7. Tax policy (Dimension 4)
A well-designed tax system is the cornerstone of an economic and social environment which guarantees competitiveness, innovation, investment, entrepreneurship and prosperity. This chapter assesses tax policy in the six Western Balkan (WB6) economies. It starts with a brief assessment of progress made in implementing the main recommendations from the 2018 report. It then presents the assessment framework for the tax policy dimension and reviews the main changes, and the evolution of the economies’ self-assessed scoring since the last report. The chapter then focuses on three sub-dimensions. The first, tax policy framework, explores whether tax policy fosters an environment conducive to inclusive economic growth and how its design affects revenues raised, investment and competitiveness. The second, tax administration, assesses the efficiency of the tax administrations across the region. Finally, the international co-operation sub-dimension explores the extent to which the economies have engaged with the international tax community on recent international tax trends and are co-operating with each other on common tax issues. For each sub-dimension, the chapter includes suggestions to strengthen the various tax policies and their implementation, which in turn would foster the competitiveness of the WB6 economies.
Most of the WB6 economies have implemented broad response packages to combat the effects of COVID-19 on their economy and citizens, in line with measures carried out in OECD countries.
The average tax-to-GDP ratio has increased slightly in recent years but remains below the OECD average, suggesting there is scope to increase tax revenue.
The tax mix is much more dependent on taxes on goods and services and social security contributions (SSCs) than in OECD countries. There is scope to diversify tax revenues.
High SSC rates place a heavy tax burden on labour income and raise the cost of labour. This may affect labour market outcomes, especially for low-skilled and low-income workers.
The WB6 economies provide an investment-friendly environment with low corporate income tax (CIT) rates and generous cost and profit-based tax incentives. But these come at a significant revenue cost; CIT revenues are below the average for OECD countries.
The WB6 economies tend to place a higher tax burden on labour income than on capital income. This creates an incentive for entrepreneurs to incorporate and receive income in the form of capital income rather than labour income, reducing tax revenues and the overall progressivity of the tax system.
Most taxes in the region are levied at the same rate across income levels, making them non-progressive. The impact of the tax system on reducing income inequality is thus expected to be modest. However, a low level of progressivity does not necessarily mean a poor redistribution model – public spending should be factored in to assess the full equity implications of the economies’ redistributive policies.
Revenues from taxes on goods and services are high despite being levied on a narrow base. Relatively high value-added tax (VAT) registration thresholds, as well as a wide range of goods and services that are taxed at a reduced VAT rate, leave scope to broaden the VAT base.
The informal sector in WB6 economies is large, meaning there is significant scope to broaden the tax base by bringing more taxpayers into the tax system.
The WB6 economies have strengthened their use of micro-simulation models to assess the distributive effects of tax reforms; they also use models to forecast tax revenues.
Tax expenditure reporting is still weak in the region. Most WB6 economies would benefit from the publication of a regular and systematic tax expenditure report.
The WB6 economies have made significant efforts to strengthen their tax administrations since the last report.
Tax administrations continue to lack strong procedural safeguards guaranteeing their independence across the region.
The WB6 economies have strengthened their involvement with the international tax community in recent years and have taken significant steps to align their system with current international tax trends.
International proposals for a global minimum tax arising from Pillar 2 of the OECD’s Tax Challenges Arising from Digitalisation tax proposals, could have a strong impact on the economies’ tax systems.
The WB6 economies continue to implement a worldwide taxation system for resident corporations, in contrast to the OCED trend.
Tax co-operation and co-ordination remains weak amongst WB6 economies.
The average scores for the WB6 economies have increased for this dimension since the last Competitiveness Outlook (CO) assessment, from 2.3 in 2018 to 3.0 in 2021. The scores for the WB6 economies are relatively similar for this dimension overall, ranging from 2.6 for Montenegro to 3.4 for Kosovo. All the economies have improved their performance, with Kosovo seeing the most significant increase, from 2.2 in 2018 to 3.4 in 2021, while the improvement for North Macedonia was more modest, from 2.4 to 2.9 (Figure 7.1).
For the first sub-dimension (tax policies), scores range from 2.0 for Montenegro and Serbia to 3.0 for Albania and North Macedonia. The average score rose from 2.0 to 2.6, driven by significant improvements in the modelling and forecasting and tax expenditure reporting indicators. For the second sub-dimension (tax administrations), the range is from 2.4 for Bosnia and Herzegovina to 4.0 for Kosovo and the average rose from 2.4 in 2018 to 3.3 in 2021 due to relatively strong performances in the independence and transparency and taxpayer services indicators.
Note: Scores for 2021 are not directly comparable to the 2018 scores due to the addition/removal of relevant qualitative indicators. Therefore, changes in the scores may reflect the change in methodology more than actual changes to policy. The reader should focus on the narrative parts of the report to compare performance over time. See the Assessment methodology and process chapter for information on the assessment methodology.
The Competitiveness Outlook 2018 highlighted a number of policy recommendations for the WB6 economies to strengthen tax policies and administrations in the region. They are presented in Table 7.1 along with a description of the progress made and an overall progress status ranging from none to limited, moderate or advanced.
In the last report, WB6 economies were advised to strengthen their tax administrations to improve overall tax compliance and to align their tax systems with international tax trends. Advanced progress has been made in implementing both recommendations across the region, due to the significant efforts made in these areas. The WB6 economies also strengthened their tools to assess the effects of tax policies on the economy or plan to do so in the near future, and have made moderate progress on this recommendation.
The implementation of other recommendations has been slower. Only limited progress has been made in areas such as the design of corporate tax incentives, adjusting the balance between personal income tax (PIT) and SSCs, broadening the VAT base, bringing additional workers and businesses into the tax base, and regional co-operation. No progress has been made on the remaining recommendations, with a lack of significant efforts in those areas.
Public finances are under stress as result of the COVID-19 outbreak and the resulting global pandemic. Governments worldwide face tremendous challenges to finance their public policies and fund their welfare system, while maintaining an environment conducive to economic recovery and inclusive growth. In this context, tax policies are even more crucial. Taxes provide governments with the revenue they need to finance public expenditures. A well-designed tax system is the cornerstone of an economic and social environment which guarantees competitiveness, innovations, investment, entrepreneurship and prosperity.
Tax systems should be designed to encourage economic growth in a sustainable and inclusive way. This implies creating rules that aim to increase prosperity and productivity among citizens, which entails managing several trade-offs. Tax reforms should find a balance between fostering equity, achieving budgetary efficiency and circumventing distortive effects, while accounting for various distributional effects. Tax and benefit policies that contribute to fostering wealth redistribution will be conducive to economic growth within each WB6 economy and across the region.
A strong tax administration is necessary to achieve a well-functioning tax system. By implementing efficient management practices and transparent institutions, governments reduce compliance costs for individuals and businesses, lower administration costs, and create trust in the tax system. All these factors optimise tax collection and positively influence tax policies as a whole.
