Articles The Bulgarian Flat Tax
Emil Kalchev* Introduction he flat tax has become broadly Summary: Tpopular in recent years, so that The flat tax has become broadly popular The Times concludes: "A flat tax revolution in Central and Eastern Europe in recent shakes up Europe", while The Independent years. Many of EU newcomers adopted flat reports that "Flat tax revolution sweeps in tax regime. Even at first glance, however, it from Eastern Europe". An IMF working paper is evident that there are large variations in its reviews experience with the flat tax and design, although flat tax is clearly defined in summarizes: "The last few years have seen literature. The question is whether this relates widespread interest - not quite a revolution, to different applications of one and the same but certainly something of a craze - in the concept or to different concepts called by the ‘flat tax’." (Keen et al., 2006, p. 3). same name – flat tax. Perceived as standard The beginning of a discussion on the the coherent tax structure of the flat tax, flat tax was an article on December, 10, proposed by Hall and Rabushka, we assess 1981 in The Wall Street Journal of Robert the current income tax system in Bulgaria. Hall and Alvin Rabushka of the Hoover We focus on the structure of the tax system Institution at Stanford University. The and design of the tax bases, because even next year, US Senator Dennis DeConcini they reflect to a greater extent the specificity provoked political debate by introducing of the flat tax. Cuts of tax rates are important; one of the first bills. The US Tax Reform they have been not only broadly discussed, Act of 1986 adopted some elements of the but also do not necessarily relate to the flat flat tax concept, reducing the top rate to tax concept. Bulgaria adopted the "flat tax", 28 percent and the tax brackets from more this did not increase the transparency of than a dozen in only two. However, it did income taxation nor did it become easier to not reform the tax bases whence it could administer. Moreover, income taxation is not not solve the issues of complexity. In the simple, neutral, and non-distortive. Despite Democratic Party’s presidential nomination the introduction of some elements of the flat in 1992 flat tax appears as a reform tax, one cannot say that a theoretical flat tax proposal. Four years later a Republican system is implemented in Bulgaria. candidate proposed a similar idea as part of his platform (Hall and Rabushka, 2007, Key words: flat tax, taxation in Bulgaria, pp. 72-75). Nevertheless, all the efforts to neutral taxation implement the flat tax in the United States JEL Classification: H24, H25, H29 remain unsuccessful.
* Assistant Professor, PhD, Department of Economics, New Bulgarian University, e-mail: [email protected]
33 Articles The Bulgarian Flat Tax
In contrast, flat tax has been adopted in of tax bases, because even they largely 22 countries, including 7 EU newcomers: the specificity of the flat tax concept. Tax Estonia, Lithuania, Latvia, Slovakia, rate cuts are important; they have been Romania, Bulgaria, and the Czech Republic. not only broadly discussed, but also do not However, one should not be misled that the necessarily closely relate to the flat tax Hall-Rabushka’s proposal was implemented concept. in these countries. Instead, wide variations A proper comparison must include of it are being used and often only the all types of income - business income, term "flat tax" is being exploited: "Their sole interest, dividends, wages, and so forth - and common feature is a single strictly positive assign total income to individuals in income marginal tax rate on labor income" (Keen, categories to see how those categories of Ibid, p. 4). A correspondence of a particular individuals fare under Hall-Rabushka versus "flat tax" with the Hall-Rabushka’s concept under current law. … It sounds complicated, is not a matter of formality, because the but it is a crucial aspect of the debate … integrated flat tax is a coherent system of now we just want to emphasize that any fair taxation, and only as a system it delivers comparison of two alternative tax systems simplicity of tax law and low costs of by income category must include corporate compliance, encourages savings and income taxes as well as individual taxes economic growth, and ensures decision (Hall and Rabushka, 2007, p. 61). neutrality and fairness. The Flat Tax of Hall and Rabushka A flat tax has been in effect in Bulgaria for a fifth year already. Its adoption has been Theoretical Foundations accompanied by many positive expectations, Individual gross income consists of such as a significant decrease of the grey two parts: labor income L, and capital economy, simplicity, attracting more foreign (business) income K. Amount C of the investments, economic growth acceleration, income can be consumed and amount and lower compliance costs. In reality, the S saved. In other words, the following introduction of flat tax has neither led to the equitation is valid: expected reduction of the grey economy L + K = C + S, (CSD, 2011, p. 28), nor has it simplified the tax or reduced compliance costs. Moreover, which is transformed to it is directly evident that there are some C = L + K − S. (1) important differences between the flat tax From (1) it is evident that consumption can and the Bulgarian income taxation. be taxed in two ways: directly (via VAT) and Generally, the point is to what extent indirectly through taxation on gross income the current Bulgarian income taxation minus savings (via integrated flat tax). is associated with the flat tax of Hall- The justification for consumption taxes Rabushka? To make it clear, we shall rests on their built-in incentives to save and compare the two tax systems, identify invest (in closed economy investment I, similarities and differences and analyse equals saving, S = I ). By exempting investment them. What is more, we will focus mainly on from taxation, consumption taxes encourage the structure of tax systems and the design investment and discourage spending (Ibid., p.
