Although promised ahead of the elections, the government does not seem to have any plans to implement this part of the election manifesto.
An old rule in economics says that lower taxes mean faster growth. However, due to its expensive state administration, Croatia has always been quick when it comes to an increase in the value-added tax, but no government has dared to reduce the general rate of tax that brings a majority of tax revenues into the state budget. On two occasions, HDZ intended to embark on a significant VAT cut but changed its mind. The first attempt was discussed by then Prime Minister Ivo Sanader, who in his first term decided to reduce the general VAT rate from 22 to 20 percent, but immediately changed his mind, for fear of a large budget hole. It was again promised by the current Prime Minister Andrej Plenković ahead of the last year’s elections, but the promise has not yet become a political decision, reports Večernji List on September 5, 2017.
Politicians in Romania were much more courageous. The country cut the general VAT rate by four percentage points, from 24 to 20 percent last year, and reduced it again by an additional percentage point this year, returning it to a level of 19 percent, which is the same as before the financial crisis. The consequence for Romania was an instant acceleration of economic activities. Macroeconomists in that country expected the GDP growth to rise from 3.7 to 4.8 percent last year, which did happen. This year, the growth exceeded all expectations and GDP in the second quarter increased by as much as 5.8 percent. For comparison, the growth in Croatia is below three percent.
Croatia did not plan to reduce the tax burden so drastically because the stability of state finances is dependent on it. Namely, 45.2 billion kunas of revenues were received last year by the state budget from the VAT, and it is estimated that the general rate of VAT cut by one percentage point would mean a loss of about two billion kunas. However, Romania’s experience is that the fall in budget revenues was not proportional to the drop in the tax rate. So, it might be worthwhile to sacrifice a small loss of income in one year in exchange for growth acceleration in the mid-term.
The question is whether, given the current expansion of personal spending, there would even be a significant fall in budget revenues, and whether the minimal deficit would have an impact on the macroeconomic balance. Whatever the reason, the government last year decided not to fulfil its primary pre-election promise and to postpone the reduction in the VAT rate for some other time or some other term in office. It even substantially increased the VAT rate for part of the tourism industry.
Macroeconomist Željko Lovrinčević from the Zagreb Institute of Economics says that the general rate of VAT should be decreased. He points out that it is the most regressive form of tax which hits the most vulnerable the hardest since the VAT burden is highest for the poorest taxpayers. Its other disadvantage is that it negatively affects business liquidity. Although it is often described as neutral for companies, for businesses which are not part of the VAT system, it represents a pure cost.
A decrease in the tax burden for Croatian entrepreneurs is necessary because, under pressure from the expensive state apparatus, it will not be possible to sustain growth for a longer period. That growth is now driven by the fact that funds are inexpensive and that Croatia’s neighbours have a growth of their economic activities.
The ECB’s expansive monetary policies will soon end and, before that happens, the state should reduce its costs and implement reforms, since the economy will not be able to pay for the state apparatus. The tax burden on citizens and entrepreneurs would enable the economy to grow on healthier grounds than thanks to the expansion of personal spending. The only argument against it is the tradition of Croatian politicians who try to expand their influence and power and to spend more in good times.
Translated from Večernji List.
