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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.