As globalisation fosters cross-border economic activity, tax systems should incorporate well-designed and comprehensive international tax rules. A high level of international co-operation and co-ordination helps governments tackle tax avoidance and reduces mismatches between tax systems. International and regional co-operation are therefore crucial for the WB6 economies to tackle base erosion and profit shifting (BEPS) practices and strengthen administrative co-ordination.
This chapter examines the extent to which WB6 economies have established competitive tax systems. The tax dimension is linked to several other policy areas examined in this report, especially:
Chapter 4. Investment policy. Well-designed investment tax incentives in a sound and non-distortive tax environment are a key part of attracting investment.
Chapter 8. Competition policy. Competition is strengthened by transparent and equitable tax policies that help prevent tax avoidance that gives some firms an unfair advantage over their competitors.
Chapter 11. Employment policy. Tax policies can influence choices in the labour market. Labour taxation determines the difference between the total labour costs faced by employers and the after-tax wage received by employees, thus affecting labour demand and supply decisions.
Chapter 12. Science, technology and innovation. Predictable tax rates and well-designed investment incentives can encourage firms to innovate.
Chapter 16. Environment policy. Tax-related incentives can help reduce the environmental impact of economic activity.
Chapter 19. Anti-corruption policy. A strong tax administration with robust safeguards that ensure the transparency of its policies and agents helps fight corruption.
Structure
The tax dimension in the 2021 Competitiveness Outlook examines the extent to which governments have established competitive tax systems. Without seeking to be exhaustive, it considers three broad sub-dimensions which are critical to healthy fiscal environments that favour economic growth and well-being across the population:
1. Sub-dimension 4.1: Tax policy framework focuses on how tax policy fosters an environment conducive to inclusive economic growth, how the design of tax policy affects revenues raised and how it influences investment and competitiveness.
2. Sub-dimension 4.2: Tax administration focuses on the different functions of tax administrations and how effective they are in ensuring tax compliance.
3. Sub-dimension 4.3: International co-operation focuses on how the WB6 economies co-operate with the international tax community and implement recent international tax trends, how they deal with the digital economy from a tax perspective, and how they co-operate with other economies in the region.
The assessment was carried out by collecting qualitative data with the help of questionnaires filled out by governments, as well as face-to-face interviews undertaken with relevant non-government stakeholders for this dimension. Alongside these qualitative inputs, quantitative data on certain indicators – provided by the economies’ statistical offices, relevant ministries and agencies, and other databases – formed an integral part of this assessment. Figure 7.2 shows how the sub-dimensions and their indicators make up the tax policy dimension assessment framework. For more information on the methodology, see the Assessment methodology and process chapter.
Key methodological changes to the assessment framework
In contrast to other dimensions, the tax policy assessment framework has not changed significantly since the last report. For Sub-dimension 4.1, the only significant change has been the addition of the investment incentives indicator. Sub-dimension 4.2 remains identical to CO 2018. Sub-dimension 4.3 does not include qualitative or quantitative indicators. This virtually identical assessment framework means the region’s performance between the two assessments can be usefully compared.
Tax revenues have increased as a share of GDP between CO 2018 and CO 2021. In 2019, on average, tax revenues were 30.6% of GDP, which represents a significant increase from 28.0% in 2015. The regional tax-to-GDP ratio remains below the OECD average of 33.8% in 2019, a fall from 34.3% in 2015 (Figure 7.3). The difference is even larger compared to EU countries (41.1% of GDP on average in 2019) and the CEEC-111 economies (34.6%).
Note: To calculate the OECD average tax-to-GDP ratio for 2019, 2018 data were used for Australia and Japan; the CEEC-11 countries are Bulgaria, Croatia, the Czech Republic, Estonia, Latvia, Lithuania, Hungary, Poland, Romania, the Slovak Republic and Slovenia.
Source: (OECD, 2019[1]), Global Revenue Statistics Database, www.oecd.org/tax/tax-policy/global-revenue-statistics-database.htm; CO2021 questionnaire.
These average regional figures mask wide disparities, as both the revenue raised and the change since 2015 vary widely across the WB6 economies. Tax revenues are particularly low in Kosovo (25.9% of GDP), Albania (25.3%) and North Macedonia (25.9%), while the shares for Montenegro (35.7%), Bosnia and Herzegovina (36.3%) and Serbia (36.8%) exceed the OECD average. There are also variations in how revenues have changed since 2015. Serbia has increased its tax revenue relative to GDP by 0.6%, Albania by 1.2%, Bosnia and Herzegovina by 7%, and North Macedonia by 9.2%. In contrast the ratio fell by 0.8% in Kosovo and 1.9% in Montenegro.
The average tax mix in the Western Balkan region differs greatly from that found in OECD countries (Figure 7.4). The WB6 economies rely significantly on revenues from social security contributions and taxes on goods and services to fund their health system and public spending programmes. Together, these taxes accounted for 80.7% of total tax revenues on average in 2019, compared to the OECD average of 58.4%, the EU average of 67.9% and the CEEC average of 78.9%. The share also varies across the WB6 economies, ranging from 66.3% in Albania to 88.1% in Bosnia and Herzegovina.
Consequently, other taxes play a smaller role. Personal and corporate income taxes only account on average for 14.9% of total tax revenues in the WB6 economies, less than half the OECD average (33.5% in 2018). In some economies, such as Albania, the share is slightly higher (20.1%) but remains in broad alignment with the regional average. On average EU countries levy 29.9% of their tax revenues from these sources, and the CEEC-11 20.1%.
Most of the WB6 economies have implemented broad response packages to combat the effects of COVID-19 on their economy and citizens, in line with measures carried out in OECD countries (Box 7.1).
Note: To calculate the 2019 OECD averages, 2018 data were used for Australia, Japan and Mexico; the CEEC-11 countries are Bulgaria, Croatia, the Czech Republic, Estonia, Latvia, Lithuania, Hungary, Poland, Romania, the Slovak Republic and Slovenia.
Source: (OECD, 2019[1]), Global Revenue Statistics Database, www.oecd.org/tax/tax-policy/global-revenue-statistics-database.htm; CO2021 questionnaire.
Governments worldwide have taken rapid and unprecedented actions to address the health crisis and the fall in economic activity caused by the outbreak of COVID-19. Containing and mitigating the spread of the virus has been a priority of public authorities. With containment measures in place, governments have focused on alleviating hardships while maintaining the productive capacity of the economy (OECD, 2021[2]).
As with OECD countries, the WB6 economies have implemented a number of tax policies to mitigate the effect of COVID-19 on their economy and citizens. Their response has been relatively heterogeneous. Some have mainly implemented tax administrative support measures, such as deferring tax payments. Others have implemented a wider response package, closely resembling measures implemented in OECD countries.
