Economic Policy Review ISSN 1313 - 0544

10% Profit Tax - the Result of Eight Years of Efforts of the Institute for Market Economics

Author: Svetla Kostadinova, Krassen Stanchev / 29.01.2007
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Yesterday’s achievement of the deputies has its prehistory. It is not their doing, but a result of the demand for such change in the society. A leading role in forming this demand has played our Institute. Here is a short overview of these efforts.

Present: From 2007 profit tax is set at 10%.

The Institute for Market Economics has been one of the major upholders of low taxes since its establishment in 1993. This is proved by the attempt for assessment of tax reforms in Bulgaria, Slovakia and Poland in 1997-1998 which also included testing the perspective for proportional (flat) low tax and by the permanent campaign since 2002 for a 10% proportional and generally applied tax. This work has also been a major priority of IME and we have been popularizing the idea through analyses, suggestions and publications.

A remarkable part in these efforts had: in the period 1997-1998 Latchezar Bogdanov – now managing partner at Industry Watch consultancy agency, and from 2002 to 2005 Georgi Angelov, now working as a senior economist at the Open Society Institute.

IME’s suggestions for tax reform are:

1. Introducing a single marginal rate of 10% for the income tax
For the period 2003 – 2006 the number of marginal rates of this tax was reduced, as well as the rates themselves.

2. Reduction of social security contribution to 10%

IME was the first and until recently the only organization to claim that a reduction of social and health security contributions is completely possible. In 2006 they were reduced for the first time in years by 6% and a new reduction has been discussed for 2007.

3. Reduction of profit tax to 10%

This goal was achieved yesterday, October 12, 2006 when the change in the law was passed at second reading.

What did we do in the last four years?

2003

On October 3, 2003, as suggested by Georgi Angelov, IME presented for the first time in its bulletin an Alternative Budget, which would underlie an alternative government policy which would accelerate the rates of economic development and would lead to an increase in the welfare of Bulgarian citizens. The reason was the elapsing of the emblematic 800 days of the government. A fundamental role in this policy has the reduction of taxes and security contributions and for this reason we prepared an alternative budget, which envisioned a reduction of the income tax and the profit tax to 10% and of the security contributions to 16.7 %.

Again in 2003 IME addressed through open letters the prime-minister, the deputy prime-minister and minister of economy, the newly elected director of the Bulgarian National Bank Mr. Iskrov, and Mr. Dogan, whose role for the stability of the majority in the parliament could not be undervalued. Our aim was to provoke reflection on some long term aspects of the taxes laid at that time, the budget and the financial (monetary and fiscal) policy. A similar letter the following year was supported by the leading Bulgarian economists, for which we are very grateful to them. Bulgarian citizens and firms also owe them such recognition. As a result of these letters, we received an answer from some of the addressees.

The Minister of Finance: “If we are speaking of reduction of taxes, then I am a supporter for them to fall even to 5%, and why not 2%. But let us be realistic. I am confident that only in a few days you will hear from representatives of the opposition how little funds are set aside for pensions, healthcare, education, for this and that. But we should be fully aware of a balance between all state expenses and have a responsible approach.”

On November 10, 2003, IME gave a press conference on the topic of Evaluation of the possibilities and perspectives for reduction of the taxes in Bulgaria, for the benefits of such policy. At this conference for the first time in Bulgaria were presented accounts for the real burden on a taxpayer, the effect of reducing the taxes on the incomes from salaries and the incomes of the self-employed was evaluated.

Realized change: Reduction of profit tax from 23.5% to 19.5% from 2004.
Realized change: Reduction of the lowest marginal rate on the income tax from 15% to 12% from 2004.

2004

In March 2004 more than 100 economists, analysts, researchers, finance experts and intellectuals sent through IME an open letter to the Minister of Finance Milen Velchev and the Prime Minister Simeon Saxe-Coburg-Gotha, declaring the position that a reform, related to tax reduction is necessary to be undertaken. More particularly, they insisted on the introduction from 2005 of a single marginal rate of 10% for all direct taxes – income tax, profit tax and security contribution payments.

