Why it is necessary to have lower labor taxes?

Due to tax policy, in Federation of Bosnia and Herzegovina (FBiH) labor is an extremely costly segment of production. On behalf of themselves and workers, employers are required to pay around 72% of the salary, on top of net salary, for the purpose of taxes and contributions. FBiH has the highest total contribution rate in the region with 41.5% of gross salary, whereas in the Republika Srpska (RS) total contribution rate is only 33%. In Montenegro, the rate is 32.5%, in Serbia 37.8% and in Croatia 37.2% of the gross salary.

Table 1: Overview of social contributions rates in BiH and the region (gross wage model)

The difference in tax burden for worker is evident when we observe the fact that a worker in FBiH with average monthly salary of BAM 940 pays to Entity budget and funds in form of income tax and contributions BAM 143 more than the worker in RS (not taking into account separate fees which make additional BAM 17 of expenses on this salary in FBiH).

Consequences of such tax policy are trends which have negative impact to the development of business sector, and consequently the entire economy. Some of the key negative effects are elaborated in the following lines.  

Low income for the workers

Basic problem lays in the low net income of the workers whose salary after taxation is lower in comparison to salaries of workers in the neighboring countries where employers pay the same amount for the gross salary. Lower net salaries equal lower purchasing power of the citizens which reflects to the quality of living, consumption level and ultimately economic growth.

From the worker’s perspective aspect of social justice is also important – what is it that workers get for their money? What is the pension plan like and if this system sustains, how high is my retirement going to be? Am I receiving proper medical care for my money? What kind of security do I have if I lose my job? What is the quality of services financed through taxation of my income, primarily of the education system? These are the questions we ask ourselves only in situation when we use public services, primarily due to their quality, thinking about the taxes we pay. Taxes are not just the power of state to take funds from workers, employers and consumers. It should guarantee access to services, as well as for the quality of the services we get for our money.

In order to get full understanding of how much we invest and what we get in return, it is important to compare the labor taxation level in FBiH to one in countries where systems provide their citizens high quality level of social welfare and public services. In order to pay the worker BAM 1 nett income, employer in FBiH needs to spend around BAM 1.72 on their labor (as a sum with all the legally required contributions for social insurance and income tax, other taxes not included for the purpose of clarification). If we compare that amount to the costs in the countries with the strongest social systems in the EU, we will see that the amount is higher in comparison to Denmark where for nett salary of   €1 employer pays €1.56, as well as in Luxemburg where employers pay €1.60, and they are equalized with costs in Finland where employers pay €1.72, and slightly lower than in Sweden where the amount is €1,75[i].

Unemployment

Unemployment is yet another problem of the system contributed by inadequate tax policy. Slow growth of employment rates and job openings in the private sector is evident and the fact is that high labor-related tax rates are significantly reflecting to the power the companies have to release the funds for investment and staring new business operations and working places, hence resulting in opening new job positions.

Tax evasion

High level of tax evasion at the labor market is, among other things, caused by struggle of private sector to maintain competitiveness, but also workers to bring their home and families the highest possible sum of money in such tax system. In such situation legal requirements are being evaded through keeping unregistered workers (black labor market), registration of workers with minimal declared income and paying the additional portion of salary in cash, most frequently over paid profit where taxes are lower, and keeping workers at part-time contracts for many years.

Such practices are widespread and common and have long-term social and economic implications. First of all, they created disadvantageous working conditions for workers in such employment status who fail to gain registered years of service and legal protection, their pension base is lower and they live and work in constant fear they would be discovered as illegal workers and in case of injury at work they are left without any means to secure existence. Such practices caused mostly by current tax policy severely damaged fiscal discipline of the companies, influenced tax morality of the population, reduced stability of funds and contributed creating a bad image of  private sector and privately-owned companies.

Competitiveness of local products

Our industry, especially in terms of production companies doing business in line with the regulations, is consequently less competitive because labor price is part of the calculation of the final price of the product, so local products fail to be more affordable than the products imported from the regional countries, which consequently prevents them from taking significant market portion. High labor taxes manifest in other forms as well: companies lack funds required for investment into marketing, design and R&D which additionally reduces competitiveness of local products on the store shelves. All the above-mentioned influences their market growth, financial and investment power and, in many cases, survival on the market.  

New contribution rates

Due to all of the aforementioned, Center for Policy and Governance has spent years in promoting reduced labor taxation. Reduced total contribution rate was one of the aims of the Reform agenda not fulfilled in the previous mandate. Association of employers of FBiH has recently filed official proposal that cumulative contribution rate should be reduced from 41.5% to 33% of the gross salary, and shortly afterwards it was followed by the latest government proposal developed by the FBiH Government about the package of tax-related laws for FBiH where contributions would amount to reduced 32.5% of the gross salary.

