A sentence taken out of context triggered (yet another) media storm — the European Commission, according to some, had recommended abolishing the flat tax. Let us set aside the fact that income taxation is a national competence, not a policy subject to harmonization within the European Union, and still take a look at what the Commission actually wrote.
Together with the report recommending the launch of an excessive deficit procedure against Bulgaria, the Commission also published its annual report under the European Semester, analyzing the socio-economic development and challenges facing each member state. In broad terms, the Commission discusses two aspects of the country’s tax system — on one hand, its ability to generate budget revenue, and on the other, various aspects of how the tax burden is distributed.
To begin with, why is there even talk of more budget revenue at all? The need follows from increased spending ambitions — from which it logically follows that if spending growth is brought under control, there is no need to start a debate about how to collect more budget revenue, and the whole topic of raising taxes falls away.
If the Bulgarian government nevertheless wants to increase spending, the Commission’s experts mention — without going into an analysis of the potential effects — a number of different ideas for new taxes or increases to existing ones. The list includes raising or removing the ceiling on insurable income, updating (i.e., increasing) property tax valuations, higher taxation of transport and the extractive industry, and higher taxes on environmental pollution; alongside this, there is discussion of the need for efforts to curb the shadow economy and collect overdue tax liabilities, and a reduction in the cash-payment limit is proposed. And among all of these — the idea of “introducing a tax-free minimum combined with an increase in the (flat) tax rate.” In other words — still a flat tax, just at a higher rate above the tax-free threshold; there is no proposal for “progressive taxation.”
But as has become clear, decisions on income taxation in Bulgaria, and on the structure of the tax system as a whole, are a sovereign matter to be decided by the governing authorities elected by Bulgarian taxpayers. That is why the arguments in the national public debate matter. Taxing income at a flat rate of ten percent — known as the “flat” tax — is perhaps the most frequently debated economic policy choice in the country over the last two decades. Let us nevertheless recall the role this tax plays in the national context and what the proposed alternatives would actually mean.
Bulgaria still has a great deal of ground to make up with the most developed countries in Europe and the world. This is achieved through rapid economic growth, and growth, everywhere and always, is the result of a great deal of labor, a great deal of investment, and an environment that fosters innovation and entrepreneurship. To this end, the tax system should tax the income of the economically active relatively lightly, in exchange for relatively higher taxation of consumption and property. This is a deliberate and rational choice for a society that wants development, economic dynamism, and high employment.
What is more, the most important long-term factor for success is human capital. That is why labor should be encouraged, including through low taxation. As we have seen in recent decades, the workforce is mobile, something greatly facilitated by the EU’s open labor market. If labor is constrained, the natural way for growth to continue is for it to become more productive — through education, the adoption of technology, structural transformation and dynamism, and more investment. The most enterprising, educated, and capable people should be incentivized, not penalized, so that they continue to create value here.
That is why it is right to seek the lightest possible tax and social-security burden on declared (“above-board”) employment, and indeed on all income from labor and personal effort.
In general, no tax should be considered in isolation, which is why the taxation of individuals’ income must be aligned with the taxation of companies’ income, i.e., corporate tax. Put most simply, the system should tax similar activities and income in the same way, rather than allowing arbitrage/tax avoidance based solely on legal form. Is anyone openly proposing an increase in corporate tax as well?
Advocates of abolishing the ten-percent flat tax and introducing a progressive scale with higher top rates try to build public support using several arguments. First — there is currently no tax-free minimum, every unit of income is taxed, and this is presented, in an appeal to emotional sympathy, as unfair. But is that really so? To begin with, Bulgaria’s current income taxation excludes huge categories of income — pensions, social-security payments, social transfers, income from renting out agricultural land, and capital-gains income on regulated capital markets in Bulgaria and the EU, among others, are not taxed.
Separately, the tax base is reduced by 10 to 60 percent (i.e., the effective tax rate becomes between 4 and 9 percent) for various types of income, such as income from freelance professions or agricultural activity. On top of that, there are tax reliefs that further reduce the tax base — some of them substantially.