While the response measures varied in the region, some tax measures were implemented by most or all of the WB6 economies. They have all implemented tax filing or tax payment deferrals for some or all their major taxes. These measures were usually complemented with more flexible tax-debt repayments, including in some cases the suspension of interest for tax arrears. All of the WB6 economies have also implemented measures to reduce or exempt medical goods from VAT or custom duties, to make it easier for medical professionals and the wider public to access them. Serbia and Kosovo have largely limited their approach to these types of measures, although they also implemented a wage subsidy scheme and Kosovo implemented a public loan guarantee. scheme
Albania, Bosnia and Herzegovina, Montenegro and North Macedonia have introduced a wider range of measures. These include wage subsidy schemes, public loan guarantees or public loan schemes, direct cash transfers to households, loss carry-forward extensions, VAT reductions for certain economic sectors, and the deferral of fixed costs for households and businesses (notably rent or loan payment deferrals).
Tax policies aim to create a competitive tax environment conducive to inclusive economic growth, which raises sufficient tax revenues to finance public expenditure and ensures that the tax burden is shared fairly across the population. This sub-dimension analyses the tax policy frameworks in the WB6 economies. It includes four qualitative indicators to assess tax policy tools applied in WB6 economies: 1) investment incentives; 2) tax revenues; 3) modelling and forecasting; and 4) tax expenditure reporting. This section also looks at other types of taxes, the level of SSCs and the overall tax burden on labour income, the taxation of dividends and interests at the individual level, and key design features of the VAT system.
The average score for this sub-dimension is 2.6 (Table 7.2). For the investment incentives and tax revenues indicators, all of the WB6 economies have relatively similar scores, while for modelling and forecasting and tax expenditure reporting, their scores differ more widely.
WB6 economies provide an investment friendly environment with low CIT rates and generous investment incentives, which come at a certain revenue cost
Statutory CIT rates in the WB6 economies are low, at 11.5% on average across the region, well below the OECD average of 23.3% in 2020. Statutory rates range from Montenegro’s standard rate of 9% to Albania and Serbia’s rate of 15%, with Bosnia and Herzegovina, Kosovo, and North Macedonia applying a 10% rate. No major CIT rate reform has been conducted since the last report. Consequently, regional revenues from CIT only account for 1.8% of GDP on average, ranging from 1.3% of GDP in Kosovo to 2.3% in Serbia. This is below the OECD average of 3.1% in 2018. These low CIT revenues may be partly explained by the low rates and generous tax incentives, but could also be influenced by the structure of activities in the economy. The vast informal sector and high number of unincorporated small enterprises restricts the CIT tax base and could explain below-average revenues.
The WB6 economies implement a diverse set of cost and profit-based tax incentives,2 but most either focus on profit-based tax incentives or implement a mix of cost and profit-based tax incentives. Serbia is the only economy to focus primarily on cost-based tax incentives. The economies’ overall score for investment incentives is 2.6 (as this indicator was introduced for this assessment, no comparison is available). North Macedonia, Albania and Bosnia and Herzegovina scored 3, while Serbia scored 2.5 and, Montenegro and Kosovo scored 2.
Many of the profit-based tax incentives are focused on small and medium-sized enterprises (SMEs). In Albania, companies operating in software production/development, agricultural co-operatives, agritourism or the automotive industry are eligible for a reduced 5% CIT rate. North Macedonia also implements a simplified tax regime for micro enterprises based on annual turnover. Companies with annual turnover under MKD 3 million (EUR 48 700) are exempt from CIT and those with an income of up to MKD 6 million (EUR 97 400) may opt for a simplified tax regime with a 1% rate levied on their turnover, instead of the standard 10% levied on their profits. Kosovo also implements profit-based incentives through special turnover tax rates of 3% and 9% – the rate varies with the type of economic activity – applied to the gross income of SMEs in certain sectors with an annual turnover below EUR 50 000. In general, such size-based thresholds are not necessarily an effective way to support investment and may restrain growth by encouraging businesses to remain below the threshold to continue benefiting from the tax regime. They may also encourage SMEs to split into different companies, or deflate their revenues/inflate costs, to continue to receive preferential treatment. Reduced turnover-based rates also tend to penalise low profit margin businesses, which end up being taxed at higher rate than those with a lower turnover but higher profits. The design of size-based tax incentives therefore needs to be evaluated regularly and, possibly, could be replaced by other measures that reduce compliance costs for SMEs.
Other profit-based tax incentives focus on special economic zones. In Montenegro, companies investing in so-called underdeveloped areas can benefit from profit-based tax incentives. These companies are exempt from CIT for an eight-year period, provided the total amount of tax paid without the incentive would not exceed the EUR 200 000 threshold. In Albania, companies established in so-called areas of technology and economic development are exempted from 50% of their CIT liability for a five-year period. In North Macedonia, companies in special economic zones (referred to as Technological Industrial Development Zones) are exempt from CIT for up to 10 years.
Given the WB6 economies’ low CIT rates, the policy rationale for generous investment incentives, particularly profit-based ones, is weak. Tax incentives increase the after-tax return of investments that would have occurred anyway, thereby yielding “windfall gains” for capital owners and investors. Tax incentives also increase costs for the tax administration, which has to monitor compliance with eligibility criteria. Research also shows that profit-based incentives can lead to a high redundancy of expenditure since the investment may have proceeded anyway, and that cost-based incentives are preferable (UNCTAD, 2015[3]).
Tax revenues are based on social security contributions and taxes on goods and services
The WB6 economies raise significant tax revenues from SSCs; they accounted for 28.8% of total tax revenues on average in 2019, ranging from 10.0% in Kosovo to 43.0% in Bosnia and Herzegovina. Such a heavy reliance on SSCs can raise a number of issues. On the one hand, high SSCs can support the direct funding of the welfare system, preventing the need for social welfare funds to be funded partly from general tax revenues, which would create challenges from a budget perspective. On the other hand, high SSCs distort labour markets, especially for low-skilled, low-income or informal workers. Furthermore, as SSCs are mostly levied at the same rate across income levels, they do not contribute to making the tax system more progressive. This is the case in the WB6 economies, where high SSC rates may be having adverse effects on the labour market and are levied at flat rates rather than progressive rates, as for PIT.
Social security contribution rates are high across the region. In 2020, the average SSC rate for the WB6 economies was 28.6%, above the OECD average of 26.9%. Kosovo has a very low rate compared to the regional average (10%, but with an additional voluntary contributions of up to 20%), but apart from that, rates range from 27.9% in Albania to 41.5% in the Federation of Bosnia and Herzegovina (FBiH). These high rates partly explain the high SSC revenues in the region. These averaged 9.3% of GDP in 2019, slightly above the 9.0% OECD average (in 2018). SSC revenue varies widely in the WB6 economies, ranging from 2.6% of GDP in Kosovo to 15.6% in Bosnia and Herzegovina. Furthermore, the average employee SSC rate is 19.9% in the region, while the average rate for employers is 9.5%. This balance between employer and employee SSCs is atypical by OECD standards, as OECD countries tend to place a greater burden on the employer than on employees.
