Kuli\u161, Danijela

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1No. 14, December 2003
Developments in the Croatian Tax System
Danijela Kuliš
The Institute of Public Finance deals with economic research and analysis related to various forms of public finances such as the budget, taxation and
customs duties. Its orientation is thus to the various economic, legal and institutional topics that are important for the sound long-term economic devel-
opment of the Republic of Croatia. So that the public should be able to have a better insight into certain issues, the Institute of Public Finance is
launching its Newsletter, in which it will  from time to time publish informed and independent analysis of economic questions.  The views expressed
in the articles published in the Newsletter will reflect the opinions of the authors, which do not necessarily coincide with those of the Institute as insti-
tution. Full text of Newsletter is also available on Institute’s Web site: http://www.ijf.hr/newsletter.
The main principles on which the Croatian tax sy-
stem was established by introducing a tax reform
ten years ago are still broadly observed, despite the
deviations caused by current economic and political
changes. While some of the changes represent a
move in the right direction (e.g. decreasing of the
tax burden, giving priority to consumption taxation
over taxation of income and savings, reducing tax
evasion, improving the efficiency of tax administra-
tion), other changes that have already been effected
or announced should be reconsidered carefully whi-
le making realistic estimates of the fiscal con-
sequences resulting from their implementation.
This relates to the introduction of new forms of tax
allowances and exemptions, additional tax rates,
e.g. the income tax or VAT rate, reduction of the
VAT rate and introduction of new taxes.
Decreasing the overall tax burden
The tax burden expressed as a share of taxes and so-
cial security contributions in GDP at the consolida-
ted general government level (Table 1) has gra-
dually decreased and was almost equal (40.8%) to
that in EU Member States (41.0%) in 2001. Howe-
ver, this burden is still 5 percentage points higher
than in the observed EU Accession Countries.
Table 1 Taxes and Social Security Contributions
as a % of GDP, 2001 
Taxes and Taxes Contributions
contributions
EU Member States
Sweden 51.4 36.1 15.3
Denmark 49.8 47.6 2.2
Finland 46.1 33.8 12.3
Belgium 45.8 31.4 14.4
Austria 45.4 30.6 14.8
France 45.0 28.6 16.4
Italy 42.0 29.9 12.1
Luxembourg 40.7 29.6 11.1
The Netherlands 39.5 25.3 14.2
United Kingdom 37.3 31.0 6.3
Greece 36.9 25.5 11.4
Germany 36.8 22.2 14.6
Spain 35.2 22.6 12.6
Portugal 33.5 24.5 9.0
Ireland 29.9 25.6 4.3
EU Member States Average 41.0 29.6 11.4
Selected EU Accession Countries
Hungary 39.0 27.5 11.5
Czech Republic 38.4 21.3 17.1
Poland 33.6 23.5 10.1
Slovakia 32.3 17.9 14.4
EU Accession 
Countries Average 35.8 22.6 13.3
Croatia (1995) 44.4 30.2 14.2
Croatia (2000) 42.6 29.3 13.3
Croatia (2001) 40.8 27.6 13.2
Croatia (2002) 41.1 28.6 12.5
Sources: Revenue Statistics 1965-2002, OECD, 2003; Ministry of
Finance of the Republic of Croatia, 2003.
and account for almost one half of the total tax re-
venues. It is advisable to continue to follow the
principle of consumption taxation rather than the
taxation of income, savings or investment.
Tax benefits, tax relieves
and tax allowances
The often invoked principle that no new tax relief,
allowance or exemption should be introduced into
the tax system irrespective of the type of tax, has
frequently been violated in the last few years.
In income tax and profit tax, the already existing bene-
fits (for war veterans, artists, the areas of special state
concern and free trade zones) were supplemented by
new benefits for highland and mountain regions (re-
duced tax base, tax exemptions or allowances). As
these benefits are regulated by the Highland and Mo-
untain Areas Act (official gazette Narodne novine, No.
12/02) the question arises why tax matters are not pri-
marily governed by tax regulations rather than by spe-
cial legislation*. More specifically, up to 2001 the pro-
visions on tax benefits were incorporated into special
acts and have later become part of the tax legislation.
