Georgi Angelov
Senior Economist
Open Society Institute

The new flat tax regulation collects 10 per cent of taxpayers' income from the beginning of 2008, replacing the previous system, which combined several different tax rates - between 20 and 24 per cent, depending on income.

The introduction of a flat rate was the second step in the tax reform after the formalisation of the 10 per cent income tax in the beginning of 2007. These amendments have achieved two objectives of the reform originally proposed in 2004 and designed to reduce all direct taxes to 10 per cent (the original proposal was published in the first issue of The Sofia Echo, and included a 10 per cent tax rate for income tax and profit contributions).

The overall reduction to 10 per cent has brought about much-discussed effects: 
- high investment growth, reported during the first quarters following the reforms (in 2007 the economy logged a record 20.7 billion euro from investments) 
- high budget growth because of tax reduction (corporate tax revenues in 2007 were half a billion euro more than in 2006, despite the lower rate)
- more dynamic economy (it scored a two-digit real growth in other areas than agriculture in Q3 of 2007 for the first time)

The effects
Assessing income tax is more complex than assessing profit tax. Along with a 10 per cent flat tax, wages are taxed with almost 34 per cent in profit contributions. In other words, total social security tax is still very high, several times greater than tax on profits. While reforms in profit tax legislation are virtually complete, income taxation underwent a number of changes, yet the amendments did not achieve their initial objective of low taxation.

Although social security tax remains high, there are identifiable positive effects stemming from the introduction of the flat tax. It should also be pointed out that at the end of 2007 the social security tax was cut by three per cent.

In the first seven months of 2008, labour taxation revenue (tax and contributions included) increased, with more than 370 million Bulgarian leva compared with 2007. This happened in spite of the official forecast in the state budget that the contribution proceeds as well as income tax revenue would decrease.

Revenue growth comes directly from the income tax as follows:
- 19.4 per cent budget growth from taxation of employees with a labour contract; the effect of the flat tax here is expected early because tax is collected on monthly
- 6.8 per cent growth in revenue from income taxation in non-labour relations; here, one should keep in mind that taxation on this kind of income is made possible only after submission of tax return forms (meaning that the actual effect of the first year of the flat tax will be reported no earlier than May 2009 when the tax returns for 2008 will be filed)
- revenue from patent tax decreased in the republic's budget, owing to the fact that taxation is assigned to the municipalities and the state budget received only late payments from previous years; there are no municipality on the implementation of the patent tax, however this tax is a fixed amount with no relation to the introduction of the flat tax.

Employment and income increase
In the second quarter of 2008 the number of employees reached a record 3.37 million. The average salary has increased by 25 per cent, according to the latest statistics. The declared average social security income has increased at a similar rate, owing to the slight decrease of stimuli for evasion of income declaration.

In 2007, the Bulgarian middle class paid almost 45 per cent in taxes and social contributions for every one leva additional income. That percentage fell to 35 per cent in 2008. Although the burden still remains high, the reduction is significant because the greater part of every income increase now remains for worker, employee or enterprise.

Economic activity accelerates
Economic growth reached a record 7.1 per cent in the first half of 2008, unprecedented for that period of the year (excluding recovery after the 1996-1997 crisis when growth was slightly higher). Moreover, the higher economic growth in Bulgaria comes at a time when the growth rates in the European economy are declining, even going into recession in some EU countries.

In conclusion, the first months of the year have seen positive benefits from the introduction of flat tax - for the state budget, the individual taxpayer, and the economy as a whole. These effects will continue in the coming months and years, as will the 10 per cent income tax.

The favourable results from the reduction of two of the direct taxes to 10 per cent are a good template for the reduction of insurance contributions to 10 per cent as well. If this happens, the benign effects will be even more significant because the personal contributions are one of the biggest incentives for the presence of the underground economy and the greatest burden on labour income.

*The article was published in the Low Tax bulletin of the Institute for Market Economics