Revenues from personal income tax are low in the region, partly explained by low PIT rates and high basic allowances. Montenegro has a flat PIT rate of 9%, while North Macedonia and Bosnia and Herzegovina have a flat rate of 10%. The other economies implement a progressive rate schedule, with top PIT rates of 10% in Kosovo, 15% in Serbia and 23% in Albania. Overall, these rates remain relatively low by international standards. Among OECD countries, the average top PIT rate was 42.8% in 2020. These low rates partly explain the region’s low PIT revenues, which amounted to 2.7% of GDP on average in 2019, drastically below the 8.1% average in OECD countries (in 2018). PIT revenue ranges from 2% of GDP in Bosnia and Herzegovina to 3.8% in Serbia. In some of the WB6 economies, low revenues could also be partly explained by high or rising PIT basic allowances. In Albania, the basic allowance was raised in 2019 from ALL 130 000 (EUR 1 050) to ALL 150 000 (EUR 1 215). In Serbia, the basic allowance grew from 31% since 2017. In Bosnia and Herzegovina, the basic allowance in the FBiH is 31% of the average net wage, while in the Republika Srpska (RS) it is 43%. In most of the WB6 economies the tax burden on capital income is low, which creates an incentive for entrepreneurs to incorporate and receive income in the form of capital rather than salaries. This incentive is further emphasised by the high tax burden on labour income described above.
Some WB6 economies levy higher tax rates on labour income than capital income, notably due to reduced rates or exemptions on dividend payments. In Albania, labour income is taxed following a progressive PIT rate schedule of 0%, 13% and 23% rate, while most types of capital income are taxed at 15%, with dividend income taxed at 8%. In Bosnia and Herzegovina and Kosovo, PIT on labour income is mostly levied at a 10% rate. Although some types of passive income are included in the PIT tax base and taxed at 10%, dividends and income from interest are excluded from the PIT tax base. Even where PIT rates are the same as those on capital income, high SSCs levied on labour income still drive the difference (see above).
While a differentiated taxation of labour and capital income allows for more targeted tax policies, the WB6 economies could conduct a cost-benefit analysis to understand the merits of retaining this differentiated taxation and perhaps consider reducing the wedge between capital income and labour income taxes.
The imbalance between PIT and SSCs may affect labour market outcomes, especially for low-skilled, low-income or informal workers. SSCs increase the cost of employing workers and reduce workers’ after-tax earnings. In general, high SSCs are an incentive to work in the informal sector, particularly when controls by tax administrations are weak. High labour taxes may also push low-productivity workers into the informal sector or unemployment. The greater the difference between total labour cost and after-tax disposable income for workers in the formal sector, the greater the incentive for employers and employees to avoid taxes by remaining or joining the informal economy. High levels of informality in turn may negatively affect productivity, growth and trust in government institutions.
Furthermore, this imbalance means taxes on labour income are less progressive, as SSCs are mostly levied at the same rate for all income levels. The WB6 economies could explore the option of rebalancing revenue from SSCs to PIT, perhaps by introducing a progressive PIT rate schedule among those with flat rates. The three WB6 economies with progressive schedules could strengthen their design to improve their wealth redistribution impact. In Albania, despite a high top rate of 23%, effective rates can be much lower: workers earning ALL 150 000 (EUR 1 215) (the income threshold for the top PIT rate), have an effective tax rate of only 12%. In Serbia, despite a progressive rate schedule with a top PIT rate of 15%, the majority of individuals are liable for the lower 10% rate. In Kosovo, the income threshold for the top PIT rate is placed slightly above the average wage, meaning the PIT system does not target high earners effectively.
The WB6 economies also rely heavily on taxes on goods and services, which accounted for 51.9% of total tax revenues in 2019. This ratio varies widely across the region, from 20% in Serbia to 74.2% in Kosovo. Revenues from these taxes amounted to 15.9% of GDP on average, compared with 10.9% for the OECD average (in 2018), ranging from 11.7% in Albania to 19.9% in Montenegro. Value-added tax rates are close to average levels found in OECD countries: 19.0% in the region in 2020, slightly below the OECD average of 19.3%.
OECD research has found that consumption taxes, and particularly VAT, may be less distortive on the decisions of households and firms, and thus on GDP per capita, than income taxes (Johansson et al., 2008[4]). The OECD’s Tax Policy Reform and Economic Growth report, which assessed the impact of four major categories of taxes on long-run GDP per capita, ranked consumption taxes as the second least damaging, after recurrent taxes on immovable property and before other property taxes and personal and corporate income taxes (OECD, 2010[5]). Furthermore, a well-designed VAT system may encourage workers and businesses to enter the formal economy. Systems based on VAT could therefore be more conducive to economic growth than systems focused on more distortive taxes, such as CIT. However, the WB6 economies could contemplate diversifying their tax resources, notably by strengthening recurrent taxes on immovable properties or environmentally related taxes.
Two factors narrow the VAT base in the WB6 economies. First, all WB6 economies have opted for a turnover-based VAT registration threshold, which is common among OECD countries but not universal. On average, the threshold is relatively high, at EUR 42 500 in 2021, ranging from EUR 18 000 in Montenegro to EUR 81 000 in Albania. A relatively high threshold may give small businesses an advantage when in competition with larger companies, while a relatively low threshold may act as a disincentive to grow or as an incentive to split activities artificially to avoid VAT. Therefore, the threshold is often the result of a trade-off between minimising compliance and administration costs and the need to avoid jeopardising revenue or distorting competition. By setting rather high VAT registration thresholds, the WB6 economies chose to concentrate their VAT administration capacities on larger businesses. As they continue to strengthen their tax administration capacity, they may consider gradually lowering registration thresholds over time.
Second, the WB6 economies have extensive lists of goods and services which are either exempt or taxed at a reduced VAT rate. All the economies except Bosnia and Herzegovina levy reduced VAT rates: 10% in Serbia, 8% in Kosovo, 7% in Montenegro, 6% in Albania and 5% in North Macedonia. While reduced VAT rates may represent good tax policy in certain cases, many of the exemptions and reduced rates in the WB6 economies are not well targeted from an equity perspective. Only Serbia, which has a relatively broad VAT base, does not have a long list of VAT exempted goods and services. For example, all the economies exempt rents on residential properties from VAT while Bosnia and Herzegovina and Montenegro exempt any activity that can be seen to be connected to the public interest. North Macedonia exempts the cross-border transport of people. Albania and Kosovo exempt newspapers, magazines and certain other types of print media. Albania exempts certain services linked to sports, services provided by dental technicians, advertisements through electronic and written media, and some printing services. Kosovo also exempts public transport. Moreover, OECD research has found that reduced rates are generally not an effective way to target low-income individuals as it may even be regressive in certain cases (OECD, n.d.[6]).
The tax burden in the WB6 economies is borne by a small number of taxpayers. Although, by its nature it is complicated to precisely estimate the size of the informal sector, it is large in the region. According to estimates by the World Bank, the informal sector in the WB6 economies accounts for around 25-35% of both GDP and the total working population (World Bank, 2021[7]). In comparison, informality in EU Member States averages around 15-20% of GDP. North Macedonia has the lowest estimated informal sector (less than 20% of the working population), while Kosovo has the highest (more than 35%). This raises a number of tax issues: informality limits the amount of tax revenue raised, restricts the ability of the tax system to help reduce inequalities, places a drag on economic growth and creates distortions between the formal and informal economy.
