrease the planned general government

decit for 2010 to 5.3 % of GDP, which remains nonetheless far above the level

generally understood as sustainable. As a consequence, the new government co-

alition committed to bring the decit down to 4.6 % in 2011 and under the 3 %

threshold by 2013.

Revenues and expenditures in 2010

Changes to the tax system may not have the predicted impact on the tax

yield. This might be due either to unexpected external shocks or to the fact that

taxpayers alter their behaviour in reaction to the changes. A closer look at the tax

yields reveals that even though the predicted real GDP growth of 0.3 % was two

percentage points below the actual 2.3 % GDP growth in 2010, the tax yields donot even reach the budgeted amounts. The corporate income tax yield, even after

the fall of the rate from 20 to 19 percent, was predicted to be 20.4 % larger than

in 2009. The statistical data show that it rose only by 3.6 percent. The excises

were expected, also due to increased rates on fuels, alcohol, beer, cigarettes, and

tobacco, to bring almost 14 percent more to the budget than in the last year. In

reality, only 5.7 % more was collected during 2010.Similar development could be observed on the social security contributions

side. Even though the contribution ceiling increased, the year-on-year growth in


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2010 was only 2.3 %, while it was expected to be 5.5 %. Not even the VAT yield

reached the expected growth of 6.7 % and was 0.4 pp lower. To sum up, despite

expectations and relatively positive economic development, the total revenues

of the state budget increased only by CZK 25.9 billion ( 1 billion; 2.7 % y-o-y).

As a reaction to some minor savings measures and the economic recovery, the

expenditures of the state budget in 2010 fell by CZK 4.1 billion ( 160 million;

-0.9 % y-o-y).

The reality observed in 2010 gives us therefore a slightly blurred image. On

one hand, the decrease of expenditures and their structure conrm that the eco-nomic growth was stronger than expected. On the other hand, the inability to

collect budgeted taxes goes against intuition. The only plausible explanation is

that the economic agents altered their behaviour either as a consequence of the

crisis or due to the tax increase.

Tax changes

As usual, very important changes appeared again on the revenue side of the

state budget. During 2010 a number of changes in the tax system were intro-

duced which come into effect with the beginning of 2011. The most signicant

ones occurred in the area of social insurance, sickness insurance, and health in-

surance. Under the sickness insurance, employees and self-employed persons in

the Czech Republic are entitled to benets in case of sickness or parental leave.Not only do the minimal insurance contributions increase (by approx. 4 % for

the social and health insurance, and from 1.4 % to 2.3 % for the sickness insur-

ance), but less individuals will benet from it, as the self-employed persons will

be eligible for the sickness benets only after twenty-two days of sickness (until

the end of 2010 it was fourteen days).

A so-called ood tax has been introduced that should be effective only in2011. The mechanism is that a general income tax deduction will be lowered by

CZK 100 a month ( 4), that is, by almost 5 %. Starting in 2011, payments going


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to former soldiers and policemen wont be subject to tax exemption. The same is

true for the presidents salary and the rent of the former president. Various non-

salary payments to politicians and judges will also for the rst time be subject to

the income tax.

In order to lower the decit as much as possible without increasing tax rates,

the government resorted to abolition of various tax exemptions. In addition to

the measures mentioned in the previous paragraph, the minister of nance de-

cided to make the interest on building savings (i.e. a government-subsidized sav-

ings account meant to be used for building or obtaining housing) subject to the15% personal income tax. Moreover, government subsidy of the building savings

from 2010 is going to be retrospectively taxed by 50 % in 2011 and decreased in

the following years.

Last new source of government income in 2011 will be the solar energy.

There was an unexpected solar energy boom in 2010 in the Czech Republic

that was caused primarily by high xed purchase prices (guaranteed price of

the electricity produced by solar power plants set by the government) and long

income tax holiday. This development is a typical example of how the govern-

mental subsidy of renewable energy sources can go wrong. At the time the law

was approved in 2005, the xed purchase prices were set according to then ex-

pected investment return. However, already during 2008 the technologies started

to cheapen. The drop was so dramatic that returns on photovoltaic power plants

went through the roof which attracted an extremely large number of investors.

As the distributors are forced to pay the xed purchase prices for renewable

power, the tremendous increase in the solar power output would lead to soaring

selling price in 2011 that is the price the consumers have to pay.

