Thursday, May 17, 2007


Via, Dan Mitchell, I came across the article Croatian Tax System is Modern and Competitive, publish in Austrian newspaper Der Standard. On a round table held in Zagreb (Croatia’s capital) Professor Christian Windhal from Vienna University gave the following recommendation to Croatian policymakers:

“The Croatian tax system is not far behind the Austrian system, and is a competitive and modern system. Don’t change taxes. Don’t practice on people as people are tired of tax changes. A stable tax system is fundamental for the stimulation of investments. Not even the rates are as crucial as stability, longevity and predictability of the tax system”
Source: Der Standard

First of all, the professor put Austria as an example of competitive tax system, which is in effect very far from a globally competitive level. Austria has a very high individual income tax, topping 50 percent and government spending is very high as well. In 2004, the ratio between GDP and public spending equaled 50,1 percent which is one of the highest “taxed-to-the-eyeballs” ratios in OECD. The OECD database shows that Austria’s rate of public social expenditures equals 26,1 percent which is, again, one of the highest rates of public spending in OECD. Further, in going for growth Austrian competitiveness is hampered by implicit taxes on productive behavior which encourages early retirement and, not surprisingly, Austria has one of the most generous pension systems in the EU marred by demographic risk and stylized growing pressures on the sustainability of public finance. Hence, the tax system in Austria implies significant administrative burden demanding nearly 272 hours to comply the overall payment of taxes. Given the data available at World Bank, labor tax contribution rate equals 36,3 percent, exceeding the OECD average of 23,7 percent overall labor tax.

Croatia suffered from a decade-long period of civil war and a laggard economic performance. To support GDP growth, the radical tax reform is inevitable together with a panel of other reforms needed to boost the overall competitiveness of the Croatian economy. The business environment, measured by the degree of the ease of doing business, is currently ranked 124th in the world. The structural problems also reflect a very low degree of economic freedom, ranking Croatia as mostly unfree economy as perceived by Heritage Foundation’s annual Index of Economic Freedom. A relatively high rate of unemployment is not surprising if we analyze in detail the state of labor market in Croatia and all persisting barriers and regulatory burden hindering fighting joblessness and the overall growth of productivity. Building a globally competitive fiscal model demands a radical reform approach needed to hold back the aggregate demand pressures and the continuity of growing public spending. Thus, it is nevertheless important to reconsider the persistence of high tax burden imposed on productive behavior such as work, risk and entrepreneurship which is essential for a small and open economy in going for growth and structural advancement. As a “case-study” post-communist economy, Croatia suffers from a lack of property rights and the quality of the legal system as the corruption perception is very high in comparison with the rest of the world. In general, high levels of external debt and debt service burden raise concerns about current
account and external debt sustainability. In recent years, public debt of Croatia increased dramatically and it would be wise to reconsider the overall structure of government expenditures to cover-up the repayment of public debt together with the interest as a liability levied by international creditors. Public debt is a serious concern and the historic evidence of Nordic peers shows how generous fiscal expansion can drive the debt high and make it unsustainable.

The overall picture of the competitiveness of Croatian economy and society is ought to be changed in the light of challenges brought by globalization and economic integration. As a small and relatively open economy, Croatia can benefit from a high quality of legal, business and macroeconomic environment perceived as a competitive advantage in making a proper strategy to accelerate GDP growth by structural reforms such as cutting taxes, labor market reform and deregulation measures to boost both, global competitiveness and the structural advancement of an economy such as Croatia.

By my opinion, copying Austrian model would be completely useless. But it would be far more appropriate to fight the EU pressures on tax harmonization which penalizes low-tax jurisdictions. The latter is a »miracle box« which Croatia can offer to the world. The competitiveness performance has shown that good institutions, sound macroeconomic management and world-class education quality is a successful strategy in going on top of the global competitiveness.

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