There are several options available for governments attempting to reduce the size of the informal sector and bring businesses and workers into the formal economy. These options can be divided into two categories. The first concerns tax administration measures, where governments implement simplified tax regimes for certain type of individual and businesses, or target their audit capacities on taxpayers most likely to evade taxes and operate in the informal economy. For example, Kosovo has developed a special unit within its tax administration in charge of SMEs and Albania has developed an IT risk module system based on the riskiest taxpayers to guide its audit plan. The second covers tax policies that aim to reduce the disincentive to work in the formal economy, by example reducing high SSC rates on labour income or high VAT registration thresholds. Bosnia and Herzegovina plans to lower the SSC rate from 41.5% to 32.5% in 2021, which should lower the overall cost of labour and therefore increase the incentive to register in the formal economy.
The WB6 economies have strengthened their use of micro-simulation models to assess the distributive effects of tax reforms on their economy
The 2018 assessment identified the modelling and forecasting of tax revenues as an area in need of progress. Overall, the WB6 economies scored 2.3 on average for the modelling and forecasting indicator in CO 2018. The assessment found that although the economies’ finance ministries maintained aggregate tax revenue forecasting models for each main tax, there was insufficient analysis of the information and a lack of micro-simulation models.
Since then, several initiatives have been carried out and good progress made, particularly in the area of micro-simulation models, with the average score for this indicator rising to 3.3. In 2018, Albania, Kosovo, and Montenegro did not use micro-simulation models at all, while Bosnia and Herzegovina, North Macedonia, and Serbia made limited use of them. Now all the WB6 economies except Kosovo are using these models. Albania and Montenegro started using them for the first time in 2019, and others have expanded their use. For example, North Macedonia developed a micro-simulation model for PIT that includes 1 million taxpayers, can carry out analysis by income groups or can estimate different type of redistributive indicator (Gini, Atkinson, etc.). Albania is also currently working with the International Monetary Fund (IMF) to develop new micro-simulation models (Box 7.2).
Tax expenditures are not reported in a regular and systematic way across the region
The last assessment identified tax expenditure reporting as an area where efforts should be strengthened. The average score was 0.7 in CO 2018, the lowest score in any indicator for the tax policy dimension. This could be explained by the lack of calculation and accounting of forgone revenues due to tax expenditures in all the WB6 economies.
The score for this indicator has increased to 1.8 on average across the WB6 economies, driven by two initiatives. Albania implemented a regular tax expenditure report in 2019, which will be issued every two years. North Macedonia is currently implementing a New Organic Budget Law, taking effect in 2021. Among other things, this law aims to instigate a regular tax expenditure report. Despite these two initiatives, the use of tax expenditure reporting remains limited in the region. Some economies, such as Montenegro, collect basic statistics on tax expenditures, but this information is not made public and only used for internal government use.
Other WB6 economies should consider publishing regular tax expenditure reports, which would increase transparency and accountability. They would allow them to monitor the use and effectiveness of tax incentives along with the tax revenue forgone (OECD, 2010[8]). These reports should identify, measure and report the cost of tax expenditures in a way that enables their monetary value to be compared with direct spending programmes (IMF, 2019[9]). The economies could also conduct cost-benefit analyses to evaluate whether specific tax incentives meet their stated objectives and, if not, whether they should be abolished or replaced.
The way forward for the tax policy framework
Continue COVID-19 support with targeted tax and subsidy measures, while focusing future efforts on measures to spark an economic recovery. Most WB6 economies have implemented a broad response package to mitigate the effects of COVID-19 on the economy and its citizens, in alignment with measures carried out in OECD countries.
Avoid the use of generous profit-based tax incentives in a context of a low standard statutory CIT rate. Instead, WB6 economies could shift the focus to cost-based tax incentives, which are less likely to lead to high redundancy of expenditure.
Weigh the advantages and disadvantages of a differentiated taxation of capital and labour income. Policy makers could consider aligning tax rates to prevent negative spillover effects and reduce the incentive for entrepreneurs to incorporate and receive income in the form of capital rather than salaries.
Increase tax revenues and diversify the tax mix. Half of the WB6 economies have relatively significant scope to increase tax revenues, as Albania, Kosovo and North Macedonia’s average tax-to-GDP ratios remain far below the OECD average. Increasing revenues would help these economies finance their public spending programmes and healthcare systems. It could also strengthen their welfare state and help reach wealth redistribution objectives. Governments should also aim to diversify the tax mix by reducing their reliance on SSCs and taxes on goods and services and instead strengthening the role of corporate and personal income taxes, environmentally related taxes, and recurrent taxes on immovable property.
Rebalance the taxation of labour income away from high employer and employee social security contributions. The current imbalance raises the cost of labour and consequently affects labour market outcomes, especially for low-income, low-skilled and informal workers. Shifting revenues away from SSCs and introducing progressive PIT rate schedules where necessary would help rebalance the taxation of labour income.
Strengthen the design and progressivity of PIT. Some of the WB6 economies use progressive PIT rate schedules but design issues hinder their impact on wealth redistribution. These economies could analyse the distribution of the PIT burden across income levels and, if necessary, redesign their rate schedule to target high earners more effectively and provide relief for low earners.
Evaluate options to broaden the VAT base. Currently, the VAT base of most WB6 economies is narrowed by high registration thresholds and extensive lists of goods and services taxed at reduced VAT rates. Broadening the VAT base, if scope exists to do so, would bring additional revenue and could increase the size of the tax base.
Reinforce efforts to broaden the tax base and encourage the registration of informal businesses and workers in the formal economy. These efforts could come through both tax administration and tax policy measures. Potential measures could range from simplified tax payment and declaration regimes to targeted tax rates and threshold reductions. Furthermore, the co-ordination between different measures and their effects should be the focus of future tax reforms.
Expand the use of micro-simulation models to forecast tax revenues and to assess the distributive effects of tax reforms. While the WB6 economies have greatly improved their use of micro-simulation models since the last report, efforts could be strengthened. Current models remain limited to a few specific taxes and could be expanded to the majority of taxes and used systematically when planning future tax reforms.
Implement regular and systematic tax expenditure reports. Current tax expenditure reporting capacities are very limited across the region and only Albania currently produces a regular and systematic report (Table 7.2). Such reports would help the WB6 economies manage their investment tax incentives and link their management with other public spending programmes.
Sound policy making, especially in tax matters, requires a comprehensive set of tools to precisely forecast and estimate the effects of reforms on the economy. They allow governments to effectively quantify the impact of potential reform options in terms of revenue forecasting, distributive effects or impact assessments. Among the WB6 economies, Albania has been particularly proactive in this field in recent years, with strong initiatives in micro-simulation models and tax expenditure reporting.
Micro-simulation models
On top of its widespread use of macro-simulation models, Albania has expanded its use of micro-simulation models since the 2018 Competitiveness Outlook.