The Minister of Finance answered the open letter, expressing partial support:

“I fully agree with you that high taxes have a negative social effect, as a result of which the unscrupulous businesses cross into the grey economy. I also agree that lower taxes "facilitate entrepreneurship and taking risk", and increase the ability to attract foreign investment...With a continuing financial and economic stability in the next years, it is logical and expedient to think in the direction set out by you.”

The open letter and the answer form the Minister of Finance and other political figures and administrators (Jordan Hristoskov, Aliosman Imamov, Alexander Bozhkov and other opponents to the changes) raised a public debate with multiple articles and opinions from different points of view.

In August 2004 representatives of IME and the Center for Liberal Strategies gave a press conference on the taxes in 2005 and on. The conference, like all similar events during the years, provoked a powerful response and was widely reflected in the media. Two organizations – the first one a department of the Ministry of Finance and the other one a private economic institute – tried to disprove our arguments and even to organize a conference against the changes proposed by us, but gave up.

Since 2004, with the assistance of Georgi Vassilev – a banker in Geneva and founder of a prize for contribution to the freedom of thought in Bulgaria (which will be announced later this year), IME started issuing a monthly Bulletin for low taxes: Flat tax. An editor of the edition from 2004 to the beginning of 2006 was Georgi Angelov, and now it is Svetla Kostadinova.

Besides being distributed through the e-mail, the bulletin is sent by post to all deputies, as well as to political parties, media, business organizations, trade unions, all ministries, state agencies, universities and non-governmental organizations.

In order that people can understand the real effect of the changes proposed in the tax laws, IME prepared a tax calculator, which shows how will the suggestions of the leading political parties for changes in taxation impact the income of the individuals. It immediately makes clear the effect of the suggestions of the ruling party National Movement Simeon II, the opposition in the face of the Union of Democratic Forces, Democrats for Strong Bulgaria, Bulgarian Socialist Party, The New Time and makes possible a comparison with the suggestion for a flat tax of 10%, made by more than 100 economists and intellectuals.

On October 29 and 30 the first annual meeting of the European Resource Bank (ERB) was held in Borovetz. In order to improve the strategies of the liberal institutes and to increase the interaction between them, a resource bank was established in Europe on the analogy of those in the United States, Africa and Asia. At the meeting there were representatives from France, Germany, USA, Italy, Sweden, Great Britain, Georgia, Israel, Denmark, Switzerland, Turkey, Spain, the Netherlands, Austria, India, Belgium, Romania, Lithuania and Russia. Problems regarding the encouragement of economic freedom as a whole, reduction and simplification of taxation, competition between countries over marginal rates and its consequences, reduction of state expenses through cutting down of the administration and introduction of e-government, fiscal decentralization were discussed at the conference.

In 2004, 2005 and 2006 IME together with ERB members – brain trusts sharing a philosophy close to ours, often under the auspices of the Institute for Research of Economy and Fisc (IREF, www.irefeurope.org) – has been one of the leading advocates of taxation competition in Europe and around the world.
At the meeting in Borovetz in 2004 a statement was made at the gala dinner by the Minister of Finance Milen Velchev: “It is a challenge for me to be the first minister of finance to endorse the recent appeal of Professor Victoria Curzon-Price, president of Mont Pelerin Society, for abolition of the corporate profit tax in the whole world. Of course, Bulgaria can afford that in coordination with the EU. This is a way of achieving a harmonization of corporate marginal rates in community at a minimum level”.

At a round table, organized by the Union of Democratic Forces, on October 28, 2004, Georgi Angelov presented the possibilities for reduction of the security contribution burden from 42.7%, as it was then, to 10%.

