TAXING TIMES

Two separate World Bank reports recently gave the Bulgarian government and business community ample food for thought. While one praised the country for a year of reforms that have had a positive effect on the domestic business environment, the other sounded strong warnings about the possible long-term consequences of the country's slow rate of productivity growth.

In late September, an annual report by World Bank Group member the International Finance Corporation, or the IFC, was published. It compared business regulations in 178 economies. In a year where Eastern European and Central Asian nations performed strongly, Bulgaria was named one of the top 10 reforming countries in general and the top reformer in terms of ease of paying taxes.

Stella Ilieva, economist for the World Bank in Bulgaria, told OBG that, “rather than being a year of dramatic change in Bulgarian tax policy, the country's position as the top tax reformer in terms of ease of paying taxes was the result of a long period of steady change”. This year Bulgaria jumped from number 122 in the list in terms of ease of paying taxes to 88, according to the IFC report.

Over the last decade Bulgaria has reduced its corporate income tax nine times. As a result, the current rate is one of the lowest in Europe. The most recent reduction in the corporate income tax rate took place at the beginning of the year when it was dropped from 15 percent to 10 percent.

In a country that has struggled against a significant grey economy since its transition from Communism to capitalism, low taxation and improved administration have increased compliance with tax collection laws. Between 2002 and 2005 voluntary compliance in paying corporate income tax increased by 4.5 percent. In the same period, VAT compliance improved by 11 percent. Revenues from corporate taxes increased from 2.4 percent of the GDP in 2005 to 2.7 percent of the GDP in 2006, although this was with the old corporate tax rate of 15 percent.

According to Ilieva, the cost of collecting revenue has dropped, through the introduction of more efficient practices. “The unification of the tax and social security collection in the Inland Revenue Agency has brought down costs. Where the country used to have over 400 regional offices, now there are 29 and the number of staff has been optimised. In 2002 the cost of tax collection was 1.1 percent of revenues, now it is only 0.6 percent.”

Doing Business 2008 also highlighted the positive effects of more widespread use of the online tax payment system but Ilieva was keen to point out that while the scheme showed promise, the number of Bulgarians filling out their tax forms online is still small compared to those in Western European countries.

Other areas of the Bulgarian economy praised in the report were the construction sector – where building inspections were made more transparent and private bailiffs introduced – and the judicial sector, where a new law has increased efficiency and transparency.

Before government legislators get too carried away with selfcongratulation, a far more sombre report on the country's prospects for convergence, produced by the World Bank, needs to be considered.

Accelerating Bulgaria's Convergence: The Challenge of Raising Productivity shows that the country's low worker productivity growth of two percent per year could prove a major stumbling block to the country's attempt to catch up with other EU economies if reforms are not undertaken. Even in the most positive of scenarios, in which Bulgarian labour productivity growth increases to five percent after 2015, it would still take until 2040 for income levels to meet the EU average.

Presently, Bulgarian wages are one third of the EU average but they are rising at a faster rate than productivity growth, fuelling already high inflationary pressure.

The report focuses on four areas where reform is necessary to improve productivity. Market competition needs to be increased and greater emphasis placed on research and development to encourage companies to innovate. The labour market also needs to be loosened and the skill gap between Bulgarian and EU workers narrowed. According to the World Bank, making it easier to register a business is crucial for productivity. The market should be liberalised further, making it easier for companies to enter and exit. At the moment Bulgaria does not fare well in terms of opening or closing a business.

Additionally, education reforms are necessary to improve the skills of the labour force as well as to increase the country's capacity for innovation. The report says there should be better integration between research institutions and the business community because, currently, the vast majority of funding for research programmes comes from the public sector. Tertiary education needs to be consolidated – there are too many universities in Bulgaria and they are too small. The vital resources needed to establish good research and development programmes are lacking.

A lack of labour mobility is also hampering productivity. In Doing Business 2006 Bulgaria was ranked 100th out of 175 countries mainly due to inflexible working hours and high hiring costs. The World Bank had previously stated that the shortage of skilled workers in Eastern European member countries of the EU could be offset by easing restrictions on foreign workers. The most likely source of such workers for Bulgaria would be Macedonia and Albania.