POLICY BRIEFING LABOUR TAX SYSTEM AND POSSIBLE WAYS OF ITS REFORM Belgrade, 19 th September 2013

1. POLICY BRIEFING LABOUR TAX SYSTEM AND POSSIBLE WAYS OF ITS REFORM Belgrade, 19th September 2013

2. Two Questions • Is the tax burden on labour too high in Serbia? • Would it be possible to reform the system of labour taxation in Serbia in a way that would reduce the tax burden on labour?

3. Why would it be desirable to reduce the tax burden on labour? • Tax burden on labour directly influences the cost of labour • The higher the tax burden, the more expensive labour becomes • The tax burden on labour therefore significantly affects the competitiveness of Serbia’s labour force, the goods and services that are produced, as well as Serbia’s attractiveness as an investment destination • Reducing it can help stimulate investments, economic growth and employment. • It can also help reduce the size of the “grey economy”

4. Existing system of labour taxation in Serbia • Labour is taxed through: • Income tax • Compulsory social insurance contributions • Income tax: • Until May 2013 income tax rate was 12%, after which it was reduced to 10% • Tax-exempted threshold (8,766 dinars until May, 11,000 after dinars) • Additional annual rate of taxation on all combined sources of (net) income above a certain level (everything over 3 gross average annual salaries is taxed at 10%, everything over 6 gross average annual salaries is taxed at 15%)

5. Compulsory social insurance contributions • Pension contributions: until May, 22% of the employee’s gross salary (half of which was paid from the employees gross salary and the other half by the employer); since May, it is 24% (13% paid from the employees gross salary and 11% by the employer) • Health insurance contributions: 12.3% of employees gross salary, split between the employee and employer • Unemployment insurance contributions: 1.5%, again split between the employee and employer

6. Gross 1 and Gross 2 • The distinction between contributions paid by the employer and employee is an accounting one • The employee receives a net salary, while the employer administers and pays everything else. • Only real consequence is that the legally defined gross salary (GROSS 1) is the net salary + income tax + contributions paid by the employee, whereas the costs of employing an employee to the employer (GROSS 2) is Gross 1 + contributions paid by the employer • Gross 1 is the base for calculating contributions and income tax

7. Effective burden on the average salary • An employee with an average net salary of 45,092 dinars costs their employer a total of 75,750 dinars (tax burden is 29,658 dinars)

8. A short digression – where do the revenues from labour taxation go? • Pension contributions: paid into the state pension fund to cover payment of existing pensions • Contributions cover only 50% of the Fund’s needs, the rest comes from budgetary transfers • Health contributions: paid into the state health insurance fund to finance public health system • Contributions cover 70% of the Fund’s needs • Unemployment contributions: paid to the National Employment Service, which administers unemployment benefits • Contributions cover only 50% of the Fund’s needs, the rest comes from budgetary transfers • Income taxation: fund general government expenditure

9. Is the tax burden on labour in Serbia too high? • We compared 30 European countries and the US over time and different income levels • International comparison relies on the concept of the tax wedge: the percentage in the total costs of employing an individual that taxes and contributions comprise. • What did we find? Great variation: e.g. France and Germany have a tax wedge of around 50% while the UK’s is 32.3% • How come? Different welfare state designs, primarily in terms of how healthcare is funded

10. International comparison of the average tax burden on labour in Serbia EU-6 (Czech Republic, Estonia, Hungary, Poland, Slovakia and Slovenia) EU-10 (EU-6 + Bulgaria, Latvia, Lithuania and Romania)

11. International comparison of the tax wedge and progressiveness of labour taxation in Serbia

12. Our conclusion so far? • The tax burden on labour in Serbia is not “too high” in comparison to other European countries. • The tax burden on low wages could be easily lowered if the tax system was made more progressive • Serbia could do better, but its not bad either. • Except when it comes to the lowest wages

13. Regional comparisons of the tax burden on labour

14. Towards a lower tax burden on labour: options for reform • The main problem in Serbia is the relatively high tax burden on low incomes, but there are also good arguments for reducing the tax burden on labour in general: • Reducing unit costs of labour makes Serbian products more competitive • Labour becomes cheaper making it more attractive to hire new workers, thus reducing unemployment • All of this makes Serbia more attractive to foreign investors • Helps reduce the size of the informal economy • Future reforms of the system of labour taxation should focus on: • Reducing the overall tax burden on labour • Reducing the tax burden on lower incomes specifically

15. Reducing the overall tax burden on labour • Given Serbia’s high public debt and budget deficit, any reduction in the taxation of labour has to be revenue-neutral in terms of the government budget, i.e. should be compensated with additional revenues from other sources of taxation. • Several possible sources of additional tax revenues: • Company profits (little room) • Property (possible in the medium-term) • Consumption (i.e. VAT, best option in the short-term)

16. Reducing the tax burden on low-wage labour • Reducing the general tax burden on labour obviously brings about a reduction in the burden on low-wage labour • However, considerable additional space exists to reduce the tax burden on low-wage labour even without (or in addition) to a general reduction through a more progressive system of labour taxation • How? Income tax is the main instrument of progressive taxation, hence we need to shift labour taxation from contributions to income tax

17. Option 1 • The first approach would involve: • Reducing existing social contribution rates while increasing income tax rates so that the total mass of revenues remains unchanged • The increased income tax revenues would be used to cover the increased deficits of the social insurance funds • Greater progressiveness would be achieved through • Increasing the tax-exemption threshold and/or • Introducing additional tax rates for incomes over a certain level • Cons: social insurance funds become even less sustainable and more dependent on budgetary transfers, hence the system becomes increasingly meaningless

18. Option 2 • A different (and better) approach would involve • Keeping pension contributions but abolishing health and unemployment contributions • The ‘taxation space’ thus opened up could be used to increase income taxation (in line with the above options for more progressive taxation) and (possibly) pension contributions • The public health system and unemployment benefits could be funded from general taxation (boosted by additional income tax revenues) • Additional benefits of funding healthcare from general taxation: • Easier to achieve comprehensive health coverage, the goal of all good public health systems • Administrative savings to the health system and businesses

19. To sum up… • The tax burden on labour in Serbia is slightly below the European average and very similar to that of other countries around Serbia, hence we cannot say that it is “too high” from a comparative point of view • Despite this, reducing it further carries benefits and the room exists to do so • The tax burden on lower incomes is higher than in Western Europe but lower than in Eastern Europe, although it is particularly high on the lowest incomes • Once again, the room exists to lower the tax burden on low incomes specifically through a more progressive tax system