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General assessment

2012 was rather good fiscal year for Bulgaria – while the economy is still underperforming, tax revenues almost fully recovered to their pre-crisis (2008) record high levels and the budget position was close to balanced, with deficit being far less than 1% for 2012. There were no big moves in tax policy, except for the introduction of 10% tax on interest payments from bank deposits – thus widening the base of the flat tax.

2013 already proved to be a challenging year for Bulgaria, with protests throughout the country and a caretaker government being appointed by the president. The social unrest in Bulgaria was fundamentally driven by the depressed labour market and the high electricity bills in the winter. While there are serious challenges ahead and a political uncertainty prior to the elections, one should note that there is no “fiscal fire” in Bulgaria. There are of course long term fiscal challenges – pressure of social systems (pensions, health), low fiscal reserve, the quality of public spending – but there are no immediate pitfalls that should be addressed in an urgent manner.

Fiscal Policy & Economic Recovery

Bulgarian economy is still struggling to recover from the crisis. While there is some anemic growth in the recent years, the labour market is still depressed – the bottom of the employment rate was hit late in 2012 and is one of the lowest in Europe (12.3% unemployment). The budget consolidated gradually, with revenues from taxes on consumption, traditionally dominating the budget, catching up in 2011-2012. Revenues from corporate taxation are still heavily depressed, meaning that the economy cannot generate profits, while the income taxation proved to be resilient to the economic downturn and the revenues stayed stable in the bad years and even increased a bit.

Bulgaria has faced budget deficits in four consecutive years (2009 – 2012) to the total amount of around BGN 5,4 billion (€ 2,7 billion) – with excessive deficits in 2009 and 2010. Those budget shortfalls were mainly financed from the fiscal reserve of the country allowing the public debt to stay relatively stable below 20% of GDP. Consequently, the fiscal reserve, mainly accumulated from budget surpluses prior to the crisis, is now down from more than BGN 10 billion (€ 5 billion) in 2008 to less than BGN 5 billion (€ 2.5 billion) in 2012, which puts it to the so-called “critical minimum”. Furthermore, most of these reserves can’t be used to cover budget shortfalls as they are part of separate funds with special purposes – for instance, almost BGN 2 billion (€ 1 billion) from the fiscal reserve are part of the pension “Silver Fund”, which shall be used (as written in the law) to cover future pension obligations and not current budget deficits. As the fiscal reserve is being used as a buffer throughout the year to finance immediate shortfalls in the budget – like payments in the beginning of each month prior to the actual revenues being collected – the lack of enough “free” financial resources in the fiscal reserve is a matter for concern.
The political crisis in the beginning of 2013 was not directly caused by fiscal policy and is not imposing any immediate threat to the financial stability of the country. The crisis was fueled by the lack of jobs and the higher electricity bills, which is quite a different story from the other European countries that experienced social tension, mainly due to fiscal policy and the so called “austerity”. While in other countries there was a need for a quick solutions to the political uncertainty, as immediate fiscal measured were to be adopted, in Bulgaria there is no “fiscal fire”, thus the caretaker government, which cannot vote any legislative texts, is perfectly capable of carrying out the budget as voted by the Parliament and keeping the sound fiscal position.

Direct Taxation (Corporate Tax & Income Tax)

Bulgaria has probably the lowest level of direct taxation (excluding social contributions) in EU with 10% flat tax for both corporate profits (introduced in 2007 – down from 15%) and income (introduced in 2008 – down from progressive scale in the range 20-24%). Moreover, the 10% flat tax on income in Bulgaria has no minimum non-taxed threshold, meaning that every lev (or euro) earned as a salary is being taxed at the same rate of 10%. Recently the flat tax is being debated, mainly due to the elections coming in 2013, but mostly regarding the income taxation and not so much the corporate tax.

When discussing direct taxation in Bulgaria, one should always note that most of the tax revenues in the country come from indirect taxation – that is VAT and excise duties, while the direct taxes are far from dominant. The main reason for that is the fact that Bulgaria is still a developing country, meaning that there is not enough capital or wealth to tax – the only way to fill up the budget is through taxation of consumption. Moreover, there is low employment and significant undeclared work, meaning that revenues from income taxation are in a way limited – that also explains the problems with social security contributions and the huge deficits in the pension system.
The revenues from direct taxation on income and profits are performing differently during the crisis. While revenues from taxing profits are still depressed, revenues from taxation of income proved to be the only tax that performed well during the crisis – they have risen even in the period of recession. The revenues from taxes on income are projected to reach BGN 2,5 billion (€ 1,25 billion), which is more than 3% of GDP, thus highest since the introduction of the flat tax. The 10% flat tax on income is performing well since it was introduced, meaning that the recent debate is driven mainly by social and ideological factors – even if it is not a dominant issue for the budget revenues, the flat tax is far more debated than the taxes on consumption for instance.