The government argued that, in order to restrain the growth of price, it had to

cancel the tax holiday and implement a special income tax on solar power plants

put into operation in 2009 and 2010 with the rate of 26 percent. The solar taxrevenues will be then partly given back to the distributors in order to cover some

of their expenses related to the solar power which would allow them to keep the


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selling price of electricity lower. A welcomed side-effect would be approximately

CZK 4 billion from the solar tax that is expected to stay in the state budget.

To sum up, the changes to the tax system introduced in 2010 had two main

goals. To increase the tax revenues as much as possible in order to push down

the decit but, at the same time, to keep unchanged the tax burden for the over-

whelming majority of the tax payers, including the highest-income groups. The

revenue side of the state budget in 2011 is planned to increase by 2.1 % com-

pared to 2010.

Public sector and the debt

Without taking any restrictive measures, the decit of the general govern-

ment would reach 6.7 % in 2011. Considering that the Czech Republic repre-

sentatives still were not able to carry out or prepare any deeper reforms, such

level of public nance decit could send the Czech Republic to the group of

unsustainable countries such as Greece and Ireland. Only with one fundamental

difference: as the Czechs do not have the euro, rich eurozone members wouldnt

feel the need to bail them out. Moreover, according to a Deutsche Bank analysis

of public debt sustainability published in March 2010, from 2020 on the Czech

Republic would face grave difculties with its debt if it doesnt quickly imple-

ment some reforms.

Deutsche Bank experts simulated various possible paths of macroeconomic

development over the next ten years in order to assess the stability of debt levels

in 38 different developed and emerging economies. Needless to say, the predic-

tions are to a large degree mechanistic. However, they do provide a useful way

of comparing possible public debt development in various countries. Using the

most plausible baseline scenario, the Czech Republic public debt would reach

69 % of GDP in 2020 with a further increasing trend. This places the CzechRepublic into the group of four worst performing emerging markets. Among

developed markets the position would be signicantly better. But still the debt-


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to-GDP ratio would be far above the 60% Maastricht debt threshold.

It is no surprise that the topics of decit, debt and scal sustainability formed

the core of the debates preceding the general election in May 2010. Also due to

the course of the Greek crisis, two new political parties promising to introduce

budget responsibility and ght corruption made it into the parliament. Together

with the conservative Civic democrats they formed a coalition government with

the emphasis put on dealing with decit and corruption.

In order to avert the grave scenario of skyrocketing debt, the new nance

minister prepared a set of remedies on the expenditure side of the state budgetbased on the coalition agreement that, as in other European countries, raised

stout resistance. To accompany the above described increase in revenues which

he expected to reach CZK 20 billion ( 0.8 billion), he made a plan of saving over

CZK 58 billion ( 2.3 billion) from the state expenditures. Most of them were di-

rectly taken away from the budgets of ministries. Hence, CZK 13.3 billion ( 0.5

billion) will be saved in 2011 by a one-tenth decrease of the amount of money

allocated to current expenditure of the ministries and a reduction of investment

expenditure by one fth. Funds for salaries of public employees will be lowered

by 10 percent, which should save another CZK 11.4 billion. The only exception

are the teachers their salaries will on average increase by 3.5 percent in 2011.

Apart from these major items, the government decreases by one tenth the

budgetary reserves (CZK 11.1 billion), and fewer resources will be available for

road and railroad construction (CZK 3 billion), farmers (CZK 3 billion), poorand mildly disabled (CZK 3.5 billion), and new-born child benet (CZK 1.3 bil-

lion).

Reform and other plans

The major shortcoming of the budget for 2011 is a complete lack of anydeeper modication of either the revenue or the expenditure side of the bud-

get. In addition to the already introduced saving measures, the governing coali-


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tion agreement sketched a roadmap of proposed longer-term goals they want to

reach. Two main topics connected with the area of public nance are the pension

and the health-care reforms.

Both reforms have already been subject of public debates for several years.

A health-care reform has been prepared that beneted from the Slovakian ex-

perience. Unfortunately, mainly due to erce opposition from social-democratic

politicians and very fragile majority of the coalition parties in the Parliament in

the period 2006-2008, it was impossible to implement a single component of

that reform. Without surprise, this inability to deal with the under-nancing ofthe Czech health sector led to protests of thousands of doctors some of whom,

in the last months of 2010, announced that they were quitting their jobs in order

to work in countries with more doctor-friendly environment. What those doc-

tors do not understand, however, is that without deeper changes in the way the

health-care is nanced, it is not feasible to allocate more resources to health-care,

especially when high public decits prevail. Plans for such changes are still very

preliminary, though.