At the beginning of November 2004, by tradition, IME prepared and presented An Alternative Budget for 2005. The budget envisioned income accounting to 34.5% of the gross domestic product, expenses accounting to 32.8% of the gross domestic product and a surplus of 1.7%. The basic reforms it contained were:

• Reduction of direct taxes to 10% - profit tax, income tax, security contribution payments.

• Reduction of state expenses through cutting down of the administration and budget employees, optimization of the spending on state administrations, reduction of the subsidies for activities incurring losses, reduction of ineffective interference with the labor market, transfer of expenses to the private sector and faster privatization.

• Using of the budget surpluses for carrying out a pension reform, capitalization of social security contribution and other structural reforms, as well as for covering any eventual unexpected changes in the economic environment.

Realized change: Reduction of profit tax from 19.5% to 15% from 2005.
Realized change: Reduction of dividend tax from 15% to 7% from 2005.
Realized change: Reduction of the highest marginal rate of income tax from 29% to 24% in 2005.

2005

On November 4, 2005, IME together with 10 other non-governmental organizations and centers for analyses, published An Open Letter for Reduction of Taxes, which once again received a wide media coverage and support. The number of people and organizations who signed it was constantly growing and we all should express our gratitude to them. Here are the basic theses of this letter:

“In recent years the consolidated state budget shows a significant over-fulfillment of incomes and a surplus. Between 2001 and 2004 the total over-fulfillment of budget incomes accounts to 2.7 billion levs. In 2005 we expect an over-fulfillment of 1.5-2 billion levs. In addition to that, on account of the requirements of the European Union Bulgaria will significantly increase its excise duties and the incomes from them. On the other hand, the big share of grey economy in the country is a significant reserve for budget incomes by creating the corresponding tax stimuli for its abolishment. Last but not least, more active measures from the government towards the carrying out of a reform in the budget sphere could increase the effectiveness and to optimize the expenses.

For these reasons we believe that a significant reduction of tax and security contribution burdens on Bulgarian citizens and the companies operating on the territory of Bulgaria, is possible through a policy of reduction of marginal rates, simplification of the taxation system and reduction of excessive procedures and expenses for its functioning.”

During the elections in 2005 IME put the debate over the taxes in the pre-election competition. Three of our colleagues at IME (Georgi Angelov, Martin Dimitrov and Dimitar Chobanov) were candidates for deputies and proved to be the undoubted leaders in the pre-election campaign with their presence in the press, the electronic media, radio and television. They changed the rhetoric and the way of leading pre-election disputes.

Here is what one of the authors of the present article noted at that time: „Thanks to IME there is one common denominator in all pre-election programs – the ideas for reduction of taxes, the attention towards reforms in the other quasi-state funds – pension security contribution, healthcare and education, and last but not least - the reduction of the quasi-taxes, i.e. the so called administrative and regulatory regimes.”

A result of the clear argumentation, the pro-market ideas for reforms, as well as the efforts for increasing people’s welfare was the invitation from The United Democratic Forces to three economists from IME to participate in the pre-election campaign and in the parliamentary elections. One of them, Martin Dimitrov, is already in the parliament as deputy chairperson of the Budget and Finance Committee and is an observer in EP. To Mr. Dimitrov the Bulgarian society owes a significant part of the improvements of the tax environment during this year.

In November, for a third successive year the Institute for Market Economics prepared An Alternative Budget for 2006, whose aim was to show that the reduction of the taxes was possible in a relatively short time. IME’s budget for 2006 envisioned incomes at 35.2% of the gross domestic product, expenses – 34.8% of GDP and respectively a surplus of 0.4% of GDP.

This budget is based on the following reforms:

• Reduction of direct taxes to 10% - profit tax, income tax, security contribution payments;

• Abolition of dividend tax;

• 8% security contribution for individuals born after 1959 in a private pension fund;

• Reduction of state expenses through decrease in the administration, decrease in the expenses for the costs of the state administrations, reduction by half of the subsidies for activities incurring losses;

• Abolition of programs for interference with the labor market, faster privatization and transfer of capital expenses towards the private sector, smaller reserve for structural reform;

• Using the budget surplus for a pension reform.

