Republic of Kosovo: Selected Issues
Author:
International Monetary Fund. European Dept.
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Publication Date:
27 Jan 2023
eISBN:
9798400231001
Language:
English
Keywords:
VAT revenue; IMF staff calculation; VAT increase; tax revenue change; revenue elasticity; Personal income tax; Value-added tax; Effective tax rate
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1. Kosovo’s tax revenue over 2021–22 has surpassed tax base growth. Following the pandemic, tax revenue grew strongly, posting the largest increase among western Balkan countries. While part of this strong performance reflects increased activity, surging inflation, and buoyance, this note explores the extent to which tax revenue increases may have also grown due to gains in formalization, both of workers and businesses.

Abstract

1. Kosovo’s tax revenue over 2021–22 has surpassed tax base growth. Following the pandemic, tax revenue grew strongly, posting the largest increase among western Balkan countries. While part of this strong performance reflects increased activity, surging inflation, and buoyance, this note explores the extent to which tax revenue increases may have also grown due to gains in formalization, both of workers and businesses.

Kosovo: Tax Revenue Growth and Formalization1

A. Introduction

1. Kosovo’s tax revenue over 2021–22 has surpassed tax base growth. Following the pandemic, tax revenue grew strongly, posting the largest increase among western Balkan countries. While part of this strong performance reflects increased activity, surging inflation, and buoyance, this note explores the extent to which tax revenue increases may have also grown due to gains in formalization, both of workers and businesses.

uA002fig01

Changes in Taxes: 2019–2022

(Percentage points of GDP)

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: World Economic Outlook, IMF and country statistics offices.

2. Kosovo’s tax system is based on consumption and income taxes, which together make up around 25 percent of GDP. Historically, consumption taxes, which include value-added taxes (VAT), excise, and customs, have been the major source of revenue in Kosovo. Income taxes, including corporate income taxes (CIT) and personal income taxes (PIT), have played a more limited role.

3. Government revenues from both consumption and income taxes are affected by relatively high informality rates. Accordingly, increasing formalization has become a policy priority in recent years, as it would contribute to larger fiscal space and a more even level playing field. At the tax administration level, this has been reflected in more frequent, risk-based audits and inspections, and at the budgetary level through incentives to formalize workers.

uA002fig02

Tax Rates in Western Balkans

(Percent)

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Source: Country tax office websites.
uA002fig03

Share of Different Taxes in Total Tax Revenues: 2012–2022

(Percent)

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: Kosovo Ministry of Finance and IMF staff calculations.
uA002fig04

Tax Revenue Growth

(Percent, year-on-year)

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: Kosovo Ministry of finance and IMF staff calculations.
uA002fig05

Contribution to Cumulative Revenue Growth

(Percent)

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: Kosovo Ministry of finance and IMF staff calculations.

B. Recent Developments in Tax Revenues

4. Tax revenues overshot pre-pandemic levels already in 2021. While a strong rebound in diaspora inflows, mobility normalization and supportive policies led to a fast recovery of economic activity, consumption taxes (VAT and excises) in percent of 2021 GDP overshot their pre-pandemic levels. Income taxes as a share of GDP also expanded, reflecting the strong performance of corporates as well as increases in both employment and salaries.

uA002fig06

Dynamics of Revenues in Percent of GDP

(Index, 2019 =100)

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: Kosovo Ministry of Finance and IMF staff calculations.

5. Tax revenue growth continued in 2022, parallel to the surge in inflation. Economic activity slowed in 2022, given the impact of the terms-of-trade shock on private demand, and inflation. Despite this, VAT and income taxes kept rising as a share of GDP; excises declined, as taxes per unit were kept largely unchanged. Custom duties continued to decline reflecting the continued implementation of free trade agreements with the European Union and Türkiye.

