Bosnia and Herzegovina: Selected Issues

Abstract

Bosnia and Herzegovina: Selected Issues

Toward a More Balanced Tax System in Bosnia and Herzegovina5

Some of the key challenges faced by Bosnia and Herzegovina are a high rate of unemployment and a large informal sector. A high tax burden on labor provides disincentives for people to move from informal to formal employment and may prevent some even from entering the labor market. Meanwhile, an aging population and a shrinking labor force stretch the social security system. Lowering social security contribution rates, however, would need to be accompanied by offsetting revenue measures and spending cuts—including by better targeting social assistance—given the limited fiscal space.

A. Introduction

1. Many economies face the challenge of mobilizing revenue in a growth-friendly way, including to provide space for social assistance and infrastructure improvement. Raising revenues in an increasingly globalized economy requires simple and broad-based taxes and strong tax compliance. Revenue mobilization efforts should be guided by three principles: efficiency, fairness, and transparency.

2. BiH has one of the highest tax revenue-to-GDP ratios in the South Eastern Europe (SEE) region. Within total tax revenues, the share of social security contributions is also one of the highest. This puts a very high tax burden on labor, putting BiH at a disadvantage compared to its neighbors. While there is little fiscal space to reduce the overall level of revenues in BiH, a shift between different taxes might be warranted to lower the burden on wages. This paper presents the level and structure of tax revenues in BiH, relative also to neighboring countries; evaluates tax efficiency; and discusses potential areas for improving the efficiency of the tax system.

uA02fig14

Revenue from Tax and Social Security Contribution (Percent of GDP)

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A002

Sources: IMF,Government Finance Statistics; IMF World Economic Outlook; Eurostat; European Commission; and country authorities.

B. Level and Structure of Tax Revenues in Bosnia and Herzegovina

3. The level of total tax and social security contribution revenues in BiH, at 38 percent of GDP, is the one of the highest in the region, and slightly above the average of EU member countries. While the overall revenue to GDP ratio in BiH has been rather stable in the last few years, the share of total taxes to GDP has been increasing (Table 1). Other revenues, including dividends from state-owned enterprises, for example, have been slowly declining. At the same time, the composition of revenues has been shifting toward an increasing share of social security contributions, while the contribution of indirect taxes has been decreasing.

Table 1.

General Government Budgetary Operations, 2005–2014

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Sources: Bosnia and Herzegovina authorities; and IMF staff calculations.

General Recommendations on Revenue Mobilization 1/

Although each tax system is different, some of the most effective recommendations for revenue mobilization are the following:

  • Building administrations that limit incentives and opportunities for rent seeking and are capable of implementing the voluntary compliance needed to extend the tax base;

  • Adopting and making readily available clear laws and regulations embodying strong taxpayer protection;

  • Eliminating exemptions that forgo revenue to little useful end;

  • Implementing a broad-based VAT with a fairly high threshold;

  • Establishing a broad-based corporate income tax, at rates competitive by international standards;

  • Extending the PIT base, and ensuring a coherent treatment of alternative forms of capital income;

  • Levying excises on a few key items that address revenue needs and wider social concerns;

  • Implementing simple but coherent regimes for taxing smaller businesses;

  • Strengthening real estate taxes; and

  • Developing capacity for tax expenditure and wider policy analysis.

1/ For a comprehensive discussion of issues and recommendations on revenue mobilization see International Monetary Fund, 2011, “Revenue Mobilization in Developing Countries,” (Washington: International Monetary Fund).

4. BiH relies more heavily on social security contributions (SSC) than its regional peers. The share of SSC within total tax and SSC revenues is over 40 percent, compared with a regional average of 31 percent and an EU average of 30.5 percent. On the other hand, the share of direct taxes, especially personal income tax (PIT), is very low compared to other countries. Direct taxes in BiH provide only 8 percent of revenues, out of which the PIT brings in about two-thirds. The regional average of direct taxes is 17.5 percent of revenues, with PIT at 11 percent. Indirect taxes provide about half of tax and SSC revenues both in BiH and in the region, which is substantially higher than the EU average of 38 percent. Revenues from property taxes are generally low in the region, well below the share in the EU member countries, but BiH collects even below regional average, only 1 percent of total tax revenues.