In 2019, the Ministry of Finance and Economy developed a set of micro-simulation models for VAT, PIT, excise and CIT. These models were created in co-operation with the World Bank. For VAT, the model is based on a supply use table from INSTAT, corrected for economic growth for 35 levels of activities and products. For PIT, the model calculates the effects of changes in tax rates for different categories of salaries. For CIT, the model includes firm-level data and can analyse revenue effects from CIT reforms across different economic sectors.
The models were expected to be first used in 2020 to forecast yearly revenues from each tax and develop the monthly distribution plan. However, due to the outbreak of COVID-19 and a significant earthquake in the country, some taxes were not paid on a regular basis, which reduced the precision of the revenue forecasting process. The process should resume in 2021. Albania is also currently working alongside the International Monetary Fund (IMF) to develop new models for VAT, PIT and CIT.
Tax expenditure reporting
Tax expenditure was identified in the CO 2018 as an area in need of reform for the WB6 economies. Since then, only Albania has started producing a regular and systematic tax expenditure report, although North Macedonia plans to do so in 2021.
In 2019, Albania instigated its first regular and systematic tax expenditure report. This report should be published every two years, with the next report expected in 2021. Previously, a limited set of basic tax expenditure information was published alongside the annual budget, but in an aggregated form. The information included in the report is published in the official website of the Ministry of Finance and Economy. Furthermore, the expenditure and their accounting are audited by the State Audit every year. The State Audit report is sent for approval to the Parliament, along with the Report of Budget Execution that is prepared by the Ministry of Finance and Economy.
The introduction of a regular tax expenditure report in Albania should help it to efficiently manage its newly founded set of investment incentives and other tax expenditures. This reform is welcomed and will bring Albania’s public finance management system closer to international best practice.
Source: CO2021 questionnaire for Albania.
Sound tax policies and clearly drafted legislation are not enough to guarantee competitive tax systems. The consistent and transparent implementation of tax policies and legislation through effective administration must also be a top priority for governments. Maximising tax compliance and revenue collection is not manageable without an efficient administration. Indeed, administrative capacities are part of the calculation when determining the optimal tax mix for an economy and are therefore a cornerstone of sound tax policies. From a business perspective, an efficient tax administration is important as it limits the costs of complying with tax obligations. The tax administration sub-dimension assesses the efficiency of the tax administration in the WB6 economies through five qualitative indicators: 1) functions and organisation; 2) compliance assessment and risk management; 3) independence and transparency; 4) tax filing and payment procedures; and 5) taxpayer services. Scoring the economies from 0 to 5 against these indicators can help to understand the degree to which they are building effective tax administrations.
In general, the WB6 economies have made significant efforts to strengthen their tax administrations, with the average score increasing from 2.4 in 2018 to 3.3 in 2021 (Table 7.3). Strengthening their tax administrations helps them to maintain low direct tax rates. There have been significant improvements in taxpayer services, tax filing and independence and transparency but the scores have not changed for compliance assessment and functions and organisation.
Functions and organisation of the tax administration have changed little overall
The organisational structure of tax administrations is a crucial component of operational efficiency and effectiveness. One of the key factors behind an efficient tax administration is a unified administrative body which covers all taxes and all core tax administration functions.
The WB6 economies’ performance in the functions and organisation indicator has been mixed. Since the 2018 assessment, Bosnia and Herzegovina, Kosovo, and Serbia have improved their score and Albania, North Macedonia and Montenegro have scored worse, leaving the average for the region unchanged at 3.3. Serbia is the best-scoring economy, with a score of 5.0.
All the WB6 economies except for Bosnia and Herzegovina have a unified tax administration body. Due to its specific political structure, Bosnia and Herzegovina’s tax administration is divided, with the entities (FBiH and RS) responsible for all direct taxes, while the top level administration is responsible for indirect taxes. The other WB6 economies follow OECD good practice and have a unified body that covers all taxes and all the core tax administration functions. In all the economies, the tax administration’s organisation follows a mix of a taxpayer and a functions approach. This means that its internal organisation mostly follows the different functions of a tax administration (audit, tax collection, taxpayer services, etc.), but there are also divisions targeted at specific taxpayer groups. All the WB6 tax administration bodies have a division for large taxpayers while Kosovo also has a division for SMEs. All the economies provide regular training for their tax administration officials.
Tax compliance assessments follow a risk-based approach
Being able to assess where the greatest compliance risks lie is a great tool for the efficient monitoring of tax compliance. Risk-based selection is a central part of modern compliance programmes as it allows tax administrations to make effective trade-off decisions and make the most efficient use of their scarce resources. Audit programmes should be regularly assessed and reported to ensure that operations are transparent to the wider public.
The high average score for the compliance assessment and risk management indicator (3.5) has not changed since the last report. All the economies received a score of 3 or more for this indicator. This high score is mainly due to the relatively widespread use of risk management in their tax compliance functions.
All the WB6 economies follow a risk-based approach to compliance assessment, which means that they focus on taxpayers showing certain abnormalities against a pre-determined set of risk criteria. Albania uses a monthly audit plan, 70% of which is based on recommendations from an IT risk module system. The remaining 30% is based on proposals from regional directorates. In the Federation of Bosnia and Herzegovina, an annual audit plan is developed, using a broad set of 19 criteria. In North Macedonia, the tax administration prepares a monthly tax audit plan, based on three methods: electronic risk assessment, analysis of individual cases and random audit based on a certain sample of risk activity. Some, such as Kosovo, have set up special risk divisions to manage this function. All the WB6 economies carry out similar types of audits: comprehensive audits (covering all types of tax), fiscal visits (focused on a single type of tax and fiscal year) and field verifications (focused on issues such as registration of taxpayers or use of non-cash register for businesses).
Tax administrations are increasingly transparent but still lack independence
Independence and transparency are crucial features of an efficient and well-developed tax administration. They allow the tax administration, and by extension the tax system as a whole, to be seen as a legitimate public authority with the necessary protections in place when collecting money from taxpayers. The tax system needs to ensure transparency to prevent tax administrations from being influenced by political or financial actors who may seek to evade established tax laws or take advantage of it. Implementing comprehensive policies to establish independent and transparent tax administrations represents a strong commitment by governments that they will maintain the integrity of the tax collection process.
In the last assessment, the WB6 economies scored an average of 0.3 in the independence and transparency indicator. This low score highlighted a lack of policies to ensure that their tax administrations act in an independent and transparent manner, leaving significant scope for reform. In this assessment the average score has risen to 2.2 and Kosovo is the best-scoring economy with a score of 4.0.
The establishment of independent tax administration management boards has been uneven across the region. The Montenegro Tax Administration (MTA) became an independent administrative body in 2019 (it was previously integrated into the Ministry of Finance). The head of the MTA is now nominated for a five-year period and reports to the Minister of Finance. In Serbia the Tax Administration Transformation Programme 2015-20 led to the development of an action plan for 2018-23 that foresees the creation of several permanent committees, including a committee on organisational transformation. Kosovo and North Macedonia have implemented policies to establish independent management boards for their tax administrations. In Albania and the FBiH, no steps have been taken to establish independent management boards.
