IZVIRNI ZNANSTVENI ČLANKI - ORIGINAL SCIENTIFIC PAPERS LEVEL AND PROGRESSIVE OF LABOUR INCOME TAXATION IN SLOVENIA: CHANGES SINCE 1991 AND INTERNATIONAL COMPARISON Raven in progresivnost obdavčitve dela v Sloveniji: spremembe po letu 1991 in mednarodna primerjava 1. Introduction In Slovenia, income from employment or labour income is one of the categories of personal income that is, as in the majority of the OECD1 countries, subject to a progressive tax rate schedule. Beside personal income tax (PIT), employees are obliged to pay compulsory social security contributions (SSC), which are (as in almost half of the OECD member states) proportional to gross wage earnings, but in contrast to several OECD countries do not have an upper ceiling. As in most OECD countries, PIT is being withheld from gross wages by the employer together with SSC every month as part of payroll accounting (so called pay-as-you-earn - PAYE taxation). By adding together net wage, PIT, and employee SSC (SSCe), we get the corresponding gross wage, which is subject to additional charges. In Slovenia, employers are liable for employer SSC (SSCf) and for a special payroll tax charged on gross wages. By summing PIT, SSCe, SSCf, and the special payroll tax altogether, we get the absolute value of total tax burden on labour income, which drives a wedge between total labour costs (labour compensation as paid by the employer) and net take-home pay of the worker. Due to different wage levels within and across countries, it is convenient to express tax burden as a percentage of total labour costs or tax base, respectively, which enables a comparative analysis of labour income taxation at the national and international levels. In this paper we adopt the established microeconomic measure of labour income taxation - the so-called tax wedge as defined by the OECD (2008).2 The OECD provides estimates of the tax wedge for only its 30 member states (including the Czech Republic, Hungary, Slovakia, and Poland). So far, there is no paper that would thoroughly analyse inter-temporal development of the average and marginal tax wedge for different wage levels in Slovenia and provide international comparisons. In this paper we provide an insight into the inter-temporal pattern of the level and progressivity of the tax wedge in Slovenia and illustrate the current international position of Slovenian workers regarding taxes. To estimate the level Organisation for Economic Cooperation and Development (OECD) Eurostat, on the other hand, calculates the implicit tax rate for labour income, which is a macroeconomic indicator calculated from national accounts data with the same structure as the tax wedge. However, the tax wedge is more indicative with respect to the incentive and behaviour of an individual worker since it shows variation in the effective tax rate across different wage levels and household types, and is therefore chosen for the analysis of labour income taxation in this paper. 2 mag. Tanja Kosi, Teching Assistant, University of Primorska, Faculty of Management Koper, Department of Economics, Cankarjeva 5, 6000 Koper, Slovenia. E-mail: tanja.kosi@fm-kp.si. dr. Štefan Bojnec, Full-time Professor, University of Primorska, Faculty of Management Koper, Department of Economics, Cankarjeva 5, 6000 Koper, Slovenia. E-mail: stefan.bojnec@fm-kp.si. Tanja Kosi* Štefan Bojnec** Abstract UDC: 336.226.112.1(497.4) The paper provides an overview of the main reforms of the labour income tax system in Slovenia since 1991. Since OECD does not provide estimates of the level of labour income taxation for Slovenia, average and marginal tax rates are estimated for the period 1991-2007 according to OECD methodology. Labour income tax progressivity is measured by coefficient of residual income progression. The results show that, despite important reductions of the marginal tax rates on labour income after 2004, the tax burden on labour income remains notably above the average for the OECD countries, especially for workers without children. The evolution of progressivity of labour income taxation shows a somewhat erratic pattern. According to international comparisons, the progressivity of labour income taxation is modest in Slovenia. Keywords: labour income, tax wedge, tax progressivity, Slovenia, OECD. Izvleček UDK: 336.226.112.1(497.4) Članek predstavlja glavne reforme na področju obdavčitve dohodkov iz dela v Sloveniji od leta 1991. Predstavljene so ocene povprečnih in mejnih davčnih stopenj za dohodke iz dela za obdobje 1991-2007, izračunane na podlagi metodologije OECD. OECD namreč za Slovenijo teh ocen ne zagotavlja. Ocene progresivnosti obdavčitve dohodkov iz dela temeljijo na koeficientu