Tax reform and income distribution for social classes

Tax reform can increase the overall size of the economy. If considered well-consulted and measured, where the commonality of the reform is the change accepted by most stakeholders, the reform sets the economy on a new growth path without further targeting changes year after year by patching and fiscal stitching to fix the bugs of rushes and poor administration.

There is often a trade-off between growth and progressiveness in that model. However, more recent work has highlighted the role of uncertainty in tax reform, noting that a progressive income tax system provides security against fluctuating income by making the percentage change in after-tax income less than the percentage change in pre-tax income.

But the ill-conceived reforms and for the interests of the moment to have some more budget income, influenced in many cases in the political campaigns in the BP6 countries also by the frivolous populist approaches of reductions and facilities fall then big problems by deforming tax morale and fiscal education of taxpayers. The reforms implemented in these circumstances have grave consequences for hundreds of thousands of contractors, with employers facing potentially higher costs and some workers seeking significant cuts to their income, as well as an additional administrative burden for both.

As firms and contractors begin to face the unpleasant scenarios created by tax reforms, we look at the consequences of the rule changes and how the categories of taxpayers affected by the reform impacts may orient the market and the behavior of taxpayers in voluntary compliance with the law in dangerous challenges for a while.

We see such interventions, which in practice do not reform but distort, in cases of personal income tax. The newest law approved in Albania, for example, on income tax without yet starting to be implemented has created uncertainty and fear in business structures. This lack of accountability for taxpayers will translate into further loss of confidence in the system and the government’s sensitivity to the equal treatment of taxpayers, the implementation of neutral taxes and a system based on tax justice. All this new policy will directly affect the reduction of fiscal compliance being considered as a devaluation of the business facilitation policy.

The new reform initiatives are closely related to the effect they have on confidence in the government’s tax relief reforms. In the period when the initiatives do not consider the level of informality, corruption, the trend of diversification and economic developments, they are perceived by taxpayers as reforms with a lack of seriousness and responsibility in the design of fiscal policies, directly influencing the strengthening of problems not addressed by governance.

However, the year 2022 and the years after it have increased the level of pressure on budgets for the increase of social transfers, a factor that affects the forced reforms of tax policies.

The distribution of budget income shows at least the level of taxes for carrying out expenses for money transfers to the population of working age and not only. It also aims to achieve that taxes on personal income are collected progressively according to income levels and the orientation in which cash transfers go where the needs of the population are most necessary in relation to the improvement of living.

The growing high level of income inequality in the Balkans continues to receive increasing attention from governments, regardless of political affiliation. Governments try to address the phenomenon of inequality, as a challenge that each country must take appropriate actions. But it is now imperative that income redistribution is clearly addressed through fiscal policy and administration.

Before it is treated as a defect in the enlargement of the capitalist system, it is necessary that the countries first update the data and make all segments aware of the means for correcting social polarization. The measurement of inequality in individual incomes, according to the GINI index (coefficient)[1] should be seen in connection with the fact that inequality is also significantly affected by taxes. One of the conducted studies published by RCC[2], income inequality is reflected by impacts coming from inequality in the labor market, but not only. Labor income inequality is the main contributor to the distribution of household income. If we look at the case of Albania, most of the income from work goes to high wage levels for a minority of less than 1% of employees.

Also, the decrease in the distribution effect according to the current fiscal policy has been accompanied by an increase in inequality in the labor market, but also in the taxation of income circulating in the informal market. In some cases, the latter circulates more income than the formal labor market itself.

Transfers of money from the budget to diverse groups of the population, such as pensioners, the unemployed, the unemployed and those in need, etc. constitute from 10.6% to 24.1% of the budget expenditures in the countries of the Western Balkans, respectively for the years 2021 and 2022. Each of the WB6 countries have modestly increased social transfers in 2022, except for Serbia and Bosnia-Herzegovina, which show a decrease theirs.

These transfers were intended in the post-pandemic years to redistribute income throughout the life of individuals following the model of an increase in consumption through redistribution, as a functional formula for the Balkan economies, which depend to a substantial extent on the consumption of the population. Although the values ​​of these transfers per individual represent small sums of money in relation to individual consumption, they remain a permanent instrument of income redistribution for long-term or permanent periods.

