On 16 November 2015 the IMF published a report on economic issues for Central, Eastern and Southeastern Europe (CESEE). The region as a whole is generally experiencing economic growth, although Russia and the other CIS economies are facing significant economic challenges. The whole region is expected to return to growth next year, expanding by an estimated 1.3% in 2016. The IMF report contains a number of recommendations on tax policy.

Tax Revenue Mix

The CESEE governments generally raise more revenue from consumption taxes such as value added tax (VAT) and excise taxes than Western European countries. Relatively little revenue is raised by CESEE countries from personal income tax or corporate income tax. The revenue yield from taxes on personal income and property is less than half the yield in Western Europe. Consumption taxes are especially important in South Eastern Europe where the revenue yields from these taxes are almost double those in advanced European countries.

Data on Tax Rates

Most of the CESEE countries have raised their VAT rates in the years since 2008. In countries of the Baltic and Central and Eastern Europe the VAT rate has increased by an average of around 3 percentage points; and in South Eastern Europe and the CIS countries the VAT rate has increased by around 1.5 percentage points. The corporate income tax rates have fallen in a number of CESEE countries and the rates are low compared to the advanced economies of Europe.

Tax on labor (personal income tax and social security) remains high with an average labor tax wedge of 39.2% in CESEE countries, but it has only increase by around 0.5 percentage points since 2008.

Conclusions from the Tax Data

The report concludes that the CESEE’s shift away from income taxes towards indirect taxes and non-tax revenues improved the revenue structure as this represented a shift generally towards growth neutral forms of taxation and away from taxes that are considered harmful to economic growth.

The report suggests that growth-friendly adjustment of the tax revenue mix now requires a shift of tax revenue away from corporate income tax or social security contributions and towards consumption tax, personal income tax and property tax. The report suggests that the scope for further growth friendly revenue-based consolidation is now limited.

Tax Policy Recommendations

The report suggests that countries with fiscal adjustment needs should focus on making a large part of the adjustment through indirect taxes, especially raising VAT rates if these are relatively low compared to other comparable countries. They should also consider introducing or increasing carbon taxes and property tax. The tax base of income taxes should be broadened by eliminating tax expenditures and reducing the marginal rates of tax.

In the countries that do not have urgent fiscal consolidation needs the growth-friendliness of the tax mix could be increased by measures to bring corporate rates more in line with comparable countries if they are currently too high. Governments that are concerned with policies for distribution could consider eliminating exemptions from personal income tax.

Social transfers could be financed more from general taxation, including particularly indirect taxes, instead of social security contributions. This would increase the growth friendliness of the tax system. Governments could also give more thought to the design of the system of social security contributions and their interaction with the withdrawal of social transfers on entering employment, so as to avoid creating a poverty trap.

Policy Priorities

The countries of the region with sizable fiscal adjustment needs are mostly in South East Europe. These countries should consider as a policy priority more fiscal consolidation though cuts in subsidies and cuts in tax incentives. They should also consider the introduction of modern property tax regimes. Also, tax compliance and administration need to be improved in a number of countries.

Where countries do not have urgent fiscal consolidation needs they could reduce corporate income taxes in line with comparable peer countries or replace corporate income taxation with increased personal income tax, especially for higher earners. A higher proportion of social spending can be financed from general taxation instead of social security contributions and unproductive transfers and subsidies could be restricted.