progresivnosti neto dohodka. Rezultati kažejo, da raven obdavčitve dohodkov iz dela v Sloveniji kljub pomembnim znižanjem po letu 2004 ostaja precej nad povprečjem držav OECD, še posebej za delavce, ki ne uveljavljajo otroških olajšav. Za gibanje progresivnosti obdavčitve dohodkov iz dela je značilen neenakomeren vzorec. Po mednarodnih primerjavah je progresivnost obdavčitev dela v Sloveniji zmerna. Ključne besede: dohodki iz dela, davčni primež, davčna progresivnost, Slovenija, OECD. JEL: H24, K34J30 and progressivity of labour income taxation in Slovenia in the last seventeen years, we employ the methodology of the OECD (2008). There are a few motives for this analysis. The first is that the OECD does not provide the estimates of average and marginal tax rates on labour income for Slovenia. These estimates could be widely used in academic research and in the formulation and evaluation of social and economic policies. The second motive is related to a lengthy list of past changes in the system of labour income taxation in Slovenia and discussions suggesting tax reforms in this field. The third one derives from the modest results of past tax reforms that have moved Slovenia only slightly closer to the average tax wedge in the European Union (EU), while most other new EU member states (i.e. Slovakia, Romania, Bulgaria, and the Baltic states) have decided to adopt more radical approaches. The paper is structured as follows. The introduction is followed by Section 2, which briefly describes changes in the labour income tax system since the declaration of Slovenian independence. In Section 3 we describe the methodology used for estimation of the average and marginal tax rates applied to labour income. In Section 4 we firstly analyze the evolution of the level of labour income taxation in Slovenia in the period 1991-2007; next we provide a detailed analysis of labour income taxation for eight family types in 2007. In addition, we illustrate the structure of the overall tax burden on labour income in Slovenia and draw parallels with the OECD countries. Section 5 presents an analysis of labour income tax progressivity in Slovenia during the past seventeen years and a comparison with other developed countries. Section 6 concludes by summarizing the main findings of the quantitative analysis. 2. Overview of the development of the labour income tax system in Slovenia Before turning to the methodology and the analysis, we briefly describe changes in the labour income tax system since the declaration of Slovenian independence. That will enable a good reasoning of the inter-temporal pattern of the level and progressivity of labour income taxation in Slovenia. Since 1990, when the foundations of the Slovenian tax system were laid down, several changes to the tax system have taken place. However, we address only those that are related to the taxation of labour income and used for the simulations of tax charges from wages in Slovenia for the period 1991-2007. Labour income is one of the categories of personal income and is thus subject to PIT. From the very beginning, each person in Slovenia is taxed separately and couples cannot opt to be taxed jointly. However, certain tax allowances depend on family circumstances. From the outset, the tax year matches up with the calendar year, which has remained unchanged. According to the 1990 PIT Act, taxes from income sources that were withheld during the year were cal- culated according to different tax rate schedules (e.g., tax rates for labour income were 12, 22, 25 and 30 percent of the gross wage). On the annual level (after submitting the annual tax return), the final PIT was assessed with respect to a progressive tax schedule with 5 tax brackets with rates ranging from 19 to 45 percent. The 1990 PIT Act did not assign any basic tax allowance to taxpayers but did, however, allow them to lower their tax base for the amount of their special expenses up to 10 percent of the tax base. Tax allowances for the first and the second child amounted each to 8 percent of the average gross wage in Slovenia. In 1993, a new PIT Act was adopted. It introduced several changes that came into force in 1994. It broadened the tax base and equalized withholding tax rates for different income sources. Tax rates for advance tax payments were harmonized with the annual tax rate schedule. The latter was made more progressive with marginal tax rates of 17, 35, 37, 40, 45 and 50 percent. The 1993 PIT Act restructured tax allowances by introducing a basic tax allowance equalling 11 percent of the average gross annual salary in Slovenia and lowering the allowable tax deduction of special expenses from 10 to 3 percent of the annual tax