As a result of the reduction of the total level of taxes in the alternative budget the disposable income and the economic activity would increase, more stimuli for entrepreneurship and labor, for investments, savings and accumulation of capital would be created, the economic growth and the welfare of people would increase.

Realized change: Reduction of security contributions with 6% from 2006.
Realized change: Abolition of the lowest marginal rate of income tax from 2006.

2006

The debate over the reduction of the tax burden was continued by IME in 2006 as well. In three issues of the Bulletin for low taxes, multiple publications in IME’s Economic Policy Review, many articles in the press and participations in the media, IME kept active the debate over the necessity of reduction of the tax burden. Again, IME’s prognosis that in 2006 again there will be a large budget surplus proved to be much more correct, than the prognosis of the government for a zero budget surplus for the year.

Realized change: Reduction of profit tax from 15% to 10% in 2007.
Projected change: reduction of security contributions in 2007.

Mechanisms used by IME:

1. Preparing of an Alternative budget – three successive years

2. Articles in the weekly bulletin of IME Economic Policy Review – more than 500 articles on this topic

3. Articles in newspapers and magazines

4. Participation in the media – scores of participations of IME economists in radio and TV programs.

5. Issuing a monthly Bulletin for law taxes “Flat tax”– more than 100 articles focused on this topic

6. A special website dedicated to Economic Freedom

7. Annual presentation of the indexes of economic freedom of the Heritage Foundation and the Fraser Institute

8. Participation in Bulgarian and international conferences on the topic – hundreds in Bulgaria and dozens abroad

9. Translation and popularization of international researches and articles on the topic of taxation

Past and Present

The review of tax policy in Bulgaria, Poland and Slovakia in 1997 and 1998 showed the following:

1. At that time the business in Bulgaria did not accept the idea of flat and low tax, the general inclination was towards enjoying privileges on the back of the taxpayers.

2. This necessitated a relatively detailed research of grey economy and the stimuli for operating in its fames, which we did in the year 2000 together with Harvard University and the Agency for Economic Analyses and Prognosis, and in 2003 on our own, but in the context of a comparison between Bulgaria, Romania and Serbia.

3. It proved necessary to also examine the procedures for following the tax and other laws. A leading role in these researches had Lachezar Bogdanov and Jordanka Gancheva, as well as the authors and all our colleagues at IME.

4. In Poland a Finance Minister and very popular reformer resigned because of the refusal of the political parties to accept his tax reforms.

5. In Slovakia the business had the same attitude towards the flat tax as in Bulgaria and Mr. Mechiar’s government started nearly persecuting the people we collaborated with. One of them – Jan Oravetz – found out how to solve the problem: he established a foundation of the taxpayers, who in 2004 imposed on the politicians the introduction of a flat tax.

6. At that time in Bulgaria emerged three organizations of the tax-payers, all of them established by former employees and past and present advisors at the ministry of finance. This made the normal functioning of such organizations in Bulgaria impossible.

The context of these efforts is also changing. Their success depends more and more on the determination of Bulgaria and the citizens to stand their ground before the EU. At a session of ECOFIN on September 25 this year, under the banner of „optimal taxation” Brussels bureaucracy initiated action towards seeking „tax harmonization” between the member-states, a harmonization aimed at the high taxation levels in the EU.

For now it is not clear whether this is the exact intention of the actions, but if they are successful – which is after all hardly probable, the result will be keeping the lower levels of welfare in New Europe for a longer period of time.

At the end, we would like to thank once again everyone who openly expressed their support to the idea of reduction of the tax burden in Bulgaria. During all this time IME received support from citizens, companies, associations, non-governmental organizations and international partners in its efforts. In the future the Institute will continue encouraging the reduction the tax burden, which remains too high in Bulgaria, especially regarding the taxation of labor. In a month IME will publish its regular alternative low taxes budget for 2007.