The introduction of an income tax ‘contribution for solidarity’: A justifiability analysis

In June, upon the recommendation of the Government of Republic of Srpska, the Law on a Special Contribution for Solidarity was adopted. The new law introduces an additional income tax contribution amounting to 3% of the net wage, intended to fund flood damage repairs.

The legislation states that this additional tax burden is to be equally distributed between employees and employers, with each party contributing 1.5%. The funds are to be collected over a one-year period and transferred to the Solidarity Fund for the Renewal of Republic of Srpska, to be used for repairing flood damage. The Ministry of Finance of RS expects to raise 65 million BAM via these contributions.

Is this the right measure, and what are its effects?

The primary positive effect is certainly the expected amount of 65 million BAM that will be paid to the Solidarity Fund for flood relief. However, if we know that, according to the latest assessments, damage caused by the floods exceeds 2 billion BAM, we can see that the funds collected by this measure will cover only around 3% of the total actual need. We can thereby conclude that this measure is of little practical use.

Furthermore, especially in light of the urgent need to decrease income taxes, the introduction of an additional wage contributions will have a significant negative impact on business. The Center for Research and Studies GEA has already written about this issue, and has published a study with comparative analyses of measures taken in recent years by countries within the region and the EU to fund flood repairs, including policy recommendations. We would like to reiterate the fact that, after this additional increase, income tax burden in RS will amount to some 65% of net salary. Even prior to this increase, the stated tax burden represents one of the highest in the region. The relatively high tax has had negative economic effects including the discouragement of new job creation and encouragement of illegal employment and inflated minimum wage reporting (thereby increasing the “grey economy”).

To what extent do these contributions actually encourage ‘solidarity’?

The legislation states that a half of the additional 3% tax contribution falls on the employer, while the other half falls on the employee – meaning 1.5% each. However, if an employer decreases an employee’s net wage by 1.5%, they can effectively place the entire tax burden on an employee. Economic theory and practice tell us that the new tax burden will be distributed between the two parties according to their current negotiation position in the market. In the case of the labor market in RS, bearing in mind the high rate of unemployment, it is obvious who holds the greater negotiation power in most cases – the employer. This is especially true as regards low-qualified employees, whose jobs are often in highest demand. In cases where an employer’s room for maneuverability is limited by a collective or individual agreement, they will be even more motivated to fire or unregister a worker protected by such means, especially if their competitors apply the same practice. Therefore, in reality, the negative effects of this tax burden will mostly affect employees – especially those with lower paid qualifications. In RS there are a total of 240,000 employees for whom wage contributions are paid (or at least entered into calculations). That is approximately every fourth person in the labor market.

Of course this new tax measure would not include the at least 68,000 unreported (illegal) workers in RS and their employers, and it would not affect any profits, dividends, leases or other payments from abroad. In other words, this tax measure is very narrowly directed and excludes income earned by wealthier segments of the population.

What are other possible options for encouraging ‘solidarity’ in fiscal policy?

Since income taxes and wage contributions are among the taxes with the most damaging impact on economic growth and employment, additional income should be raised via other forms of taxes. These might include, for example, property taxes, taxes on the consumption of luxury products, or VAT. According to calculations from our most recent study on this subject, a 1% increase of VAT would secure approximately the same amount of income as a solidarity income contribution of 3%. This is due to the fact that VAT has a significantly greater tax base. If we wish to improve conditions for the creation of new jobs, it is necessary to promote significant tax burden relief.

The total allocation for gross wages and allowances for all levels of the RS Government for 2014 was some 666 million BAM. Therefore, decreasing these governmental costs by 10% would save 66.6 million BAM annually – even more than the amount expected to be collected by the solidarity income tax contribution. A recent analysis by GEA determined that in the Republic of Srpska, the average wage in the public sector is over 60% higher than the average wage in the private sector.

Is there any room for solidarity here?