Taxation in Europe 2011

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Taxation in Europe 2011

The yearly report on theevolution of European taxsystems

a publication from theInstitute for Research

on Economic andFiscal Issues

Edited byPierre

Garello


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AboutIREF

IREF is a private institute foundedin 2002 by representatives of the civilsociety coming from the academic aswell as business worlds. It is designedto be an efficient platform for theinvestigation of fiscal and taxationpolicies. Taxation is a many-faceted

issue and existing studies are mostlyincomplete if not biased. It is the aimof IREF to explore systematically andcompletely questions related totaxation and public finance.

IREF has a strong Europeandimension. Tax studies can no longerignore the process of globalisation andits consequences in terms of taxcompetition. In particular, taxauthorities are currently under the

strain of two opposing forces:centralisation and harmonization onone hand, devolution and competitionon the other. It is IREF's intention toreintroduce in this debate the essentiallinks between tax competition andindividual freedom.

In order to achieve its goals, IREFrelies on a network of specialists.Today, a team of over 25 scholars or professionalseconomists andlawyersreport regularly on thequantitative as well as qualitativeevolution of the fiscal systems of theirrespective countries or regions.

Besides its Yearbook on Taxation inEurope, IREF is editing books,reports, briefs and academic studieson topics related to taxation andpublic finance. Those studies togetherwith general information on taxation

in Europe can be found on IREFwebsite at: http://www.irefeurope.org
http://www.irefeurope.org/http://www.irefeurope.org/


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CONCURRENCEFISCALE ETLIBERTEECONOMIQUE

Taxation in Europe 2011

The yearly report on the

evolution of European taxsystems

a publication from the Institutefor Research on Economic and

Fiscal Issues

Edited by Pierre Garello

IREF 2011


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A short presentation of IREF'Yearbook on taxation in

Europe'Series

Among the many ways to

understand the climate of opinion andthe culture of a country, looking at itsfiscal system is one of the mostrewarding. Sure, fiscal systems almostalways rhyme with complexity; eachsystem bearing the weight of itshistory. But the attempts to change thesystem, to give it a new direction, arehighly instructive.

To observe changes, debates andnew directions in tax systems isprecisely what IREF yearbook is all

about. In that sense, the yearbook isnot in direct competition with otheryearly reports on taxation thattypically focus on numbers rather thanon the philosophy behind them.

Another unique trait of thisyearbook is to provide the latestinformation on the topic. What is presented here are the last knownfigures (this year, data for 2010) andthe on-going debates. This approachallows the reader to judge whether

public decision makers have beenkeeping their promises or have beenvictims of inter-temporalinconsistency; drawing plans that theyare later unable or unwilling tomaintain.

The yearbook is conceived for allthose who look for a dynamicunderstanding of tax and budgetary policies. This includes scholars andstudents, of course, but also journalists, businessmen and publicdecision makers. While avoidingtechnical jargon, authors do nothesitate to enter the details of amechanism whenever it is necessary.For we all know that there issometimes a world between notionaland real taxation.

Those reports can be used all along the year for quickreference whenever mention is made of one of thetwenty countries presented here. The country profile


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cards, that have been added this year for the first time,should further facilitate such use of the yearbook.


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Table of contents

Main findings for 2010 11Austria 15Belgium 21Bulgaria 31Croatia 39Czech Republic 44Denmark 53France 66

Germany 73Italy 80Lithuania 86Luxembourg 95The Netherlands 102Norway 106Poland 118Portugal 126

Slovakia 140Romania 147Spain 157Sweden 166Switzerland 173United Kingdom 179Country Profiles 189Austria 2010 190

Belgium 2010 191Bulgaria 2010 192Croatia 193Czech Republic 194Denmark 195France 197


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Germany 198

Italy 199Lithuania 200Luxembourg 201Netherlands 203Norway 204Poland 205Portugal 206


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Romania208Slovakia 2010

209Spain

210Sweden

211Switzerland

212United Kingdom

213


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12 Taxation in Europe2011


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Main findings for 2010 Pierre Garello 13

Main findings for 2010

Pierre Garello

IREFBalancing between constraints

rather than reforming

Once again, IREF's yearbook ontaxation confirms that in Europe,including within the European Union,fiscal policies are far fromhomogeneous.

One obvious reason for this is thatcountries are not confronted withsimilar situations. While some, suchas the Netherlands, Norway, Slovakia,Luxembourg, Germany, Sweden orSwitzerland, are close to a balancedbudget, others are more or less - andsometimes badly - in need for fiscalconsolidation. The latter group ofcountriesthose that must urgentlyreduce public deficit and public debt,forms a large majority.

But divergences between fiscal policies can also be traced back to"ideologies". If today almost no onesuggests that deficit and debt couldsafely be increased (a good point atlast after many stimulus packages hadto be swallowed in 2009!), only fewbelieve that the present situation callsfor a deep rethinking of the welfarestate. Almost nowhere politicians


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behave as if the sovereign debt crisiswas calling for a fundamentalreorientation of economic policies.

As a result, in most countries 2010was a year of mildbut sometimes painfulreforms aimed at balancingthe budget or at least at getting the budget closer to balance. Surely,many governments hope that a strongeconomic recovery will allow for aprogressive reduction of the share ofthe state in the economy and, moreimportantly in their opinion, to themuch-desired fiscal consolidation.This scenario is, however, veryunlikely. For one thing, the generallevel of taxation remains much toohigh to be compatible with stronggrowth. But also, the social acquis that make the welfare state requireexpenses that are likely to grow atleast as fast as the economy. Such isthe case with unemployment benefits,free access to schooling anduniversity, health care benefits, etc.As an illustration, end of 2010,hundreds of doctors in CzechRepublic threatened to quit their jobsand leave for countries with more

"doctor-friendly" environment. Whatthey must understand, however, is thatno real improvement for them will betaking place unless deep reforms areimplemented.

What needs to be done is todemystify the notion of "socialacquis", and, as all the signals of public finances are turning red, itcould be the right time to do so. It


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could be the right time to explain thatwealth and welfare can't be writtendone in the lawIf citizen have aright to the pursuit of happiness, onecan't guarantee a right to happiness!As a matter of fact, sound economicanalysis teaches us that state-runredistribution mechanisms aredifficult to sustain in the long run andthat a much safer and fruitfulmechanism for development is tomake individuals responsible for theirfuture. Pooling of risks being ofcourse welcome.

Trends in taxation

Having made the choice to balancethe budget and to restore growth by allmeans without introducing structuralchanges, we observe almosteverywhere a mix of various, predictable policies. More precisely,the trends are:

to lower ormore oftento leaveunchanged rates related to directtaxation (corporate and personalincome taxation), but often with a

broadening of the basis (getting rid ofexemptions, tax-credits and the like)to increase indirect taxes, startingwith VAT and continuing withexcisesto increase top marginal income rate

(because, it has argued, an increase ofVAT harms more the low than thehighest incomes)to increase


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these interest payments themselveswill count as taxable income."

Lithuania has learned a good lessonin economic theory and mechanismdesign: The state having decided to pay mandatory health insurancecontributions for the unemployed, asurge in unemployment figurefollowed as a number of individualsofficially registered unemployed inorder to avoid having to pay con-tributions. The mechanism was thenamended.

Romania also received a goodlesson. The making of the Romanian"sausage" was made of an increase ofVAT by 5 points (from 19% to 24%)and a shortening of the list of goods benefiting from a preferential rate.The result of this double increase ofrate and base was a disappointingincrease of VAT revenues of only10%. At the opposite, Sweden thatconsistently lowered taxes for the pastfour years was rewarded with higherrevenues...

Governments also adopt differentrecipes to fight fraud and tax evasion.Hence, in late November 2010 the

German Constitutional Court hasruled that the fact that data on clientsof foreign banks had been collectedillegally does not protect tax evadersfrom prosecution, even if theaccusations rely entirely on illegalsources of information. But in thesame time, the Belgian court took theopposite direction. The Brussels Courtof Appeal has confirmed the judgment


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of the Court of First Instance rejectingthe claims of the Treasury based onlistings that came into the possessionof the Treasury through thecommission of a crime, namely theftby dishonest employees

Many lost opportunities

Reading last year's reports we hadthe feeling that something wascooking but it wasn't clear yet whatdirection the various governmentswould take. For once, everyone sharedthe view that changes had to beimplemented, that the bill was nolonger affordable. The title of thepreface for the 2009 yearbook was:2009, A transition towards what? Oneyear later, one must sadly observe thatlittle has happened. The goal wassurvival, not the setting of a newdynamics. As our UK report puts it,2010 was a year of lost opportunitiesin the midst of fiscal panic. As alwaysin Europe, and fortunately, this is noteverywhere the case.

