It became quite exciting to follow the recent policy debate triggered by Bit Alliance’s initiative for introducing exemptions in tax policy for the software industry.
Namely, Government of FBiH initiated a process of adopting new Law on Personal Income Tax and Law on Contributions in this entity. Initially, it was planned by the Economic Reform Programme 2017-209 for these laws to be adopted in 2017. One of the aims of this policy change is to lower the aggregate contribution rate from 41.5% to 33% and introduce (effectively) two tax rates (0% for salaries up to BAM 800 – by increasing the personal allowance – and 13% for net salaries that exceed that amount), instead of the existing flat tax rate of 10%. I will not go into details or analysis here. You can take a look at the TV debate that includes representatives of government, a trade union and employers to get a sense of the current policy debate and familiarise yourself with different points of view.
To make the whole debate even hotter, Bit Alliance, an organisation that represents almost 60 IT companies, articulated a request for introducing exemptions in labour taxation for employees of IT (software) industry and submitted an amendment to the law (see the link for more details about the proposal). In a quick response, FBiH Tax Administration listed a few arguments against the proposal (including unequal treatment of sectors, employees – e.g. IT professionals in different sectors – and complexity of administering such policy solution), advocating for equal treatment of industries (sectors). However, the debate continued and, in the meantime, Bit Alliance released a statement, trying to defend their case, and AmCham BiH supported Bit Alliance’s proposal. In my opinion, none of the two sides defended their case strongly.
This is my humble contribution to the debate.
State Aid System in Bosnia and Herzegovina and the policy course: Should we promote vertical industrial policy?
Bosnia and Herzegovina adopted the state-level Law on State Aid System in 2012 (Official Gazette of Bosnia and Herzegovina 10/12), which is compatible with the EU acquis and it was articulated in cooperation with the European Commission. This Law regulates the conditions under which the government can support businesses or industries/sectors. The Law prohibits any kind of State’s support (subsidies, tax exemptions, grants, etc., see Article 2) to specific companies or industries/sector that could harm competition or competitive behaviour (Article 5), except for (1) agriculture and fishing, (2) military industry and (3) infrastructure. In that sense, this Law prevents so-called vertical industrial policy to some extent, but also signalises commitment of the country not to promote vertical support. Of course, the rationale behind this policy course is something that could and should be critically reviewed and discussed and there is a pretty vital debate among scholars and policymakers on vertical industrial policy in the EU and broader.
To learn more about the State Aid System in BiH, please take a look at the following:
- Law on State Aid System: https://bit.ly/2neENYY
- Foreign Policy Initiative’s (VPI) analysis of the State Aid System in Bosnia and Herzegovina: https://bit.ly/2o4mk1x
- Centres for Civic Initiatives’ (CCI) analysis of the State Aid System in Bosnia and Herzegovina: https://bit.ly/2o8fQ1J
- Commission Opinion on Bosnia and Herzegovina’s application for membership of the European Union, 2019 (assesses and discusses the State Aid System): https://bit.ly/2o4kD4b
Boosting informalities: Misuses of the proposed policy
As FBiH Tax Administration properly noticed – but poorly explained – the introduction of exemptions in labour taxation for IT sector would create a fruitful ground for misuses and informalities. A case of Romania is a good case to illustrate this assumption, as explained later in the text. It would require investing additional efforts and resources in monitoring and enhancing deterrence. Finally, it would be more complex to administer the measure. In that sense, along with a reduction in public revenues due to tax exemptions, it bears the risk of inducing additional losses as a result of increased informalities.
Unequal treatment of sectors: From injustice to market distortion
The proposed amendment is s sector-specific one and, therefore, tends to put a sector in a (more) favourable position rather than particular profession(s) or products (goods or services). Therefore, for instance, IT professionals in other industries would not be treated (in a legal sense) in the same way as their peers in the IT industry. However, there is a bigger potential problem than the issue of unequal treatment of sectors or employees in different sectors: it could create a market distortion by policy-induced widening of a gap between working conditions for IT professionals in the IT industry and other industries, meaning that it can boost “migration” of IT professionals from other sectors to IT sectors, at the cost of first ones.