Apart from investment and employment incentives,
in late 2003 additional incentives to research and
development were introduced into the profit tax
and income tax acts. They included a 100%-reduc-
tion in the tax base by the costs of research and de-
velopment and depreciation charges for the acqui-
red intangible assets, as well as the allowance of
education and professional improvement costs.
Developments in the Croatian Tax System
2
Reducing social security
contribution rates
The share of total social security contributions in
the Croatian GDP has also decreased (Table 1) and
is approximately 1 percentage point higher than in
EU Member States. This favourable trend resulted
from reducing the total rates of social security con-
tributions from wages and on wages from 43.4% in
1995 to 37.2% in 2003. This change was by all
means beneficial as it led to a reduction in labour
costs and improved the competitiveness of Croa-
tian export products. However, it is open to que-
stion whether the reduced contributions will be suf-
ficient to cover the existing, but also the growing fu-
ture needs of the pension and health care systems.
The tax revenue structure
The share of income tax collected in total tax reve-
nues (Table 2) is on the decrease, while the share of
turnover tax collected goes up. VAT and excise
taxes represent the most significant tax revenues
(million kuna) 1999 2000 2001 2002
Total tax revenue 62,395 65,049 66,406 72,598
Income tax 7,538 7,486 6,445 7,227
Profit tax 3,341 2,387 2,789 3,714
Social Security
Contributions 19,453 20,282 21,550 21,984
Real property
transaction tax 760 804 661 624
Turnover taxes on
goods and services 26,537 29,827 31,262 36,527
VAT 19,830 21,979 23,562 26,691
Excise taxes 6,161 7,730 7,699 9,835
Other taxes 546 118 0,0 0,0
International
trade tax 4,288 3,795 3,215 2,051
Other taxes 478 468 484 472
Tax revenue structure 100 100 100 100
Income tax 12.1 11.5 9.7 10.0
Profit tax 5.4 3.7 4.2 5.1
Social Security
Contributions 31.2 31.2 32.5 30.3
Real property
transaction tax 1.2 1.2 1.0 0.9
Turnover taxes on
goods and services 42.5 45.9 47.1 50.3
VAT 31.8 33.8 35.5 36.8
Excise taxes 9.9 11.9 11.6 13.5
Other taxes 0.9 0.2 0.0 0.0
International trade tax 6.9 5.8 4.8 2.8
Other taxes 0.8 0.7 0.7 0.7
GDP
(at current prices) 141,579 152,519 162,909 176,429
Share of tax
revenue in GDP 44.1 42.6 40.8 41.1
Share of social security
contributions in GDP 13.7 13.3 13.2 12.5
Table 2 Tax Revenues of the Consolidated
General Government
Figure 1 Revenue Structure of the Consolidated
General Government (%)

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* The Act on the Amendments to the Income Tax Act of 20 October
2003 (official gazette Narodne novine, No. 163/03) includes the provi-
sion on tax relief for highland and mountain areas.Source: Ministry of Finance of the Republic of Croatia, 2003.
Some arguments in favour of
a uniform VAT rate
• The introduction of multiple VAT rates requires detailed
definition of taxable products. If foodstuffs are taxed at
lower rates in order to support the lower-income gro-
ups, should the same rate apply to both cabbage and
broccoli? While both vegetables belong to the same
group, broccoli is more expensive and thus more fre-
quently eaten by the rich. This dilemma should be re-
solved by a competent tax administration, which should
be able to determine clearly and with valid arguments,
which products should be subject to a lower VAT rate.
• Unclear definition of products opens the way to tax
evasion. This particularly concerns products, which
are not unambiguously classified as subject to a
lower tax rate. However, the application of multiple
rates may lead to bribery and lobbyism, since many
wish that precisely their products would be included
in the lower-rate taxation category.
• Multiple rates increase tax collection costs. A govern-
ment that applies multiple VAT rates needs more em-
ployees to define taxable and non-taxable products
and to process more sophisticated tax returns. This al-
so increases the costs of VAT calculation and payment
by companies. A famous tax expert and long-time Di-
rector of the IMF's Fiscal Affairs Department Vito
Tanzi points out that switching from one to two VAT
rates doubles the VAT administration costs, while
choosing three rates results in ten times higher costs.