One of the best moves in our

opinion took place in Slovakia whereemployees will from now on be paid a"super-gross" wage (superhruba mzdain Slovak). This means that eachemployee will receive on his bankaccount not only his "regular wage" but also the social and healthcontributions that used to be paid byhis employers. Hence the wagereceived will express the total labor


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cost. This is in stark contrast withrules prevailing almost everywhere inEurope. More importantly, itconstitutes the best way to prepare theground for true reforms; makingtaxpayers aware of the costs andbenefits of the prevailing systems.2011 is again a year full of uncertainty due, in particular, to thecrisis of the euro-zone that is far frombeing over. Nonetheless, for decisionmakers that are convinced that further postponing reforms is unwise,interesting ideas such as the one justmentioned can be drawn from thosereports.

Austria

StefanBuczolich The

HayekInstitute,

Vienna

Current situation

Austria is currently one of thecountries with the highest tax burdensin Europe with a progressive personalincome tax system with top marginalrate at 50%, a corporate tax rate at25% (lowered from 34% in 2005) and,as will be explained, a new flat capitalgains tax rate which is independentfrom individual income and amountsto 25% for both short and long-terminvestments.


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Notwithstanding this heavy fiscal burden, public debt in Austria wasapproaching 200 billion on 31st ofDecember, that is, about 68.6% ofGDP (Source: CIA World Factbook).This places Austria at the 25th placeglobally. Compared to other WesternEuropean countries such as Germanyand France with a percentage of publicdebt of GDP of 74.85 and 83.5%respectively, and amid rising deficitsall over Europe, the short-term risks inAustria still seems to be moderate.

Development of Public Debt since2006 in absolute numbers and as apercentage 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 costlyand inefficient administration wereomitted in the 2011 Budget, theincrease of public debt is expected tocontinue, although its pace shoulddecrease. The 2011 Budget is


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expected to lead to a Budget deficit of3.2%. The WIFO institute, founded byFriedrich A. Hayek and Ludwig v.Mises in 1927, recently presented itsconcept for an administrative reformyielding cost reductions of up to 5billion per year.A long-awaited coalition budget

In 2010, the political agenda washeavily dictated by the budgetnegotiation between the coalition partners SPO (Social DemocraticParty) and the OVP (People's Party).Rising costs resulting from still highunemployment and bank bail-outs

along with a substantial decrease intax revenues urged the coalition totake measures against a furtherincrease of public deficit, although theSocial Democrats and the People'sParty did certainly not agree on howthis problem should be addressed.

The final presentation of the budgetwas postponed as the coalitionintended to wait for updatedinformation to be offered by researchorganizations that would enable themto adapt the budget to the most recentforecasts of economic growth andpredicted budget deficit. According tothe constitution the budget has to bepresented in the Parliament ten weeks before the end of the year, on 22October. Nevertheless, FinanceMinister Josef Proll held his firstspeech on 30 November. When both


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parties reached an agreement about thekey measures at a meeting at the endof October, the elections in Viennawere already past. Both SPO and OVPhad suffered heavy losses, whereas theright-wing populist party FPO couldincrease its result by almost 11percentage points to 25.77%. Stressingthe importance of savings in order toconsolidate the Budget, the coalitionagreed on a ratio of 60:40 of savingsand new sources of tax income. In2010 the SPO proposed an Eight-Point plan unexceptionally consisting of proposals ranging from new andhigher taxes on wealth and capitalgains to a bank tax based on the banks'assets. Finance Minister Josef Proll,member of the OVP, repeatedly statedthat there were no plans to introducenew taxes in order not to harm themiddle class and small to mediumsized enterprises.

The final budget was announced tobe one of the most ambitious in thelast decades. Critics however said thatthe budget lacked necessary broadstructural reforms.

Child Support and tuition fees

Austria is currently one of thecountries with the longest childsupport in the European Union. Thecoalition decided to reduce themaximum age for students to qualifyfor child support from the 26th to the24th birthday and also to cut the 13 th


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child support to 100 and limit it toscholars (child support is usually paid13 times per year, 12 payments foreach month of the year and oneadditional payment in September,when school starts in most of thestates as compensation for the costs of books, etc.) The expected savingsamount to 270 million per year.Tuition fees, that were abolished in2001 for students who manage tocomplete their studies within a certaintime span (usually the minimum time plus one semester), are once moreconsidered by the conservative OVP,citing the lack of capacity anddeteriorating conditions for students atuniversities.

Capital Gains Tax

So far profits from securityinvestments are exempt from taxationif the asset is not disposed of withinone year, whereas the individual'spersonal income tax rate is levied onspeculative earnings. A flat 25% taxrate is applicable on dividends andinterest income regardless of thesource and regardless of the in-dividual's income. As of 1 January2011 a flat tax rate of 25% isapplicable on all capital gains fromstocks and mutual funds, regardless ofthe individual's income and the timethe asset has been held. Any short-term capital gains from investmentspurchased in 2011 and sold before 1stof October will be subject to the


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individual marginal tax rate and haveto be declared separately. Incomefrom derivative instruments and bonds(excluding interest payments) will betax-exempt after one year. BeginningOctober 1, any realized profit fromassets purchased after 2010 taxes will be withheld automatically, causingconsiderable discomfort since in caseof losses in the same period taxes willnot be refunded before declarationafter the end of the year. The new flattax is no longer dependent on neither personal income nor on the timehorizon of the investment; it is there-fore questionable whether the newsolution will particularly targetspeculative earnings as mostindividuals with medium to highincomes will pay less taxes on theirshort term capital gains, whereas long-term investments aiming to insure acertain standard of living duringretirement will be affected by thediscontinuation of the speculative period. One might think theintroduced capital gains tax is similarto that imposed in Germany in 2009,in-depth scrutiny reveals a few details

that differ significantly from theGerman model.Losses from financial transactions

may not be carried forward in order toreduce taxable capital gains in thefuture.

Capital gains from the sale of stocks,bonds or derivatives may not be con-solidated with other forms of income


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including interest payments of savingsaccounts.

Transaction costs or other brokeragefees such as escrow costs are not taxdeductible.

In contrast to German law that offersa 801 tax allowance for individuals,such an allowance is not implementedin the current law.

A few other aspects of the new ruleswill hopefully give rise to further dis-cussion, in particular the fact that amajor discrimination has beenintroduced, between asset classes.Profits from life insurance will beexempt as well as long-term capitalgains from real estate, while gains

realized within 10 years will betaxable. If an apartment has been usedby the owner, profits from its sale aretax exempt after two years.

Parallel to the introduction of thecapital gains tax, the tax levied onincome of private (for-profit)foundations has been increased from12.5 to 25%.

As of January 2011 many bankshave already voiced their concernsabout


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the costs related to the new capitalgains tax and claim that the short timespan provided to implement the new

legislation would cause overall costshigher than the expected tax revenues.On February 1st 14 Austrian Banksfiled suit against the newlyimplemented capital gains tax,complaining about the short period for banks to implement necessary newtechnologies and high overall cost thatare expected to surmount future taxrevenues in the next years to come.

Bank TaxThe Bankenabgabe" is a Bank Tax

with estimated revenues of 500million consisting of 340 millionfrom taxing total assets only targetinglarger banks and an additional 160million of higher taxation onderivative transactions. Total assets ofbanks will be taxed at a rate of 0.04%if above 1 billion Euros, while a taxrate of 0,08% will be applicable if thebank's assets exceed 20 billion Euros.

Tobacco Tax

Taxes on one pack of cigarettes willrise by 15 to 25 cents yielding 100-150million.

Fuel Tax

Fuel Tax on gas and diesel willincrease by 4 cents and 5 centsrespectively. In order to protectcommuters from additionalexpenditures they will be givenadditional compensation. The increaseof the fuel tax, along with othermeasures as the flight tax, is part of asomewhat opaque ambition of thecoalition that is praised to combine


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tax increases with desired aspects ofenvironmental policy.Flight Tax

A flight tax of 8 for continentalflights with European destinations anda of up to 35 for international flightswill be effective on January 1st and isexpected to yield 60 million in 2011and 90 million per year in the nextyears. Since both national andinternational airlines have to chargethe fuel tax for every flight taking offfrom Austria, shifts to airports like

Bratislava, only one hour away fromVienna by train, are expected toincrease as the tax may make up asubstantial amount of the total pricewhen consumers choose to book aflight with a low cost carrier. Asimilar tax was abolished in the Netherlands after having been ineffect for just one year.