Similarly, a proposal for pension reform has been prepared during 2010 by

an expert advisory committee which was asked to update of similar report writ-

ten as early as in 2005. According to the calculations, the Czech pension system

will inevitably generate a decit of 4 % of GDP each year starting in 2050. As a

consequence of social security payments and taxes adjustments during the crisis,

the system generated a decit of CZK32 billions (approx. 0.8 % of GDP; 1.3billion) already in 2010. The expert committee proposes two possible ways of

reforming; both of them assume a decrease of the social security contribution

rate from 28 % to 23 % of gross wage, that social security contribution ceiling

be halved, and, in order to scally compensate, that the two VAT rates (10 and

20 %) be unied to one 19 % rate which should be enough to cover not only the

current decit but also the consequences of the reform in the coming years.The rst and preferred proposal requires to direct 20 percentage points from

the 23 percent point of social contributions into the currently existing pay-as-


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you-go (PAYG) pillar, whereas the remaining 3 pp. will go into new funded pillar.

The reformed pension funds, investment companies or other asset managers will

then manage investment of the pension savings within the framework of the

second pillar according to the participants choice. Participation in both reform

pillars will be compulsory for all individuals under 40. The third pillar will, be-

side life insurance, consist of reformed voluntary pension insurance with a state

contribution.

In the second variant the whole 23 percent will be directed into the rst

PAYG pillar. The second pillar will be managed by the reformed pension fundsand the direct state support will be 3 percent of the gross wage, provided the

participant saves at least the same amount. The entry into this second pillar will

be voluntary.

The government made a promise to follow the conclusions of the advisory

committee to the largest possible extent. Part of the plan is to use all future

privatization incomes and dividends from state-owned enterprises for smooth

transformation of the pension system. The timing is however so far unknown.

As a part of the coalition agreement, the government committed to simplify

the tax system, explicitly mentioning transformation of inheritance tax and gift

tax under the income tax. Moreover, the government wants to abolish most of

the existing income tax exemptions. They stated that they do not want to increase

the progressivity but are determined to eliminate regressivity that occurs when

the tax payer hits social security and health security ceilings. Last major planned

modication of the tax system is higher taxation of lottery and gambling.

The future

In a ght against structural decit the Czech government prepared in 2010

a mix of measures that should raise revenues by CZK 20 billion and shrinkexpenditures by CZK 58 billion. At rst glance the strategy was successful, but

there are still several risks awaiting. To begin with, according to the Czech Na-


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tional Bank, the ministry of nance builds on overoptimistic prediction of the

2011 GDP growth: while the ministry expects the economy to grow by 2.3 %,

the CNB would rather bet on 1.6 %. And lower growth means, of course, lower

revenues and higher expenditures.

Second, there are no sign that a specic reform allowing for a sizable and

permanent decrease of government expenditure will come soon. It is very un-

likely or totally unrealistic that the minister of nance will be able to continue

balancing the budget in following years by further cutting the salaries of public

ofcials and current expenses of the ministries.And last but not least, there also exists a risk for the taxpayers that continu-

ous shift from direct to indirect and less visible taxes would allow the politicians

to silently and unobtrusively increase the tax burden while keeping the most vis-

ible income tax constant as promised. Without profound reforms, there may be

no other way to tame the decits in the end.


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53Denmark Jacob Braestrup

Denmark

Jacob Braestrup,M. Sc (Political science)Senior adviser, Confederation of Danish Industries

In January 2010, the largest tax reform in more than ten years began taking

effect, shifting some DKK 30 billion ( 4.0 billion) of tax revenue when fully

implemented in 2019. Of this, more than DKK 25 billion ( 3.4 billion) is used to

lower the marginal tax on income in order to encourage work and investment. In2010 the top marginal tax rate was lowered from 63 percent to 56.1 percent its

lowest level in at least 40 years. Later in the year, an economic recovery package

postponed some of the tax cuts and increased other taxes in order to improve

public nances. Along with the tax reform and other (minor) tax changes, the

combined effect has been a general lowering of almost all margina

IREF Yearbook Taxation 2011

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