Over time, various policy changes have made it easier for businesses to enjoy the benefits of corporate status without being subject to the corporate income tax. Reform should reflect the guiding principle that firms engaging in similar activities and enjoying similar legal benefits should be taxed at similar rates.
When businesses headquarter, invest, and produce their goods and services in Albania, they help increase country living standards through the jobs they create and the tax revenues they produce. In seeking to promote the Albania as a hub for business activity and investment, many have focused on the notion of competitiveness the idea that policies can attract profitable activities to this country or develop such activities domestically. For instance, consider calls for the reduction in the Albania statutory corporate tax rate from its current level of 15 percent in the name of competitiveness.
As a standalone policy, a lower corporate rate would enhance incentives for investment, reduce the gap between effective tax rates on corporate businesses and SMEs and micro-businesses, narrow the tax preference for debt financing relative to equity financing, and reduce pressures on multinational firms regarding the location of headquarters, production, or tax avoidance.
However, an obvious disadvantage is that each percentage point reduction in the corporate tax rate reduces revenues by roughly ALL 6 billion per year, leading many to consider revenue-neutral options for corporate tax reform.
By definition, revenue-neutral reform options involve a trade-off between reductions in the statutory rate and an increase in taxes somewhere else. Adjudicating those trade-offs is particularly difficult within the corporate tax system because many of the tax provisions being eyed as revenue raisers are themselves policies intended to promote one specific avenue of competitiveness and often also apply to non-corporate businesses.
Each option provides for meaningful reductions in the corporate rate. Many would also reduce some of the negative tax distortions that contribute to inefficiencies in the corporate sector. For instance, limiting the deductibility of interest expense would help equalize the treatment of debt-financed investments relative to equity-financed investments, and reviewing the boundary between corporate and SMEs could help level the playing field between similar businesses currently operating under unequal tax regimes. But even seemingly beneficial reforms are not without potential economic or political drawbacks. It is clear that the current income tax law needs to be improved to promote Albania living standards and competitiveness. The challenge will be agreeing on a reform that levels the playing field across different industries and different investments in the face of the competing need to maintain revenues.
The goal of corporate tax reform should be to promote economic growth and to build a sustainable revenue base for government, without compromising the equity and fairness of the system.
Corporate tax revenues are now at historical lows as a share of the economy, at a time when the Albania faces deficits and debt that are expected to remain like this to unsustainable levels. Although the statutory corporate tax rate is higher than in some of neighboring countries with Albania, the average tax rate -- that is, the share of profits that companies actually pay in taxes -- is substantially lower because of the tax law's many preferences (deductions, credits and other write-offs that corporations can take to reduce their taxes). Moreover, when measured as a share of the economy, Albania corporate tax receipts are actually low compared to other Balkan countries. All parts of the budget and the income tax law, including corporate taxes, should contribute to deficit reduction. Well-designed corporate tax reform can improve economic efficiency and help on the deficit-reduction front at the same time.
However, if tax reform is packaged together with social security reform to alleviate the increased burden on them, it may make such tax reform politically feasible. It is possible to alleviate the burden for the poor through the social security system and through the personal income tax system.
If policymakers decide for the statutory corporate tax rate to be well below the top individual (personal) tax rate, they should also establish safeguards to prevent high-income individuals from sheltering their income in corporations in order to pay taxes at a lower rate.