News

The Annual Regional Report for 2019 will be presented on January 30, 2020

Sofia continues to be Bulgaria's main economic driver, but the capital's labour market is already beginning to run out of energy and its expansion is becoming increasingly more difficult. This is clear from the Economic and Investment Profile of Sofia (link in Bulgarian), compiled by IME for the Sofia Municipal Agency for Privatization and Investments.

Sofia produced approximately 40% of the country's gross domestic product for 2018, a share that has gradually increased in recent years. However, the capital has a very different economic structure compared to Bulgaria as a whole, due to the significantly higher role of services, as opposed to a smaller share of agriculture and industry.

Due to the rapid expansion of outsourcing of services and information and communication technologies, the capital is among the districts in Bulgaria that are rapidly increasing their productivity. These subsectors combine a considerable part of the investments in the field and the commercial activity.

If the previous period of economic crisis is of any indication, even with the presence of a marked slowdown in Bulgaria's economic growth, Sofia is likely to remain  less affected than other districts, especially compared to those with an industrial profile.

At the moment the biggest challenge for further development of the capital's economy is its labour market restrictions. In the last quarters with available data employment in Sofia exceeds ¾ of the working-age population, and at the same time, unemployment has almost reached its natural minimum (depending on the quarter, about 10 thousand people), and going below that minimum would severely restrict the labour market mobility.

There are several sources of additional labour resources in the capital - the main one is the positive migration, thanks to which Sofia attracts many of the talented and educated workers from other districts in the country. Over the last two years, there has also been a significant increase in employment among the elderly (over 55 years), which means that companies are increasingly turning to them. Thanks to the boom in construction, even people with lower education are already able to find a job. The least used source of additional labour force for the capital so far is employment of foreigners, mainly due to restrictions on hiring people from third countries, and difficult competition with living standards in other European countries (although in some industries, especially in ICT, this is already changing).

If Sofia manages to overcome the restrictions on the labour market, there are positive prospects of its economic development. Due to its significantly faster growth, the capital is likely to continue to concentrate an increasingly bigger part of the country's economy, especially services, and to attract the best-educated and talented workers and entrepreneurs.

9 months ago, when the first version of the tariff for the new toll system was published, we commented in detail what the expected revenue would be for the state, what would be negotiated and why the government would be forced to make concessions. Today there is already an agreement which confirmed out expectations for the reduction of fees, but at the same time raises two important questions - will there be enough revenue and whether there will be another discussion this year about a new tariff update?

There are two major changes to the new tariff - one is the smaller scope of the toll system and the other is the reduction of fees. The change in scope was anticipated as the initial proposal covered about half of the republican road network - 10,800 km. from the road network, including second and third-class roads. Although some roads were predicted to be zero rate due to poor condition, the range was still too big. The new proposal is for the system to cover 3,100 km, such as highways and first-class roads. It is important to note that this was reflected in the state budget for 2020, with pledged revenues (BGN 450 million in 2020) being exactly within that type of scope of the system.

However, this is not the case with the tariff. The proposed toll taxes have undergone several changes, with the government backing down in the last option and simply accepting the industry’s proposal. The new taxes range from 3 to 20 cents per kilometre, depending on the size and environmental category of the vehicle. In the original version of the tariff, the taxes ranged from 8 to nearly 90 cents per kilometre. For the largest commercial vehicles (3.5 to 12 tonnes) the reduction is within 2.6 times - from 7.8 to 3 cents per kilometre for Euro 6 and from 15.6 to 6 cents per kilometre for Euro 1 and 2. For the heaviest trucks (over 12 tons and 4+ axes) the reduction is more than 4 times - a heavy truck with the highest Euro standard (Euro 6) under the new system will pay 11 cents per kilometre, while in the first version it would have to pay 45 pennies per kilometre.

The original version of the toll system projected BGN 1.3 billion in revenue. With at least double or even triple the scope and reduced tariffs within 2.6 to 4 times depending on the vehicle, the pledged BGN 450 million in the 2020 budget seems difficult to achieve. It is no coincidence that the ministry announced that after three months of commercial operation of the system, if the revenues are lagging behind the budgeted BGN 450 million, the tariffs will be updated. This is very likely to happen, meaning there will be new tensions between carriers and the government in the summer.

