3 measures to stimulate the economy in response to the pandemic

After the purely health measures aimed at protecting the health of Bulgarian citizens in the current Covid-19 pandemic, the next package of measures that it will have to take are purely financial. The pandemic is causing enormous economic damage, with Europe being the most affected, given the massive spread of the virus in some of the most fragile European economies such as Italy. This will also have a very sharp impact on Bulgaria's economy, and recession is becoming an increasingly likely scenario. In this regard, the government will certainly take measures to stimulate the economy. However, it is important that these measures are well thought out, because if it makes the wrong decision, instead of alleviating it, the government could worsen the economic crisis.

1. Temporary tax holiday

The first measure that should be introduced is a tax holiday for all businesses that will be affected by the coronavirus, specifically the restrictive measures imposed by the government. This applies to all taxes – corporate tax, VAT, personal income tax. The same applies to social security. All businesses that are forced to close will start to accumulate losses due to the extraordinary cessation of activity. This will lead to a deficit of financial liquidity in these businesses.

This deficit can be addressed most effectively by easing the financial burden that the state imposes through the tax system. The introduction of a tax holiday would lead to an immediate influx of liquidity to compensate for the losses. Given that the total tax burden on labor in the country is 39.35%, short-term tax simplification is the most large-scale stimulus that the government can undertake.

The question is, how long should the tax holiday last? First, it is obvious that it cannot last only for the quarantine period, because during this period businesses are not working anyway. The tax holiday should cover a period during which businesses have already restored their commercial activity and are starting to accumulate revenues. Tax simplification will significantly increase net financial revenues for this period of restored work, in order to compensate for the losses from before.

Here we could take an example from other countries that have already introduced similar measures. In Greece, the government announced the simplification of VAT and social security contributions for a period of 4 months for those businesses that were closed in order to limit the spread of the virus. Our government could follow this example.

2. Abolition of corporate tax

The short-term tax holiday will most likely not be enough on its own to compensate for all the economic damage caused by the pandemic. A crisis is expected especially in Europe. Recession is certain in Italy and Germany and therefore very likely in other major European economies such as France and Spain. This cannot but affect Bulgaria. In the most optimistic scenario, in 2020, GDP growth in our country will fall dramatically and will not be higher than 1%.

The recession could turn into a longer and deeper one if it leads to a crisis in the Italian banking system, which could lead to the collapse of the financial system of the whole of Europe. This scenario seems very likely if Italy does not manage to control the crisis in the shortest possible time. If this happens, a recession is guaranteed in Bulgaria as well.

In this situation, Bulgaria's economy needs very ambitious incentives and financial relief for business not only in the short term, but also in the long term. The abolition of corporate tax is one such measure that we have already proposed in the past from the EKIP. The main advantage of such a reform is that it would stimulate investment. In colloquial speech, we call the tax on the undistributed profits of enterprises "corporate tax". This is the profit that is set aside for reinvestment in the business itself, and not distributed to the owners.

The most important thing for a quick exit from the crisis is the restoration of investments. Investments are what drive any economy forward and investment spending is the first to collapse in crisis periods. Eliminating the tax on retained earnings would give a serious incentive to enterprises in Bulgaria to invest more, which would at least partially offset the negative impact of the economic crisis.

3. Raising the threshold for VAT registration

Small and medium-sized businesses, which are the backbone of the Bulgarian economy, will suffer the most from the expected sharp deterioration in the economic situation. Most of the Bulgarian businesses are smaller in scale than their Western competitors and are therefore in a more vulnerable position. The best way the state can provide them with financial relief and stimulate their recovery from the crisis is by raising the threshold for VAT registration.

Currently, this threshold is only 50,000 leva annual turnover. This is an extremely low level at which businesses should start paying VAT. A business with up to 50,000 leva turnover is even more "micro" than "small". Bulgarian enterprises cannot be burdened with paying VAT, which is the heaviest tax for businesses, at such an early stage of their development. Therefore, it is advisable to raise the threshold for registration under this tax as much as possible. From EKIP, we are proposing 200,000 leva.

This would allow every new and small business in the country to develop more freely in the first stages of its economic life and thus accumulate a sufficiently stable financial base that allows it to bear the tax burden without bringing it to the brink of bankruptcy. Currently, the combination of the extremely low threshold for VAT registration and the critical economic situation caused by the coronavirus are putting crushing pressure on small businesses in Bulgaria, which will certainly lead to the closure of many small enterprises. The government can at least partially prevent this by raising the threshold for VAT registration.

What should the government NOT do?

In the current situation, it is very important to realize not only what measures should be taken to stimulate the economy, but also what it is highly advisable to avoid. This includes any state-guaranteed loans and other similar ideas for granting some form of crisis subsidy. Such targeted subsidy measures by the state should be avoided for two reasons. First, they are more complex and slower to implement than tax holidays and tax cuts, and second, they are not market-neutral measures and can easily be abused.

The first reason is the most obvious. From a purely practical point of view, introducing a tax holiday requires less administrative effort than designing a comprehensive program to subsidize distressed businesses through government loans or grants. Allocating such funding requires careful project planning and an assessment of all applicants in terms of exactly how much to allocate.

These measures are necessary to ensure that there are no errors in the allocation of resources and that financing is maximally optimized, so that the money goes to those who are in the most serious need. After approval, it also takes technological time to transfer the corresponding amount. All this makes the process complex and slow. On the other hand, the tax holiday is much easier to implement.

Moreover, targeted financial assistance can be easily abused. It is very easy to imagine how in Bulgaria, after the government announces a 200 million leva crisis fund, half of it goes to very specific businesses that are known to have connections with the authorities... and have not even suffered that much from the pandemic and the imposed quarantine. Alas, given the high levels of corruption in our country and constant suspicions of misuse of taxpayers' money, targeted crisis subsidization of businesses should be avoided as much as the coronavirus itself.

Conclusion

The great advantage of tax holidays and tax cuts is that they are market-neutral. They do not discriminate, but apply to everyone, and accordingly there is no way for any specific business to abuse power through lobbying or direct corruption. If the government follows the advice set out in this article, Bulgaria will be one of the economies in Europe that will recover the fastest from the inevitable crisis that the pandemic is bringing us into. If not, then we risk a short-term crisis turning into a long-term one.

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