REFORM OF TAXATION SYSTEM (2) Center for Liberal-Democratic Studies Boris Begović, Milica Bisić, Gordana Ilić-Popov, Boško Mijatović, Dejan Popović REFORM OF TAXATION SYSTEM (2) Published by Center for Liberal-Democratic Studies Belgrade Serbia Printed in Serbia by »Goragraf«, Belgrade Circulation 500 ISBN 86-83557-32-4 Belgrade, 2004 REFORM OF TAXATION SYSTEM (2) Boris Begović Milica Bisić Gordana Ilić-Popov Boško Mijatović Dejan Popović Belgrade, 2004 We are grateful for the support of the USAID and its’ implementing partner BearingPoint Contents Foreword 7 I Property Taxation Reform 9 II Tax on Revenue from Self-Employment 23 III Tax on Income from Agriculture 39 IV Fees and Charges for Use of Natural and Public Goods 61 V Local Utility Fees 137 Introduction This Study is a continuation of the research of the revenue side of the Serbian fiscal system which was undertaken last year and the prod- uct of which was the study, Tax System Reform published by CLDS (2003). That Study addressed the principal issues of tax reform, such as changes in the profit tax, excise tax, contributions for social insurance, property tax, a part of personal income tax, funding of local communi- ties, and tax debts. The proposals of reforms mentioned in the Study were well received both in the Ministry of Finance and by experts. The result was that the proposals of amendments and supplements to these laws, as prepared by CLDS, were forwarded by the Government of the Republic of Serbia at the time, to the Parliament for its approval. The Study includes assessments and proposals for the reform of parts of tax laws that as yet have not been changed or have only been partly reformed (property tax, personal income tax, and agricultural tax), but also of the charges for the use of natural and public resources and local utility fees which constitute widely neglected and almost unknown areas of the public revenue system. A more thorough analysis revealed some very serious inadequacies in the above – mentioned forms of revenues, as well as the need for radical reforms. These two areas are fraught with bad solutions and represent the unfair, inconsistent, unstimulating, and non-transparent part of the public revenues system. The Study highlighted the proposals for further reforms, which is only natural since it was made in the light of the requirements of the Ministry of Finance and Economy. Authors of individual headings are: Heading I – Boris Begović; Heading II – Dejan Popović; Heading III – Boško Mijatović; Heading IV – Milica Bisić, Gordana Ilić-Popov, and Boško Mijatović; and Heading V – Milica Bisić. We would like to express our gratitude to the Permanent Conference of Cities and Municipalities for their kind cooperation in conducting the survey on the revenues of local government units. We would also like to thank the participants in the conference on taxation reform held on 12th September 2004 under the auspices of the CLDS for their helpful suggestions that have improved this study. June 28th 2004 Boško Mijatović 7 I Property Tax Reform INTRODUCTION The concept of Property Tax Reform is defined in the previous study (Reform of Taxation System, CLDS, 2003) and relies on the fol- lowing elements: • Reform of the method for periodic property tax base determina- tion, where a property value assessment for determining absolute rights transfer tax liability is used as a best approximation of the property value, which constitutes the tax base. • Introduction of a single tax rate for periodic property tax, regard- less of the property value or level of tax base. • Introduction of decentralized decision-making with regard to tax rate level, by allowing local authorities to choose the level of the tax rate applied within their jurisdiction, while leaving definition of the range within which the tax rate may vary to the Law. Local authorities should independently determine the effective tax rate as well, which implies that they should be mandated to allow tax credits, within the range defined by Law. • Revenues from charged and collected periodic property tax are autonomous revenues of local authorities, which is the case in the present Law as well. • Examining the possibility of abolishing the fee for using construc- tion land and incorporating it in the periodic property tax. These elements of property tax reform call for the following steps to be taken in course of the reform implementation: • Implementation of the new model for tax base evaluation, based on assessed property market value for determining absolute rights transfer tax liability. • Defining the revenue neutral tax rate and analyzing the impact of its application to the new tax base. • Defining the revenue neutral tax rate for the integrated fee for use of construction land. • Defining a range within which local authorities may determine periodic property tax