Bulgaria's plans to introduce a flat personal income tax and raise pensions will fuel consumption and worsen its main economic headache, the ballooning current account deficit, economists said on Monday.
The Socialist-led ruling coalition, whose popularity is eroding as Bulgaria remains the poorest European Union member, unveiled plans late on Sunday to introduce flat income tax of 10 percent from 2008 to boost living standards.
The leaders of the three political parties in the ruling coalition also decided to raise state pensions and lower social insurance contributions in October, which analysts said was an attempt to woo voters ahead of this autumn's municipal vote.
"This is too much to offer ahead of local elections. They should have waited until 2009, it is totally unnecessary," said Agata Urbanska, emerging Europe economist at ING Wholesale Banking London.
"You can easily imagine the current account deficit heading above 20 percent of GDP next year. Financing too is only worsening, so it is a very strange policy," she said.
The government said on Sunday it expected a current account gap of 17.2 percent of GDP next year, up from a previous forecast of 12.8 percent. Simon Quijano-Evans of Bank Austria said international rating agencies would also be worried about the growing pressure on the current account deficit and could cut their investment outlooks for Bulgaria.
Sofia runs one of the tightest fiscal policies in Europe, but is under pressure from the International Monetary Fund to rein in spending and surging imports further to counter its current account gap, which is seen at 18 percent this year. But with its popularity waning, the government is also under pressure at home to raise incomes and create more jobs.
Many Bulgarians say they are disappointed with the lack of progress in fighting rampant corruption and organised crime and raising living standards. The government said a current budget surplus of about 3.7 percent of GDP would allow it to raise state pensions for a second time this year by 10 percent from October 1 and lower contributions to the social insurance budget by 3 percent.
A 2008 draft budget, yet to be approved by the government, envisages a 10-percent annual hike in public wages after a similar rise this year. The government argued that the flat income tax would help attract more foreign investment, needed to make up for booming imports that outpace exports. Analysts, however, said slashing the corporate tax to 10 percent had failed to draw in big investment and Bulgaria should tackle problems like corruption to build trust abroad.
"Maybe it is about what the European Commission is going on and on all the time - corruption and organised crime. Maybe those are the issues the government should focus on, not flat tax," said Urbanska.
The European Commission has threatened to freeze some payments to Bulgaria, which joined the EU together with Balkan neighbour Romania in January, if Sofia fails to show tangible progress in clamping down on graft and organised crime.
Trade unions also criticised the government's plans for a flat income tax, saying the poor would suffer. The flat income tax would replace a graduated income tax, where monthly incomes of 180 levs ($127) were free of tax. The statistics office puts the average monthly wage at 384 levs.
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