At the end of 2012 one of the main tax issues in Bulgaria was the proposal for introducing a 10% tax on interest payments from bank deposits – in practice widening the base for the flat tax. The arguments were mainly balancing between the effects for the budget – more revenues – and the implications for the banking sector – probably discouraging savings to some extent. At the end of the day the proposition was adopted and since the beginning of 2013 the new tax on interest payments is in place. The first few months of the year show that there is no serious impact on savings, but also, that the revenues for the budget are not significant. There is some talk against the new tax within the election debate, but most probably the tax will stay – fiscal authorities in Bulgaria have proven that a new source for revenues is not easily given away.

Indirect Taxation (VAT & Excise Duties)

Indirect taxes include VAT and excise duties on special goods such as fuels, cigarettes and alcohol beverages. Bulgarian tax regime is mainly oriented towards indirect taxation, meaning that the State prefers to tax consumption, rather than income and profits. To put that into perspective, revenues from income and corporate taxation combined are slightly less than those from excise duties only and almost twice less than those from VAT.

VAT in Bulgaria is set at 20% and despite the various discussions that took place in the recent years it is supposed to stay at that level for the years to come. Revenues from VAT are expected to recover and to reach almost BGN 8 billion (€ 4 billion) or close to 10% of GDP in 2013. This is above their record high 2008 level, meaning that revenues from taxing consumption are fully recovered. Some changes in the preferential VAT for tourism were introduced in April 2011 – a single reduced VAT rate of 9% now apply to hotel accommodation services regardless of whether they are a part of a tourist package or bought individually. Before that the preferential rate was 7%, applying only to tourist package services. While the rate was increased by 2 percentage points, the preference was in effect widen for more services (individual tourists included) – the data shows that the budget is losing more money from the new regime, as the tax base of the preferential VAT rate increased substantially.

Meanwhile, Bulgaria has to harmonize its tax regime with that of the European Union by introducing the minimum excise duties of the European Community on tobacco, alcoholic beverages, and fuels. Started in 2002, the harmonization process should be completed by the end of 2013. As a result, excise duties are the only taxes that are continuously increasing year after year generating some clearly negative effects. One example is the increased excise duties on cigarettes in 2010, which resulted in a collapse of the (official) consumption, while smuggling went up. Excise duties on motor fuels are also proving to be problematic, as the prices are increasing and EU obligations are seen as a burden to consumers. Nevertheless, excise duties are highly important for the budget, as the revenues are expected to reach above BGN 4 billion (€ 2 billion), which is more than 5% of GDP.

Additionally a new indirect tax was recently (2011) introduced in Bulgaria – a 2% tax is due on insurance premiums for insurance contracts covering risks on the territory of Bulgaria. The tax is to be collected by insurance companies but it is practically a burden for the insured – nevertheless the revenues are limited at around BGN 30 million (€ 15 million).

Social Security Contributions

Social security (including health) contributions are traditionally highly disputable in Bulgaria. In 2005 the contributions were above 40% of the gross wage, but following some consecutive cuts (mainly pension and unemployment contributions) prior to the crisis they went down to around 30% of gross wage. Since then, they stayed relatively stable (slightly up and down) and in 2013 the social contributions will be at around 31% of the gross wage, paid by both the employer and the employee in a certain ratio (as shown in the table). In addition, the contribution base was capped in the last years at BGN 2000 (€ 1000) monthly and any income above that level was not subject to any obligatory social security contributions. However, in 2013 the bar was put higher at BGN 2200 (€ 1100), meaning that those with higher income will pay the same obligatory social insurance rates, but at a higher base (up with 10%). The official data shows that around 100 thousand people will be subject to the higher cap – these are around 3-4% of the workers in the country.

In the last few years the so-called minimum social security thresholds for the main economic activities and professions were increased several times – regardless of the big drop in employment after 2009. These thresholds are being used as a minimum tax base for social security contributions and are playing important role in Bulgarian tax policy – official data shows that 1 out of every 4 workers is insured on administratively levied minimum thresholds. There are strong indications that this policy is hurting job creation, especially in less developed regions in the country.