• Lower VAT rates are no guarantee against price
growth. A lower VAT rate on medicines of food-
stuffs does not necessarily mean lower prices of the-
se products. Consequently, lower VAT rates cannot
guarantee that the poor will be able to buy these
products at lower prices. Neither in tourism can a
lower VAT rate provide any magic solution to all the
problems with which this industry is faced.
Developments in the Croatian Tax System
3
During the pre-election campaign, promises were
made to reduce the current and/or introduce an ad-
ditional lower VAT rate. The Croatian VAT rate is
definitely higher compared with EU Member Sta-
tes (excluding Denmark and Sweden, which apply
the 25% rate), but it remains within the limits of the
rates applied in transition countries (19%-25%).
A reduction in the standard rate would be prefera-
ble to introducing another rate, but the question is
how to make up for reduced budget revenues and
how this problem can be solved. There are several
options. The first and the best one would be to re-
duce government expenditure, while the other two
(less favourable) options include raising other taxes
or introducing new ones.
As of 1 January 2003, a new income tax allowance
was introduced for health care costs and for sa-
tisfying certain housing needs, along with a reduc-
tion in the tax base for the wages paid to new em-
ployees and the amount of awards paid to pupils
during their practical work and apprenticeship.
This was paralleled with an increase in the basic
personal allowance (from 1,250.00 kuna to 1,500.00
kuna), the introduction of an additional 45% tax ra-
te and a change in tax brackets.
At end-2003, the non-taxable amount of special bo-
nuses was increased from 1,000.00 to 1,600.00 kuna.
All these changes in income tax were aimed at re-
lieving the tax burden on income and improving the
financial status of lower-income population. Ne-
vertheless, this will certainly result in reduced inco-
me tax revenues in the future.
In real property transaction tax, a new exemption for the
first time property purchase has been introduced. Un-
fortunately, the exemptions that followed were not re-
gulated by the Act on Real Property Transaction Tax
but by other regulations, which resulted in the lack of
transparency and impossibility to get full information
on a particular tax from the act that regulates it.
The Act on Government Incentive to Housing
Construction regulates the tax relief, which allows
the Agency for Legal Transactions and Mediation
in Real Estate to be exempt from paying tax on the
acquisition of land. By virtue of the Act on the Le-
gal Position of Religious Communities from 2002,
religious communities are also exempt from tax on
the acquisition of religious facilities and the sites
for their construction. 
A tax allowance for real property transactions has al-
so been introduced in highland and mountain areas.
Reducing the standard VAT rate
instead of introducing new rates
Value added tax was introduced on 1 January 1998
with a uniform rate of 22% and was based on the
principle of efficiency (as few as possible tax rates and
exemptions). As a result of strong pressures from va-
rious interest groups that lasted for almost two years,
a zero rate was introduced for particular products
(bread, milk, books and some medicines). Since mid-
2000, the list of products and services to which the ze-
ro rate applies has been extended (by including books
on CD-ROM, showing movies, delivery of goods by
free-lance artists and artistic organisations, in some
cases of imports, as well as some tourist services).
Developments in the Croatian Tax System
4
• Lower VAT rates on certain products also help the rich.
It is often stated that lower VAT rates should be in-
troduced to support the low-income population.
However, why should the rich, too, be supported by
lower VAT rates on food? The poor would be more
efficiently helped through direct budget transfers,
while food should be taxed at the standard VAT rate.
• Lower VAT rates result in reduced budget revenues. In
2002, revenues from VAT accounted for as much as
38% of the total tax revenues of the government
budget. Therefore, even a small reduction in the
VAT rate could effect significant changes in the le-
vel of revenues. By lowering the VAT rate on certain
products tax revenues would additionally decrease,
which could lead to a rise in some other taxes or a
serious re-examination of government expenditure.
• European Union favours reducing the number of rates.
EU recommends the use of two or three rates for its
Member States: a standard rate of minimum15% and
two or three lower rates but not below 5% each. The
number of rates has been reduced in most EU Member
States. For example, Italy, France and Ireland, which
used to apply 10, 8 and 6 different rates respectively in
1980s, reduced those numbers to 3, 3 and 4 rates respec-
tively in 2002. Modern theory of taxation mainly sup-
ports a single VAT rate with a small number of exemp-
tions and a wide tax base, so further reductions in the
number of VAT rates can be expected in the EU.