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63). Under the integrated flat tax of Hall and flat tax is utmost simple – its two tax forms Rabushka labor income (wages, salaries, and fits on postcards. The differentiation of its pensions) is taxed by individual wage tax and both structures is also optimal: individual capital (business) income minus investment wage tax is levied only on wages, salaries by business tax, both at the same tax rate. and pensions, while all other personal The business tax base revenues (from business) are covered by B = K − I the business tax. Both impose a tax at one is decomposed into and the same rate. All individual income B = P − N − I, is thus taxed only and exactly once at the P where are the positive payments (e.g. same rate. Flat tax is progressive because revenues from sales of products, services, of its general personal allowance. It is fix assets) and N the negative operating payments (e.g. purchases, wages and based on the principles of consumption salaries, pensions) of the business. Such a and cash flow taxation – taxes not saving/ tax, based on expensing of investments in investment. real assets and not-allowing, for example, a deduction for interest on business debt and The Individual Wage Tax interest revenues is called R-based cash Its purpose is to tax the income received flow tax (Meade Committee, 1978). by workers in the form of wages, salaries or General Features pensions. Pensions under Hall-Rabushka are Following not a legal sense, as other tax subject to a downstream taxation - pension systems, but economic logic the integrated contributions are deductible (tax free), but
Fig. 1. Individual Wage – Tax Form
35 Articles The Bulgarian Flat Tax
Fig. 2. Business Wage – Tax Form when the retired worker receives the pension is subtracted from the payments from sales it is subject to the individual wage tax. of products, services and fixed assets. All Although the form of this tax fits on postcard, financial transactions (e.g. payments on loans, it has three important economic features: it dividends) are not regulated within the framework is progressive, contains family splitting and a of the business tax. Losses from business can system for social security (financial support be carried forward for unlimited time period. for dependents). All three are reached by The business tax form is even simpler then the providing each taxpayer with allowances individual tax form (ibid., p. 94): according to his personal situation, as seen The Bulgarian Income Tax below on the tax form, which best explains the nature of the individual wage tax (Hall The Bulgarian income tax consists of and Rabushka, 2007, p. 89): two separate structures: the corporation The business tax is a giant, comprehensive tax and the personal income tax. They are withholding tax on all types of personal income not integrated and are based on the so- other than wages, salaries, and pensions. The called classical system, i.e. paid dividends tax is assessed on all the income originating are subject to double taxation (10 percent in a business but not on any income that corporation tax plus 5 percent personal originates in other businesses (Ibid., pp. 91- income tax). 92). The tax base is calculated in a pretty The Personal Income Tax simple manner and costs on purchases (of goods, services, materials, and fix assets) The personal income tax is a complete and on labor (wages, salaries, and pensions) income tax of natural persons. Although
36 Economic Alternatives, Issue 1, 2014 Articles income is the core of it, the Law on Taxes The base of taxable income (total tax on the Income of Natural Persons does not base) is calculated in tree steps. First, explicitly define it. Instead, it puts the income bases of each source of income are to be in connection with its sources. Depending computed separately. Second, they have to on the source the types of income are: be totaled. Third, tax reliefs are subtracted 1. Income from employment; from the total. 2. Income from business as a sole Against the total tax base flat tax rate of proprietor; 10 percent is applied. 3. Income from other personal businesses; To narrow the total tax base the following 4. Income from rents; tax reliefs are applicable: 5. Income from the transfer of rights or yy Persons with reduced capacity to work property; (invalids) can exempt 7.920 BGN from 6. Income from other sources. taxation, i.e. decrease their total tax base Because the other sources of income by this amount. are not a specified limited number, in fact, yy Exclusions for personal social security nearly everything could be considered as contributions: up to 10 percent of the income. Gifts and legacies are the only two total tax base for personal contributions types of income excluded from the endless for additional voluntary pension, and up list of income sources. to 10 percent for additional voluntary Taxable income is the income from all health and life insurance. sources, with exception of items defined yy Deductions for donations (in total, up to 65 as non-taxable. The catalogue includes percent of the total tax base): (1) up to 5 more than 30 precisely defined non-taxable percent – in 14 precisely defined cases; items, such as: (2) up to 15 percent – in favour of culture; yy Income from the sale of one housing real (3) up to 50 percent – in favor of the "Fund estate; yy Dividends which have been distributed in for Treatment of Children" Centre. the form of new stocks or shares; yy Deductions for mortgage interest: interest yy Income from mandatory social security on the first 100.000 BGN of the mortgage (including pensions); loan of married couples up to 35 years yy Income from additional (and voluntary) old, when the mortgaged residence is the social security (including pensions); only residence of the family. yy Interest on Bulgarian state, municipal and Parallel to the mainstream taxation of corporate bonds; natural persons presented above income yy Scholarships; yy Amounts and objects which have been from dividends or liquidation shares are taxed received from gambling; separately at 5 percent (through compensated yy Amounts for business travelling, taxation). Such tax of 10 percent is also due on accommodation etc. the amounts paid for: life insurance, voluntary yy Income from rent or lease of agricultural land; health insurance, and additional voluntary yy Income from unmanufactured agricultural pension, at their reverse receipt when the production, and so forth. insured event has not occurred.
