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Why Don’t We Have the Will to Improve the Investment Climate?

August 2015 - Corporate & Commercial. Legal Developments by Penkov, Markov & Partners.

More articles by this firm.

All investors, especially those from abroad, when asked about the investment climate in the country indicate a number of factors, besides tax rate, that influence their overall assessment. These factors relate to different areas of business and life in general, but have so far unfortunately gone unnoticed by governments.

Said factors are not only logical but also easy to comprehend by professionals and those who want unbiased reform and modernization of the country, aimed at motivating new initiatives, increasing confidence and understanding the significance of setting high goals. All this should be safeguarded by the country’s legal framework and given all needed support through concrete government measures, regardless of party affiliation, because it falls within the main priorities that can stop the economy’s collapse and young people’s overwhelming desire to seek opportunities abroad. Already emerged negative developments in our economy, all walks of life and the nation as a whole could not be halted without the immediate implementation of measures in the above sense. And such measures are not difficult to execute, they simply need to be understood and initiated in the first place.

There should be no fear of reform, especially not in such tense times. Quite the opposite – the strain will be reduced if such reforms are implemented, which aim at economic development and socio-public relations, as well as aiding investors, workers, pensioners andyoung people alike.

According to the World Bank, precisely the lack of reforms aiming to improve Bulgaria’s business climate is the reason for the country’s drop in Doing Business rankings. This applies even to starting up a company in Bulgaria and the respective, mainly bureaucratic obstacles, considering that a capital of BGN 2 is all it takes to register an Ltd.

All-round populism, detrimental to the entire society, needs to finally cease.

The 10% flat tax was introduced in 2008. Already the year thereafter, as statistical data shows, it undisputedly led to an increase in tax collection. Both investors and people should know that it is not feasible for every government to reconsider the already chosen taxation approach. Still, yet again, we discuss the pros and cons of the flat tax. Undoubtedly, there are a number of different taxation systems. But in the period since its introduction, our flat tax system has without any doubt stopped capital outflow and contributed to transparency in business. Ongoing ‘for and against’ discussion create only uncertainty and distrust.

The flat tax, which is and should be owed by everyone, creates the necessary taxation equity and solidarity, as a citizen with a BGN 500 income would pay only BGN  50 income tax BGN 20 000 salary – BGN 2 000. That is 40 times more.  The higher social security contributions should also be kept in mind.

Undoubtedly, the right way to go is to aim at higher wages, rather than to commensurate with the lowest incomes and make palliative populist decisions, in order to “please” those on low incomes. Let the state provide such a framework which allows for an increase in incomes.

In this respect, the tax system could be improved. For example, why introduce a maximum threshold on social security and health insurance contributions when they can be increased, while at the same time reasonably reducing them percentage wise. In the context of abovementioned example with a high monthly salary of BGN 20 000, the contribution for a self-insured individual will not be merely BGN 640, as is the case given the current max threshold of BGN 2 200, or BGN 703 in case of the planned BGN 2 400 ceiling, respectively BGN 680 or BGN 740 for an employee under a labor contract, but let us say BGN 2 500. These BGN 2 500 equal 12,5% of the salary, not the current 29,3%, which by the way would be unacceptable and a completely unfair discrepancy, beyond any principles of solidarity, and consequently - could not work. I am, however, convinced that whoever receives a salary of BGN 20 000 would be willing to pay BGN 2 500 in social security contributions. Of course, solidarity should go hand in hand with certain risk and service coverage.

The above also includes the necessary pension reform, going beyond increasing the retirement age. In order to achieve fairness and a working approach, it is essential that the maximum pension threshold in its current form be dropped, of course avoiding any automatism and taking into consideration expectations for a certain life standard in Bulgarian. It is not feasible and workable, nor is it stimulating for people with incomes of BGN 7 000 – 8 000, or even BGN 4 000 to 5 000, which represent the group of innovators, people who create added value in the economy, to be offered a pension of BGN 770, or 35% of the maximum BGN 2 200 threshold. There must be an end to this nonsense, which indeed induces apathy, indifference and unlawful behavior among employers and employees alike, who hide the bigger part of their remuneration. This incentivizes the grey sector, as well as working outside normal employment relations as governed by law. In turn, the economy is weakened and the state is deprived of an important source of finance for reforms. As a rule, pensions should not be lower than 60-70% of a person’s labor income. Still, in terms of solidarity, initially and for a fixed term a reasonable maximum limit, but not less than BGN 5 000, could be introduced.

Of course, mandatory and voluntary pension contributions should not be restricted and have to be recognized as an expense. At the same time an appropriate mechanism, incentives and security on part of the state are needed, which would guarantee the investment of these funds in the economy at the pension funds’ discretion.