Wealth Tax

The last year's debate ahead of thefinal agreement on the 2011 Budgetwas dominated by the calls for awealth tax, a (preferably international)financial transaction tax, higher taxesfor private foundations and a capitalgains tax. Although a wealth tax hasnot been included in the currentBudget, many politicians of the SPOand members of the the AustrianChamber of Labour have repeatedly

stressed their continuing efforts tointroduce a wealth tax. ChancellorFaymann said he was in favour of awealth tax applied on net assets above 1 million with the tax rate in a rangebetween 0.3 and 0.7%. Supporters ofthe wealth tax name high taxes onlabour income and comparably lowtaxes on capitals gains and wealth inAustria as their main arguments.


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28 Taxation in Europe 2011

BelgiumThierry

AFSCHRIFTProfessor at the Free

University ofBrusselsLawyerwww.afsc

hrift.com

The Belgian paradox

One could obviously not talk aboutBelgium without tackling its politicalcrisis. Belgium holds a sad record forfacing the longest political crisis inEurope: being without any

government for more than 249 days.Should Belgium fail to get a newgovernment by March 30 it wouldbeat... Iraq's world record of 289days in 2009.

This political crisis has of courseenormous consequences on whathappened - or did not happen - lastyear but could also deeply impact oureconomic future. In December 2010,the rating agency Standard & Poorlowered to "negative" its perspectiveon the Belgian financial rating, duenotably to the legislative paralysis andthe lack of a credible budget policyfor 2011.

However, economically, Belgiumworks relatively well. The growth rateis not bad. Belgium finished 2010with a public deficit of 4.6 % of itsGDP. This is better than the 4.8 %deficit determined by the Belgian
http://www.afschrift.com/http://www.afschrift.com/http://www.afschrift.com/http://www.afschrift.com/


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Belgium Thierry Afschrift 29

stability program. In addition, publicdebt reached 97.2 % of GDP and it isalso less than the forecast. This is theBelgian paradox. One cannevertheless fear that the caretakercabinet will not be able to deal with

the economic issues of the future.While most European countries haveadopted various measures to reducetheir deficit for years to come,Belgium has not yet a real budgetarypolicy or a concrete tax policy. No-one can predict what will be the fiscalor budgetary orientations of the futuregovernment. However, in order toreduce its astronomical public debtand to avoid its debt reaching morethan 100 % of GDP, the future

government - whatever itscomposition - will inevitably have tocut spending. It will have to strugglewith structural deficits. Far fromexpecting a corresponding reductionof taxes, it will be essential to boostinvestment and enhanced Belgiancompetitiveness and attractiveness.The deficit struggle will certainlyinvolve some fiscal effort. Where theBelgian State already takes 46% ofwhat its inhabitants produce andspends 53% of it, tax competitionmight be the only thing which can stillmoderate the government's temptationto always prefer an increase inreceipts to a reduction of expenditurein order to balance the budget.

Despites the Belgian political andlegislative apathy of the last months,few measures were adopted at the beginning of 2010, and one can


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underline the case law relating toprivacy, European freedoms, etc. Onecan also draw an outline of what couldhappen in a near future.

Fight against tax fraud and banking

secrecy

In accordance with most Europeancountries' policies on this issue, theBelgian state gives itself more andmore means to fight tax fraud and toreduce banking secrecy to nil. Itsinterventions are however prejudicialto the right to privacy.

The new article 335 of the BelgianTax Code ("BTC") gives tax

authorities wider investigative powers: any officer is entitled tocollect any information related to anytax, even one for which the officer hasabsolutely no jurisdiction, and canconvey this information to other taxadministrations. It seems at leastdoubtful that the new version of thisdisposition complies with article 8 ofthe European Convention on HumanRights, with article 22 of theConstitution and with the law of 8December 1992 on the protection ofprivacy with regard to the processingof personal data. It creates indeedsystematic and spontaneous trans-mission of information between taxadministrations without anypreconditions.

In 2010, the fight against bankingsecrecy continues as it began in the

wake of the economic crisis. Different


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double tax treaties have been modifiedin order to insert "on demand" data

information exchange clauses. Manyvague proposals have also been made

by different members of Parliament inorder to abolish the last rampart of the

Belgian banking secrecy, article 318BTC. On that subject, the currentpolitical crisis gives this secrecy a few

moments grace. However, if theproposals are adopted without being

modified the new law will beprejudicial to the right of privacy. Inthis regard it is symptomatic that, in

Belgium, the right of privacy and theright of ownership are most of the

time sacrificed in favour of an alwaysmore powerful State.

To strengthen the fiscal anti-evasionpolicy, a new reporting obligation has been introduced. The new measureconcerns legal persons who makepayments to persons established in atax haven as soon as the total amountof 100,000 is exceeded.Consequently these payments shouldbe included in a separate declaration.

In May 2010, the Belgiangovernment published a royal decreeupdating the list of the tax havens, andthe 'non-existent or low taxation'countries. The list covers countrieswhere certain companies are not orslightly taxed (a nominal tax ratelower than 10%). This is used torequire that any payment to acompany established in a listedcountry is only deductible if thiscompany is the subject of a specialdeclaration, and the payment


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corresponds to "industrial and com-mercial considerations and not anartificial construction". We observethat the Belgian tax authorities do notconsider as tax havens: Liechtenstein,Gibraltar, Hong Kong, Macau or

Panama, for example. Therefore payments made to companiesestablished in these countries do notfall within the scope of the new legalprovisions.

A law of 18 January 2010, publishedin the "Moniteur belge" of 26 January2010, overloads the legal provisionson the prevention of moneylaundering, dating from 1993, whichhave been reinforced many timessince then. Among the multiple

obligations it prescribes, this lawstates that, from now on, "any personor entity who acquires securitiesrepresenting capital or otherwiseconferring the right to vote in stockcompanies ... and has issued bearer ordematerialized shares, must declare tothe company, not later than the 5th business day following the date ofacquisition, how many securities itowns when the voting rights attachedto those securities achieve aproportion of 25% or more of the totalvoting rights ... ". The text aims atpreventing companies, with bearer ordematerialized shares, from being ableto declare that they are unaware oftheir shareholder's identity when abank account is opened or during a taxaudit. These obligations do not existfor shareholders holding less than25% of voting rights in a company,


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even if the companies in question arecontrolled by the same person, byspouses or relatives. Shareholderswishing to keep their anonymity -which can be for very good reasons -should place themselves in a situation

where they hold less than 25% of theshares. This new measure againstshareholders' anonymity--that the law justifies by the fight against moneylaundering--might have consequencesin terms of inheritance. At the time ofdeath, in order to tax the value of theshares, tax authorities will only haveto ask the company who are theshareholders (if the shares were to beowned by an individual).Notwithstanding the legislative will

to fight tax fraud, tax evasion and taxhavens, the Belgian Courts rightly pointed out that this battle and therepression of this fraud cannot beconducted at any price or on anyconditions. In the tax component ofthe KB Lux case, the tax authoritieshave nothing to be delighted about because almost all judgments pronounced by our Courts arefavourable to taxpayers challengingtax assessments after the "discovery"of the famous listings comingallegedly from the Luxembourg bank.One of the arguments for rejecting theclaims of the Treasury was that thelistings on the basis of which thedisputed taxes were established arenot conclusive: they are mere copiesof microfiches containing noreference to their author, signature,stamp or other evidence to identify


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their origin. Another argument hasbeen advanced to challenge these taxassessments: the listings concernedcame into the possession of theTreasury through the commission of acrime, namely theft by dishonest

employees. As far as the criminalaspect of this case is concerned, theBrussels


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Court of Appeal has confirmed the

judgment of the Court of FirstInstance that relied on this secondargument to declare the prosecutioninadmissible. One can only welcomethis brave decision which will remindthe Public Prosecutor's office that,under the rule of law, the end does notjustify the means and it is not possibleto prosecute someone for an offenceon the basis of the commission ofanother. This will give some food forthought in a setting that seems quite

similar to the LGT case inLiechtenstein and the HSBC case inSwitzerland.

Corporate Tax

In the wake of the recession,corporate tax receipts have fallen andin order to boost economic activity,this tax rate could be reduced. With acorporate tax rate of 34 %, Belgium

has in fact one of the highest inEurope. But instead of that, themaximum "tax deduction for equitycapital" rate for the 2011 and 2012assessment years is reduced from6.5% to 3.8%. Admittedly the "taxdeduction for equity capital" has played a role in the tax incomeinflexion, but according to the National Bank this has been to alimited extent.