Meanwhile, government transfers to EU countries have an average of 20.1% of GDP [3] it can be seen that WB6 countries have maintained levels that average 14.2% of GDP, where North Macedonia makes a big difference with this average having maintained a level of redistribution of up to 24.1% of GDP towards the social strata and the revitalization of consumption by carrying out this action at the right time and for the important purposes of the policies of keeping consumption and production at high levels.

In particular, the higher the fiscal burden, the lower the Gini Index. According to the summarized information about the Gini index in WB6 countries [4] there is data for each country, it is explicitly shown that the higher the tax burden, the lower the inequality.

This can also be supported by the explanation why countries like Sweden, Norway, and Finland, which have high tax rates for wealthy individuals, suffer less from inequality compared to BP6 countries.

Greater inequality can also negatively affect growth if, for example, it encourages populist policies that fail to redistribute the fiscal burden. Although the relationship between inequality and economic growth may not have the same interdependence in every country, a generalized pattern can be observed depending on a country’s level of development. When an economy is at an early stage of its development, the return to physical capital tends to be higher than the return provided by human capital, and greater inequality may cause higher growth. As an economy reaches a more advanced stage of development, the return on physical capital tends to decrease while that on human capital tends to increase, so the increase in inequality can negatively affect the growth of the economy [5].

But studies conducted [6] show that a 1% increase in inequality reduces GDP by 0.6% to 1.1%. So, at least in OECD countries, higher levels of inequality can lower GDP per capita.

This conclusion studied for developed countries seems to be proven by the indicator of average income per capita because of economic growth during the years 2020-2021. In the same ranking as in the case of the Gini coefficient, it is seen that Montenegro has the largest increase in income per capita and from the same ranking it is related to the GINI coefficient, where the average income per capita in relation to the population have increased by 15.6% in two years. Even in Serbia there is a high level of income per capita, although their growth in the last two years is 11.8%. In North Macedonia we see the biggest increase in income per capita at a high level of 20.4%.

Whereas, Albania has an increase in income per capita at the level close to the average with 14%%, but with a difference of at least 3-6 percentage points from the two neighboring countries, Serbia and Kosovo, the latter of which has an increase above the average BP6 for income per capita by 17%.

Bosnia-Herzegovina, with an average level in the ranking of the GINI coefficient, has an increase in income per capita in the penultimate country with 12.1%.

This comparative analysis is in fact the most visible indicator of the productivity of the economy, policies, and strategies for development, as well as the appropriate level of addressing economic models towards increasing the well-being of BP taxpayers.

When the GDP growth rate is reduced, income inequality is also reduced.

While it is said that Albania in 2022 has had an economic growth of 4.84% in 2022 [7] it has used formal and informal resources to revive the supply in the construction sector, it will have to curb the impact of this growth within a sector with little impact on development long-term as it has little impact on increasing the productive capacities of the economy, and this is evident in the fact that it has failed to result in an increase in well-being in the same way as its closest eastern and northern neighbors that develop an economy based on production and optimization of internal resources.

Although both countries do not have the potential that Albania possesses, they seem to have better utilized the internal resources and capacities available as well as foreign and domestic investments, creating a higher well-being than the Albanians.

[1] The Gini Index or Gini Coefficient measures the distribution of income, or the distribution of wealth in the population of a country and beyond. The coefficient goes from 0 (or 0%) to 1 (or 100%), where 0 means perfect equality and 1 means inequality at the highest levels
[2] https://www.rcc.int/download/docs/ESAP-Social-Rights-Pillar-Report-regional-overview.pdf/4c23f2c78e7c02a4bdfd7253ddb05a82.pdf
[3] https://ec.europa.eu/eurostat/statistics-explained/index.php?title=Government_expenditure_on_social_protection
[4] https://wisevoter.com/country-rankings/gini-coefficient-by-country/#gini-coefficient-by-country
[5] https://www.caixabankresearch.com/en/economics-markets/activity-growth/how-does-inequality-affect-economic-growth
[6] https://ourworldindata.org/grapher/gdp-per-capita-vs-economic-inequality
[7] https://ata.gov.al/2023/03/30/rritja-ekonomike-4-84-ne-vitin-2022-u-udhehoq-nga-ndertimi/