C. Disentangling the Sources of Tax Revenue Increase: The Role of Formalization

6. This note applies a simple accounting framework to disentangle the sources of tax collection increases. Tax revenue changes reflect changes in the tax base, the effective tax rate, buoyancy, and tax collection improvements. Tax revenues can be defined as follows:

TtR=τtE,R[[PtQt(1−λtR)](Yt/Yt*)ηR](I)

where TtR is tax revenue in time t, and τtE,R is the effective tax rate in time t, measured as the ratio of tax revenue to declared tax base; Pt denotes the price level, changes of which are defined as inflation πt = (P1/Pt-1-1) and Qt denotes the real tax base, changes of which are defined as γt = (P1/Qt-1).2 The yield (Yt/Yt*)ηR “denotes the GDP to potential GDP ratio to the power of revenue elasticity with respect to the output gap, ηt, and changes in this yield gt=(Yt/Yt*−1) provide buoyancy.3 And the tax gap, λt, is the difference between the actual tax base and effective revenues, changes in which represent changes in tax collection, including through improved formalization and other factors. Changes in revenues can then be expressed as follows:

(1+φtR)=τtE,Rτt−1E,R(1+πt)(1+γt)(1−λtR1−λt−1R)(1+gt1+gt−1)ηR(II)

Applying logarithms, (II) can be re-expressed as:

φtR≈πt+γt+ΔλtR+Δgt+Δτt(E,R)(III)

7. About a third of VAT revenue increases in 2020–22 could be explained by improvements in tax administration, including increased formalization (Table 1A). While the VAT increase is mainly explained by the evolution of the tax base, increases in formalization have played a significant role. This has been supported by efforts by the Tax Administration of Kosovo (TAK) in the form of increased in-person audits and controls, and inspections. On a year-on-year basis, improvements in tax administration contributed about 35 percent of VAT revenue increases in 2021 and around 22 percent of VAT increases in 2022.

uA002fig07

VAT Revenues and Number of VAT Paying Businesses

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: Kosovo authorities and IMF staff calculations.
Table 1a.

Kosovo: Value-Added Taxes: Revenue Change and Contributing Factors

article image
Sources: Tax Administration Authority of Kosovo and IMF staff calculations.

8. Improvements in tax collection could also explain about one fifth of PIT revenue increases over 2020–22 (Table 1B). Although public sector wages remained unchanged, private sector wages continued to increase, especially in 2022, leading to increases in PIT revenues. In 2020-21, the government subsidies for registered employees to mitigate the negative impact of the COVID-19 pandemic on households and firms helped to shift more employees from the informal to the formal sector. This effort, coupled with increased labor demand at the time of the strong activity rebound resulted in increased numbers of employees (shown as change in real demand in Table 1B), which contributed around 60 percent of PIT revenue growth in 2021.

Table 1b.

Kosovo: Personal Income Taxes: Revenue Change and Contributing Factors

article image
Sources: Tax Administration Authority of Kosovo and IMF staff calculations.

9. Sector-level data shows that government support to increase formal employment, including of females, also led to PIT revenue growth. Increased employment in sectors that tend to have relatively high levels of informality, such as accommodation and food service and construction have expanded the PIT’s tax base. Increased female employment can also explain part of the growth in registered employees. While female employment in Kosovo has been relatively low, it grew more rapidly than male employment over the past decade, resulting in an increase in the share of females in total employment from around 30 percent in 2012 to around 40 percent in 2022.

uA002fig08

Registered Workers

(Growth in percent, year-on-year)

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: Kosovo Tax Administration, Kosovo Statistics Agency and IMF staff calculations.
uA002fig09

Registered Workers by Sector

(Growth in percent, 2021 vs. 2019)

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: Kosovo Tax Administration and IMF staff calculations.
uA002fig10

CIT paying businesses and CIT revenues

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: Kosovo authorities and IMF staff calculations.
uA002fig11

Average number of registered businesses

(Growth in percent, 2022 vs. 2019)

Citation: IMF Staff Country Reports 2023, 055; 10.5089/9798400231001.002.A002

Sources: Kosovo Tax Administration and IMF staff calculations.

