Tax environment and policy reforms

Macroeconomic changes in recent years, along with tax policy reforms, have led to numerous changes in tax structures. Briefly, below it is a summary of the more notable changes:

Significant increases in indirect taxation of goods and services. The ongoing and constant expansion of levels of collection of the value added tax and excise taxes together with the increase of their tax base has made the consume taxes the principal source of revenue in Albania, replacing the declining revenues from foreign trade and problems in tax administration.

Simplification of taxes on small firms. The large size of the informal economy, in terms of both labor and microenterprises, has led to the use of presumed-tax mechanisms for small taxpayers. To facilitate compliance with tax requirements, there has been a shift from a tax system based on formal accounting to one that relies on a single tax on the possible income of small firms. The presence of a large number of microenterprises, in response to the difficulty of obtaining formal work, has led to institute tax policies designed to address the difficulty of maintaining control over taxation of small firms.

Strengthening of the corporate income tax in the wake of big investments, thus making taxable the profits of public and private enterprises, accompanied by an expansion of the tax base of these fast-growing sectors, as a consequence of decreased prices for commodities and natural resources.

As a result of this combination of factors, businesses bore a greater weight from imposition of the income tax, while natural or physical persons shouldered less of the load, thus creating a bias in the application of the income tax.

Decreased role for wage-based charges in funding social security systems.

The social security system has kept social security contributions rate constant at around 27.9% of wage.

Reduced minimum marginal personal income tax rates and increased the marginal tax rate of profit tax. In keeping with the international situation, including the gradual deregulation of capital movements, the Albania as a whole reduced income tax rates for both employee and small businesses, while neglecting to simultaneously broaden the relevant tax bases. Between the year 2014 and mid-2015, for the employee with low salaries it was applied a 0% tax rate, and a decline by 20% to 100% of the average maximum marginal tax rates for small businesses, respectively a decrease from 7.5% to 5% for segments of businesses with an annual turnover ALL 5-8 million and from ALL 25.000 to ALL 0 for segments of businesses with an annual turnover ALL 2-5 million. The reduction in the maximum personal income tax rates in Albania has been much greater than the average reduction in Balkan countries, where personal tax rates have remained above 10%, as flat tax rates or above than that in other countries of region.

Meantime the increase of profit tax rate on medium and big businesses with a maximum, tax rate of 50%, registering an increase of tax rate from 10% to 15% since 2014 has increased somehow the burden on capitals of domestic and foreign companies.

A number of the trends cited above have undoubtedly been reactions to the levels of evasion for the various taxes. For example, the significant increase in indirect taxation, through the expansion of the value added tax base and, as well as the increase in the rates for excise, is the result not only of good will, but also of the greater ease of collection and reduced opportunity for evasion.

Tax distortions in the income tax

A similar rationale can be advanced with regard to simplifying the tax system, both in general and, specifically, for small businesses, which are more difficult to monitor, and where informality is more common and evasion more pervasive. The reduction of maximum marginal income tax rates seeks to discourage tax avoidance, abuse of tax laws generally.

A characteristic feature of taxation in the last years is the distorted structure of the income tax, relying heavily on corporate taxes, and not harmonized with the other taxes and especially with the tax system in which the effects of tax shifting and tax incidence are uncertain, as they depend on market conditions. Corporations account for an average of more than 60% of the tax revenue generated by the income tax and value added tax and excise taxes.

Most of the individual income tax revenue comes from income of formal professionals, with a smaller percentage derived from professional incomes, financial rents and corporate profits. Unfortunately, as the result of a variety of factors prevalent in these countries, there is limited opportunity for collecting personal income taxes in significant amounts.

A further element in this equation is the fact that capital gains receive generous preferential treatment, where these earnings are subject to flat tax rate instead of a progressive tax rate based in the capital gain sum, thus explaining the weak taxation of capital income.

The failure of the personal income tax together with the individual income tax to become an important source of revenue is due to the fact that there is little or no taxation of non-wage income, which is largely composed of return on capital (rents, interest, dividends and capital gains). As a result of this combination of factors, taxes on personal income and capital gains generate a mere 1.4% of GDP, on average, far below the average level in OECD countries, where the figure exceeds 9% of GDP.

The narrow tax base necessarily consists of the compensation received by wage workers in the formal labor market, a small proportion of country total value added. Moreover, a large proportion of wage earners receive income below the threshold for paying income tax. Thus, only a minority group no more than 13% of the economically active population is taxed. Adding to this situation is a high level of non-compliance and evasion on the part of independent or own-account workers.

An additional element that has impeded the ability of tax system to achieve his objectives of solvency, efficiency and equity is the narrow tax bases. A range of factors accounts for the narrowness of the tax bases.

So-called tax expenditures are revenues that, as a result of preferential tax treatment designed to favor or stimulate certain sectors, activities, regions or economic agents, the government fails to receive. During recent decade, the implementation of such incentives has eroded the tax bases of main taxes.

The promotion of tax exemptions and other tax benefits began in the 1990s, based on the idea that the most important driver of development was investment. Private investment was encouraged through tax incentives for necessary or essential activities. At present, tax expenditure is being justified not only by economic growth and the consequent reduction in unemployment, but also by the need to provide incentives for foreign capital to settle in the Albania and to promote exports of exportable goods.

The results obtained show that in many cases these instruments not only have failed to increase levels of investment and economic activity, but have also, in some cases, encouraged corruption. In many instances, the instruments have been exploited opportunistically by businesses, which used them to increase their profitability by reducing the costs of paying certain taxes.

While these incentives have generally succeeded in modifying the sectoral allocation of investment within the country, they have not substantially altered the rate of domestic investment.

Tax expenditure has a negative effect on equity, as well as on efficiency. Foregoing potential tax revenue limits the room for fiscal manoeuvring and, hence, for social investment. Moreover, granting benefits to a specific group of taxpayers or activities has led to a loss of horizontal equity. In terms of efficiency, tax expenditure has created problems in terms of inter-jurisdictional tax authority and has led to other distortions in decisions about industrial siting and production.