Since 1 January 2006, a Belgiancompany can benefit from a "taxdeduction for equity capital" alsoknown as a "deduction for notionalinterest" (Art. 205bis-205novies,BTC). All companies are treated, froma tax point of view, as if they hadborrowed their own funds at an annualrate of interest equivalent to the ratefor ten years bonds issued by theBelgian state. The "notional interest"


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calculated in this way is deductiblefrom the taxable base for corporationtax purposes. Since its coming intoexistence, this measure has been adisputed one. This deduction ispresented as "gifts" to companies andone criticizes their cost for the budget,as well as their social uselessness. It isnot impossible that the deduction will be soon linked to an employmentcondition. Proposals have been raisedin this direction.

Tax deduction for equity capitalThere are three objectives behind

this deduction scheme. First, to establish equilibrium between the tax treatment of theequity capital and the tax treatment ofloans. Under the former system, it isfiscally more attractive for a companyto be funded by means of loansbecause the interest can be deductible

for tax purposes. The equity capital,on the other hand, gives rise to non-deductible dividends. The newscheme remedies this situation partlyby decreasing the taxable base by anamount corresponding to the interestthat the company would have paid if ithad borrowed the same amount.

Second, the new measure offers anattractive alternative for "coordinationcentres" whose present low tax regimeshould be withdrawn at some point because it is incompatible with EUstates aid law.

Last, the new fiscal treatmentallows Belgium to compete with thegeneral fall in the corporation taxrates throughout Europe. Although thenominal corporation rate tax stays at


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33, 99%, the new measure cuts theeffective rate down to 26 % onaverage, a little less than the Europeanaverage.

Nevertheless, few modificationsoccurred: a few explanationsconcerning the basis for thecalculation are inserted in the law andany deduction that is not used duringthe taxable period can henceforth beconsecutively transferred to the fol-lowing seven "taxable periods"

instead of during seven "years", aspreviously.In the context of tax neutral cross-

border mergers, the notional amountof interest deductible and the taxcredits for research and developmentmay now be fully transferred as if themerger or de-merger had not takenplace. Moreover, the parts taken overor acquired that are located inBelgium must no longer necessarilybe used in a Belgian "establishment"

(of the acquired foreign company), but these can also be used in theBelgian acquiring "company".

The Belgian Tax Code provides that,under certain conditions, dividendsfrom stocks and shares held by aBelgian company are deductible fromthe profits of this Belgian company as"definitively taxed income". Thisdeduction is allowed up to a limit of95 % of the gross amount paid. One ofthe conditions concerns a minimumparticipation of 10% in the capital ofthe paying company or a minimum participation of at least 1,200,000(purchase value). As of assessment2010 year, this condition also appliesto dividends acquired by creditinstitutions, insurance companies andlisted companies. Once again, thiscomes with the proviso that anyamendment made after 1 January


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2009 to the closing date of the annualaccounts is without effect. Moreover,the minimum participation is raised to 2,500,000 (or still a minimum of10%). This applies to income that isallocated or made payable as of 10January 2010.

Finally, amendments have beenmade to the favourable so-called "taxshelter" system. Under certainconditions, this system providesexemption from corporate tax forinvestments in recognized audio-

visual works. Those amendmentsenlarge the scope of the tax sheltersystem. For example, it is no longernecessary for the "productioncompany" to be a "domesticcompany", but from now on it mayalso be the "Belgian establishment ofa foreign company". The notion of"fiction films" replaces that of 'long-play films" and thus includes films notonly of long, but also of medium andshort duration.

Personal Income tax

As in 2009, the year was poor ininteresting measures. No fundamentalmodification occurred at a legislativelevel. In Belgium, whatever thecomposition of the government isgoing to be, one should fear, in theshort or medium term, an increase inthe rate of withholding tax on interest,

the imposition of a tax on the capitalgains on shares, and perhaps anincrease in the marginal income taxrate for high incomes.

Its is however interesting to mentionthat, on 1 July 2010, the European

Court


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of Justice judged that Belgian

legislation imposing an additionallocal tax on income from capitalwhere the income is received by aBelgian resident without theintervention of a Belgian financialinstitution, violates EU laws on thefree movement of capital. UnderBelgian tax law, foreign interestand/or dividends received without theintervention of a Belgian financialinstitution have to be reported in one'sBelgian income tax return and an

additional local tax (varying from 0%to 9,5%) is levied. However, in thecase of interest and/or dividendsreceived via a Belgian financialinstitution, a withholding tax of 15%is deducted and there is no obligationto report this income in one's Belgianincome tax return, so that noadditional local tax is due. TheBelgian Tax Authority confirmed inits circular letter dated 19 October2010, that it would abide by the

decision handed down by theEuropean Court of Justice on 1 July2010.

Moreover one can welcome thesetting up of a tax conciliation service,introduced by the "Program" Law of25 April 2007. This service isoperational since 1 June 2010.

The new service, workingindependently from the FederalFinance Department, has the purposeof assisting the taxpayer to find"possibilities for an agreement ratherthan going to court" according to theMinister of Finance.

Green tax legislation

For many years Belgian tax policyhas been influenced by environmentalconsiderations. Energy-saving


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measures tend to be encouraged bythe granting of tax advantages. Thecrisis and the budgetary constraintsimply nevertheless that thoseadvantages are tending to be reducedor limited.

As of 1 January 2010, thecalculation of the benefit in kind forthe free private use of company cars by employees or company directorsdepends on the CO2 emissions of thecar and is no longer based on thefiscal horsepower.


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VAT

Belgium is being found at odds withthe interpretation of the Court ofJustice developed in the Breitsohl casefor nearly ten years since in Belgiumreal estate transactions remainedexcluded from the application ofVAT. However, from 1 January 2011,Belgium complies with the Europeanrequirements. From now on, thesimultaneous sale of land and a newbuilding will be subject to VAT. Thenew regulation replaces the formerregistration tax. This measure isfavourable to VAT taxable persons.Indeed, enjoying full right ofdeduction, they can fully deduct input

VAT in their VAT account.Moreover, they will no longer pay aregistration fee on the land value.Other purchasers of land will bear aheavier tax burden. Indeed, they willhave to pay 21% VAT on the value ofthe land adjacent to the buildinginstead of registration tax of 12.5% or10% and the VAT will not berecoverable.

Until recently, in order to benefitfrom the reduced VAT rate in the real

estate sector, construction works onland needed to be executed by aregistered building contractor. Thisrequirement for the application of the6% VAT rate applicable in suchsituations has now been abolished bymeans of Royal Decree dated 2June 2010.

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


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from 21% to 12 %. The measureshould have been analyzed and theresults submitted to the Governmentin late October at the latest. Thepolitical crisis postponed this analysis.This reduction should be maintained ifit does not lead to a reduction in tax

revenue.Conclusion

While a caretaker cabinet is at thehelm of a boat without captain, andtrying to keep the trains running ontime, fears are growing of threateningeconomic troubles. Rating agenciesand the nation's Central Bank havewarned of a poten


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tial threat from financial markets if

politicians fail to strike a deal soon."This chaotic situation... could havelong-lasting effects on the Belgianeconomy... The markets will bemerciless if the country does notemerge promptly from thisunprecedented hell" said billionaireinvestor Albert Frre, a leadingshareholder in energy groups Totaland GDF Suez.

Despite the current political crisis being the biggest challenge Belgium

has to deal with, the country shouldnot delay important long-termeconomic decisions that will end notonly by delaying or avoidinginvestment projects but also bycorporate expatriation. Measures haveto be taken soon in order notably toreinforce the competitiveness ofBelgian companies.


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Bulgaria

Petar GanevInstitute for

Market Economy,

Sofia2010 was a controversial year for

the Bulgarian fiscal policy thecommon use phrase in the recentyears "balanced budget" was replacedby "excessive deficit"; the budget wasrevised in the middle of the year, eventhough no major changes took placein the tax policy; the health and pension reforms were debated allthrough the year; some partialnationalization of private pension ac-counts for early retirement took place;the shadow economy was once againan issue. Along with all these, thegovernment started a campaigntowards the rich with helicoptersflying over some big estates taking pictures and also a proposal forintroducing a "luxury tax".

In 2011 Bulgaria will struggle toachieve a "reasonable" deficit below 3

percent of GDP. No major taxes arechanged, except for the slightly highersocial contributions and some exciseduties. There are, however, concernsthat the budged would have to berevised throughout the year, ashappened in 2010.

Fiscal Issues


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Bulgaria Petar Ganev 45

Bulgarian economy did not improvemuch in 2010 the economy grewless than 1%, employment is source ofworries and foreign investments arenot coming back. Expectations arenow that the recovery will finallyhappen in 2011, with an economicgrowth of 3,6%. The fiscal stability ofthe country depends on that growth.