Social Security Contributions in Bulgaria
(% of gross wage, capped at BGN 2200)
Social Contributions (2013) State Fund Private Fund
Total Employer Employee Employer Employee
Pension 17.80% 7.10% 5.70% 2.80% 2.20%
Illness & Maternity 3.50% 2.10% 1.40% X X
Unemployment 1.00% 0.60% 0.40% X X
Labour Accidents
& Professional Illness[[The rate for Labour Accidents and Professional Illness is averaged – there are
several rates depending on the labour category – varying from 0.4 to 1.1 percent]]
0.50% 0.50% 0.00% X X
Health 8.00% 4.80% 3.20% X X
Overall 30.80% 15.10% 10.70% 2.80% 2.20%

From 2009 on, along with social contributions paid by the employee and the employer (as in most European countries), the State itself started to pay social (pension) contributions for every worker – 12% of the gross wage. Those “new” State contributions, however, are more of an accountant’s trick than a real reform. Actually, the State had always made payments from the budget to the Pension Fund – the difference is that those payments used be called transfers (or subsidies) and are now called contributions. More importantly, even with these “State contributions”, the state pension fund is far from balanced and needs further government subsidies (transfers) to cover the deficits. The data shows that the sole pensions contributions – by employers, employees and selfemployed – are not sufficient to cover even half of all the pension payments.

In recent years the crisis put additional pressure on the pension system, which resulted in a long-term pension reform drafted at the end of 2010, but by being too soft and inadequate, amended in 2011. One the most debated measures in the plan is the increase of the retirement age starting from the beginning of 2012 – by 4 months a year until it reaches 65 for men (63 before the amendments) and 63 for women (60 before the amendments). While the “official” retirement age is being increased, there are still challenges concerning the so-called early retirement – the effective retirement age in Bulgaria is actually less than 60, because of the wide opportunities for early retirement.

One of the most heated controversies in the crisis years has been the partial nationalization of the private professional pension funds (2010) – those are actually early retirement accounts in private funds. Around BGN 100 million (€ 50 million) were transferred from the private funds to the State fund, with the idea to support the early retirement obligations for the next 3-4 years. Nevertheless, in 2011 the Constitutional Court ruled this as unconstitutional and the argumentation was astonishingly strong in favour of the personal accounts and against any right for a politician to make such decisions.
The recent years have seen the healthcare system in Bulgaria hit by a deep crisis; with ministers being replaced every year or two. The state of the system is still best describe as chaos – bad organization and artificial pricing, inefficient spending, perverse incentives and fraud, not to mention the absence of agreement on an expected reform. The health contributions are still at 8% of gross wage, which now go entirely and directly into the system. The so called “health reserve”, which used to be held at the Bulgarian National Bank (around BGN 1.5 billion or € 750 million) is no longer available, as it was “transformed” at the end of 2010 and actually used to cover budget deficits. Whether the health contributions should be split in some way and partly directed towards a chosen private health fund is still the object of debates. While accepted as one the biggest challenges in Bulgaria, the healthcare system is not at the centre of the election debate.

Further changes in the social security contributions are to be expected in the forthcoming years – not so much because of the election debate, but mainly because of the growing pressure for the budget. The long-term plan for pension reform is in place, but subject to minor or major changes – as we saw with retirement age in late 2011. The healthcare system has proven to be highly vulnerable in the recent years and it is expected to remain so in the years to come.


Fiscal policy in Bulgaria proved to be rather resilient in the recent years. The excessive budget deficits in 2009 and 2010 were overcome with no serious tax hikes – 10% flat tax on income and profits, and 20% VAT are still in place. Excise duties are going up, due to the EU policy, which has some negative implications and is driving a strong opposition against any attempts for tax harmonization within the EU. The political uncertainty in the country was not driven by fiscal policy and while there is a caretaker government in place with no legislative powers, there is no “fiscal fire” and the budget shall be conducted as written in the law – with deficit of around 1% of GDP. There are strong fiscal rules in place and the election debate shows that these rules are generally supported by most of the political parties. The biggest challenge is not so much the fiscal policy, but the anaemic economic growth and the depressed labour market. The social systems (pensions, healthcare) will be the long-term challenges and a more policy measures are to be expected in the years to come.

Petar Ganev
Institute for Market Economics, Sofia

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