rates. • Identifying the possibility to decrease the absolute rights transfer tax rate. 9 THE NEW MODEL OF TAX BASE EVALUATION Basic Features of the Model The new tax base evaluation model rests on the inference that real estate value is far better assessed (closer to the market value) for pur- poses of absolute rights transfer tax determination (dynamic tax), than in case of periodic property tax determination (static tax). In other words, analysis has shown that real estate values assessed for the pur- pose of dynamic tax are very close to the actual market values of the real estate, thus pointing to the dynamic tax base as the best approxi- mation of the actual market real estate value. This inference represents a fundamental assumption of the developed model which uses infor- mation on the real estate values, assessed for purposes of dynamic tax, as a base for determining assessment of the market value of all real estate, including those that have not been traded, but are subject to property tax. The model of tax base evaluation for property tax purposes was derived from application of the NCSS statistical software, which speci- fied and assessed a non-linear regression model, all that based on infor- mation on value (assessed dynamic tax base) of 809 real estate items traded (sold) in 2003. The parameters resulting from the model are applied to a sample of 40,394 real estate items in a statistical data base (periodic property tax collection data base), including those real estate items which have not been traded, but which are subject to periodic property tax. This value assessment method was used for every real estate item in the sample. In order to get effective revenue neutral tax rates (meaning those tax rates whose application to the new tax base specified by this model would result in the same level of tax revenues as is the case presently), the exist- ing tax burden for every particular real estate item in the sample was divided by the appropriate assessed market value. In addition, real estate items in the sample were classified depending on their purpose and municipality, in order to calculate average revenue neutral tax rates for all these categories. In this way it is possible to compare the present tax burden with that which would come after implementation of the real estate value assessment method, or the method for determining the base for property tax. Furthermore, this procedure enables further widening of the analysis to allow examination of the effects of possible inclusion of the fee for use of construction land into property tax. The Results of the Model The statistical (stochastic) model used for the analysis utilized data on the value of 809 real estate items traded in 2003, in Belgrade, Niš and Novi Sad. Initial analysis was based on about 1,700 items of real estate, but this number was reduced to 809, due to an insufficient 10 Reform of taxation system (2) quality of data. All identified real estate items in the case of property sales tax were juxtaposed to all real estate items in the case of property tax on these addresses. In that way, 809 real estate items in dynamics were successfully matched up with around 40,000 real estate items in the property tax base, which resulted in significant enlargement of the sample used for the analysis. Utilizing the actual geographical coordinates of the real estate item (position in real space), the new model was defined to attach value (based on dynamics) per square meter to the actual geographical loca- tion of the real estate. This means that the model emphasized the loca- tion of the real estate as the basic variable influencing its value per unit of usable surface area. Based on the data on price and geographical location, the NCSS software drew isovalue lines (the lines showing equal value of real estate items). Based on these lines the so-called high value real estate location centers were determined for the cities of Belgrade, Niš and Novi Sad, as well as the distance of every item of real estate from these high value location centers.1 Thus calculated, the dis- tance became a new independent variable, used in the model for explaining changes in the value of a real estate item. The map of isoval- ue lines for the city of Belgrade is presented in the following image: Image 1 Isovalue lines 468625.0 Assessed market value 20,000.0 30,000.0 40,000.0 465448.0 50,000.0 60,000.0 70,000.0 y 462271.0 459094.0 455917.0 –49942.0 –46592.8 –43243.5 –39894.3 –36545.0 x 1 High value center is the spot in real space around which there is no spot with a higher value of real estate per unit of usable area. Property Tax Reform 11 Besides the distance from a high value center, the stochastic model used another independent variable – an indicator of a zone determined in the course of the property tax assessment by the Tax Administration.