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Taxation and Public Finance in Transition and Developing Economies pp 433–459Cite as

The Croatian Tax System: From Consumption Based to Income-Based

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Notes

  1. 1.

    Some of its most famous advocates were Hobbes, Smith, Mill, Weber, Marshall, Einaudi, Pigou, Schumpeter, Fisher and Kaldor, who first implemented it, only as a supplementary tax in India (1958-1962) and twice in Sri Lanka (1958-1962, 1976-1978). Unfortunately, these attempts were not successful.

  2. 2.

    Some of the most famous contributions were made by Meade, Bradford, Lodin, Aaron and Galper, Kay and King, Hall and Rabushka, McLure and Zodrow, Boadway, Bruce and Mintz, IFS Capital Taxes Group, Rose and Wenger…(see for instance IFS 1978; Pechman, Ed. 1980; Bradford 1982; Bradford and the U.S. Treasury Tax Policy Staff 1984; Hall and Rabushka 1985; Rose, Ed. 1990; Kaiser 1992; Wiswesser 1999; Keen and King 2002…) including for instance the proposed consumption-based reform alternatives for the USA in the nineties-Nunn-Domenici USA Tax and Flat Tax (for instance Christian 1995; Boyer, Russell 1995; Toder 1995; Holz-Eakin 1996; Feld 1995) and some of first simulations (for instance Aaron, Gale, 1996; Ventura 1999).

  3. 3.

    For instance McLure 1991; Rose, Wenger 1992.

  4. 4.

    The famous Hall and Rabushka Flat Tax is mostly that type of tax.

  5. 5.

    The earlier proposals refer to corporate income tax only (for instance IFS 1978). Some later proposals advocate a uniform tax for the all business entities, including the corporate as well as the noncorporate sector [for instance the Nunn-Domenici USA tax as well as the Flat tax proposal for the USA (for instance Christian, 1995; Boyer, Russell 1995; Toder 1995; Holz-Eakin 1996; Feld 1995)].

  6. 6.

    R-basis, R+F-basis, but also S-basis (IFS 1978), R+A basis (Boadway et al. 1983), dividend tax (Kaiser 1992).

  7. 7.

    It is known as the "ACE" tax (Allowance for Corporate Equity) or "equity allowance" (IFS Capital Taxes Group 1991; acc. to Wiswesser 1999 and Keen and King 2002). The first proposal for this sort of tax was from Boadway and Bruce (1982) and Wenger (1983, 1985) (acc. to Wiswesser 1999 and Kaiser 1992). Rose and Wenger (1992) proposed it for Croatia (as well as some other transition countries).

  8. 8.

    Resulting even in «hybrid» models of direct tax on consumption (for instance see Bradford 1984; Kaiser 1992; Zodrow 2004). Still, the term "hybrid" in this paper is used mostly to denote hybridism between income-based and consumption-based tax models.

  9. 9.

    Since the relevant comparable data were obtainable for Russia too, it is also included in the analysis, although it does not belong either to the first or to the second group of transition countries.

  10. 10.

    Since the term «income tax» is not used in Croatia in relation to corporations/companies and their taxation (see next footnote), the term «income tax» is equal to "individual/personal income tax" and covers all individuals (including self-employed, even if they are some sort of partnership).

  11. 11.

    The term "corporate income tax" would not be completely appropriate. The payers of the profit tax are corporations, but also some part of the noncorporate sector (partnerships with "trader status" and even sole traders: the self-employed can opt to pay profit tax). In this way the typical distortion of the classical income tax concept-between the corporate and the noncorporate sector-was avoided, as the consumption tax concept requires, and this remains even now. On the other hand, it could be argued that it is simply replaced by the distortion between business units (enterprises) that pay profit tax and business units that pay income tax (see previous note). In order to mitigate the problem, the Croatian legislation has given the self-employed the option of paying profit tax instead of income tax (still relevant).

  12. 12.

    Prof. Manfred Rose from Heidelberg University.

  13. 13.

    In addition, capital income from the corporate sector (dividends and partly capital gains) is taxed once again because of the corporate income tax.

  14. 14.

    The middle part of this section is based mostly on Blažic (1998).

  15. 15.

    The term "enterprise" comprises here both profit taxpayers and self-employed income taxpayers, because the later had the right to deduct "equity allowance" too.

  16. 16.

    It was calculated by applying "normal" a interest rate (3% and later 5%) defined by the tax law and corrected for the inflation rate to the invested enterprise equity (at the beginning of the year).

  17. 17.

    Payments connected with debt capital.

  18. 18.

    According to its traditional (ex post) concept. The rethinking of the horizontal equity inside the framework of a "prepayment" consumption model results in its definition not as equality of results, but as equality of opportunities (Kay 1990).

  19. 19.

    Interest on debt capital.

  20. 20.

    Such a treatment of real estate is the result of the Croatian tax code having departed from the proposed reform draft of the Heidelberg KNS Group (Konsumorientierte Neuordnung des Steuersystems), in which the equity allowance concerning invested real estate capital was planned.

  21. 21.

    Official straight line rates were allowed to be doubled (depreciation period halved).

  22. 22.

    At the beginning of the reform the rate was only 25%, followed by the 3% equity allowance. In order to avoid distortions, because of the highest personal income tax bracket rate being 35%, the profit rate was raised to the same level, followed by the increase of equity allowance at 5% in order to offset the rise in the nominal profit tax rate.

  23. 23.

    For instance unrealized capital gains, imputed income, barter arrangements, income in-kind, nonmarket income in general.

  24. 24.

    Although even there his "pure" form was partially abandoned.

  25. 25.