base. Thereon, the PIT rate schedule and the formula for the basic tax allowance was not changed until 2004. In 2004, the new PIT Act was adopted, which entered into force on 1 January 2005. The number of tax brackets was cut from 6 to 5, while preserving the top marginal tax rate of 50 percent (16, 33, 38, 42, and 50 percent). The threshold for tax-exempt income increased and higher tax allowances for children were given. Further changes to the tax code affecting labour income taxation were adopted in 2006 and are effective from January 2007. Thenceforth, there are only three tax brackets in the annual tax schedule with tax rates of 16, 27 and 41 percent for active income, with the highest marginal tax rate finally being lowered. Let us just mention that the 2006 PIT Act introduced dual income taxation with a flat tax rate of 20 percent on dividend and interest, and a flat tax rate on capital gains that depends on the holding period. The most important element of labour income taxation in Slovenia is compulsory SSC paid by employees and employers. The law of 1990 on SSC prescribed high contribution rates that were subsequently lowered several times. In 1991 the overall SSC rate amounted to 46.06 percent of the gross salary. It reached a peak in 1992, when SSC rates added up to 50.35 percent. Since 1992, the overall SSC rate was gradually reduced to 47.8 percent in 1993, 45.3 percent in 1994, 44.7 percent in 1995, and 42 percent in the first half of 1996. The overall SSC rate was additionally lowered by 4 percent by the introduction of the Social Security Contributions Act (SSC Act) in June 1996. From 1997 to 2001, the overall SSC rate was stable at 38 percent, while it was raised slightly again to 38.2 percent in 2002, and has not changed since then. In June 1996, at the same time as SSC rates for employers were lowered by 4 percentage points, Slovenia introduced a special highly progressive payroll tax on labour income paid by employers. The aim of this tax reform was primarily to reduce the tax burden for low-income workers and thus on labour intensive firms. The payroll tax is levied on gross wage payments of employees who are obliged to pay SSC under a special law. The tax is applied to a gross wage at progressive rates, which have been changed several times since the introduction of the payroll tax. Although this type of tax is relatively easy to collect, it has a serious drawback that is caused by the steep progressivity of tax rates. This is one of the reasons why this tax is being gradually reduced and will be completely phased out on 1 January 2009. In the next section, we present the methodology used to show how the described changes in the labour income tax system have affected the level and progressivity of labour income taxation in Slovenia. 3. Methodology We employ the methodology of the OECD (2008) on taxing wages to estimate the level and progressivity of labour income taxation in Slovenia in the last seventeen years. We focus on two microeconomic indicators of labour income taxation. The first indicator is the personal tax rate, which takes into account only taxes on labour income legally imposed on workers. We distinguish between the average and marginal personal tax rate. The average personal tax rate (ATRp) denotes the sum of PIT and employee SSC (net of cash benefits) expressed as a percentage of gross wage earnings: ATR = p PIT + SSCe (-cash benefits) w + PIT + SSC (1) This measure reveals the relative difference between gross wage earnings (W = w + PIT + SSCe) and net wage (w) of a worker and does not take into account taxes and SSC that are imposed on the employer. The marginal personal tax rate (MTRp) is calculated by considering the impact of a 1-percent increase in gross wage earnings on taxes and SSC imposed on employees. The second indicator is the tax wedge between total labour costs and net take-home pay (hereafter referred to as the tax wedge). The tax wedge is a broader measure of labour income taxation than the personal tax rate, since it takes into account all taxes and (employee and employer) SSC levied on labour income. We distinguish between the average tax wedge (simply called the tax wedge) and the marginal tax wedge, which play different roles in decision making concerning employment (see Cahuc & Zylberberg 2004, p. 766, and Sorensen 1997). According to the OECD (2008) methodology, the average tax wedge (ATW) is calculated on the basis of national tax legislation and does not relate to the actual tax revenue. The ATW is the ratio of total labour taxes to total labour costs as paid by a hypothetical employer: PIT + SSC + SSC, + T, - cash benefits ATW =-e-f-f-— (w + PIT + SSCe ) + SSCf + Tf (2) Hereby total labour taxes are defined as the sum of PIT, employee plus employer compulsory SSC, and any payroll tax (Tf) lowered by direct cash benefits for dependent children. Total labour costs are defined as gross wage earnings plus employer SSC and special payroll taxes (OECD 2008). It should be recognized that the considered total labour costs may not reflect the true labour costs faced by employers since they do not include food and mobility reimbursement (which are tax free in Slovenia). The marginal tax wedge (MTW) is calculated by considering the impact of a 1-percent increase in total labour costs (the numerator in Equation 2) on taxes and SSC imposed on employees and employers (the denominator in Equation 2). The OECD calculates the indicators for eight family types that differ by income levels and household composition. Following the OECD (2008) methodological approach, we assume that the annual income of a single worker or a family corresponds to their annual income from employment as there are no other income sources. It is expressed as a fraction of the average gross wage earnings of a full-time average worker (AW) covering industry sectors C-K in ISIC Rev. 3. We do not consider any income tax that might be due to non-wage income or other kinds of taxes. 4. Level of labour income taxation in Slovenia To analyze the level of labour income taxation in Slovenia in the period 1991-2007, we use the following indicators of labour income taxation: the ATR , the MTR , the ATW, and p' p' ' the MTW. Firstly, we illustrate the inter-temporal pattern of labour income taxation of a single individual without children. Afterwards, we show the values of chosen tax indicators for eight family types and illustrate the structure of the tax wedge in 2007. Lastly, we move to international comparisons. Figure 1 portrays the evolution of the ATW for a single person without children at six different wage levels since 1991 in Slovenia. Wage levels are expressed in terms of the gross wage of an average worker (hereafter referred to as average gross wage or simply average wage) in Slovenia in the respective year. Until 1994 we have two separate lines showing the ATW for the same income group of workers. The solid line refers to the ATW estimated on the annual level, while the dashed line refers to the ATW estimated on the monthly level. After 1994 the lines overlap since the 1993 PIT Act harmonized the monthly withholding tax rate schedule with the annual tax rate schedule. The curves are all hump-backed in the second half of the period but reach maxima in different years. We can observe that the ATW for workers earning at the most five-thirds of the average wage reaches its maximum level (51 to 55 percent, depending on the wage level) in the period 1992-1994. In 2007 the ATW for these workers is notably lower and ranges from 41 to 50 percent. The ATW for higher-wage earners reaches the maximum level in the period 2002-2004 (59 and 65 percent at three and five average wages, respectively). In 2007 the ATW for these workers ranges from 57 to 60 percent. Thus, while the level of taxation of low to medium-high wages started to fall in the early 1990s, the tax burden on the highest wages was not cut down till 2004. Figure 1: Average tax wedge (ATW) for single persons without children at different wage levels in Slovenia in the period 1991-2007 0.700 0.650 0.600 cn f 0.550 CP as I 0.500 C OD ! 0.450 "C! cä =E 0.400 < 0.350 1991 1992 1993 1994 1995 1996a 1996b 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year —■—67AW —» -67AW (annual) —*—100AW — * -100AW (annual) —A—133AW 133AW (annual) —•—167AW 167AW (annual) —s—300AW — o 300AW (annual) —e—500AW -O- 500AW (annual) Notes: Wage levels are expressed as a percentage of the gross wage of an average worker (AW) in the respective year. AW67, for example, denotes two-thirds of the gross wage of an AW. Other labels are interpreted analogically. The solid lines refer to annual estimates, while the dashed lines refer to monthly estimates. Monthly estimates refer to July of the respective year. The only exception is year 1996, for which we prepared two estimates: the first (denoted by 1996a) is for the period prior to introduction of the payroll tax, and the second (denoted by 1996b) refers to the period after introduction of this tax. We use the new definition of an average worker (see OECD 2008) over the whole time period to provide inter-temporal comparability of the estimates for Slovenia. Source: Authors' calculations. Figure 2: Marginal tax wedge (MTW) for single persons without children at different wage levels in Slovenia in the period 1991-2007 0.750 0.700 0.650 0.600 I 0.550 TO I 0.500