Regarding the fact that tax revenues from direct and indirect taxation have increased in the past few years – something we can attribute to the agility of the private sector and improvement of the market surveillance by the FBiH Tax Office – we now have conditions favorable for introducing reduction of the labor tax burden without increasing consumption taxation, which is often regarded a key strategy for amortization of reduced labor taxation.  

It is the estimate of the FBiH Government that its latest proposal regarding tax reform with proposed reduction in contribution rates (reduced burden) will not lead to reduction of budget revenues, i.e. funds for health care and pension. Unfortunately, public access to such calculations was not available. FBiH Government should publish estimate of macroeconomic effects of suggested Amendments to the Draft Law on Contributions and Draft Law on Income Tax because the citizens, as well as elected representatives in the FBiH Parliament should be aware of the effect of the suggested measure to the revenue created by income tax and contributions, the estimated trend in increase of income, employment and consumption, as well as increase of VAT revenue, which would all allow them to reach  a decision to support such solution based on arguments.

In theory, it is to be expected that less burden to labor taxes would provide incentive to economic development and influence introduction of new and unregistered workers into the system, improve the ratio between received and declared incomes and eventually increase, not reduce, budget revenue. Even with the risk of their reduction in the initial phase, the above-mentioned increase in revenue might absorb short-term negative effects, whereas long-term stability and improvement in quality of public services could eventually be provided in form of higher consumption taxes.  

Nonetheless, simultaneously with the tax reform it is crucial to continue with the reforms which would through efficiency increase (rationalization) of the social welfare system and public services influence the expenditure side and reduce ‘losses’ caused by inefficiencies. In that regard, functioning and financing the health care system is of greatest significance. It is stated in various estimates that in BiH 450,000–500,000 people have no access to basic health care. In addition to that, quality of providing medical services in our country is far from satisfactory. We pay much and get very little, and possibilities to choose health care provider are limited.

Something to be done in the area could be transferring the financing of basic health care from labor to consumption (possibly through higher VAT) which would create room for establishing universal basic health care , i.e. development of package of basic medical services available to all citizens regardless of their employment status.  That would resolve the problem of high number of citizens without access to medical care.  In addition to that, it is important to introduce competitiveness in the system of providing medical services itself, in other words, to ensure that workers with health care insurance would be able to choose both privately or publicly owned medical institutions where they receive medical treatments.

Finally, new amendments to the Draft Law on Income Taxes left open the issue of difference in taxation of labor income of 13% in comparison to capital income (dividends as distribution of profit, income from interests on deposit) tax of 10%. It is evident that FBiH Government has no wish to increase tax on income from capital over 10% because this rate is one of strategic advantages of our country to attract investment (in the region only Montenegro has more attractive rate of 9%). In relation to income taxation, proposal of the Government is that on one hand, workers with lower income should be relieved of burden by significant increase of non-taxable base (from BAM 3,600 to BAM 9,600), with relief from personal deductions for the purpose of administration simplification. On the other hand, whatsoever, tax base would be complemented with introduction of all the cash payments to the tax base and increase of tax rate from current 10% to 13%.  

Introduction of two tax rates opens the Pandora’s box of unequal taxation of labor and capital income. Critics will argue that workers bread is more hardly earned than the employer’s (and they will be correct), so it should not be taxed with higher rate.  That would most certainly cause a dose of resentment in part of population for the reason of discrimination and that may lead to reaction in form of future reform aimed at punishing the ones who own the capital. Such solution can create fertile grounds for economic populism, which is for sure weak point of our political system, and it provides argumentation for future populist proposals aimed at making the system more complicated as well as discrimination of one worker in relation to another, and one entrepreneur in relation to another, workers in relation to entrepreneurs and vice versa, with arguments on one side which support ‘higher level of social justice’ and on another ‘require tax incentives for investment and industrial development’.

Maintaining single income tax rate would be more logical solution, with the rate which is balanced between competitiveness of the tax system for investors, loss of revenue due to increase of tax-free base and increase in revenue due to tax base with included cash payments (complemented base). Since projections of the effects to the revenue of municipalities in case of implementation of this model are not publicly available, it is impossible to discuss whether this solution is justified and whether there are positive fiscal effects to the municipal budgets worthy of negative social and political implications which may be caused by introduction of new income tax rate.

Bosnia and Herzegovina needs a tax reform which would genuinely release the workers and companies from burden, create real social sensitivity and protection of vulnerable categories with greater freedom of choice for the citizens. Current proposal of the FBiH Government in relation to labor taxation, although not ideal, most certainly reduces the tax wedge, so it is therefore significantly better model than the current one. One can hope that in would not become/remain the hostage of failure to form the government on BiH and FBiH level. Odds that the government would start functioning again and that the House of Peoples of the FBiH Parliament would start with sessions very soon are rather low, which increases the risk of another long wait for change in the tax policies in FBiH.