    Some of them have even entirely moved to the flat tax (or taxes). The most known is the Slovakian case (19%), although here also Estonia (26% with continuous reduction to 20% in 2007) and Latvia (25%), as well as Lithuania (33% general rate, 15% for most capital incomes and some special incomes), Russia (3 flat rates: 13% general rate, 6% dividend rate and 35% for some special incomes) and Serbia (10%, 20% for capital gains) should be mentioned. Still, it should be mentioned, that the use of the term "flat rate" could be misleading, taking into account right "consumption-based" taxation literature. Slovakian tax (as well as "flat" taxes of other countries) should not be regarded as a Hall-Rabushka Flat Tax, which is an "interest-adjusted income tax" with cash flow taxation of business income (Hall, Rabushka 1985). The Estonian tax represents a unique form of taxation, which will be addressed in the next part. Still, in some way, this tax as well as the Latvian tax, is closer to a consumption-based tax than the Slovakian tax.

  26. 26.

    Still, although very favorable for higher incomes, it is not favorable for the lowest incomes (under the exemption threshold). It is not possible for the time being to include rental income into the individual tax return. So, the withholding tax paid can not be refunded, if the income is below the personal exemption. On the other hand, capital gains are taxed at a higher rate (35%), but still under the highest marginal rate (45%), which is also considered as final (no inclusion in tax return).

  27. 27.

    In cases of dual income tax (not accompanied by the imputation method) the assessment is complicated. Namely, by serving the purpose of a dual tax, the lower rate serves also for the purpose of the mitigation of double dividend taxation. In effect, dividends should be granted additional preferential treatment in order to fulfill both goals simultaneously.

  28. 28.

    The most appropriate integration method-the only one that completely follows the S-H-S logic is the full imputation method (corporate income tax treated as advanced payment of personal income tax (withholding tax) and shareholders taxed at their individual marginal tax rates).

  29. 29.

    Ireland is an interesting exception. It left the imputation system in 1999 and turned to the classical system.

  30. 30.

    Iceland and Germany were the last countries that employed these systems. Iceland abandoned its dividend deduction system in 1999 and Germany its split rate system in 2001.

  31. 31.

    It is interesting to note that some authors include the specific Estonian system of corporate taxation in that category-namely under "split rate" (Jacobs et al. 2003). In our opinion this is wrong, because "split rate" in the context of economic double taxation and its mitigation means in effect a normal (higher) rate on retained profits and a preferential (lower) rate on distributed profits (in order to mitigate economic double taxation of dividends). In Estonia we have the opposite situation (zero rate on retained profits and taxation only of distributed profits), which corresponds more to consumption-based taxes at the corporate level.

  32. 32.

    They could also be denoted as "shareholder relief" (Jacobs et al. 2003) when they reduce double taxation (full exemption of dividends results in the avoidance of double taxation).

  33. 33.

    Even a rising trend in developed countries.

  34. 34.

    The degree of mitigation of double taxation (called also «dividend relief») for the given level of income (marginal tax rate) is calculated according to the following standardized formula (OECD 1991, Cnossen 1993):

    \({\rm Degree}\,{\rm of}\,{\rm mitigation}\,\left( {{\rm degree}\,{\rm of}\,{\rm dividend}\,{\rm relief}} \right) = \frac{{{\rm Td}_{\rm k} - {\rm Td}_{\rm r} }}{{{\rm Td}_{\rm k} - {\rm m}}}\)

    where the following notations are used:

    • Tdk - Tax under no mitigation - Total corporate (profit) and personal income tax per unit of distributed profit where there is no mitigation = classical system

    • Tdr -Total tax burden - Actual combined (total) corporate and personal income tax burden per unit of distributed profit of the system where the degree of mitigation (dividend relief) is measured (here: the total tax burden in the Croatian system).

    • m - Tax under full mitigation = elimination of economic double taxation of dividend (where full dividend relief exists) - this tax burden corresponds to the marginal tax rate of the personal income tax.

    The dividend relief (degree of mitigation of double taxation of dividends) in Croatia is: 0% for first tax bracket - 15%marginal tax rate, 53% for the 25% rate, 123% for the 35% rate and 220% for the 45% rate. For the detailed calculations see: Blažic 2002.

  35. 35.

    Combined tax rate = Tdr. For separate tax rate (final witholding tax) Tdr = td + (1-td) w, where "w" represents a rate of final withholding tax. In the case of exemption Tdr = td + (1-td-e (1-td))m, where "e" represents the percentage (grade) of exemption (1=full exemption) and "m" represents the highest marginal rate of personal income tax.

  36. 36.

    For the details concerning EU accession and CEE countries see: IBFD: The EU Accession States Tax Memo, 2004.

  37. 37.

    Tax holiday could be an example, although not an adequate one, because it is temporary.

  38. 38.

    In the already mentioned examples of Italy and Austria, they are taxed at the lower rate.

  39. 39.

    With this change there is almost no tax on capital income for individuals (nonbusiness). The only exception is the real estate income and interests for the loans given.

  40. 40.

    Greece also has a 100% exemption.

  41. 41.

    In effect that means that the period of depreciation (years) could be halved.

  42. 42.

    Only for cars if the SL rate lowered from 25 to 20%.

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  1. Helena Blažić

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  1. Florida International University, NE., 151st Street 3000, North Miami, 33181, USA

    Robert W. McGee

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Blažić, H. (2008). The Croatian Tax System: From Consumption Based to Income-Based. In: McGee, R. (eds) Taxation and Public Finance in Transition and Developing Economies. Springer, Boston, MA. https://doi.org/10.1007/978-0-387-25712-9_23

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