2010 was a bad year for Bulgarianfiscal policy. Throughout the middleof the year the revenues were far fromtheir expected levels and this led to asevere revision of the budget fromalmost balanced to one with excessivedeficit.Moreover, the deficit for 2009 was

also revised upwards, which gave anentirely new look to Bulgarian fiscalstability. If, consequently, tons ofmeasures were discussed through theyear to get the budget back on track,only a few of them have beenimplemented. The revision of thebudget didn't affect the tax policy.

In 2011 Bulgaria is expected torecover partly from the crisis, whichmeans more revenues and lesspressure for the budget. The deficit is

projected to be just below the 3% line,which will be a success after twoconsecutive years with excessivedeficits. More revenues are expectedmainly from VAT and corporatetaxation, thus depending on therecovery of the economy.

In 2011 the government is supposedto redistribute around 36,5% of GDP,which is slightly less than the


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previous years some cuts in theadministration took place and the pensions were frozen. Nevertheless,the pressure on the government andthe budget will remain high, as allsectors are asking for more moneyand opposing all unpopular measures.The fiscal debate promised to beintense in 2011.

Direct Taxation (Corporate Tax &

Income Tax)

In 2007 the corporate tax rate inBulgaria was reduced to 10% (downfrom 15%). The following year the

income tax was also reformed replacing the progressive scale (20%,22% and 24%) with one singe flat rateof 10%. Those tax cuts made Bulgariathe country with the lowest directtaxes in the EU, excluding the socialcontributions off course. Both tax cutsbrought about positive effects for theeconomy and the state budget thatwere clearly visible prior to the crisis.

The revenue from corporate taxationwent straight up after the reform

both in 2007 (up almost 40%) and in2008 (an additional 20%).Nevertheless, the crisis had a severeimpact on corporate tax revenues thatfelt by almost 20% both in 2009 and2010, going back almost to their level before the reform. In 2011 thecorporate tax will still be at 10% withprojection to stay at that level for theyears to come. The official projections


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for 2011 are that the revenues fromcorporate taxation will start to recover(up 17%) and will reach 1.7 billionlevs (870 million) which representsmore or less 2.2% of the GDP.

The flat tax story is somewhatdifferent. Since the introduction of thesingle flat rate in 2008 the revenuesalso went up, but also prove to bestable during the crisis. The positive budgetary effect of the flat tax isindisputable with a single tax ratetwo times lower than the lowestmarginal rate of the previous progres-sive scale, the revenues went up andstayed stable during the crisis. In 2011the 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 purelyideological debate over the flat tax inBulgaria, the official projection is thatthe flat tax will stay unchanged 10% flat rate and no tax-exemptminimum.

Tax exemptions continue to be anissue. Since the beginning of 2010some tax exemptions for farmers wereremoved--they were not supposed to

pay any income tax in the previousyears. Earlier, beginning of 2009, atax exemptions for young familieswith mortgage loans was introduced deduction of interest payments.This exemption was highly disputedin the recent years and the object ofseveral votes in the Parliament. Nevertheless, it will be upheld in2011. The data shows that in 2009


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more than 5 thousand families benefited from it; a shortfall in taxrevenues of around BGN 2 million(1 million).

Indirect Taxation (VAT & ExciseDuties)

Indirect taxes include VAT andexcise duties on special goods such ascigarettes and alcohol beverages. TheVAT in Bulgaria is set at 20% and,despite the various discussions thattook place during the year, it issupposed to stay at that level for theyears to come. The budget revenues

from VAT are expected to reach BGN6.5 billion (3.3 billion) or 8.4% ofGDP in 2011. This is above their 2010level and back to the revenues of2009.

Some changes in the preferentialVAT for tourism were made effective 1 April 2011 a singlereduced VAT rate of 9% will apply tohotel accommodation servicesregardless of whether they are a partof a tourist package or bought

individually. Until now the reducedVAT rate of 7% applied only to hotelaccommodation if it is a part of atourist package.

Bulgaria has to harmonize its taxregime with that of the EuropeanUnion by introducing the minimumexcise duties of the EuropeanCommunity on tobacco, alcoholicbeverages, and fuels. Started in 2002,


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the harmonization process isscheduled to be completed by the endof 2013.

In 2010 excise duties on kerosene,electricity for industrial purposes andcigarettes increased, while on gasolineand diesel, as well as on liquor therewere no changes. The fiscal effect ofthe higher excise duties on the budgetwas expected to reach BGN 300million (150 million), mostly due tothe higher excise duties on cigarettes.But in fact, the revenues collapsedeven below their 2009 level theadditional revenue from excise dutieson cigarettes never materialized asconsumption felt and smuggling went

up. Once again the Laffer curve proveto be right in this case higher taxeson consumption led to lowerrevenues, as trade shifted to theshadow economy.

In 2011 excise duties on tobacco andsome fuels have been increased, butstill the budgetary effect of this isexpected to be remote. Overall therevenues from excise duties in 2011are supposed to reach BGN 3.8 billion(1.9 billion) or 4.9% of GDP, which

would be more than 2010, but lessthan 2009.

Social Security Contributions

Social contributions are still themost disputable tax in Bulgaria. In2005 the contributions were above40% of the gross wage, but following


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a 6 percentage points cut in 2006 anda 3 percentage points cut in late 2007,they felt to 33.5% of the gross wage.At the start of 2009 a further reductionof 2.4 percentage points was enacted,followed by another 2 percentage points cut in 2010, bringing thecontributions bellow 30% of grosswage. The cuts did not reacheduniformly all the contributions: if the pension contributions were reduced,along with those for unemployment,the healthcare contributions wereincreased.

Also, starting in 2009 and alongwith social contributions paid by theemployee and the employer (as in

most European countries), the Stateitself started to pay socialcontributions for every worker 12% of the gross wage. Those "new"State contributions, however, aremore of an accountant's trick than areal reform. Actually, the State hadalways made payments from the budget to the Pension Fund thedifference is that those payments werecalled transfers (or subsidies) and nowthey are called contributions. Even

with these state contributions, thestate pension fund is far frombalanced and need further governmentsubsidies (transfers).

Throughout 2010, the crisis putadditional pressure to the pensionsystem and the government wasforced to take action. The negotiationswith the so-called "social partners",namely the trade unions and the


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business organizations, were intenseand lasted months. The result was along term reform plan, which includesfrozen pensions, higher socialcontributions, higher retirement agefor both men and women (starting 10years from now), and also somemeasures to reduce a wide spreadstrategy of early retirement. Still, the pension plan was not welcome andthere is a probability that the longterm measures would not be enforcedas written.

One of the most heatedcontroversies in the country was the partial nationalization of the privateprofessional pension funds the idea

was to transfer the money from theearly retirement accounts in privatefunds to a newly set-up state "earlyretirement" fund. The goal was not somuch to reform the pension system, but mainly to indirectly support the budget. At the end, the governmentstepped back and transferred into theNational Social Security Institute onlythe money of those to retire in thenext 3 years thus, not establishing anew state "early retirement" fund and

not shutting down the private professional funds. Still, partialnationalization did take place andsome private accounts were shifted tothe solidarity system. This action isnow supposed to be reviewed by theConstitutional Court.

At the end of 2010 the healthcaresystem in Bulgaria went through adeep crisis, pushing for the second


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time in just one year the minister ofhealthcare to leave office. The state ofthe system was chaos badorganization and artificial pricing,lack of financing, perverse incentivesand fraud, and absence of agreementon the expected reform. Nevertheless,by the end of the year some changesdid take place the most importantchange is that the health contributions(8% of the gross wage) willhenceforth go entirely and directlyinto the system, while until now 25%of the money (2 percentage points)was going to the "health reserve" heldat the Bulgarian National Bank.Meanwhile, the money that wasaccumulated in the "health reserve" around BGN 1.5 billion (800million), is now considered to be partof the fiscal reserve. Meaning, it can be spend on everything, notnecessarily health.

In 2011, another 1.8 percentage points will increase socialcontributions: 1 percentage pointincrease in pension contribution forthe employer and 0.8 percentage points for the employee. Thus, the

social contributions as a whole willagain be over 30% of gross wage.Again, the employer contributions arehigher than those of the employee, butthat is not so important as both ofthese payments lay, one way oranother, on the shoulders of theemployee (as they are taxes onlabour).


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Moreover, the 0.1% employer'scontribution to the Salary GuaranteeFund is abolished for several years, asthe amount of money accumulated inthe fund is sufficient. There is also anincrease in the amounts of theminimum social security thresholdsfor the main economic activities andgroups of professions by 5.6%average. Also the minimum socialsecurity thresholds for self-employedindividuals in 2011 will bedetermined, based on their taxableincome receivedin 2009.

