Following consultations in Bosnia by IMF staff under Article IV of the IMF’s articles of agreement a staff report and a selected issues paper were published on 28 October 2015. The selected issues paper includes a section on moving towards a more balanced tax system in Bosnia and Herzegovina.
Bosnia and Herzegovina (BiH) has one of the highest tax to GDP ratios in the region at 38% and the social security contributions represent a high proportion of total tax revenues. The result is a high burden of tax on labor. Although there is currently little room for reducing the overall tax burden Bosnia could shift the burden of taxation away from labor by collecting more revenue from other types of taxation.
In recent years although the government revenue to GDP ratio has remained stable the ratio of total taxation to GDP has risen while other sources of government revenue such as dividends from state owned enterprises have been decreasing. The share of social security contributions in total tax and social security revenue is more than 40%. However the standard rates of taxes such as personal income tax (10%) and corporate income tax (10%) are much lower than the regional average.
Tax efficiency
Tax efficiency is measured by comparing the actual tax collected with the theoretical maximum amount that could be collected. The gap between these two figures is analyzed as a policy gap and a compliance gap. The policy gap is represented by tax exemptions that do not correspond to best practice and by the creation of reduced rates. The compliance gap is the difference between the tax collected and the tax that could be collected if the laws were perfectly enforced.
The VAT system has a single standard rate without any lower rates, an arrangement that increases the efficiency of the tax. However the VAT registration threshold is among the lowest in the region, putting a burden on the tax administration by including many small and medium enterprises within the VAT net. The efficiency of the corporate income tax is around the average for the region and could be increased by policy and administration measures such as a review of tax incentives and exemptions. Tax administration reform could also improve efficiency but this normally requires some time to complete.
Tax on labor
The tax wedge consisting of personal income tax and social security contributions is high, and most of this tax burden is due to social security contributions. The tax treatment of allowances is not harmonized across the two parts of the country – the Federation of BiH (FBiH) and the Srpska Republic (RS) – and this leads to economic distortions and adds to the compliance burden on businesses. High labor taxation reduces competitiveness and contributes to the increase of informal employment. Reduction of the labor tax wedge is necessary to improve competitiveness in the economy and attract foreign investment.
Proposed tax reform
The IMF considers that in the current global economy taxation must be simple and broadly based, backed up by high levels of compliance. Efforts to mobilize more revenue must be made on the basis of efficiency, fairness and transparency.
The rates of social security contributions must be decreased to increase labor market incentives. Other revenue measures will be needed to offset this reduction, including broadening the tax base and improving tax compliance, as well as possible government spending cuts.
The IMF considers that the tax system must be reviewed to identify measures that could be taken to broaden the tax base of the major taxes. This could be done for example by amending the tax free allowances and abolishing tax exemptions and incentives. A review of tax rates should be performed to identify possibilities for mobilizing revenue from other taxes to enable social security contributions to be lowered. Property taxes could also be increased.