Tax burden and inflation

In response to the economic situation of 2023 dominated by inflation, we think that it has had its own impact on the tax burden, especially on indirect taxes that are based on consumption and have a direct effect on daily prices.

Inflation affects public budgets and one of its effects is the distortion of tax systems, since a tax system is not neutral to inflation and inflation can modify, for some taxes and types of taxpayers, the incentive structure that is part of tax systems.

In the face of tax policies to adapt to the distortions caused by inflation, we find that there is no change in VAT rates to fight inflation and achieve the desired results (incentives and distribution).

Meanwhile, the VAT tax bases have also had insensitive movements[1], as well as the main one related to the VAT burden has no visible changes with 2022 or even the year before the pandemic.

We believe that the non-adjustment of tax parameters, time and nominal determinations of the tax base has caused a distortion of the neutrality of the tax system[2].

This distorted neutrality is observed to have an increase in direct taxes as well as national and local taxes.

As the IMF has recently shown, nominal personal income tax (PIT) and nominal corporate income tax (CIT) can result in changes in effective tax rates due to inflation, and this appears to have happened with the transition of tax rates in the progressive system, both for income tax, but also for (corporate) profit tax. The only countries that have not changed the tax rates for direct taxes are BiH and Montenegro. This approach to tax policies in these countries has directly resulted in a lower burden for these taxes, as we will see below.

When tax thresholds are held constant, inflation may push households with constant real incomes into higher tax brackets, resulting in a heavier income tax burden. Similarly, nominal tax breaks and credits lose their real value in inflationary conditions. In contrast, the value of specific nominal taxes, excise duties, fees and fixed penalties is eroded by inflation over time.

An appropriate reaction to adjust the demand for liquidity from businesses and the increase in VAT pressure from inflation was the timing of tax payments and refunds at the right time and defined by law.

Longer time delays increase the tax pressure and directly affect the company’s coffers, reducing it due to the increase in the amount of expenses and non-receipt of collections on time, both for refunds, but also from the customer chain.

In general, the tax policy of progressivity for income tax is appropriate since the elasticity of income tax tends to be higher than the elasticity of consumption taxes. Politically, income tax may become more important compared to consumption taxes in the situation of inflation.

But, in the conditions of a high informality, as well as the non-implementation of tax policies, both on time and at the required level, considering the reality, that prices rise first, while wages follow them (as a reaction from governments and businesses), then the burden of consumption tax has increased before the burden of income tax, which during 2023 has influenced the increase of the burden of consumption taxes.

From the experience of other countries in the EU, a broad base of TAP in addition to bringing income, it is also a progressive tax imposing higher rates on those with higher incomes and this performance is assumed to directly affect the reduction in measurable way of inequality. But for the effect of tax burden distribution to work on all categories of individuals, the tax administrations in WB6 countries must significantly reduce the informality of the market, as well as minimize evasion. Otherwise, the application of progressive tax rates on personal income creates inequality and discrimination, as happened in the case of its application in Albania [3].

While the tax on labor income can increase the taxable base, the distribution of personal income tax towards capital income tax is needed above all. This method of taxation increases more budget revenues, but creates even less distortion of taxation, as it is less related to the demand and supply in the consumer market in relation to the labor tax, which directly affects the fragile labor market in BP6.

Improvements in tax administration may play a role in increasing revenue, although this approach also has an effect on other taxes. Moreover, the accelerated transition to digitized services can pave the way for better income tax design and implementation.

But, if it is not possible to increase the capacities of the administration, as well as curb the corruption tendencies within it, then any other measure is of low effectiveness and short-term performance.

[1] https://www.iota-tax.org/iota-papers

[2] refers to a principle or goal of public finance that fiscal (taxation) decisions should avoid distortions that affect economic decisions by businesses, workers and consumers.

[3] https://altax.al/en/consequences-of-different-tax-rates-on-freelancers-from-the-rest-of-professions/