Table 2a.

General Government: Tax Structure and Tax Levels for Selected European Countries

(Percent of GDP)

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Sources: IMF, Government Finance Statistics; IMF World Economic Outlook; Eurostat; EU

Preliminary data. Negative “Other Taxes” reflects tax refunds. Social Security Contribution data not available.

Central Government

Table 2b.

General Government: Tax Structure and Tax Levels for Selected European Countries

(Percent of total tax revenues and social security contributions)

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Sources: IMF, Government Finance Statistics; IMF World Economic Outlook; Eurostat; EU

Preliminary data. Negative “Other Taxes” reflects tax refunds. Social Security Contribution data not available.

Central Government

C. Tax Rate Structure

5. The standard tax rates of all taxes in BiH are on the low side compared to other countries in the SEE region. Both the FBiH and the RS have a PIT rate of 10 percent. While many countries in the region have low flat rate personal income tax systems, the 10 percent PIT rate is one of the lowest in the region. Similarly, the corporate income tax (CIT) rate of 10 percent in both entities is one of the lowest in the region, substantially below the regional average. The value added taxation (VAT) system has a single standard rate, with no reduced rates, which enhances efficiency of the VAT. While many countries have a higher standard VAT rate than BiH, they usually have a multiple rate structure. The VAT threshold on the other hand is one of the lowest in the region, which places a larger burden on tax administration by keeping many small and medium-sized taxpayers in the VAT net.

Table 3.

VAT, Corporate, and Individual Income Tax Rates for Selected European Countries, 2014

(Percent)

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Source: International Bureau of Fiscal Documentation

6. While the PIT rate is low in BiH, SSC put a high burden on labor. The SSC rate is high compared to neighboring countries, especially in the FBiH. The structure of SSC is different in the two entities: the RS collects all contributions from the employees, while the FBiH also collects some of the contributions from the employers.

7. Consequently, BiH raises a higher share in SSC revenues both in percent of GDP and in percent of total tax revenues compared with other countries in the region. SSC revenues are also above those collected by some of the more advanced European countries with extensive social safety nets. While both entities are at the top of the range, SSC collection in the FBiH is higher than in the RS.

uA02fig15

Social Security Contributions, 2014 1/

(Percent)

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A002

Source: International Bureau of Fiscal Documentation.1/ Total level of social security contributions in the FBiH, RS and Selected European countries.
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Social security contribution revenue in percent of GDP and Total tax revenue, Selected European Countries, 2012

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A002

Sources: IMF,World Economic Outlook; IMF, Government Finance Statistics; Eurostat; and country authorities.

8. The property tax systems are different in the two entities. In the FBiH, property tax is levied at the cantonal level and the allocation of revenues between cantons and municipalities are defined by cantonal laws. Most cantons impose a property tax on buildings for recreation and parking spaces, but the overall revenue take from recurrent taxes on immovable property is very low. A property transfer tax is also collected in the FBiH. The RS, on the other hand, introduced a comprehensive recurrent property tax system in 2012. The central government defines the range for the property tax rate with upper and lower limits, currently at 0.05%–0.5%, and each municipality decides its own rate within this range. The tax base is the estimated market value of the property. Property taxes are administered and levied by the central government for the benefit of the local governments. The RS tax administration maintains a real estate cadastre. With the introduction of the recurrent property tax, the property transfer tax was abolished in the RS.

D. Tax Efficiency

9. Tax efficiency measures the share of tax revenue in percent of GDP relative to the statutory tax rate. It compares the actual collection of a tax type with a theoretical maximum defined by the statutory rate. Improving tax efficiency to raise tax revenues has two components. The “policy gap” is the difference between collections under current law and those obtained if all exemptions not consistent with best practice and all reduced rates were eliminated. The policy gap can be reduced by broadening the tax bases. The “compliance gap” is the difference between current tax collections and those that would be obtained if the existing tax law was perfectly enforced. The compliance gap can be reduced by revenue administration reforms.

