BULGARIA TO INTRODUCE FLAT INCOME TAX

UNCLAS SECTION 01 OF 02 SOFIA 000962

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON PGOV EINV KCOR BU
SUBJECT: BULGARIA TO INTRODUCE FLAT INCOME TAX

1. (SBU) SUMMARY: Bulgaria's center-left government approved the
introduction of a flat 10 percent income tax on July 29. This
move, largely unexpected from a socialist-dominated government, aims

to boost domestic economic activity, stimulate investment, and curb
the grey economy. Business organizations and economists hailed the
decision, calling it "a fiscal revolution," while trade unions
voiced concerns about its impact on the poor. At the same time, the
government also approved its second pension hike of the year, a move
clearly aimed to please the Bulgarian Socialist Party (BSP) base
ahead of local elections scheduled for October 28. END SUMMARY
FLAT 10 PERCENT INCOME TAX

2. (U) On July 29 the Socialist-led ruling coalition, which also
includes the National Movement Simeon II (NMSS, soon to be called
the National Movement for Stability and Progress) and the
predominantly ethnic-Turkish Movement for Rights and Freedoms (MRF),
voted to introduce a flat 10 percent tax rate for personal income.
The current income tax rate ranges from 20 to 24 percent. After
expected approval by Parliament in the fall, the new tax rate will
come into effect January 1, 2008. The introduction of the flat
income tax comes on the heels of a similarly radical reduction of
the corporate tax rate to 10 percent, which came into effect at the
beginning 2007.

3. (U) The aim of the flat tax is to stimulate investment, improve
the business climate and curb the informal sector, which is
officially estimated at 10-12 percent of GDP, but which is widely
believed to account for 20-30 percent of economic activity in the
country. The GOB is also aware it faces stiff competition for
foreign investment from other East European countries in the EU and
even from neighbors Romania, Serbia, and Macedonia, which have
already instituted flat corporate and income taxes. With this in
mind, the government also decided to cut employers' social
contributions by three percent beginning October 1, a move strongly
praised by business.

4. (SBU) Katia Koleva, deputy head of the National Revenue Agency
and a Socialist Party official, told us that with anticipated
increased compliance with a flat tax, tax revenue is expected to
rise by 43 million leva (USD 30 million) next year. In addition,
she noted the flat tax would significantly simplify her agency's
examination duties, allowing the revenue agency to focus more on
collection control and monitoring which, in turn, will curb the
"grey" economy. Koleva lamented, however, that the government did
not adequately plan the public roll-out of the tax cut. She said
her party now needed to explain the social consequences of the flat
tax -- widely perceived as a "rightist" tax policy approach favoring
the wealthy -- to its traditional constituencies.
THROWING A BONE TO THE BASE

5. (U) Also on July 29, the ruling coalition approved a 10 percent
hike in pensions as of October 1, 2007. This is the second such
move this year. The new increase, totaling 100 million leva (USD 70
million),will be covered by a budget surplus which stands at two
billion leva (USD 1.4 billion) so far this year. The pension hike
is largely seen as a BSP populist move to please its core electorate
ahead of October 28 local elections.

6. (SBU) Insiders tell us that Finance Minister Plamen Oresharski,
a center-right financier known for his conservative fiscal stance,
did not favor the pension increase. He reportedly warned against
attempting to "mix center-right measures with leftist populism" and
urged the BSP to be more consistent with its economic policies.
STEALING A PAGE FROM THE OPPOSITION

7. (SBU) News of the flat tax brought predominantly positive
reactions from both the business community and economists. Business
has seen the flat tax as a tool for boosting economic activity and
improving the business climate, while leading to higher growth in
labor productivity. Krassen Stanchev, of the Institute for Market
Economics (IME),a long-time proponent of the flat tax and former
adviser to the opposition, noted with irony the fact that a
socialist-led government had nearly "removed IME's raison d'etre"
with the introduction of the tax. The center-right opposition
parties, whose economic platforms envision the introduction of such
a tax, criticized the decision as belated and said the government
could have reduced social insurance payments even further. Trade
unions in Bulgaria expressed concerns about the regressive nature of
the flat tax and its effects on lower income workers (i.e.,
relieving higher earners of a greater tax burden).
EXCISE TAX TO GO UP AGAIN


8. (U) To offset any potential revenue risks of the tax cut, the GOB
decided to increase excise taxes on tobacco (by 33 percent),coal
(25 percent),electricity (16.7 percent) and fuels (7.8 percent)
next year. These excise taxes will be raised again in 2009 in order
to reach EU averages. The excise tax increase is expected to
contribute mildly to inflation in 2008.