As administrative measures, the period for calculation of the

compensations for unemployment,pregnancy and birth is increased to 18months and the period for calculationof the compensations for temporarydisability is increased to 12 months.The current regulation for payment ofmonetary compensations fortemporary disability by the insurer forthe first three days of the disabilitywill be extended until the end of 2011.

Social Security Contributions in

Bulgaria (% of the gross wage)

SocialContributions State FundPrivateFund(2011)

Total

Employer

Employe

Employer

Employe


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e ePension 17.8

0%7.10%

5.70%

2.80%

2.20%

Illness &Maternit

y

3.50%

2.10%

1.40%

X X

Unemployment

1.00%

0.60%

0.40%

X X

LabourAccidents &ProfessionalIllness*

0.50%

0.50%

0.00%

X X

Health 8.00%

4.80%

3.20%

X X

Overall 30.80%

15.10%

10.70%

2.80%

2.20%

(*) The rate for Labour Accidents andProfessional Illness is averaged there are several rates depending onthe labour category varying from0.4 to 1.1 percent.

Further changes in the social securitycontributions are to be expected in theforthcoming years. Either the pensionplan will be enforced as written or anew plan will be developed in bothcases changes in contributions andretirementage are coming. The healthcaresystem has proven to be highlyvulnerable in the


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recent years and it is expected toremain so in the years to come changes inhealth contributions are also possible.

Local Taxes and IssuesThe local taxes were also an issue andrecently some changes took place: In 2011 Bulgarian municipalities willbe allowed to set the annual real estatetax rate within the range between0.01% and 0.45% on the highest ofthe gross


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book value and the tax value of theimmovable property. Before that themaximum rate was 0.25%.

A new tourist tax has beenintroduced replacing the tourist fee.As of 1 February 2011 the ratesdetermined by municipalities shouldbe in the range of BGN 0.2 to BGN 3.The tax is due per night and is payable by the property owners providinglodging.

Along with these, the debate focusedaround the government campaign to-wards the rich helicopters were sentto fly over some large estates to take pictures while a proposal forintroducing a "luxury tax" was made.Those actions (and pictures) were allover the media, triggering vividdiscussions, but achieving nothingsubstantial.

Conclusions

Fiscal policy in Bulgaria has playeda crucial role for the development ofthe economy in the recent years.Balanced budgets and low taxes proved to be a success prior to thecrisis, while the excessive budgetdeficits in 2009 and 2010 did notstrengthen the economy. 2011 will bea tough fiscal year, as the deficit issupposed to stay below 3% of GDP.

As for the taxes, the 10% flatincome tax, the 10% corporate tax andthe 20% VAT should remainuntouched in the years to come. Socialcontributions will once again dragattention, as further reforms in pension system and healthcare areinevitable.


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Croatia Giorgio Brosio 57

Croatia

GiorgioBrosio

University

of TorinoA delayed economic recovery

A very few substantial tax measureshave been introduced in Croatia in2010. The most important of which,the earlier repeal of the special tax onsalary income introduced in 2009, hasbeen due to the necessity of sustaininghousehold consumption in the face of

the persisting slow-down of theeconomy. The second measure,consisting in a restructuring of the taxrate schedule applying to the personalincome tax, has a more structuralcharacter and it is also oriented to re-align the Croatian tax system to thestructure prevailing in most EUcountries.

Tax measures have clearly to beinserted in the evolution of Croatia'seconomy that continued to beaffected, even in 2010, by the globaleconomic crisis. GDP continued tocontract in 2010, although at adecelerated pace. The decrease of 5.8 percent observed for 2009 wasreduced to an estimated 1.6% in 2010.While the drop in 2009 was due to ahuge fall of exports of goods andservices (consisting mainly of


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tourism) and to a contraction ofpersonal consumption-exacerbated bythe tax measures--the surge in foreigndemand that took place in 2010 wasnot big enough to compensate for thesluggish trend of domestic demand.Domestic consumers still felt the burnof the increases of VAT and of specialtax on salaries. Householdconsumption was also negativelyaffected by repayment of personalloans to banks and by the reducedpropensity of the latter to extend newloans to families. Domesticinvestment showed a further drop,particularly in the construction sector,where the activity had reached a hugepeak just before the time of arrival ofeconomic crisis. Projections for 2011show the return of the economy to positive although modest growth:GDP is expected to


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increase by 1.5 percent under thestimulus of personal consumption andreconstruction of inventories in firms.

Tax measures

As mentioned above and in the previous report, to keep the publicsector deficit under control thegovernment introduced in July 2009 aspecial crisis tax. This was atemporary levy to be applied until31 December 2010 - on salaries,pensions and other income with a taxrate of 2 percent on incomesexceeding HRK 3,000 (the equivalentof 409 per month) and with a tax rateof 4 percent on incomes exceedingHRK 6,000 (818 per month).

This levy was rather substantial andwas seated on top of an existing personal income tax that, while notparticularly productive, holds the topstatutory tax rates among EasternEuropean countries. (The sameapplies also to the corporation incometax).

The prolongation of the economicdownturn brought to a sharp inversionof the tax policy. On July 2010 theCroatian parliament decided toeliminate, starting from July 1, thespecial tax of 2 per cent, and toeliminate the remaining special tax of4 per cent starting from November2010. It has been calculated that some1,254,000 taxpayers had been affected by the tax measure and that it hascontributed about 400 million to thecentral government budget.

Moreover, significant changes meantto slightly reduce the tax burden andto realign the tax rates applying todifferent categories of income havealso been introduced with anamendment to the personal income taxlaw approved by the nationalparliament in 1 July 2010. They aredetailed in the two following tables.


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Table 1. Croatia: changes in the

personal income tax applying toincome from wages and salaries

New tax schedule from 2011 Taxschedule applying to 2010 filings

Taxrates

Incomebrackets

Taxrates

Incomebrackets

Kunas Kunas

12% 43,200 13,50% 43,200

25%

43,200 -129,600

25% 43,201 -108,000

40%

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

37,50%

129,601 -302,400

42,50% 302,400

The changes in the tax ratesschedules were accompanied by theelimination of a number of tax relievesthat have a considerable importanceweight for taxpayers. They are, moreprecisely, the deduction from incomeof expenses for:

health services; voluntary and additional healthinsurance; insurance premiums paid in

respect of life insurance with aretirement savings component;

certain costs for the purchase orconstruction or maintenance of a firstmain (principal) residence, as well as


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interest expenses paid for thesepurposes; and;

rental costs for a main (principal)residence.On the other hand, it was also

decided that employer payments to pension funds payments byemployers made to Croatian voluntary pension funds (pillar III pensioninsurance) on behalf of employees upto a maximum of HRK 500 monthlyper employee will be treated as non-taxable income for PIT purposes (and

as a corporate profits tax deductibleexpense for the employer).


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Table 2. Croatia: tax rates scheduleapplying on income from capital

Tax schedule applyingTax

schedule applyinguntil June 30, 2010

from July 1,2010

Income from renting property 15%12%Income from interest 35% 40%Income from dividends 15% 12%Income from insurance 15% 12%

Budgetary policy

Central government revenuedeclined by 1.4% during the first eightmonths of 2010, compared with thesame period of the previous year(National Bank of Croatia, EconomicBulletin, N-164, December 2010).The decline was due to a large extentto the combined effect of the impactof the system of collections of thetaxes on business and to theslowdown of the economy in 2009(tax advances on profits in a year are based on effective profit of the previous year). Also social

contributions have had a sharp declinebecause of the fall of wage bills. Thedecline in tax revenues would have been much sharper without theintroduction in mid 2009 of thespecial tax on salary income thatimpacted positively on collectionsalso in the year 2010.

Government expenditure stagnatedduring 2010. Stagnation derived from


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the combination of widely divergingtrends in the components. Whileexpenditure for personnel declineddue to cuts taken in 20009,expenditure for pensions and social benefits increased. In particular,unemployment benefits had sharp in-crease. To keep expenditure undercontrol the government had to cutprograms of capital expenditure.

The combined effect of decliningrevenues and stagnating expenditureshas been to increase the public sectordeficit that is estimated to reach alevel of 4.2


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in 2010, up from the2.9% of the previousyear.