10. VAT efficiency is very high in BiH, due to the low policy gap. There are few exemptions in the VAT system, no reduced rate, and a zero VAT rate is limited to very few items (e.g., exports and diplomats). Altogether this makes the VAT system in BiH more efficient than in countries with multiple rates and extensive exemptions. Efficiency of the CIT is around the average of the region. CIT efficiency could be improved through both policy and administration measures. Tax incentives and exemptions should be reviewed, with a view to their elimination. Tax administration reform efforts should aim to improve compliance. Tax administration measures, however, usually take time before they show significant results.

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Tax Efficiency in Selected Countries 1/

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A002

Sources: IMF,World Economic Outlook; IMF, Government Finance Statistics; International Bureau of Fiscal Documentation; and IMF staff calculations.1/ Tax efficiency is measured as tax revenue in percent of GDP divided by the statutory tax rate. C-efficiency is tax efficiency of VAT calculated based on consumption.

E. Total Tax Wedge

11. The tax burden on labor is high in BiH. The tax wedge—consisting of PIT and SSC—differs between the entities given the decentralized structure of the country. For a single average wage earner, the tax wedge amounts to 42 percent of the gross wage in the FBiH and slightly over 39 percent in the RS, with most of the burden coming from SSC.

12. The labor tax wedge in BiH is also relatively high compared with other countries. The current BiH rates are more in line with advanced EU countries than many emerging economies. Moreover, in 2013 the tax wedge in both entities was notably higher than the EU or Euro Area averages.

uA02fig18

Tax Wedge Rate, 2013

(Percent of total labor cost)

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A002

Sources: Eurostat; and IMF staff calculations.1/ Data for tax wedge refers to 2012.
Table 4.

Labor Income Taxation

(Percent of November 2014 gross wage)

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Source: IMF staff calculation.

Gross wage = Net Wage + Taxes + Employee Contributions; Labor Cost = Gross Wage + Contributions, Employer + Other Fees; Tax wedge = Net Wage / Labor cost

Effective rates for gross average wage paid in November 2014. Taxable base = gross wage minus employee contributions minus personal exemption. Personal exemption is KM 300 in the Federation and KM 200 in RS. Statutory tax rate 10% in Federation, and 10% in RS on net wage.

RS introduced temporary flood related contribution of 1.5 percent on net wage (0.9 percent on gross wage).

13. The tax treatment of allowances is not harmonized across the two entities, creating distortions and adding to administrative burden for businesses operating in both entities. Besides wages, employees in BiH often receive meal, holiday, and transportation allowances as part of their remuneration. In the RS, these allowances are treated as part of the overall compensation and subject to taxation. In contrast, in the FBiH these allowances are tax-free. This means that the effective labor tax wedge in the FBiH is lower if these allowances are included in the calculations. The tax free allowances can be viewed as an increase in tax deduction for PIT purposes.

uA02fig19

Labor Tax Wedge, No Allowances

(Percent of labor cost)

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A002

Source: IMF staff calculations.

14. High labor taxation undermines cost competitiveness and contributes to the high share of informal employment in BiH. In order to increase overall employment—and employment in the formal sector in particular—and to improve competitiveness of the economy to attract foreign investment the labor tax wedge will need to be reduced.

F. Conclusion

  • Lowering SSC rates is necessary to improve labor market incentives. A reduction will need to be accompanied by offsetting revenue measures, including base broadening and improving compliance, and/or spending cuts.

  • A review of the tax system is necessary to identify measures to broaden the tax base of all major taxes, by capturing tax-free allowances and curtailing tax exemptions and incentives. Tax rates also need to be reviewed to identify options to mobilize revenues from other taxes than SSC. Similarly, property taxes could be expanded, notably in the FBiH.

5

Prepared by Ruben Atoyan, Dora Benedek, and Irena Jankulov.

Bosnia and Herzegovina: Selected Issues
Author: International Monetary Fund. European Dept.