All the tax administrations of the WB6 economies have rules to deal with staff abusing tax collection powers. In Bosnia and Herzegovina, North Macedonia and Serbia, employees of the tax administration are subject to disciplinary measures in cases of abuse of power. In Albania, staff abusing tax collection powers are subject to the criminal code and the law on tax procedures. In, Kosovo and Montenegro, staff have a code of ethics. All the economies also provide a protection framework for whistle-blowers.
The use of e-filing is widespread across the region
Compliance with tax obligations may be burdensome and require businesses and individuals to access a certain number of resources. This can mean high costs for taxpayers, which might be a burden on low-earners and SMEs. For that reason, streamlining and simplifying tax compliance procedures should be a central objective for tax administrations.
The WB6 economies report that filing and paying taxes is a reasonably quick and relatively simple process. Their average score for the tax filing and payment procedures indicator is 3.5, an increase from the average of 2.8 in 2018. All the economies make widespread use of e-filing. In Albania, e-filing is mandatory for all taxes. In Bosnia and Herzegovina, Kosovo, and North Macedonia e-filing is available for all major taxes but only mandatory for VAT and excise duties. In Montenegro, it is mandatory for CIT and PIT and available for all major taxes, but only to taxpayers who have purchased a EUR 110 digital certificate. In Serbia, e-filing is only mandatory for taxes paid by businesses, while individuals may choose between electronic and paper forms.
WB6 economies have improved their taxpayer services since the last report
Taxpayers need a certain level of assistance and information to meet their tax obligations and achieve voluntary compliance. Taxpayer services play a crucial role in meeting these needs. These services can take different forms, and typically include responding to in-person and telephones enquiries, providing general information, and online filing and payment systems. Tax administrations should also use surveys to gauge taxpayer satisfaction, and guarantee an easy and accessible service to taxpayers. Governments may also provide taxpayer ombudsmen.
The WB6 economies have improved their performance in the taxpayer services indicator from an average score of 1.5 in 2018 to 4.2 in 2021. All the economies obtained high scores for this indicator, ranging from 3.75 for Bosnia and Herzegovina to 5 for Serbia. Various services are at the public’s disposal in all the economies, including online access to information, electronic communications with taxpayer and in-person inquiries. Each of the WB6 economies, except Albania, implements customer segmentation models to better meet taxpayer needs. In the 2018 assessment, only Albania and Kosovo had taxpayer ombudsmen. Since then, Serbia, North Macedonia and the FBiH have nominated taxpayer ombudsmen, partly explaining the increase in their scores since the last report. Kosovo, the only economy that did not conduct surveys of taxpayer’s satisfaction in the last report is now conducting such surveys.
The way forward for tax administration
Continue efforts to strengthen tax administrations, which would bring more taxpayers into the tax system and broaden the tax base. It could also improve tax certainty, lower the costs of compliance and enforcement, increase tax revenues, and make the tax system more efficient.
Develop strong procedural safeguards to guarantee the independence of tax administrations across the region. An independent tax administration board is a crucial aspect of sound tax policy management and the WB6 economies would benefit from implementing procedural safeguards that protect these boards’ independence.
Streamline taxpayer services and tax filing procedures further to increase tax compliance. The WB6 economies have carried out significant efforts in this area since the last assessment and are encouraged to continue in that direction.
International and regional co-operation on tax policy is vital for addressing tax evasion and avoidance and ensuring that profits are taxed in the economies where the profit-generating activities are performed and value is created. A strong international taxation framework allows economies to protect their domestic tax base from erosion due to tax avoidance and evasion. Regional co-operation over tax matters also allows economies to learn from each other’s best practices. The international tax co-operation sub-dimension considers whether the tax codes of the WB6 economies include key international tax rules. It examines whether the economies participate in international taxation frameworks and co-operate with other economies, particularly within the region. It also considers recent developments on digital taxation, in particular the OECD’s Tax Challenges arising from digitalisation and its expected global minimum tax. The information in this sub-dimension is not scored, but analysed using descriptive information.
Involvement with international tax initiatives and alignment with international tax trends are increasing
Base erosion and profit shifting arises when businesses can exploit gaps and mismatches between different tax systems. BEPS negatively affects tax revenues, the efficiency of tax systems and their ability to create a level playing field for all firms. While BEPS is a worldwide concern, it is of particular importance to developing and emerging economies whose tax legislation and administrations may struggle with the complexities of modern business. Aligning with international standards ensures a coherent and efficient application of the tax system, eliminating tax uncertainty.
The CO 2018 assessment identified co-operation with the international tax community and the implementation of international best practices as areas where the WB6 economies could strengthen their efforts. At that time, no WB6 economy had joined the Inclusive Framework on Base Erosion and Profit Shifting or the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS. The assessment also highlighted the lack of initiatives in areas such as administrative co-operation and exchange of information.
Since the last assessment, the WB6 economies have made significant efforts to align their tax systems with international best practices. North Macedonia and Serbia joined the Inclusive Framework on BEPS in 2018, followed by Albania, Bosnia and Herzegovina, and Montenegro in 2019. This led to a series of initiatives to tackle harmful tax practices (Action 5), prevention of tax treaty abuse (Action 6), country-by-country reporting (Action 13) and mutual agreement procedures (Action 14). Only Kosovo has not joined the framework but it has indicated use of the OECD Model Tax Convention as a basis for its double-tax treaties, which informally, leads to the implementation of some BEPS minimum standards. Albania, Bosnia and Herzegovina, North Macedonia and Serbia have also implemented the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS since the last assessment.
The OECD Global Forum on Transparency and Exchange of Information for Tax Purposes has developed two different international standards for the exchange of information for tax purposes: exchange of information upon request (EOIR) and automatic exchange of information (AEOI). Economies are evaluated for compliance with the EOIR standard through peer review. For the purpose of AEOI, a common reporting standard has been developed that is incorporated into the domestic law of participating jurisdictions. The Convention on Mutual Administrative Assistance in Tax Matters is also an important part of recent initiatives of the international tax community with regard to exchange of information. In 2018, only Albania had signed the Convention on Mutual Administrative Assistance in Tax Matters and the Multilateral Competent Authority Agreement for AEOI. Albania and North Macedonia had also been subject to peer review for EOIR, performed by the assessment team of the Global Forum, and both economies were found to be largely compliant. Since the 2018 assessment, there have been several notable initiatives. Bosnia and Herzegovina, North Macedonia, Montenegro and Serbia have joined the Convention on Mutual Administrative Assistance in Tax Matters. Bosnia and Herzegovina, Montenegro and Serbia have also been subject to or have scheduled a peer review for EOIR by the OECD Global Forum. Finally, Montenegro has signed the Multilateral Competent Authority Agreement for AEOI.
In theory, there are two models for the taxation of cross-border income: 1) worldwide taxation systems, which tax corporations on their worldwide income; and 2) territorial tax systems, which only tax income that has its source in the economy. In recent decades, most OECD countries have adopted territorial tax systems although in practice most apply a combination of both systems. Pure territorial tax systems are rare as most OECD countries have adopted some form of exemption. OECD members with territorial tax systems commonly exempt most active earnings from tax if they were repatriated from subsidiaries incorporated in host countries.