2007% on total2008%on total2009% on

total2010%on totalPersonal incomeTax1772.72.91687.02.51399.02.51200.81.9Profittax8816.314.510564.715.99439.815.96314.810.2TaxesonProperty578.61635.90.9532.20.9491.20.8VAT37747.9624130862.237050.362.237884.961.1Salestax168.50.3166.50.25123.50.2122.10.2Excises9096.915588.60.98205.10.811283.718.2Taxes ongamesand505.10.8543.80.82532.80.8609.41.0gamblingTaxesoninternational1641.52.71900.802.81721.22.81658.12.7tradeOther taxes509.60.8001590.102436.33.9Total taxrevenue60837.110066344.91006059410062001.3100

Table 3. Structure and recent evolution of taxrevenue in Croatia

2007-2010 (millions of kunas)

Source: Ministry ofFinance of Croatia


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Czech Republic

Jin Schwarz jr.Resident Research Fellow, LiberalniInstitut (Prague)

The year 2010 was an election yearin the Czech Republic. The debatesboth before and after the election wereconcerned mainly with growingdeficit. In order to reverse the trend ofrecent years, the newly electedgovernment implemented a number ofmeasures on revenue and expendituresides with a plan to lower the deficitunder 3 % of GDP in 2013. However,no deeper reforms were so farimplemented, nor planned in greaterdetail. It is therefore not clear whatways will the government use tofurther balance the budget. Without profound reforms, there may be noother way to tame the deficits than toincrease the tax burden.

"PIGS" effect and the deficit

The year 2010 was markedlyinfluenced by the development of theso-called PIGS, or southern-wing EUcountries Portugal, Italy/Ireland,Spain, and especially Greece. Whilstduring the previous years after thefinancial crisis outbreak the emphasisof fiscal and monetary policy was put


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on fight against the recession andfinancial system instability, in 2010the sustainability of public finance became one of the most importantissues.

The Czech Republic was havingdeficit problems already in 2007, thatis, even before the crisis hit itseconomy. Extraordinary andunexpected high tax revenues in 2008temporarily pushed the deficit belowthe 3 % Maastricht criterion. How-ever, the inability to seriously tacklethe issues of budgetary imbalanceresulted in a government deficit of 6.1% of GDP in 2009. According to themethodology of the ESCB (EuropeanSystem of Central Banks), the cyclicalpart of thedeficit was literally zero. In otherwords, even if we adjust for theimpact of the business cycle and one-off factors, the remaining structuraldeficit of the CzechRepublic in 2009 was 6.1 %.

It became were soon clear thatwithout restrictive measures thedeficit in 2010 was going to reach 8 %

of GDP. The technical government,appointed after the previousgovernment fell due to a vote of noconfidence, was therefore looking forways to decrease the deficit. Political pressures from both ends of thepolitical spectrum led however to suchmeasures on both revenue and expen-diture sides, that the resulting mix wasmore a tax increase than an


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expenditure cut. Still, the governmentmanaged to decrease the plannedgeneral government deficit for 2010 to5.3 % of GDP, which remainsnonetheless far above the levelgenerally understood as sustainable.As a consequence, the newgovernment coalition committed to bring the deficit down to 4.6 % in2011 and under the 3 %threshold by 2013.

Revenues and expenditures in 2010

Changes to the tax system may nothave the predicted impact on the tax

yield. This might be due either tounexpected external shocks or to thefact that taxpayers alter theirbehaviour in reaction to the changes.A closer look at the tax yields revealsthat even though the predicted realGDP growth of 0.3 % was twopercentage points below the actual 2.3% GDP growth in 2010, the tax yieldsdo not even reach the budgetedamounts. The corporate income taxyield, even after the fall of the ratefrom 20 to 19 percent, was predictedto be 20.4 % larger than in 2009. Thestatistical data show that it rose only by 3.6 percent. The excises wereexpected, also due to increased rateson fuels, alcohol, beer, cigarettes, andtobacco, to bring almost 14 percentmore to the budget than in the lastyear. In reality, only 5.7 % more wascollected during 2010.


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Similar development could beobserved on the social securitycontributions' side. Even though thecontribution ceiling increased, theyear-on-year growth in2010 was only 2.3 %, while it wasexpected to be 5.5 %. Not even theVAT yield reached the expectedgrowth of 6.7 % and was 0.4 pplower. To sum up, despiteexpectations and relatively positiveeconomic development, the totalrevenues of the state budget increasedonly by CZK 25.9 billion ( 1 billion;2.7 % y-o-y). As a reaction to someminor savings measures and theeconomic recovery, the expenditures

of the state budget in 2010 fell byCZK 4.1 billion ( 160 million;-0.9 % y-o-y).

The reality observed in 2010 givesus therefore a slightly blurred image.On one hand, the decrease ofexpenditures and their structureconfirm that the economic growth wasstronger than expected. On the otherhand, the inability to collect budgetedtaxes goes against intuition. The only plausible explanation is that the

economic agents altered theirbehaviour either as a consequenceof the crisis or due to the tax increase.

Tax changes

As usual, very important changesappeared again on the revenue side ofthe state budget. During 2010 a


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number of changes in the tax systemwere introduced which come intoeffect with the beginning of 2011. Themost significant ones occurred in thearea of social insurance, sicknessinsurance, and health insurance.Under the sickness insurance,employees and self-employed personsin the Czech Republic are entitled tobenefits in case of sickness or parentalleave. Not only do the minimalinsurance contributions increase (byapprox. 4 % for the social and healthinsurance, and from 1.4 % to 2.3 %for the sickness insurance), but lessindividuals will benefit from it, as theself-employed persons will be eligiblefor the sickness benefits only aftertwenty-two days of sickness (until theend of 2010 it was fourteen days).

A so-called "flood tax" has beenintroduced that should be effectiveonly in 2011. The mechanism is that ageneral income tax deduction will belowered by CZK 100 a month ( 4),that is, by almost 5 %. Starting in2011, payments going to formersoldiers and policemen won't besubject to tax exemption. The same is

true for the president's salary and therent of the former president. Variousnon-salary payments to politicians andjudges will also for the first time besubject to the income tax.

In order to lower the deficit as muchas possible without increasing taxrates, the government resorted toabolition of various tax exemptions.In addition to the measures mentioned


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in the previous paragraph, the ministerof finance decided to make theinterest on building savings (i.e. agovernment-subsidized savingsaccount meant to be used for buildingor obtaining housing) subject to the15% personal income tax. Moreover,government subsidy of the buildingsavings from 2010 is going to beretrospectively taxed by 50 % in 2011and decreased in the following years.

Last new source of governmentincome in 2011 will be the solarenergy. There was an unexpectedsolar energy boom in 2010 in theCzech Republic that was caused primarily by high fixed purchase prices (guaranteed price of theelectricity produced by solar power plants set by the government) andlong income tax holiday. Thisdevelopment is a typical example ofhow the governmental subsidy ofrenewable energy sources can gowrong. At the time the law wasapproved in 2005, the fixed purchaseprices were set according to then expected investment return. However,already during 2008 the technologies

started to cheapen. The drop was sodramatic that returns on photovoltaicpower plants went through the roofwhich attracted an extremely largenumber of investors. As thedistributors are forced to pay the fixedpurchase prices for renewable power,the tremendous increase in the solar power output would lead to soaring


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

The government argued that, inorder to restrain the growth of price, ithad to cancel the tax holiday andimplement a special income tax onsolar power plants put into operationin 2009 and 2010 with the rate of 26percent. The solar tax revenues will bethen partly given back to thedistributors in order to cover some oftheir expenses related to the solar power which would allow them tokeep the selling price of electricitylower. A welcomed side-effect wouldbe approximately CZK 4 billion fromthe solar tax that is expected to stay inthe state budget.

To sum up, the changes to the taxsystem introduced in 2010 had twomain goals. To increase the taxrevenues as much as possible in orderto push down the deficit but, at thesame time, to keep unchanged the taxburden for the overwhelming majorityof the tax payers, including thehighest-income groups. The revenueside 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 restrictivemeasures, the deficit of the generalgovernment would reach 6.7 % in2011. Considering that the CzechRepublic representatives still were not


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able to carry out or prepare any deeperreforms, such level of public financedeficit could send the Czech Republicto the group of unsustainablecountries such as Greece and Ireland.Only with one fundamentaldifference: as the Czechs do not havethe euro, rich eurozone memberswouldn't feel the need to bail themout. Moreover, according to aDeutsche Bank analysis of public debtsustainability published in March2010, from 2020 on the CzechRepublic would face grave difficultieswith its debt if it doesn't quicklyimplement some reforms.

Deutsche Bank experts simulatedvarious possible paths of macroeconomic development over thenext ten years in order to assess thestability of debt levels in 38 differentdeveloped and emerging economies.Needless to say, the predictions are toa large degree mechanistic. However,they do provide a useful way ofcomparing possible public debtdevelopment in various countries.Using the most plausible baselinescenario, the Czech Republic public

debt would reach 69 % of GDP in2020 with a further increasing trend.This places the Czech Republic intothe group of four worst performingemerging markets. Among developedmarkets the position would besignificantly better. But still the debt-to-GDP ratio would be far above the60% Maastricht debt threshold.