It is clear that the government's leading line now is for the system to start working without any further delay – even with the tariffs proposed by the industry, since investments in road infrastructure are already dependent on the expected revenue. Once the system is up and running, pressure could be used to expand and increase tariffs. Preparations for this are in place - even in the last proposal, for example, there are second-class roads, even with zero taxes, and the State Budget Act 2020 states that "in the coming years the plan is to extend the scope of the toll system and to cover second-class roads as well." In short, the long-term push will be for a broader scope of the system and an attempt to update the tariff, and the corresponding tension in the sector can be expected in the coming summer.

Northern Bulgaria will be held hostage to the new toll system and expected revenues more than other regions. The government's strategic infrastructure projects include the Vidin-Botevgrad express road, the completion of the Hemus highway, the Gabrovo perimeter and the Shipka tunnel, the Ruse-Veliko Turnovo highway and the Black Sea highway. These are projects that cover the whole of Northern Bulgaria and provide connectivity between the economic centres in the north as well as better connectivity with the southern industrial zones. If the toll system fails to meet the revenue targets, some of the investment in road infrastructure in the north may be delayed.

Sofia has been the champion of labor market development for the last five years - the capital has been among the fastest recovering municipalities since the economic crisis, and continues to create very new employment even against the backdrop of slowdowns in many parts of the country. In this presentation, we simultaneously look at the individual indicators included in the broader analysis and the projections for their future development.

During the past week the 2018 data for employment and labour costs on district level from the annual statistics has been published. This statistic is particularly interesting because it comes from company reports and is therefore exhaustive, as opposed to the Labour force survey, for example, which is a sample survey. The overall picture for 2018 is already known – the number of employees is only slightly increasing and is now about 2 320 thousand people, and the average salary in the country is increasing by over 10%. In 2018, the average monthly salary in Bulgaria ranges from 752 BGN in Blagoevgrad district to 1 586 BGN in the capital Sofia. However, breakdown by sector and by region is only now available and is particularly interesting.

An important focus is the manufacturing industry where more than 1/5 of the country's employees are traditionally employed. This is a sector where, following the major downturn in 2008-2010 (from 600 to 500 thousand employees), there seems to be little change at first glance - since 2010 the number of employees has been relatively constant, but in 2017 and 2018 they reached 520 000. However, the big change is within the industry itself - there is a constant decrease in employment in traditional sectors, such as clothing and furniture production (where the added value is EUR 6-8 thousand per employee), but at the same time there is growth in the production of electrical equipment, machinery, computer equipment, cars and other vehicles (added value of EUR 15-20 thousand per employee). That is why in the last 7-8 years we have been talking about the transformation of the industry, not so much about growth in terms of the number of employees.

The industry breakdown on district level shows where the dynamics are more noticeable. Although almost 100 000 fewer people worked in the industry in 2018 than in 2008, some areas not only did not lose, but even won more employees. In 2018 the districts Sofia, Plovdiv, Smolyan and Yambol had more people employed in industries compared to 2008, in Targovishte and Kardzhali the number is the same compared to 2008. While Plovdiv was a leader in the accumulation of new employees in the industry in 2016 and 2017, in 2018 the capital and the surrounding industrial zones on the territory of Sofia District came to fore, as well as the districts of Pazardzhik and Haskovo. The leader for 2018 is Haskovo with a growth of 7% (+1 000 employees) in just one year. For the first time a South Central Region takes away the first place from the Southwest by the total number of employees in the industry.

The good news, in terms of salaries, is that almost in all districts the salaries in manufacturing are already above the average. In 2013, for example, the year after which the industry started to increase slightly, the number of employees in more than half of the districts, including the ones in South Central region, the average salary in industry lags (10-15%) than the average for the district. In 2018, in more than 20 districts, including the ones in the South Central region, manufacturing salaries outstrip the district average. Apparently, the transformation of the Bulgarian industry into higher value-added sectors is leading to higher pay. It is logical that this process will continue and the skilled labour in the factories will gradually become higher-paid than others - be it seasonal work abroad or at seaside, farm labour, etc.