The WB6 economies all have pure worldwide tax systems, in which income earned abroad by resident corporations is integrated into the domestic CIT tax base. Such systems create a heavy administrative burden for the economies implementing them. In practice, income earned abroad will have been taxed in the host economy where the income has its source under that economy’s CIT (or via withholding tax for payments made directly to corporations with their tax residence in the region). The WB6 tax administrations then have to assess the difference between taxes paid abroad and the remaining domestic tax liability (if the host economy has a lower tax rate), granting a tax credit as a relief against double taxation. This administrative burden has to be balanced against potential revenue from foreign sourced income to assess whether a worldwide taxation system offers a net benefit. In practice, potential revenues are limited by the low CIT rates across the region, meaning that taxes paid at source on foreign income are very likely to be higher than those payable in the WB6 economies.
As a result, the WB6 economies are unlikely to raise enough revenue from the taxation of foreign-sourced income to justify the high administrative costs. Small open economies like the WB6 economies typically have territorial tax systems. The WB6 economies should conduct a cost-benefit analysis of the merits of their worldwide taxation systems. They could also contemplate introducing additional tax base protection measures, such as limiting of how much expense incurred to earn foreign-source income is deductible from the domestic CIT base.
Digital taxation is improving but can still be strengthened
Digital taxation has been a subject of growing importance in recent years for the international tax community. Tax systems have had to adapt in order to capture these new and growing forms of revenues, which raise challenges from a tax perspective. The WB6 economies have engaged in some initiatives in this area but could strengthen their efforts.
Only Albania implements international VAT and goods and services tax (GST) guidelines on cross-border digital services, which it has done since 2014. Although it is the only economy formally implementing these guidelines, four of the remaining five economies levy VAT on cross-border digital services using a logic similar to the destination principle (i.e. levying tax in the place where the service recipient is established, the cornerstone of international VAT/GST guidelines). Only Kosovo currently levies VAT on cross-border digital services in the place where the service provider is established. However, WB6 economies would still benefit from the implementation of international VAT/GST guidelines.
Only two of the WB6 economies integrate revenues from digital platforms into the PIT tax base; North Macedonia and Montenegro levy PIT on these revenues at their default flat tax rate. Some of the other economies are currently assessing possible actions in this area. Albania’s tax administration has requested from Airbnb the list of individuals renting out properties through their platform. Once this information is obtained, it will be cross referenced with these individuals’ tax returns, which should allow this income to be included in the PIT tax base in the future. The Strategic Risk Department of Serbia’s tax administration carried out an analysis of tax compliance on this subject. It found that the reporting of revenues from digital platforms was weak and that there was a low rate of tax compliance among individual taxpayers. As a result, Serbia’s Tax Administration requested data from commercial banks on payments received by individuals from digital platforms. It is currently developing a risk response plan to audit these taxpayers.
The OECD’s Tax Challenges Arising from Digitalisation project, especially the global minimum tax under its Pillar 2, could have a substantial impact on the WB6 economies’ tax systems if consensus is reached among members of the Inclusive Framework. The GLOBE proposal intends to define a minimum taxation rate for corporate profits. Even though the final rate is subject to ongoing discussions, there is a high risk that it will be set above the current CIT rates in the region (as discussed above, the average CIT rate in the WB6 in 2020 was 11.5%, ranging from 9% to 15%). The risk is particularly acute for Montenegro (9% rate), as well as for Kosovo, North Macedonia, and Bosnia and Herzegovina (10% rate). If the minimum tax rate was set above these levels, economies would face the choice of either raising their CIT rate to the minimum tax, or risk forgoing domestically sourced tax revenues to foreign jurisdictions. This does not mean the remaining WB6 economies with a higher CIT rate would be spared. Albania and Serbia (15% CIT rate) would most probably be still affected by the GLOBE proposal.
Even if any minimum tax is set below their statutory CIT rate, it could still have an impact on their taxation of corporate profits. As discussed above, most of the WB6 economies offer generous CIT investment incentives, which may lower the effective rates on corporate profits to a level below the global minimum tax. The economies would then be faced with a similar choice, of either redesigning their investment incentives to raise their effective rates to a level above the minimum tax or risk forgoing domestically sourced tax revenues to foreign jurisdictions. They are advised to carefully assess their position on this issue and draft an action plan in response.
Regional co-operation and co-ordination are modest
The WB6 economies all carry out some form of regional co-operation and co-ordination. Albania and Kosovo work together to strengthen the functioning of their VAT and to provide training to their staff. Montenegro has concluded agreements on mutual co-operation with Bosnia and Herzegovina, Croatia, Serbia and Slovenia to exchange information and provide assistance in the detection of VAT fraud and avoidance. North Macedonia exchanges information with Albania, Bosnia and Herzegovina, Kosovo and Serbia.
The WB6 economies would benefit from greater regional tax co-ordination and tax co-operation. The intensification of co-operation efforts will help them to tackle tax avoidance and evasion in a coherent manner across the region. As the economies all face similar tax challenges, they would gain mutual benefits from intensifying their information sharing and learning together.
The way forward for international co-operation
Define an action plan in case of international consensus on a global minimum tax. This could greatly affect the taxation of corporate profits in the region; the economies should define their position on this issue.
Continue to engage with the international tax community and implement international best practice. The WB6 economies’ strong engagement to align their system with recent international tax trends should be continued. Among other elements, automatic exchange of information could be an area of focus for future initiatives.
Carry out a cost-benefit analysis on the merits of retaining a worldwide taxation system for resident corporations. Such systems are uncommon in the OECD, particularly for small open economies like the WB6. Their worldwide taxation systems may, among other issues, be incurring high administrative costs without raising significant additional revenue.
Foster regional co-operation and co-ordination on common tax issues within the region. The WB6 economies face similar challenges in many areas such as tax compliance, training of tax administration staff and the exchange of information. These areas would greatly benefit from a co-ordinated regional approach.
Since the 2018 Competitiveness Outlook, the WB6 economies have been strengthening their general taxation framework and tax administration. However, from a domestic and international tax policy standpoint, they continue to face major challenges which have only been deepened by the global pandemic. Taxes are levied on narrow bases, particularly VAT and CIT. SSCs are levied at high rates, imposing a heavy tax burden on labour income and restricting the use of PIT to reduce inequality. All the WB6 economies need to develop their tax policy measurement tools, such as enhanced tax revenue statistics, efficient tax rate analysis and strengthened tax expenditure reporting. They should also keep strengthening their tax administrations to achieve efficient management practices and transparent institutions. They will need to reconsider their wide variety of corporate tax benefits and take action to avoid falling victim to a tax race to the bottom. Instead, they should strengthen their tax co-operation, both within the region and more globally.
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Notes
← 1. The 11 Central and Eastern European countries (CEECs) which have joined the European Union: Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic and Slovenia.
← 2. Profit-based incentives generally reduce the tax rate applicable on taxable income, while cost-based incentives lower the cost of an investment and increase with the size of the investment.