Budget introduces controversial flat tax rate

In late December 2007, the Bulgarian parliament adopted the state budget for 2008. The most contentious issue was the introduction of a flat income tax rate of 10%, and the abolition of the minimum threshold for taxable income. This decision was welcomed by employers but opposed by trade unions. Some commentators are surprised by the move, as many other European countries have maintained or increased their minimum income threshold for taxation purposes.

Main points of 2008 budget

The left-liberal coalition government’s 2008 state budget makes no basic changes in the principles underlying public revenue and expenditure. As in previous years, a budget surplus is planned as a buffer against the constantly increasing current account deficit. The macroeconomic indicators on which the 2008 budget is based include the following: real gross domestic product (GDP) growth of 6.4%; growth in capital expenditure of 5.1%, taking EU funds into account; high growth in direct foreign investment to €4.738 billion; stable exchange rates; growth in production and sales; low basic interest rates; a low level of official unemployment; a high fiscal reserve; and a reduced national debt.

Alongside these positive developments, there are also a number of deep-seated negative tendencies. The basic problem in the public accounts is a substantially high current account deficit. This stands at 21.9% of GDP, which is why the government is seeking a budget surplus of 3% of GDP. At the same time, a serious inflation problem has been evident for three continuous years – the average annual rate of inflation for 2008 is expected to be 6.9% (in 2006 it was 7.3% and in 2007 it reached 8.4%).

Price convergence with the other EU Member States continues. Growth in the levies on basic products, such as petrol, coke and coals, electricity and tobacco, is also expected. The price of imported natural gas will also rise, hence the increased price of heating. Upward trends in the prices of electricity and water will also continue.

Key sectors of the economy such as education and healthcare will undergo slight reforms. Despite the fact that they are declared to be priorities, expenditure on these sectors will remain at under 5% of GDP. The budget provides for 5% to 10% growth in wages in the sector covered by the state budget and 9.5% growth in pensions, as of the middle of 2008. Given the possible high inflation rate, this means insignificant real growth in incomes.

After the corporation tax rate was reduced from 15% to 10% in 2007, the 2008 government budget reforms personal income tax. The budget introduces a flat tax rate of 10%, abolishing the current progressive tax scale, which rises from 20% to 22% and 24%. At the same time, the new flat tax rate will apply to all income and the non-taxable allowance has been abolished, meaning that even those on the lowest incomes will pay income tax. Some commentators consider this move surprising because, of the 15 countries in central and eastern Europe that have introduced a flat tax rate since 1994, 14 have maintained a minimum income threshold below which no tax is payable, and some have even increased this threshold.

Reactions to budget changes

Employers

The nationally represented employer organisations (BG0606019I) have published a joint statement in support of the 2008 state budget. According to them, the tax changes will stimulate higher levels of tax collection, while a significant part of the clandestine ‘grey’ economy will come out into the open, which on a whole will have a positive effect on business, employment and economic growth.

Opposition parties

The right-wing opposition parties in parliament support the introduction of the flat tax rate, but at the same time oppose the elimination of the non-taxable minimum income. According to them, this aspect of the new tax regime is unfair, causes increased difficulties for low-income groups and will lead to even more income polarisation in society.

Trade unions

The two largest trade union confederations – the Confederation of Independent Trade Unions in Bulgaria (Конфедерация на независимите синдикати в България, CITUB) and the Confederation of Labour Podkrepa (Страница на КТ Подкрепа, CL Podkrepa) – oppose the introduction of the flat tax rate, arguing that it will benefit only high-income groups. The government has suggested that the negative consequences of the flat tax rate on low and middle-income earners could be offset by increasing monthly wages to BGN 430 (about €220 as at 27 February 2008), which will be implemented in the public sector. However, the trade unions regard this decision as ineffective and state that there is no guarantee that private companies will undertake actions in this direction.

Independent economic experts

Many economic experts are rather uncertain about whether the flat tax rate will have long-term beneficial effects for the economy, and about whether it will automatically increase the level of tax collection. In an online newspaper article (in Bulgarian), some experts regard the move from a progressive to a flat tax system as ‘a tax illusion’.

Pay deal

Despite different views on the flat tax rate, on 7 December 2007, trade unions and employers’ organisations concluded an agreement to increase wages in the private sector.

Lyuben Tomev, Institute for Social and Trade Union Research

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