10. Improved tax collection could explain about two thirds of CIT revenue increases over 2020–22 (Table 1C). The number of CIT paying businesses increased strongly during the recovery following the pandemic-related downturn. The contribution of newly registered firms to CIT revenues increased from around 4 percent of annual CIT in 2019 to 6 percent in 2021, reflecting more business registrations also from sectors that tend to have relatively high levels of informality. The authorities have aimed to maintain and increase the number of registered businesses including through the help of grants and loan guarantees, even though according to the authorities the take-up of these support measures has been lower than the allocated amounts in the budget, particularly with regards to support for female entrepreneurs.

Table 1c.

Kosovo: Corporate Income Taxes: Revenue Change and Contributing Factors

article image
Sources: Tax Administration Authority of Kosovo and IMF staff calculations.

11. Overall, increased formalization is estimated to be behind about one third of tax revenue increases over 2020–22 (Table 2). Formalization efforts by the government, Kosovo’s Agency of Statistics (KAS), and Customs have borne fruit, contributing around 35 percent of the cumulative change in tax revenues in 2020–22. Inflation, which contributed around 65 percent of the cumulative increase in revenues, reflected price pressures, such as commodity prices and wage increases. Tax base changes (including both inflation and changes in the real tax base) explained about 60 percent of the increase of tax revenues, with other factors playing a relatively minor role, as effective tax rates remained about constant, and the output gap at end-2022 is only slightly negative.

Table 2.

Kosovo: Total Tax Revenue Change and Contributing Factors

(Millions of euro)

article image
Sources: Tax Administration Authority of Kosovo and IMF staff calculations.

D. Conclusions and Stylized Policy Implications

12. Continued gains in formalization will require a multi-pronged approach. Tax administration efforts by both TAK and Customs, in the form of audits, inspections, penalties and other measures, should be sustained and deepened. However, informality is a multidimensional challenge that requires to be tackled from different angles. This includes simplifying tax procedures, enhancing public governance and transparency to raise awareness and trust in public institutions, strengthening the education system, improving financial inclusion, increasing electronic payments, and improving the judicial system.

1

Prepared by Amanda Edwards, Ezgi O. Ozturk, and Selim Thaci. Sabiha Mohona provided research assistance.

2

Inflation reflects the taxable goods deflator change for VAT, wage inflation for PIT, and profit inflation for CIT. Real demand reflects the quantity of taxable goods, calculated based on domestic demand for VAT, the actual number of employees, which is calculated based on Labor Force Survey data and assuming an informal employment rate of 20 percent, a share of labor in GDP at factor cost of 0.5, for PIT, and the number of CIT paying businesses for CIT.

3

Based on related literature in emerging markets, the elasticity of tax revenues to the output gap is assumed to be 0.85 for VAT, 0.5 for PIT, and 0.7 for CIT.

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Cover IMF Staff Country Reports
Republic of Kosovo: Selected Issues
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2023: Issue 055
Publisher:
International Monetary Fund
ISBN:
9798400231001
ISSN:
1934-7685
Pages:
24
DOI:
https://doi.org/10.5089/9798400231001.002

Changes in Taxes: 2019–2022

(Percentage points of GDP)

Tax Rates in Western Balkans

(Percent)

Share of Different Taxes in Total Tax Revenues: 2012–2022

(Percent)

Tax Revenue Growth

(Percent, year-on-year)

Contribution to Cumulative Revenue Growth

(Percent)

Dynamics of Revenues in Percent of GDP

(Index, 2019 =100)

VAT Revenues and Number of VAT Paying Businesses

Registered Workers

(Growth in percent, year-on-year)

Registered Workers by Sector

(Growth in percent, 2021 vs. 2019)

CIT paying businesses and CIT revenues

Average number of registered businesses

(Growth in percent, 2022 vs. 2019)