Let’s take a look at the most dynamic sector - information and communication technologies (ICT), in 2018 it creates the most job places (+4593 employees), and salaries are 2.7 times higher than those in the manufacturing industry. Here we can add the sector of professional activities (+2083 employees), which includes outsourcing and where salaries are 1.6 times higher than those in the manufacturing industry. In these sectors, however, the capital Sofia is the absolute leader - the growth of the ICT sector employed in the capital in 2018 is 3929, followed by Plovdiv with a growth of 400 people and Varna with 261. In all the other districts there is a negligible increase or even decline.

The total number of employees in the ICT sector in 2018 in these three leading districts is divided as follows: Sofia – 79 050 employees, Plovdiv – 4409, and Varna – 3796. In the ICT sector the following in the list of districts are Burgas (1230 employees), Ruse (890 employees), Veliko Tarnovo (830 employees) and Stara Zagora (695 employees) – there is no tangible growth in employment in 2018. There is an upward growth of salaries in the ICT sector in these cities, which shows a positive dynamic, but there is still a lack of growth in employment, which has been observed in Plovdiv, for example, in the last 4-5 years.

The overall picture in these two sectors is that the manufacturing industry has a marked regional orientation, with South Central region pulling ahead - first with Plovdiv and Smolyan, and in the last year with good results from Pazardzhik and Haskovo. Sofia and the industrial areas around the capital also show very good dynamics in 2018. In the ICT sector, the capital continues to be an absolute leader, which also increases salaries. Only Varna and Plovdiv manage to have a noticeable growth in the number of employees in the IT technologies and this has its effect on salaries. Secondary centres - such as Burgas, Ruse and Veliko Tarnovo still do not manage to follow the dynamics of the ICT sector. However, there is potential - also backed by various news stories in the current 2019, so it would be normal to see some movement in the near future.

10 days ago, IME published its Alternative Budget for 2019. As part of the presentation, we made it clear that we are facing a wave of local tax increases, which has also become a major focus of the event for the media (see here and here). To date, ideas for increasing local taxes are already a fact, with the largest municipalities - Sofia and Plovdiv also joining the race. Undoubtedly the biggest focus falls on Sofia Municipality, since the increase is the first in at least 10 years and usually media attention is focused on the capital.

Why are local taxes rising now?

Traditionally in Bulgaria local taxes closely follow the political cycle. Taxes are raised in the first and second years of the term of office, after which there is a quiet period until local elections are held (see local tax history here). Local taxes are specific - they are not automatic deductions (such as income tax or VAT), but are actually paid in the municipalitis by each citizen, which makes them extremely unpopular. In 2017 and 2018, for example, pension contributions were raised by 1 percentage point, which costs more than any increase in local taxes on an annual basis, but there was almost no public reaction. The situation is more complicated in the municipalities - any increase leads to a very negative reaction, which means that no one would do it right before local elections.

IME's review on local tax policy over the years shows about 60-70 examples of local tax increases in the years following the elections. The situation is likely to be the same now - in 2020 and 2021 at least half of the municipalities will take some steps to increase local taxes. Note that in this account we exclude the household waste tax, which will also go up. This wave of higher local taxes will, in a sense, respond to the call of the finance minister - municipalities to use their power over taxes more actively, but at the same time it will not dramatically change the structure of municipal budgets. Dependence on the state budget and European funds, on the one hand, and the lack of adequate resources for public investment, on the other, will remain the same. The topic of fiscal decentralization - the transfer of 1/5 of the income from the income taxation of individuals to the municipalities not only will not disappear, but will increasingly appear on the agenda. Financial autonomy cannot be achieved only with property taxes - 10 years of efforts to raise rates and increase collectability clearly prove it.

What happened in Sofia?

Anyone who closely follows the activities of Sofia Municipality knows that a rise in local taxes was on the verge of happening last year. The reason for that not to happen then was entirely tied to the election – looking at the results now it seems possible that a tax increase a year ago would have turned them in favour of the other candidate. The proposal now focuses on the acquisition of property and the taxation of vehicles. However, the two topics are not identical and it is better to comment on them separately.

