Economic analysts have welcomed caretaker Finance Minister Zdravko Maric's announcement of tax breaks but they warn that the planned tax changes are only one in a number of measures that need to be implemented to make the national economy more competitive.

Maric has said that as of next year the non-taxable income will be increased to HRK 3,700, that tax brackets will be expanded and the highest income tax rate lowered and applied to income amounting to more than HRK 20,000.

Maric has also announced that the profit tax rate would be lowered from 20% to 18% and that farmers and small business owners whose annual income does not exceed HRK 3 million will pay profit taxes at a rate of 12%.

"Reducing the tax burden and increasing available income for citizens would encourage consumption and a lower profit tax would facilitate business operations in the private sector," says Zrinka Zivkovic-Matijevic of Raiffeisenbank Austria (RBA).

Maric also intends to lower the general VAT rate of 25% by one percentage point once the GDP growth rate is higher than it is now. Before that is done, goods and services that are subject to a lower VAT rate will be redefined.

"However, the tax reform itself will not solve the structural problems of the public sector and the poor investment climate and it is only a small part in a string of measures that need to be taken," says Zivkovic-Matijevic.

Zdeslav Santic, the chief economist at Societe Generale Splitska Banka, believes lower taxes would encourage household consumption as well as help make the national economy more competitive.

Retail trade and personal consumption have been recovering for some time as a result of a higher available real income of households, resulting from earlier tax changes, deflation, and recovering employment, he says.

According to the latest data from the national bureau of statistics, retail trade in July grew in real terms by 4.5% on the year. July was the 23rd consecutive month to see an increase in retail trade. Consumer prices in August and July dropped 1.5% on the year, with deflationary trends entering their third year.

"However, citizens are more careful when taking loans than they were in the years before the crisis, so future long-term movements in retail trade and personal consumption will depend mostly on the real movement of salaries as well as on employment," said Santic.

According to the latest data from the central bank, household lending in late July this year was HRK 117.5 billion, 9.3 billion less than in July 2015. July 2016 was the 13th consecutive month to see a decline in household lending.

Santic welcomes the possible reduction of the VAT rate but warns about the pressure of deflation and the possibility of prices going down even more due to VAT reduction.

Santic warns that Croatia must not return to the pre-crisis model of stimulating GDP growth exclusively by boosting domestic consumption.

"Tax breaks will contribute to stronger competitiveness, but if competitiveness is not facilitated by other economic policy measures as well, economic growth will be fragile," says Santic.

He believes that the general purpose of the announced tax reform is good and that labour costs should be reduced as a way of boosting investments.

Revenues from income tax are predominantly used to finance local self-government units and their budgets could be faced with problems because the system of local self-government has not been reformed, Santic says, noting that this will require compensation measures. 

One should also avoid jeopardising local self-government units' financial capacity to participate in the co-funding of EU projects that are an important lever of economic development, says Santic.

"Real estate tax will have to be introduced in the coming period to compensate for a part of the revenues local self-government units will lose. That is still not being talked about, but that tax is necessary if labour costs are to be further cut, which is also Croatia's commitment to the European Commission," Santic said.

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