With the introduction of the flat tax in 2008 even the scant regulation on family taxation, providing some additional tax incentives, mainly related to the number of children, was dropped. It looks as though since then all reasoning in this direction has been completely neglected, and although we hear from the Prime Minister that it might be wise to consider the subject, it will not happen in 2014. This is not only a huge mistake, but a huge waste of time given this powerful stimulus for consumption, production and trade – all three of which are economic growth "engines". The talk is, however, of an effective family income tax, inherently linked to state priorities, so that the joint resolution of family issues and state priority issues could create conditions of economic development. This could be the case when the state finally defines resolving issues related to refurbishment, with a view to the introduction of modern environmental and energy balances, household appliances aimed at energy efficiency, distribution of computers and spread of the Internet, trainin, and why not replacing the vehicle population, which currently averages 20 years of use and is a burden on us all, as a clear-cut state priority.

It would be wise for an annual income of BGN 3 000 or 4 000 (could be more) to be released from the taxation base, in case demonstrable expenses in areas designated as state priorities have been made. Moreover, taxation should be based on the average income per family member, i.e. families should not receive child benefits, but children should be counted as family members. No discrimination and/or provisionality should be allowed here either.

It is clear that carriers of increased consumption, who revive the economy, are not those families who earn less than BGN 1 000 to 1 500 monthly income and we should clearly not expect them to be. It would be even more wrong to direct our overall thinking towards creating legislation aimed at low incomes. Creating conditions for a significant increase in lower wages and solving important social issues comes with focusing on middle and high incomes, stimulating transparency and directing investment towards priority sectors in the economy, which would stimulate production and trade.

Along the same line of thought, there must be clear regulations, providing that only the individual’s income within an 8-hour working day is subject to tax. Income from a second job or from after-hours should be absolutely free of tax. Thus, the durable, the can-dos and the willing will be motivated to work effectively and sophisticatedly, creating significant added value, currently so important for the country.

Here again, the State needs to restore confidence and set up as a consensus priority such a policy and its economic framework for the next 20 - 30 years, which no government would dare to change.

There are also some potential reserves in the license tax, though not as it exists since 2008, applying only to natural persons and within very narrow limits. This tax could be a powerful tool for doing business in specific areas such as catering, services, the hotel sector and small manufacturers. Given the volume of work, such businesses should negotiate with tax authorities an annual tax rate, of course within criteria laid down by the law, thereby eliminating the need for both accounting and checks and audits by said authorities. This would encourage family businesses, significantly reduce the workload on state and municipal authorities, and will at the same time tempt not only young entrepreneurs to dare and try again to start a business.

Also important is that other businesses also enjoy collegial and respectable relationships with tax and other government bodies, which in return owe them proper respect as generators of added value that ultimately provides for life and growth in the country. And let the turnover of such enterprises be BGN 300 000, even BGN 500 000, while the tax rate is renegotiated between tax authorities and entrepreneurs on an annual basis. Be that as it may, since we have opted for coexistence of license and flat tax, which I am in favor of, the license tax must by all means be lower than the flat tax.

Particularly important is also that VAT refunds are not delayed more than 15 days, while the hundreds of redundant state and municipal licensing regimes further "poisoning" the investment climate, especially for SMEs, are lapsed. Only the most necessary licensing regimes, providing such state regulations which correspond with newly set priorities, should remain.

The government must without fail restore confidence in the State and in municipalities, which must once more become a preferred partner and reliable payer and not as of late, withhold payments, for various reasons and through various means, to bona fide companies, who have successfully completed their respective public procurement projects.

According to the World Bank, the need to issue a number of unnecessary documents related to the numerous redundant licensing regimes takes an average of 104 days, going through 18 procedures. These are most often applied to small SME investments, which in the end impedes any motivation to invest.

Of course, the effective functioning of the institutions must also be ensured. The latter should be required to adjudge within statutory deadlines and support the investment process. This should be applicable also to the judiciary. According to the World Bank, on average lawsuits continue  for 564 days and related expenses reach 23.8% of the claim itself, which, given existing well-known conditions for doing business in Bulgaria, is unacceptable.

Everything mentioned above must go hand in hand with the widespread introduction of e-government in accordance with best European practices. The latter amplifies the public authorities’ and their employees’ liability, while saving time and increasing security for citizens. A working principle of the tacit consent on parts of state and local authorities also needs to be introduced. This principle should fully and categorically replace the currently existing principle of silent refusal, increasing bureaucracy and creating conditions for corruption. Silent refusal is a product of the long gone years of socialism, but continues to influence even current free market relations. It effectively restricts competition and fair market contest practices, because where there are unnecessary licensing regimes and silent refusal, there are also rooted corruption conditions and as a matter of course, huge bureaucratic hurdles are put in place.

Vladimir Penkov