37 Articles The Bulgarian Flat Tax
The Corporation Tax increased by such expenses - occurrence of a tax temporary difference. When Similar to natural persons, legal entities conditions for recognition are fulfilled, these (e.g. corporations) are also subject to taxation. expenses decrease the subsequent net The tax on companies’ pre-tax income income of company’s financial statement (profit) is called in Bulgaria corporation tax. It - reverse manifestation of tax temporary is regulated by the Law on Corporate Income difference. The situation with revenues Taxation. The base for corporation tax is is the opposite - they are the first out of the so called tax profit, which is obtained by financial statement, and when conditions adjusting the accounting profit (loss) before for recognition occur, these revenues are tax. The tax rate is 10 percent. added to them. Revenues and expenses Although corporation tax seems to be so causing tax temporary differences are far utmost simple, in fact, it is not due to diverse. Mentioned may be only some of the fact the adjustment of income (loss) to them, such as differences from subsequent tax profit (tax loss) is very complex. At that, evaluations of assets and liabilities – they the total revenues and expenses of income are not recognized in the year of reporting statement are recalculated according to tax but at their write-off; expenditures for law. In practice, for tax purposes a separate provisions for obligations – are recognized (tax) financial accounting has to be applied at the pay-off of obligations by the provision; to prevent profit manipulations, which are expenditures for unused leaves - are not in violation of the accounting law. recognized in the year of payment, etc. Basically, the adjustment is done by adding Amounts involved in determining the tax and subtracting items to and from total revenues profit are used under the adjustment to clear and expenses. Technically, these items are the effects, for instance, of investments in classified in four groups: (1) tax permanent securities on the income (profit) before tax. differences, (2) tax temporary differences, (3) Gains of such financial investments are amounts involved in determining the tax profit, subtracted and losses added to the income and (4) depreciations. before tax. Thus, tax profit consists mainly Tax permanent differences are those of operating revenues. revenues (expenses) which are not recognized Depreciations are the "classical" by tax law. When these are expenses, they instrument for manipulation of profits, hence increase the accounting profit (before tax). the primary attention of tax legislation to Conversely, it has to be decreased by not them. The motives behind profit manipulation recognized revenues. Such items are, for may not only be related to tax evasion, but example, expenses not connected with the also may pursue shifting the tax payments business, expenses for fines, confiscations, forward in time leading to lower net present donations (except for those specified in law), value of them. To prevent this straight-line expenses on dividends from other companies, tax depreciation allowances are introduced. and so forth. Technically, accounting depreciations are Tax temporary differences arise when not recognized and have to be added back certain revenues or expenses are recognized to net profit, and then tax depreciations for tax purposes but not in the year of their have to be subtracted. reporting. Again, accounting profit has to be
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Depreciation rates Categories Assets (percent) solid-structured buildings, including investment property, I equipment, power transmission devices, communication 4 lines II Machinery, production equipment, apparatuses 30 means of transportation, with the exception of motor III 10 vehicles; pavement of roads and runways Computers, peripheral devices for computers, software IV 50 and the right to software use, mobile phones V motor vehicles 25 100/years of the legal those tax fixed tangible and intangible assets the term limitation. The annual VI of use of which is limited under contractual relationships rate may not exceed or a legal obligation 33 1/3. VII all other depreciable assets 15
Fixed tangible and intangible assets Comparison between the Flat Tax worth over BGN 500 are depreciable, and the Bulgarian Income Tax which depreciation base is their historical Simplicity value. These assets are divided into seven categories and each is determined The income tax was introduced maximum straight-line depreciation rate as in Bulgaria in 1997 and at that time it follows: covered 135 paragraphs written out on 56 Companies can carry forward for up to pages. Ten years later in 2007 (before the five years the tax loss, deducting it from introduction of the flat tax) paragraphs were subsequent tax profits. 364 and pages 135. In 2012, four years after Abatements, assignments, and introduction of flat tax, the paragraph and exemptions from taxation with corporation page numbers remain almost the same as tax are allowed. For instance, in assignment before. Moreover, the actual income tax forms are spread over more then 30 pages companies do not pay the tax due which in total (including enclosures). Obviously, remains in their patrimony and has to be the introduction of the flat tax in Bulgaria used for purposes determined by law. has nothing to do with "postcard tax reform" Assignment or abatement is applicable and simplicity. Bulgarian income tax remains in cases of employment of long term as complicated as before. unemployed people or such of reduced capacity for work. Collective investment General Design schemes which are admitted to being Various principles (for example economic, offered to the public at large, the licensed judicial, and other principles) can provide closed-type investment companies, etc. the basis for the structure of a tax system. are not liable for corporate tax. It is these principles that render different the