9. (SBU) COMMENT: By implementing this bold idea, first raised in
Bulgaria by reform-minded financiers ten years ago, the BSP-led
government has taken over one of the main economic initiatives of
the struggling center-right opposition. The move is likely to boost
economic activity and bring more businesses and employees into the
legitimate economy. From a macroeconomic standpoint, the combined
tax decrease and pension increase could increase household income.
That, in turn, may put additional upward pressure on domestic price

SOFIA 00000962 002 OF 002


1. (SBU) SUMMARY: Bulgaria's center-left government approved the
introduction of a flat 10 percent income tax on July 29. This
move, largely unexpected from a socialist-dominated government, aims
to boost domestic economic activity, stimulate investment, and curb
the grey economy. Business organizations and economists hailed the
decision, calling it "a fiscal revolution," while trade unions
voiced concerns about its impact on the poor. At the same time, the
government also approved its second pension hike of the year, a move
clearly aimed to please the Bulgarian Socialist Party (BSP) base
ahead of local elections scheduled for October 28. END SUMMARY
FLAT 10 PERCENT INCOME TAX

2. (U) On July 29 the Socialist-led ruling coalition, which also
includes the National Movement Simeon II (NMSS, soon to be called
the National Movement for Stability and Progress) and the
predominantly ethnic-Turkish Movement for Rights and Freedoms (MRF),
voted to introduce a flat 10 percent tax rate for personal income.
The current income tax rate ranges from 20 to 24 percent. After
expected approval by Parliament in the fall, the new tax rate will
come into effect January 1, 2008. The introduction of the flat
income tax comes on the heels of a similarly radical reduction of
the corporate tax rate to 10 percent, which came into effect at the
beginning 2007.

3. (U) The aim of the flat tax is to stimulate investment, improve
the business climate and curb the informal sector, which is
officially estimated at 10-12 percent of GDP, but which is widely
believed to account for 20-30 percent of economic activity in the
country. The GOB is also aware it faces stiff competition for
foreign investment from other East European countries in the EU and
even from neighbors Romania, Serbia, and Macedonia, which have
already instituted flat corporate and income taxes. With this in
mind, the government also decided to cut employers' social
contributions by three percent beginning October 1, a move strongly
praised by business.

4. (SBU) Katia Koleva, deputy head of the National Revenue Agency
and a Socialist Party official, told us that with anticipated
increased compliance with a flat tax, tax revenue is expected to
rise by 43 million leva (USD 30 million) next year. In addition,
she noted the flat tax would significantly simplify her agency's
examination duties, allowing the revenue agency to focus more on
collection control and monitoring which, in turn, will curb the
"grey" economy. Koleva lamented, however, that the government did
not adequately plan the public roll-out of the tax cut. She said
her party now needed to explain the social consequences of the flat
tax -- widely perceived as a "rightist" tax policy approach favoring
the wealthy -- to its traditional constituencies.
THROWING A BONE TO THE BASE

5. (U) Also on July 29, the ruling coalition approved a 10 percent
hike in pensions as of October 1, 2007. This is the second such
move this year. The new increase, totaling 100 million leva (USD 70
million),will be covered by a budget surplus which stands at two
billion leva (USD 1.4 billion) so far this year. The pension hike
is largely seen as a BSP populist move to please its core electorate
ahead of October 28 local elections.

6. (SBU) Insiders tell us that Finance Minister Plamen Oresharski,
a center-right financier known for his conservative fiscal stance,
did not favor the pension increase. He reportedly warned against
attempting to "mix center-right measures with leftist populism" and
urged the BSP to be more consistent with its economic policies.
STEALING A PAGE FROM THE OPPOSITION

7. (SBU) News of the flat tax brought predominantly positive
reactions from both the business community and economists. Business
has seen the flat tax as a tool for boosting economic activity and
improving the business climate, while leading to higher growth in
labor productivity. Krassen Stanchev, of the Institute for Market
Economics (IME),a long-time proponent of the flat tax and former
adviser to the opposition, noted with irony the fact that a
socialist-led government had nearly "removed IME's raison d'etre"
with the introduction of the tax. The center-right opposition
parties, whose economic platforms envision the introduction of such
a tax, criticized the decision as belated and said the government
could have reduced social insurance payments even further. Trade
unions in Bulgaria expressed concerns about the regressive nature of
the flat tax and its effects on lower income workers (i.e.,
relieving higher earners of a greater tax burden).
EXCISE TAX TO GO UP AGAIN

levels next year. Persistent inflation (7.3 percent in 2006) is
holding back Bulgaria's efforts to join the Euro zone. The tax cut
may also increase consumption, further aggravating the current
account deficit (15.8 percent in 2006),the country's most pressing
macroeconomic concern.

KARAGIANNIS