Finding a justification in the wider economic benefits?
The IT/software industry is one of the fastest growing industries in BiH and deserves special attention of policymakers. It has a huge potential to advance other sectors and the economy as a whole through knowledge and technology spill-over effects. Also, it plays an important – if not crucial – role in the transition toward the 4.0 economy. However, these effects should not be overestimated. First of all, it is questionable if other sectors have a sufficient absorptive capacity to benefit from spillovers. Second, the IT sector in BiH is predominantly export-oriented and due to high demand on overseas market (which inflate prices), the services are usually not affordable or accessible to a large portion of domestic businesses. Third, existing analyses suggest that major portion of the IT sector in BiH is comprised of ITO (IT outsourcing) companies, which provide programming services to the overseas companies but do not invest in developing and trading their own products (software solutions). Finally, the IT sector is rapidly growing but it is still not among the top contributors to the domestic economy, whether it be measured as a contribution to GDP or job creation.
Romania as a role model: Behind the fairytale
Bit Alliance refers to the Romanian case as a good example: a simplistic narrative says that Romania has introduced a personal income tax exemption for IT employees, thus boosting the industry’s outcomes. Partially yes, but things are way more complicated than they seem. This policy created numerous challenges and enabled various misuses. For instance, companies were declaring a wider spectrum of jobs as IT jobs to take advantage of the measure. Therefore, the Romanian government has introduced some changes in 2016, by shifting focus toward start-ups and by adding:
the phrase ”final product” for the companies to prove that they have a software product at the end of the line and therefore receive the incentive for the employees. The phrase meant that companies that were making software by command for global markets could no longer get the incentive, just like many other from the outsourcing business. Also, the companies were eligible for the incentive after overtaking a level of EUR 10,000 in revenues from each programmer that worked for the software, including the start-ups for which there was no way of reaching the number very fast.
In other words, the rearranged policy applied for companies that are on the higher end of the value chain, i.e. this measure could be understood as a measure that promotes R&D-driven software (product) development and innovation and, therefore, has less of a “vertical” character (although it kept some degree of verticality), compared to pre-2016 approach. Having in mind that the software industry in BiH is dominated by ITO (IT outsourcing) companies, which deliver services at the lower end of the value chain, i.e. with lower added value, such a measure would not be applicable for the larger portion of the industry.
However, due to negative impact on the industry, the Romanian government decided to eliminate the phrase, lower barriers for start-ups, and expand the eligibility for the measure to IT professionals that work in non-software companies (making it profession-specific rather than sector-specific). In that sense, there is a list of job positions that are entitled to tax exemptions. Further reforms in fiscal policy, that occurred soon after this change, negatively affected the income of IT professionals – more details can be found HERE.
Conclusion: Instead of exclusivity
It is actually great news that the industry is trying to influence policy-making processes and ensure better conditions for doing business. Bit Alliance is a particularly successful player in this domain and already achieved to induce important policy changes. However, I consider the latest proposal as a not-so-well shaped initiative.
The software industry should definitely seek and advocate for a better policy framework and more favourable conditions for business development. Although the industry is the best in recognising its own interests and policy obstacles/bottlenecks that undermine the growth, I suggest considering and focusing on:
- Further reducing tax wedge, but without looking for any sectoral exclusivity in that domain. It should be a contribution to overall efforts oriented toward reducing the taxation of labour (personal income tax and contributions) and gradually shifting toward higher taxation of consumption (value-added tax) to ensure the stability of public revenues.
- Enhancing horizontal industrial policy in a way to ensure better policy instruments and measures for promotion of innovation, including tax incentives for R&D that could encompass deductions in labour taxation for the R&D staff. This policy, which would apply for all high-tech sectors, promotes technology advancement and could substantially contribute to moving up the value chain, i.e. ITO sector to move toward more sophisticated economic activities and own product development. See my blog post on this topic.
* Post reflects my own opinions and cannot be associated with institutions and organisations I am affiliated with.