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It is no surprise that the topics ofdeficit, debt and fiscal sustainabilityformed the core of the debatespreceding the general election in May2010. Also due to the course of theGreek crisis, two new political parties promising to introduce budgetresponsibility and fight corruptionmade it into the parliament. Togetherwith the conservative Civic democratsthey formed a coalition governmentwith the emphasis put on dealing withdeficit and corruption.

In order to avert the grave scenarioof skyrocketing debt, the new financeminister prepared a set of remedies onthe expenditure side of the state budget based on the coalitionagreement that, as in other Europeancountries, raised stout resistance. Toaccompany the above describedincrease in revenues which heexpected to reach CZK 20 billion (0.8 billion), he made a plan of savingover CZK 58 billion ( 2.3 billion)from the state expenditures. Most ofthem were directly taken away fromthe budgets of ministries. Hence, CZK13.3 billion ( 0.5 billion) will be

saved in 2011 by a one-tenth decreaseof the amount of money allocated tocurrent expenditure of the ministriesand a reduction of investmentexpenditure by one fifth. Funds forsalaries of public employees will belowered by 10 percent, which shouldsave another CZK 11.4 billion. Theonly exception are the teachers


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their salaries will on average increaseby 3.5 percent in 2011.

Apart from these major items, thegovernment decreases by one tenththe budgetary reserves (CZK 11.1billion), and fewer resources will beavailable for road and railroadconstruction (CZK 3 billion), farmers(CZK 3 billion), poor and mildlydisabled (CZK 3.5 billion), and new-born child benefit (CZK 1.3 billion).

Reform and other plans

The major shortcoming of thebudget for 2011 is a complete lack ofany deeper modification of either the

revenue or the expenditure side of the budget. In addition to the alreadyintroduced saving measures, thegoverning coalition agreementsketched a roadmap of proposedlonger-term goals they want to reach.Two main topics connected with thearea of public finance are the pensionand the health-care reforms.

Both reforms have already beensubject of public debates for severalyears. A health-care reform has been prepared that benefited from theSlovakian experience. Unfortunately,mainly due to fierce opposition fromsocial-democratic politicians and veryfragile majority of the coalition partiesin the Parliament in the period 2006-2008, it was impossible to implementa single component of that reform.Without surprise, this inability to dealwith the under-financing of the Czech


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health sector led to protests ofthousands of doctors some of whom,in the last months of 2010, announcedthat they were quitting their jobs inorder to work in countries with more"doctor-friendly" environment. Whatthose doctors do not understand,however, is that without deeperchanges in the way the health-care isfinanced, it is not feasible to allocatemore resources to health-care,especially when high public deficits prevail. Plans for such changes arestill very preliminary, though.

Similarly, a proposal for pensionreform has been prepared during 2010 by an expert advisory committeewhich was asked to update of similarreport written as early as in 2005.According to the calculations, theCzech pension system will inevitablygenerate a deficit of 4 % of GDP eachyear starting in 2050. As aconsequence of social security payments and taxes adjustmentsduring the crisis, the system generateda deficit of CZK32 billions (approx.0.8 % of GDP; 1.3 billion) already in2010. The expert committee proposes

two possible ways of reforming; bothof them assume a decrease of thesocial security contribution rate from28 % to 23 % of gross wage, thatsocial security contribution ceiling behalved, and, in order to fiscallycompensate, that the two VAT rates(10 and 20 %) be unified to one 19 %rate which should be enough to covernot only the current deficit but also


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the consequences of the reform in thecoming years.

The first and preferred proposalrequires to direct 20 percentage pointsfrom the 23 percent point of socialcontributions into the currentlyexisting pay-asyou-go (PAYG) pillar,whereas the remaining 3 pp. will gointo new funded pillar. The reformedpension funds, investment companiesor other asset managers will thenmanage investment of the pensionsavings within the framework of thesecond pillar according to the participant's choice. Participation inboth reform pillars will be compulsoryfor all individuals under 40. The third pillar will, beside life insurance,consist of reformed voluntary pensioninsurance with a state contribution.

In the second variant the whole 23percent will be directed into the firstPAYG pillar. The second pillar willbe managed by the reformed pensionfunds and the direct state support will be 3 percent of the gross wage,provided the participant saves at leastthe same amount. The entry into thissecond pillar will be voluntary.

The government made a promise tofollow the conclusions of the advisorycommittee to the largest possibleextent. Part of the plan is to use allfuture privatization incomes anddividends from state-ownedenterprises for smooth transformationof the pension system. The timing ishowever so far unknown.


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As a part of the coalition agreement,the government committed to simplifythe tax system, explicitly mentioningtransformation of inheritance tax andgift tax under the income tax.Moreover, the government wants toabolish most of the existing incometax exemptions. They stated that theydo not want to increase the progressivity but are determined toeliminate regressivity that occurswhen the tax payer hits social securityand health security ceilings. Lastmajor planned modification of the taxsystem is higher taxation of lotteryand gambling.

The future

In a fight against structural deficitthe Czech government prepared in2010 a mix of measures that shouldraise revenues by CZK 20 billion andshrink expenditures by CZK 58 billion. At first glance the strategywas successful, but there are stillseveral risks awaiting. To begin with,according to the Czech Na


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tional Bank, the ministry of financebuilds on overoptimistic prediction ofthe 2011 GDP growth: while theministry expects the economy to growby 2.3 %, the CNB would rather beton 1.6 %. And lower growth means,of course, lower revenues and higherexpenditures.

Second, there are no sign that aspecific reform allowing for a sizableand permanent decrease of government expenditure will come

soon. It is very unlikely or totallyunrealistic that the minister offinance will be able to continue balancing the budget in followingyears by further cutting the salaries ofpublic officials and current expensesof the ministries.

And last but not least, there alsoexists a risk for the taxpayers thatcontinuous shift from direct toindirect and less visible taxes wouldallow the politicians to silently and

unobtrusively increase the tax burdenwhile keeping the most visible incometax constant as promised. Without profound reforms, there may be noother way to tame the deficits in theend.


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Denmark Jacob Braestrup 79

DenmarkJacob Braestrup, M. Sc

(Political science) Senioradviser, Confederation of

Danish Industries

In January 2010, the largest taxreform in more than ten years begantaking effect, shifting some DKK 30billion ( 4.0 billion) of tax revenuewhen fully implemented in 2019. Ofthis, more than DKK 25 billion ( 3.4billion) is used to lower the marginaltax on income in order to encouragework and investment. In 2010 the topmarginal tax rate was lowered from63 percent to 56.1 percent itslowest level in at least 40 years. Laterin the year, an "economic recoverypackage" postponed some of the tax

cuts and increased other taxes in orderto improve public finances. Alongwith the tax reform and other (minor)tax changes, the combined effect hasbeen a general lowering of almost allmarginal tax rates alongside a broadening of the tax base that willincrease the overall tax burden inwhat is already the world's mostheavily taxed country.

Lowest marginal tax since 1970The most notable element of the tax

reform, which was agreed upon in2009, and which began to take effectin 2010, was the abolition of themiddle income tax rate of 6 percent.This effectively changed the Danishtax system from a three-tier system toa two-tier system. More importantly it


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also reduced the top marginal tax rateon labour income by some 5%percentage points. The bottom incometax was also reduced by 1.5 percentage points, taking the totalreduction in top income tax rate onlabour to 6.9 percentage points (from63 percent to 56.1 percent).

The tax reform also increased the

threshold for the top income tax,therefore reducing the number of people affected by the tax. Thethreshold was increasedfrom DKK 377,400 ( 50,630) in2009 to DKK 423,800 ( 56,860) in2010. As a consequence, the numberof taxpayers paying the top incometax fell from just over 900.000

persons in 2009 to less than 640,000persons in 2010 (from 19 percent to13 percent of all taxpayers).Originally, the threshold was set to beincreased further in 2011 (to DKK444,700 / 59,660), but, as part of the"economic recovery package" agreedupon in 2010, this increase has been

postponed to 2014.For persons earning less than thethreshold for the top income tax, thereduction in the bottom income taxhas lowered the marginal income tax by 1.4 percentage points to 40.9percent and 42.3 percent respectively,depending on whether one benefitsfrom the reduction in marginal tax due


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Denmark Jacob Braestrup 81

to the "employment deduction", whichreaches its maximum at an income(gross labour income) of DKK320,000 ( 42,930). The reduction inthe bottom income tax also lowers thetax on transfer incomes such asunemployment benefits, etc.

The very positive effects of the taxreform on marginal taxes were unfor-

tunately marred by one aspect of thereform. In order to offse

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