Should Falling Deficits Lead to Lower Taxes?

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With falling budget deficits, some believe it is time for the government to reduce taxes.

In the first half of the year, the general government budget recorded a slight surplus of several million kunas, according to the data of the Ministry of Finance. If only budget users are taken into account, without extra-budgetary users and local government units, the deficit is still the lowest ever – it amounts to just 1.6 billion kunas or 0.4 percent of GDP. At the same period last year, the budget deficit was 2.4 billion kunas or 0.7 percent of GDP, reports Jutarnji List on 10 August 2017.

Improved public finances, positive economic trends, excellent tourist season, the annual retail turnover growth of 8 percent, GDP growth… Is it time to further reduce the tax burden for citizens and entrepreneurs? Should HDZ fulfil its pre-election promise and reduce the general VAT rate from 25 to 24 percent next year, followed by another one point drop by the end of this Parliament, as promised?

Entrepreneurs, the Croatian Association of Employers and the Lipa Taxpayer Association say it is time to reduce the general rate of VAT while, on the other hand, Deputy Prime Minister and Economy Minister Martina Dalić and economist Velimir Šonje believe that a reduction in VAT would not bring benefits to citizens and that possible tax cut should go in the direction of additional income tax cuts.

Davor Huić, of the Lipa Association, who advocates for smaller taxes, says it is now time for the state to nominally freeze consumption, slow down the growth in expenditures, and reduce taxes in a way that will continue to be sustainable.

“The good news is that we are doing well, and there is a surplus, which means that the state can finance its expenditures but, on the other hand, the share of the state expenditures in the GDP is increasing, and the growth of budget revenues is higher than the GDP growth. That share grew by 2.4 percentage points from 2015 to 2016, and is now at 47.6 percent, while in comparable countries it is between 35 and 40 percent. The VAT was raised twice during the economic crisis, and now when the crisis has passed, I think it should be reduced. It is good that the income tax and the corporate tax rates have been reduced, but there could be room for further reduction, and VAT is next in line. That would need to be accompanied with slowing down of state expenditures, but in the budgetary guidelines there is no sign of that,” said Huić.

Employers expect lower costs of doing business in Croatia, which means reforms, said Davor Majetić, director of the Croatian Employers’ Association (HUP). “In other words, that means serious reform measures, which will have as a consequence serious changes in the expenditure side of the budget, or a reduction in the state’s spending. This would, along with the expected growth, create preconditions for a more serious reduction of the tax burden. In such circumstances, the VAT cut could and should be a very realistic option.”

“The HUP believes that the time of economic growth is the best time for serious and profound changes, which we expect from this government during the rest of the term,” said Majetić.

Croatia is among the four countries of the European Union with the highest general VAT rate. Hungary has a general rate of 27 percent, while Denmark and Sweden have a rate of 25 percent, just like Croatia. According to VAT revenues as a percentage of GDP, in 2016 Croatia was the first among all EU countries with a share of almost 14 percent, followed by Denmark with about nine percent. If HDZ were to fulfil its promise and reduce the rate to 23 percent by the end of this Parliament, then Croatia would join countries such as Poland, Portugal and Ireland.

However, Deputy Prime Minister Dalić argues that the overall goal of fiscal policy is to reduce public debt and that it demands to have a number of years in which a significant primary surplus will be maintained.

“We are now in this position, and this needs to be kept. In determining the direction of the fiscal policy, we should take into account the state of the business cycle. The economy is growing and it does not need additional fiscal incentives. On the contrary, we should make reserves when the economic cycle begins to slow down. That means shrinking debt and deficit now when times are good in order to be able to intervene with increasing the deficit when the crisis comes,” explained Dalić.

“The VAT is a consumption tax and its reduction would not result in lower prices and benefits for citizens but would be turned into a one-time subsidy for retailers. The rate would decrease, but the retail prices would mostly remain the same, and the difference would be taken by retailers,” said Dalić.

Economist Velimir Šonje agreed with Dalić, adding that the priority is to reduce public debt further, and only then to execute the further tax deduction. “There is a need to be careful when interpreting large surplus numbers due to massive debts in the healthcare system. I do not think that the VAT should be reduced because I believe that a slight reduction would not have any effect on prices, which means that the first step should go in the direction of further decreases in the cost of labour to stimulate employment,” concluded Šonje.

Translated from Jutarnji List.


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