One of the challenges that Sofia Municipality is facing is how to finance its investment program, especially in the new neighborhoods, where there is a lack of adequate infrastructure. And, if possible, this will happen as more burden falls on these new neighborhoods. There are two ways this can happen through taxes - one through changes in the property tax base, the other through a higher transaction tax rate. If the first cannot be done, you lean towards the second. This is happening in Sofia too.

The problem with the tax base of real estate

The real estate tax in Sofia is based on a very complicated formula for tax assessment of the property, which is based on the zoning of the capital. Depending on the area in which your home is, the coefficient for location varies from 28.1 to 93.6 per square meter - this is more than 3 times difference in taxes between neighborhoods. The current boundaries of the zones in Sofia were determined in 1998. These areas are undoubtedly out of date both because of the change in the dynamics of some of the old neighborhoods and because of the development of new neighborhoods which had a completely different look 30 years ago.

The big problem in the taxation of property in the capital is precisely in the tax base and specifically in zoning. However, change is politically difficult. The last proposal for such a reform was Minko Gerdzhikov’s in 2011. The proposal for a new zoning then caused a scandal and led to his resignation. Decision like that is difficult to make, but there is more to it. Municipalities (not only Sofia) expect that there will soon be legislative reforms that will change the formula for the tax assessment of real estate and/or directly link the tax to the market valuation. This would solve the city's problem with zoning, and especially when it comes to the new prestigious neighborhoods, without making a big deal out of it. However, waiting can also become a trap - postponing a decision because of expected legislative reforms, which can also always be delayed.

The environmental component in cars was introduced because of Sofia

While taxing transactions are connected with raising the tax burden, the situation is slightly different when it comes to taxing vehicles. The legislative reform at the end of last year changed the taxation of cars - the tax is now being formed in a completely different way, including the environmental component. This environmental component should be more of a burden to those with a low environmental category and should ease those with a high category. However, in Sofia, as in most municipalities in the country, for the current 2019, the levels of the environmental component remained minimum. They range from 0.40 to 1.10, which means that almost everyone receives a tax discount, with the exception of the Euro 1 and 2 categories, which receive a coefficient of 1.10 and EUR 3 (a coefficient of 1). In 2018, most of Sofia's vehicles pay a lower tax than in previous years. This is also evident from the half-yearly report of the municipality - BGN 6.5 million less are collected from vehicle tax for the first 6 months of 2018, and by the end of the year the difference will reach about BGN 10 million.

The proposal now takes advantage of the legal possibilities and raises the taxation of low-category vehicles (with a maximum legal rate of 1.40), eliminates the discount for cars with euro 4 (instead of 0.80 it becomes 1.00) and maintains discounts for euro cars 5 and 6.

And while these changes were anticipated - the law was changed mainly for the sake of Sofia Municipality, and it was clear that the capital would make the most of the differentiated rates - a little more surprising is the change in taxation and power, while affecting  everyone over 74 kW. Thus, the only ones unaffected by higher taxation will be cars up to 74 kW that have a Euro 5 or 6. Compared to 2017, if a car has a Euro 5 or 6, even the more powerful ones will probably not pay higher tax. The weight in this case will fall mainly on cars with Euro 1 and 2 and high power.

The role of regional mayors

All that has been said so far is trying to explain the general framework and specifically the situation in the Sofia Municipality. Higher taxes may not be good news for taxpayers, but in many places they were expected. Without fiscal decentralization and with poorly made property tax base, all municipalities have an incentive to push transaction tax upwards - it's no coincidence that this is the only tax at which municipalities go massively at the maximum rate (3 percent). The effect of the higher transaction tax in Sofia will be about BGN 20 million in additional revenue. In this case, it is at least a good idea regional mayors to spend half of the money collected - so there would be some competition as to who and how is coping with the public resource. Sofia municipality, in this case, is ready to take some steps for decentralization in the direction of regional mayors, and it is state’s turn to make changes in the line state budget - municipal authorities.