These take many forms, for example for cashless payments, donations, home repairs, or voluntary pension and insurance contributions, with some — such as those for children, children with disabilities, or people with reduced working capacity — being significant. In fact, the tax reliefs for children and for people with disabilities act as a kind of tax-free minimum for hundreds of thousands of households. In short — neither all income, nor the entire income of all taxpayers, is taxed.
Is the flat tax to blame for social inequality — does it harm the poorest? A large part of inequality in Bulgaria actually arises outside the labor market, as the highest-risk groups do not, in fact, receive taxable employment income. A huge share of the poor pay no tax at all, so no amount of progressivity in taxation or tax-free minimum would improve their welfare. Who are the poor in Bulgaria? To a large extent, they are elderly people — pensioners, especially those living alone — or people with disabilities who cannot work, or the unemployed, or those inactive in the labor market, or large families, or single parents.
These categories of households either have no income at all, or receive untaxed income such as pensions or social assistance, or benefit from substantial tax relief for children. The tax does not weigh on them either way, even now — put simply, if a general tax-free minimum were introduced, their disposable income would not increase.
It is not only the poorest who pay no income tax, but also almost all of the wealthiest. That is because the wealthiest earn either profits from business activity — meaning the corporate income of the companies they own is taxed instead — or so-called passive investment income, and as already mentioned, no tax is due on capital gains in Bulgaria or the EU. A separate category altogether consists of those who have grown rich from illegal activity or undeclared ventures, while gambling is taxed under a different regime. Assets inherited within the family are likewise untaxed. For all these groups of “wealthy” people, it makes no difference what the income tax rate is — it simply does not “catch” their high incomes.
So what happened to the goal of collecting more money for the budget? Incidentally, one of the reasons the tax model has been preserved under a wide range of governments — left-wing, right-wing, or outright populist — is the stable behavior of tax revenue even through the most severe crises, from the global financial crisis, through the eurozone debt crisis, to the pandemic and the ensuing period of political instability. Predictability is not only for business, it is also for the finance minister.
Can the state collect more revenue from this tax? It can, but inevitably by increasing the burden on Bulgaria’s emerging middle class — all those who earn their living through highly skilled labor, personal skill, and entrepreneurship, far from fitting the common notion of “the wealthy.” Introducing a tax-free minimum reduces budget revenue without, however, significantly helping those most in need.
There is a version in which the government keeps the tax proportional, simply raising the rate, but in a way that does not increase the burden on the majority. This achieves precisely nothing — for the same money in the budget, a small number of households, but not the neediest, get a minimal income increase, a large number feel nothing at all, and a small number will pay more and be unhappy. Political and fiscal nonsense.
The government, in fact, has no rational, useful move for revising the flat tax. If it wants to protect the middle class, it will have to keep the current rate up to a fairly high income threshold. But that would leave very few taxpayers above the threshold, meaning that to collect more tax revenue, an extremely high rate would have to be introduced. Statistics and arithmetic — since the tax must not be raised for three million taxpayers, it must be raised sharply for a few tens of thousands, if the goal is to increase budget revenue.
That sounds good in a media “class war,” except that these few thousand affluent, economically active people, facing tax rates of 40, 50 percent or more (such as Bulgaria had in the 1990s), have plenty of ways to arrange their affairs so as to pay no income tax at all. And as already noted, a large part of the imagined enemy — “the wealthy” — do not actually receive their income in this form at all.
That leaves “hitting” a large share of citizens with higher taxation instead. People earning, say, EUR 1,500 a month are hardly likely to see themselves as especially wealthy — yet in the pursuit of more revenue through progressivity, they would end up paying more than now. Which brings us back to the point made above — there is no way to collect more budget revenue, ostensibly to be spent on social policies, without the burden falling on the average taxpayer. And all of this for a none-too-impressive fiscal effect, comparable to or smaller than, for example, one year’s increase in Interior Ministry salaries or the construction of a single highway lot. But at the cost of a long-term erosion of trust, both among investors and employers and among the vast majority of citizens.
The article was originally published in Bulgarian at: https://ime.bg/articles/nenuzhni-uprazhneniya-vyrhu-povishavane-na-danytsite/