CROATIAN TAX REFORM: A step in the Right Direction

capture27 December 2016, VG Intelligence Weekly Issue 36

The new Croatian Government has taken a step in the right direction by implementing a comprehensive tax reform based on two key pillars. First, a very high progressivity of the personal income tax is reduced, starting from January 2017, due to lowering of the rate in the highest tax bracket from 40% to 36% and applying it on the monthly net incomes above 17,500 HRK (2,320 EUR compared to 1,750 EUR before the reform) and also lowering the base income tax rate from 25% to 24%. Second, the general corporate income tax rate is reduced from 20% to 18% with additional reduction for small businesses to 12%. Both measures will contribute to the international competitiveness of Croatian enterprises and workers.

Overall public revenue foregone, due to lower tax rates, is estimated at 2.5 billion HRK (0.7% of GDP), which is the main reason for a slowdown of fiscal adjustment compared to 2015 and 2016. The fiscal deficit is expected to remain the same in 2017 compared to 2016, so it can fall only as a percentage of GDP (from 1.7% to 1.6%) because GDP is expected to grow around 3% in 2017.

A somewhat slower fiscal adjustment compared to 2015 and 2016 is the result of the new Government missing the opportunity to freeze or cut government expenditures in the first year of its mandate. Such a move would send a strong message to international creditors with a likely cut in public debt to GDP ratio and, most importantly, it would have probably led to reduced interest rates on Government bonds. We must recall that Croatia pays the highest interest rate on government bonds in the EU after Greece and Cyprus – presently a 10-year yield is around 3.2%, while e.g. Italy with much higher public debt ratio, pays 2%…

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