39 Articles The Bulgarian Flat Tax tax systems. The next level of comparison Tax Rates between the flat tax and the Bulgarian The flat tax of Hall and Rabushka income tax would be at system level. consists of R-cash-flow tax on business The flat tax classifies all income as income and a tax on workers’ income, both either business income or wages. The wage levied at the same single rate. tax is levied only on wages, salaries, and On the contrary, under the Bulgarian pensions and it is not a complete income tax system worker’s income is taxed at 10 tax on individuals. The business tax covers percent and business income at 10 percent all other income sources. Both tax structures corporation tax plus 5 per cent tax on form a very clear and simple tax system. dividends. The income of sole proprietorships Unlike the flat tax, the separation of both is taxed directly at 15 percent. taxation structures in Bulgaria does not follow economic logic but legal sense, which Individual Tax in turn creates a number of organizational The individual wage tax stipulates problems and significant complications. generous personal allowance, providing Income taxation consists of a complete progressivity, but no exceptions or other income tax on individuals and a tax on deductions. Pension contributions are exempt the profits of legal entities (companies, from taxes, but when the retired worker corporations etc.). This (traditional) design actually receives the pension it is taxed as not only implies double regulation of a "worker’s income" at the usual single tax rate. business income – by the Law on Corporate Conversely, the taxation on workers’ Income Taxation and by the Law on Taxes income in Bulgaria does not provide for on the Income of Natural Persons, but a personal allowance but for numerous also results in different tax treatment of deductions, exemptions, and exceptions. alternative forms of business organizations. For those taxpayers, who can exempt To overcome this problem to some components of their income from taxation extent, sole proprietors which as natural or are allowed to realize deductions the persons are subject to the individual income Bulgarian individual tax is progressive. For tax have to calculate their tax base under the other taxpayers it is proportional. the corporation tax regulations and then to "import" them back into the framework of Business Tax the deductible individual income tax. The business tax does not predict One-time Taxation deductions (expenses)/revenues for/from financial transactions (e.g. interest payments, A major feature of the flat tax is that all dividends). Only expenses for costs of income is taxed exactly one time. goods, materials, services, wages, salaries, Unlike the flat tax, in Bulgaria some and pensions are recognized. Moreover, an income components (e.g. fringe benefits, immediate 100 percent first-year tax write-off some kinds of interest, pensions) are never of all investment spending is allowed, which taxed, while, for example, dividends and characterizes the flat tax as a consumption capital gains are taxed twice under the so- tax. In fact, the base of the business tax is called classic system. the cash flow of real business.
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Contrariwise, the corporation tax mess. It is not efficient. It is not fair. It is not recognizes expenses/revenues for/from simple. It is not comprehensible. It fosters interest payments, dividends, etc. as well tax avoidance and evasion. … It costs as deductions for costs of goods, materials, taxpayers billions of dollars in wasting time services, wages, salaries, and pensions. on filling out tax forms and other forms of However, it does not allow expensing compliance. It costs the economy billions of of investments and a very complicated dollars in lost output of goods and services apparatus of depreciation deductions has to from investments being made for tax rather be applied. The Bulgarian corporation tax is than for economic purposes" (Hall and not a consumption tax but a component of Rabushka, 2007, p. 1-2). a traditional income tax. Its base is not the References: cash flow of real business. The business sources of income under the CSD, 2011 (Center for Studies of personal income tax have also to be compared Democracy). Dinamika na skritata to the giant business tax. Sole proprietorships ikonomika v Bulgaria po vreme na krizata calculate their tax base under the corporation [online] Available at:
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