See more in: Marina Kesner-Škreb: "Ten Reasons in Favour
of a Uniform Rate of a Value Added Tax", Newsletter No. 2,
September 1999.
Reduced Standard
Denmark 25
Sweden 12; 6 25
Finland 17; 8 22
Italy 10; 4 20
Austria 10 20
Belgium 12; 6; 1 21
Ireland 12.5; 4.3 21
France 5.5; 2; 1 19.6
The Netherlands 6 19
Greece 8; 4 18
United Kingdom 5 17.5
Portugal 12; 5 17
Germany 7 16
Spain 7; 4 16
Luxembourg 12; 6; 3 15
Average standard rate
in EU Member State 19.5
Selected EU Accession Countries
Hungary 12 25
Slovakia 10 23
Czech Republic 5 22
Poland 7; 3; 0 22
Slovenia 8.5 20
Average standard rate
in EU Accession Countries 24.4
Table 3 VAT Rates in 2001
Source: European Tax Handbook, IBFD, 2002.
Excise taxes
Since 2002, the excise tax system has included the
tax on insurance premiums for automobile respon-
sibility, which was supplemented by the tax on pre-
miums for comprehensive motor (automobile) insu-
rance in early 2003. Even though this is not a typi-
cal excise tax it has been classified as such in all IMF
reports, which is why we do the same. While the tax-
payers are insurance companies, they shift the fi-
nancial burden to the owners of vehicles, who are
generally have to pay 10-15% higher insurance pre-
miums due to the introduction of this tax. As the ju-
stifiability of excise taxes on non-alcoholic bevera-
ges is still disputable (taxable products are discrimi-
nated in favour of other food products; they are
usually not taxable in the EU; the tax collection
procedure is complicated and the share of this tax in
budget revenues is relatively small), the tax on insu-
rance premiums for cars was probably introduced in
order to compensate (to a certain degree) for the
revenue loss that may arise from lifting the tax on
non-alcoholic drinks. 
Since the beginning of 2002, the implementation
and supervision of excise tax collection has been
transferred from the Tax Administration to Cu-
stoms Administration, which is a common practice
in other European countries.
Reducing tax evasion
A survey on the unofficial economy in Croatia in
the period 1990-2000, conducted by the Institute of
Public Finance in 2001, demonstrates that the unof-
ficial economy, measured by using the method of
discrepancies in national accounts, declined from
some 25% in the period 1990 -1995 to 10% of GDP
in the period 1996-2000. One of the factors that in-
fluenced this slowdown was the tax system, particu-
larly the introduction of VAT, which resulted in im-
proved tax collection and tax controls and might ha-
ve also been a sign of a more efficient operation of
the Tax Administration.
Conclusions and recommendations
The major breakthroughs in the Croatian tax sy-
stem include the degreasing of the tax burden ex-
pressed as a share of total taxes and social security
contributions in GDP, reducing tax evasion and im-
proving the efficiency of the tax administration, as
well as relieving the tax burden on income.
Developments in the Croatian Tax System
5
The introduction of the new tax exemptions and tax
benefits threatens the consistency, transparency
and stability of the tax system. The tax collection
and controlling procedures become more compli-
cated, thus increasing the costs and reducing the ef-
ficiency of the system. Frequent changes, which of-
ten include ad hoc measures, have adverse effects
on taxpayers' economic decision-making. The tax
policy should not be used for the implementation of
social, economic or development policy measures.
Its main goal and purpose should rather be to col-
lect in a most simple, efficient and equitable way,
the tax revenues that will be used to cover public
expenditures.
Indeed, it is the expenditure side of the budget that
represents a problem in Croatia, and no change on
the revenue side can improve the status of public fi-
nance in Croatia unless a radical expenditure re-
form is carried out.
Institut za javne financije
Katanèiæeva 5
Zagreb, Hrvatska
p.p. 320
Institute of Public Finance
Katanèiæeva 5
Zagreb, Croatia
PO Box 320
Poštarina plaæena 
u poštanskom uredu 10000
ZAGREB
TISKANICA


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