Reduce inequality within and among countries

In most of the EU and other developed countries, a system of graduated income tax combined with a progressive social protection system serves to redistribute income from the higher to the lower income segments of the population, stabilizing the polity as well as the economy and ensuring relatively equitable access to social goods.  The system of taxation in BiH lacks a redistributive mechanism, as indirect tax revenues are distributed based on the relative amounts collected.  In RS nearly three quarters of its share is retained by the central government.  In FBiH, close to two thirds is distributed to the Cantons and the Municipalities, largely on the basis of size of population, reinforcing the dynamic of concentration of both population and wealth. 

Over the past 25 years, BiH has changed from a country with relatively low inequality and high social mobility, based on equitable access to social goods, to a country with a relatively high level of inequality and low social mobility.  Between 1985 and 2005, BiH moved from a relatively egalitarian income distribution to a much more unequal society. 

The rising trend in the redistribution of income to the upper 10% was flattened by the introduction of VAT in 2006, however the massive transfer of income to the top income decile remains unaffected.  A regressive tax system with virtually no redistributive functions either across income quintiles or territorial units reinforces a low level of social and economic mobility, which together with high degree of inequality in access to employment or public and social services, appears to be another driver of emigration.

The largest source of public income in BiH, after social insurance contributions is the Value Added Tax.  The system of taxation in BiH is deeply regressive with a 17% VAT on all goods and services, a 10% flat income tax with a low personal deduction, and social insurance contributions on which there is no lower limit.  As households with an income below the personal deduction level are extremely likely to spend their entire incomes on goods and services subject to VAT consumes another 17% of the net incomes of low wage individuals after the deduction of social insurance contributions.  High social insurance contributions are a significant disincentive to participation in the formal labor market and blanket VAT a major burden on the household budgets of the poor and vulnerable.  At this time, reductions in the social insurance contribution rate and increases in the personal deduction are under discussion in FBiH, as well as an increase in the VAT from 17% to 19%, with the introduction of certain exclusions. 

VAT is common among the countries of the EU, however in the large majority of them, specific categories of social goods are excluded. In BiH, the only significant exclusion is for the diplomatic corps. The policy discussions recommended below provide an opening for an equity-based re-examination of the tax system and its social impacts