The intertwined negative effect of a flat tax system and the Covid crisis. Evidence from Bulgaria.

Sofia, the capital of Bulgaria. Source: Wikipedia.

Bulgaria joined the EU only 14 years ago, in 2007. What has always been considered interesting about their economic system is that Bulgaria is one of the over 20 countries in the world to have implemented a flat tax for both personal income and corporate income. The flat tax rate corresponds to 10%, aiming at attracting foreign capitals and investors in order to relaunch the bad situation Bulgaria economy faces.

This low flat tax system was introduced in order to let Bulgaria retain the most skilled workers in the country, but at the same time to attract entrepreneurs. All in all, this was the aimed boost for economic growth.

It can be generally argued that a flat tax simplifies tax compliance and increases the revenues perspectives, but in Bulgaria this is not the case. The complexity of the relatively new system does not allow all of the different income categories to benefit from the taxation, as a high level is recorded of after tax inequality across the population.

It has been shown that this kind of system tends to favour the higher income households, thanks to a massive presence of exceptions for the rich, consequently leading to a deep polarisation within the system.

When the pandemic hit Bulgaria, the country’s economy was performing strongly. That was the case thanks to the adoption of a well defined set of macroeconomic policies. Data show that the unemployment rate was at its minimum levels and that the country was recording a 3% increase in the annual growth rate.

Nevertheless, Bulgaria has been slow to catch up with the rest of the EU and in 2019 it was still the EU Member with the highest levels of poverty (32.8% of the population at risk of poverty or social exclusion) and income inequality.

The income share of the top 20% of the population was 8.1 times higher than that of the bottom 20% compared to the EU average of 4.9 times (Eurostat, 2019). Since its introduction, the flat tax reduced income inequality by only 4% compared to a 13% decrease for EU countries with progressive taxation systems (Eurostat, 2021).

The COVID-19 pandemic has become a protracted international crisis raising health, economic and social challenges for the world’s population. Bulgaria is the European country with the lowest vaccination rate: only a fifth of the nearly 7 million Bulgarians are fully vaccinated (OWID, 2021). The crisis and the adoption of containment measures is having major repercussions on the Bulgarian national economy, which shrank by 4.1%, the most significant decline since the country's integration into the EU (OECD, 2021).

The Bulgarian and other EU leaders agreed on the adoption of the Next Generation EU in July 2020, a 750€billion recovery effort with the goal of navigating the pandemic and ensuring an effective post-recovery based on lowering inequalities and boosting employment, growth and investments in all EU member states.

The initial measures taken by the government such as wage subsidies and temporary tax exemptions helped to temporarily stop the disruptive effect of the crisis on the labour market, with a low reduction of employment.

What are the categories mostly hit by the pandemic?

Women have suffered disproportionate job and income losses because of their over- representation in the hardest-hit sectors of service-providing, with their jobs being 1.2 times more vulnerable than men’s.

Young aged women as well are facing a sharp increase in unemployment rates. Even here the number of women losing their job is disproportionately higher than that of men, this being justifiable by barriers to part-time jobs, nearly absent in the Bulgarian labour market.

The pandemic has heightened pre-existing economic and social inequalities. Low-income households and vulnerable groups, such as women, ethnic minorities and the elderly, faced disproportionate deteriorations in their socio-economic situations.

According to IMF forecasts (2021), income loss, consumption-related issues, such as rising prices and health expenses, as well as service disruption, will have long-term consequences, exacerbating existing inequalities. Reduced saving capacity, accentuated divide between urban and rural areas, uneven access to health and education are a few examples of such long-term inequality.

The need to introduce a fee specifically to allow for expansionary measures supports concerns regarding the sustainability of Bulgaria’s fiscal system when facing exogenous shocks. Similarly, as the flat tax system kept government revenues before the pandemic low, the measures adopted failed to reach the equity goals envisaged.