The Fiscal Incentives Do Work
In February the report on the State Budget implementation for 2007 was released. Now it is possible to evaluate the effects of the fiscal policy carried out during the year and its impact on the public revenues, which are a reflection of the development of the private sector of the economy. As the economy grows, new jobs are created and the revenues in the budget increase accordingly.
The presence of a current account deficit, that is equal to 18.9% of the GDP, with a trend towards growing, is a source of concern for most of the foreign observers. The Fitch rating agency already reduced the prospective for the credit rating of four countries in Eastern Europe, among which is Bulgaria, as a result of the relatively high CA deficits. The concerns come from the fact that the trade disbalance was a predictor of economic crises in many other countries and makes the economy more sensitive to sudden shocks and changes in the macroeconomic environment, such as the financial crises with the mortgage bonds in the USA, which quickly grew into a global financial and liquidity crises. In order to counter this risk the government maintains a restrictive fiscal policy in the country.
The data show that the budget surplus for 2007 is 2.11 billion levs or 3.75% of the GDP, although the planned surplus at the beginning of the year was only 0.8 per cent of GDP. Only in December, however, the government spent more than 4 billion levs, which by itself contradicts to the idea of maintaining a restrictive fiscal policy. The inflow of funds in the economy means increased money supply, which has an inflationary effect and changes the relative prices in the economy and thus, sends wrong signals to the market. Far more sensible would be a policy, where less income is taken out of the private sector through taxes and social security contributions so that the taxpayers are let to decide by themselves how to spend their money, and not the government to implement "urgent" large-scale projects at their expense at the end of the year.
The incentive
From the beginning of 2007 the corporate tax rate was reduced from 15% to 10%, i.e. by one third. The result is as follows – the revenues from corporate taxes are equal to 1.68 billion levs or 139% compared to 2006. The actual surplus is 18.8% of the planned revenues. These favorable results are due to the positive effects of the lower taxes – companies coming out from the gray economy and economic growth. The dynamic effects will continue to work in the following years, since lower taxes mean more incentives to work for the entrepreneurs.
The total amount of revenues from the social security and health insurance payments during 2007 is 4.89 billion levs, i.e. over-fulfillment compared to the budget forecast is by 7%, although the social security payments were reduced by 3 percentage points from October 1st 2007. The government again underestimated the revenues, by expecting the reduced social security rates to cost to the treasury 118.4 million levs. However, during the last quarter of the year the revenues from social security payments are 51.2 million levs more compared to the previous quarter of the year. The social security payments represent the biggest tax load for the employees and their reduction is a strong incentive for people to come out from the gray sector and declare their real income.
What is the conclusion?
The reduction of the tax rates has a positive effect on the revenue part of the budget. However, more important are the indirect effects, which lead to more economic growth as a result of the increase in the more productive formal sector rather than the non-formal, enhanced flow of investments and reduced distortions on the market.
According to one of the latest empirical studies of the effect of corporate taxes on investments and business development in the economies (with a co-author Simeon Dyankov, chief economist with the World Bank) the increase of the corporate profit tax by 10 percentage points leads to reduction of investment as a percentage of GDP with two percentage points and increase in the gray sector of the economy. Hence, the reduction of corporate taxes, respectively, has a positive effect on the investments and the economic activity.
The data about Bulgaria indicate how these macroeconomic relations work in real and prove the claim that the tax revenues grow faster at lower levels of tax rates. The reduction of taxes will show its effects in the future in other areas of the economy, not only in the fiscal sector, since it has long term effects such as increased potential of the economy to produce goods and services and to create added value.
