The main medium-term scenario summarized in Table 7 depends on assumptions about macro-economic developments and policies on taxes and expenditures. The scenario treats Kosovo as a continuing autonomous economic entity.

Medium-Term Fiscal Scenarios

The main medium-term scenario summarized in Table 7 depends on assumptions about macro-economic developments and policies on taxes and expenditures. The scenario treats Kosovo as a continuing autonomous economic entity.

Macroeconomic Assumptions

Under the main scenario, real GDP is projected to grow by 10 percent a year on average through 2006. Such growth would be a little above the rate seen in Albania following episodes of internal conflict, but a little below the rate seen in Bosnia and Herzegovina, which suffered a longer and more devastating conflict than Kosovo. Annual inflation is projected to be about 2 percent, assuming that Kosovo continues to use the deutsche mark or euro. Implicit in the growth projection is a strong private sector performance that would return agricultural production rapidly to at least preconflict levels and allow the industrial sector of the economy to recover much of its lost share in output. The importance of the construction sector would decline as the reconstruction boom eases.

Consistent with this broad pattern of growth, domestic saving would have to rise as a share of GDP to assume more of the burden of financing investment in the medium term. Specifically, the scenario assumes that private consumption growth is 2 percentage points below that of incomes, which in turn would be growing slower than GDP because (1) income support from humanitarian aid drops off; (2) remittances from abroad are assumed to grow inline with more slowly growing foreign income levels; and (3) income growth from rapidly rising employment is attenuated by relatively modest real wage growth (3 percent a year).14 As a result, private consumption declines in the scenario from 136 percent of GDP in 2000 to 100 percent of GDP by 2006 (Table 8). Total investment also declines as a share of GDP because private sector investment does not compensate for the dropoff in foreign-financed reconstruction investment in the medium term.15 The reduction in domestic expenditure as a share of GDP is compensated by an improvement in the trade balance: exports begin to emerge with the recovery of private sector industry and agriculture, reaching 7 percent of GDP by 2006, while the share of imports is sharply reduced. The projection for net exports is cross-checked with the assumed financing from remittances, donor support, and a small amount of inward foreign direct investment.

Under the alternative lower-growth scenario, Kosovo’s real GDP is assumed to expand by about 5 percent a year. Behind the scenario is an assumed slower pace of private sector development and less buoyant employment growth. As a result, GDP is about 21 percent lower than in the main scenario by 2006. However, for the same absolute levels of remittances and external donor support, the drop-off in consumption, investment, and imports relative to the main scenario would be less than this.

Table 8.

Main Scenario: Expenditure as Percent of GDP

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Revenue Projections

The revenue projections assume that the tax policy program outlined in Box 3 is fully implemented. The macroeconomic assumptions, together with some specific assumptions about tax compliance, combine to define the evolution of the tax base. The key specific assumptions are outlined below.

Wage Tax

The projection assumes that only 20,000 workers in the private sector will file the tax in 2001.16 This number might appear rather low, but unemployment in Kosovo is high, and experience in neighboring Albania points to major difficulties in capturing wage income accurately. Not only are there many evasion schemes, which are difficult to detect for an inexperienced administration, but the absence of a well-functioning payments system will make withholding not an option. Over the medium term, the number of workers filing for the wage tax is projected to increase to 130,000 in 2006 owing to improvements in tax administration and development of the banking system. Private sector wage levels are assumed to be the same as in the public sector. Although anecdotal evidence points to monthly wages substantially above DM 1,000 for some workers, particularly in the construction sector, there are many other workers (for example, in agriculture or factories operating at minimum capacity) who earn less than budgetary wages or at least are not paid regularly.

Profit Tax

Projections for the profit tax are the most difficult, given a lack of coherent information on the corporate sector. However, since many enterprises are crippled by years of underinvestment and the recent war, the profit tax is not likely to be a major revenue raiser in the early years. The scenarios thus make the ad hoc assumption that revenues from the profit tax are DM 10 million in 2002—the year of its introduction—and from then onward are related to GDP growth, with an elasticity of 1.7 in 2003 and 1.2 thereafter.

Value-added Tax

Projections for the VAT are based on the value of dutiable imports and on calculations of the domestic VAT base on the basis of preliminary business registration data. It is assumed that the VAT, which will be limited initially to large taxpayers, will be extended to the medium-sized businesses in 2003, resulting in an increase of the tax base by 60 percent. The VAT base is projected to grow with nominal growth in the manufacturing and trade sectors.

While the projection of the VAT collection from imports is straightforward, a key parameter for the calculation of the domestic VAT component is how much VAT is creditable from the import stage. With exports negligible, it is assumed that about 50 percent of the domestically produced value-added has to be credited for imports and that this amount will increase to more than 60 percent with the extension to the retail sector and an increase in exports.

Excise Taxes

Petroleum products. Consumption of petroleum products is assumed to increase in line with a weighted average of real consumption growth (0.75) and real GDP growth (0.25). The specific excises are adjusted from DM 0.4 per liter of gasoline in 2001 to DM 0.45 in 2005 and from DM 0.30 per liter of heating oil and diesel in 2001 to DM 0.35 in 2005.

Spirits. The tax base grows in line with private consumption. The specific tax rate is adjusted from DM 2.0 per 100 percent of alcohol in 2001 to DM 2.3 in 2005.

Beer. The tax base grows in line with private consumption. The rate is adjusted from DM 0.30 per liter in 2001 to DM 0.35 in 2005.

Cigarettes. The tax base grows in line with private consumption. The rate is adjusted from DM 0.08 per package in 2001 to DM 0.12 in 2005.

Customs Duties

Customs duties depend on import growth. The estimated average tariff rate (7.2 percent in 2000) is assumed to be unchanged in the medium term.

Vehicle Tax

The stock of vehicles is estimated at 250,000 by the car registration office.

Expenditure Projections

In the scenarios, recurrent expenditure is constrained by the projected revenue envelope to eliminate donor budget support by 2003. In the main scenario, this implies about 5 percent nominal growth (3 percent real) on average for 2001-03. With declining donor support no longer a drag on resources, and tax revenues continuing to rise quickly, spending constraints ease thereafter. For the purposes of the scenario, it is assumed that about half of the increase in revenues after 2003 is allocated to recurrent spending and the remainder to capital spending. Consistent with the macroeconomic scenario, foreign-financed capital spending declines sharply as a percent of GDP from 2001 onward.


Taxable employment income, however, would grow much more rapidly as workers are integrated into the formal economy.


The scenario assumes the current pipeline of reconstruction support is refreshed, but at a lower level than before.


Note that the wage bill in the scenarios is calculated net of wage tax payments.