12 November 2019

TO

BOYKO BORISOV

PRIME MINISTER

COPY TO:

TOMISLAV DONCHEV

DEPUTY PRIME MINISTER

VLADISLAV GORANOV

MINISTER OF FINANCE

Open Letter

In relation to

The necessity of remising part of the revenue from personal income taxation to municipalities

Dear Mr. Borisov

We believe that a consensus exists as to the goal of achieving rapid regional development in Bulgaria and the continuous rise in the living standards of Bulgarian citizens, regardless of their location. During your recent travels around the country you must have noticed both the large discrepancy between the wealth of different municipalities, and the severe dependency of localities on constant financial transfers from the central government. Inevitably, the following question arises: Why do all municipalities, even regional centers with nearly no unemployment, regularly find themselves faced with financial troubles and are unable to independently influence the public environment and the lives of their own citizens?

With this letter, we would like to direct your attention to this exceptionally important tax reform whose essence is the remising of part of personal income taxation revenues to the budgets of municipalities. This reform goes beyond the financial framework of the budget and concerns a wider set of issues, including the very functioning of democracy in Bulgaria. A hospital in a regional center that lacks necessary equipment is not merely a budget matter, but a large problem for the entire health system of the country. A social housing that is on the brink of closure in a small municipality equally is not just a fiscal issue. Insufficient local budget for the provision of local transport undermines regional development and deters access to work, social and health services. Resources’ availability in regions, or lack thereof, impacts each aspect of our lives.

In 2018, regional level spending in Bulgaria reached 7.2 billion leva. Almost 5 billion of that amount are not regional resources – about 4 billion leva are transfers from the central government and roughly 1 billion is EU funding. The remaining 2.3 billion are municipalities’ own income, only 1 billion of which comes from taxes. In practice, of 7 leva spent at the regional level only 1 is revenue from local taxes. All the rest comes from state transfers, EU subsidies and non-tax revenue. This breakdown clearly illustrates the vast structural problem that faces local budgets in Bulgaria – municipalities have no adequate own resource and are entirely dependent on transfers (from the central government) and subsidies (from the EU taxpayer).

The want for sufficient own resources prevents municipalities from pursuing reasonable independent policies and makes them largely unresponsive to the needs and priorities of their populations. The problem is legally founded – the lack of free public resource is not the result of local governments’ failure. Revenues from taxation of incomes, profits and consumption which are generated at the local level are almost exclusively handed over to the central government. There are some exceptions but they are insignificant – patent taxes, levies on tourism, etc. Municipalities collect their own revenues, primarily through property taxes, which are highly insufficient for their needs, even when measures for improved tax collection have been enacted. Paradoxically, in the recent years of stable economic growth and budget surpluses, municipalities still suffer from lack of resources and expect governmental aid.

We believe that the moment has come for municipalities in Bulgaria to receive a share of the generated tax revenues from the economic activity of their own citizens. Discussions throughout the last 10 years have convinced us that the most effective means for solving this issue is for parts of tax incomes’ revenues to be ceded to municipalities. Thus, regional budgets will be way more connected to the condition of the local economy, the number of employed and their wages – What is a better stimulus for local governments to work to attract further investments and jobs?

Our proposal, which is well-known and has been widely embraced and shared by a number of other experts, is that 1/5 of the revenues from personal income taxation be automatically handed over to municipalities, as ‘money follow the personal ID’ – when an individual’s permanent address is in a given municipality, 1/5 of their income tax shall stay there. According to our own estimations, this would amount to about 800 million leva which would nearly double municipalities’ own tax revenues without any tax increases – we suggest a restructuring of revenues rather than heavier taxation. Naturally, this would allow for and require changes in the equalizing subsidy and municipalities’ responsibilities that we are prepared to discuss as experts. The goal is clear – that municipalities receive more own resources without anyone losing from the reform.

We are hopeful that fiscal decentralization shall be recognized as a central priority by the government. We find that the reform can be elaborated and supported by all interested parts within half a year and be completely applied with the correspondent legislative changes and the voting of the state budget for 2021. It is no coincidence that we send this letter a week after the local elections in the country. We did not want the question to be politicized and so decided to wait for the cooling of political passions. Presently, there are legitimately elected local governments – let this be the beginning of the change which would allow them to work successfully and in the interest of their citizens.

With respect,

Petar Ganev

Senior Research Fellow, Institute for Market Economics