WPS8370 Policy Research Working Paper 8370 Public Disclosure Authorized The Distributional Impact of the Fiscal System in Albania Public Disclosure Authorized María E. Dávalos Monica Robayo-Abril Esmeralda Shehaj Aida Gjika Public Disclosure Authorized Public Disclosure Authorized Poverty and Equity Global Practice March 2018 Policy Research Working Paper 8370 Abstract In a context of fiscal consolidation and the need to deliver on effect. Specifically, taxes and social protection contributions a structural reform agenda, policy makers in Albania must have a poverty-increasing effect; indirect taxes, particularly not lose sight of the critical redistributive role of the fiscal the value-added tax, account for the largest increases in system, particularly its impact on poverty and inequality. poverty. This effect is somewhat compensated by direct Using household survey data, this paper estimates the redis- government transfers, which are pro-poor and equalizing, tributive effect of fiscal policy on income distribution and but are not large enough to offset fully the negative impact poverty in Albania, assessing the individual and combined on the taxation side. Ongoing reforms aimed at improving effects of taxes and public social spending. The findings the efficiency and targeting of social assistance can contrib- show that the fiscal system in Albania plays a positive role in ute to enhancing the pro-poor impact of the fiscal system. reducing inequality. Yet, it has a moderate poverty-increasing This paper is a product of the Poverty and Equity Global Practice. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at mdavalos@ worldbank.org and [email protected]. The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. Produced by the Research Support Team The Distributional Impact of the 1 Fiscal System in Albania María E. Dávalos, Monica Robayo-Abril, Esmeralda Shehaj and Aida Gjika JEL classification: H22, I38, D31 Keywords: fiscal policy, inequality, poverty, taxes, transfers, Albania 1 This analysis was prepared as part of the Poverty Program for the Western Balkans in the Poverty and Equity Global Practice of the World Bank, by a team including María E. Dávalos (Senior Economist, World Bank), Monica Robayo-Abril (Economist, World Bank) and Esmeralda Shehaj and Aida Gjika (consultants). The authors are grateful for comments received from Maynor Cabrera, Barbara Cunha, Karolina Goraus, Maddalena Honorati, Gabriela Inchauste, Nora Lustig, Sandra Martínez and Stephen Younger. Table of Contents I. Introduction ........................................................................................................................................... 3 II. Overview of the fiscal system in Albania ............................................................................................. 5 III. Methodology ..................................................................................................................................... 9 IV. Applying the Method to Albania: Data and Empirical Strategy ..................................................... 12 Household Survey Data .......................................................................................................................... 12 Fiscal Interventions Included .................................................................................................................. 12 Empirical Strategy .................................................................................................................................. 13 Model performance ................................................................................................................................. 17 V. Results: Distributional Impact of the Net Fiscal System in Albania................................................... 18 VI. Incidence, Progressivity and Marginal Contributions of Taxes and Social Spending .................... 21 Taxes and Contributions ......................................................................................................................... 23 Direct and In-Kind Transfers .................................................................................................................. 26 VII. Additional applications for policymaking ....................................................................................... 28 VIII. Conclusions and Policy Insights ..................................................................................................... 31 IX. References ....................................................................................................................................... 32 X. Annexes............................................................................................................................................... 37 2 I. Introduction Albania’s economy is expanding and the economic outlook is positive. Following a slowdown in growth since the global economic crisis, the Albanian economy has been accelerating in recent years and is expected to grow at a rate of 3.6 percent in 2017, driven mostly by private investments and consumption. Faster economic growth has translated into improvements in living standards. Although data availability remains a constraint to measuring poverty post 2012,2 recent estimates suggest that the poverty rate (at US$ 5.5/day, 2011 PPP) has been gradually decreasing. After a rise during the global economic crisis and a negative across-the-board consumption growth, poverty has been declining (Figure 1), mostly linked to improvements in labor markets. Figure 1. Poverty rate in Albania (US$ 2.5/day, 2005 PPP) Beyond the role of labor markets, the fiscal and Private Consumption per Capita system can also have important effects on living standards. Evidence across countries has shown that taxes and transfers can have 8 190,000 quantitatively important effects on poverty 7 185,000 6 and inequality. Understanding how the fiscal 5 180,000 system in Albania impacts households, 4 beyond the specific impact of one intervention 3 175,000 but from a more comprehensive standpoint, 2 170,000 can shed light on its redistributive effect and Percentage Points Percentage 1 contribute to the agenda of growing the 0 165,000 2012 2013 2014 2015 2016 2017 2018 middle class in Albania. Poverty Headcount ($2.5/day PPP) Moreover, sustaining economic growth and Private Consumption oer capita (constant LCU) poverty reduction in Albania calls for macroeconomic stability and delivering on Source: Calculations based on ECAPOV harmonization, using 2012-LSMS. the structural reform agenda with an Projection using neutral distribution (2012) with pass-through = 0.87 (Med) based on private consumption per capita in constant LCU. Poverty equity lens. This includes efforts towards projections start in 2013; projections on private consumption start in 2016. fiscal consolidation, as well as judiciary reforms, energy reform, enhancing public investment management, and improving skills. As part of this reform agenda, the government plan for the next four years, with fiscal stabilization as a central objective, includes changes to specific fiscal interventions at the individual level, such as the personal income tax. As part of the reform process, it is key to understand the distributional impacts of policies and, if relevant, ensure that mitigation mechanisms are in place to protect the less well-off. 2 The latest LSMS survey, which is the household survey used to measure national poverty, was last carried out in 2012. The country has collected the income-based EU SILC data for the first time with results to be released by October 2017, including the reporting of indicators aligned to those of EU countries. The World Bank is supporting capacity strengthening in the statistical agency to also measure and monitor welfare using the Household Budget Survey. 3 To our knowledge, no previous study has examined the distributional effects of tax policy or the fiscal system as a whole. There has been substantial work in better understanding the role of fiscal policy in Albania. Some studies looked at the effect of fiscal policy on economic growth (Shijaku & Gjokuta, 2013; Milova & Vokshi-Abazi, 2014; Trebicka, 2015; Patonov, 2016), the macroeconomic effects of fiscal policy in general (Mançellari, 2011; Llollari & Kripa, 2016; Merko et al., 2017), the effects of a flat tax rates on inequality and informal employment in particular (Mara & Narazani, 2011), the performance of the tax system (Fortuzi & Doda, 2015), and the perceptions of the current tax system (Muceku & Balliu, 2017). However, none of these studies evaluates the role of fiscal policy in reducing poverty and inequality.