Reform of Kosovo Tax System after Independence and Its Key Functions

In this paper we have analysed the initial circumstances which characterize tax system in Kosovo after independence. After the Declaration of Independence, it is of the paramount importance that Kosovo has undergone through a reform of policy and tax system by exploring more seriously the economic functions. However, policy and tax system of Kosovo should be more in function of economic development by achieving equilibrium between direct and indirect taxes, increasing efficiency of public expenditures and to offer more tax incentives. Designers’ preliminary requirement is to analyse fiscal, economic, etc., effects of each tax form which aims to apply in accordance with tax policy objectives and to analyse the role and effects of tax incentives to each tax form. Taking into account that Kosovo regarding the application of tax incentives of CIT, compared with other countries is the last, designers by using the experiences of other countries should apply more tax incentives in order that tax policy to be more in function for economic development.


Introduction
The Balkan states, in distinction to other European countries, made the economic transition, including tax reforms, under the influence of quite specific political factors and circumstances. Reformation of taxation systems constituted only one of the main components of the reforming process within the socialeconomic transition. The designing of an appropriate and functional taxation reform has not been an easy objective to be reached in any of the Balkan countries. This is due to the fact that all post-communist countries possessed taxation systems drafted for the planned economy and incompatible with the market economy and with a tax administration which needed a complete reorganization for the purpose of a successful operation in new conditions 1 . Difficulties have especially risen in making the reforms acceptable and then successfully implementable. Every Balkan country, involved in making a tax reform, went through a specific path, different from another country.
Each tax reform in each country, therefore, bore in itself certain features. However, the trends were common. In this context, all the Balkan countries in different years applied VAT, corporate income tax, and personal income tax in their tax systems.
In the long historical context, the policy and tax systems of Kosovo were followed during their evolution by many changes that were made based on the challenges of the political and socio-economic structure of Kosovo (initially the structure on the Federal basis, then the structure by the UNMIK administration), as well as those of socio-economic relations in the production process.
The transition process, which in early '90s encompassed many countries of Southeastern Europe, found Kosovo initially in a situation of an undeclared war, which broke out in 1998 and ended with the Kumanova Agreement (Military Technical Agreement) on 10 th June 1999. On 10 th June 1999, the UN _____________________________ Iliria International Review -2013/2 © Felix-Verlag, Holzkirchen, Germany and Iliria College, Pristina, Kosovo Security Council approved Resolution 1244, by which UNMIK was created 2 and therewith the sovereignty of the SFRY over Kosovo was abolished. Until final status settlement (2008), resolution 1244 vested UNMIK with legislative, judicial and executive powers 3 . Upon UNMIK installation in Kosova, the Central Fiscal Authority in cooperation with World Bank, The Europian Commission and the International Monetary Fund, started the work in formulation of measures and strategy for creating an efficient tax system in the spirit of the overall economic and social development of Kosova. The creation of the policy and tax system in Kosovo by UNMIK is a sui generis case, as it was created in practice without any internal influence and without a political dialogue of Kosovar actors.
The highest authority of the fiscal power in Kosovo from 1999 till the Declaration of independence of Kosovo, on 17.02.2008, was the Special representative of the Secretary General (SRSG) of the UN together with the Fiscal Economic Council as an advisory body to the SRSG for fiscal policy issues 4 .
Fiscal policy of Kosovo, which was set in 1999 by UNMIK, has had only fiscal functions, and not the function of economic development.
After proclamation of independence, the fiscal sovereignty moves from UNMIK to the Kosovo Institutions, respectively to the Parliamet of Kosovo, as the greatest taxing power in applying taxes through tax laws. In this way, Kosovo institutions inherited a policy and tax system designed by UNMIK, which mainly had fiscal functions. This, due to the fact that the main objective of policy and tax system was gathering funds for financing foreseen public costs, by not giving importance to the economic and social functions which can be achieved through policy and tax system. So, policy and tax system inherited from UNMIK had a very limited function vis-à-vis socio-economic needs of Kosovo and trends of taxing competition in Balkan countries. In such a situation, creators of tax policy of independent Kosovo were forced to consider the reformation of system and tax policy. In this context, after proclamation of Independence, Kosovo government has made the first tax reform. Therefore, the aim of this analysis is highlighting some of basic specifics which characterize policy and tax system in Kosovo, after proclamation of its independence in the case of its reformation. For this purpose we have made these questions: which are the specifics which characterize tax structure of Kosovo tax system before and after the independence proclamation? Which are _____________________________ Iliria International Review -2013/2 © Felix-Verlag, Holzkirchen, Germany and Iliria College, Pristina, Kosovo the components that constitute tax reform? Which are tax incentive measures that are applied in the tax system of Kosovo?
In this analysis we have used the research method of case study, based on theoretical and empirical data. Furthermore, the methodology of the research is based on analyzing taxing laws based on which the system and fiscal politics are developed, as well as reports of Ministry of Finances. For comprehensive purposes the analysis of case in Kosovo was made based on different papers which talked about transition countries, based on reports of IMF, World Bank, reports of Ministry of Economy and Finances, as well as other secondary sources.
Apart from introduction, paper is laid out as follows: Part II analyzes the structure of Kosovo tax system after independence. Part III presents the overview of tax reforms in selected Balkan countries -Kosovo Case. Part IV has to do with an analysis of Tax incentives -the Kosovo Case. At the end conclusions are given.

Tax structure of Kosovo tax system after Independence
The countries in transition have applied different tax forms as far as the selection of their tax structure is concerned. Countries with higher per capita income and with a more developed tax administration have a tax structure resembling more the European Union countries. This was a result of the efforts of these countries to become the EU members through the harmonization of their tax systems, whereas countries with lower income (revenues) and with a poorer tax administration have built their tax structure on the basis of indirect taxes 5 . For the purpose of analysing the development of Kosovo tax structure after independence, we have analyzed it for the years 2007, 2011 and 2012. From the analysis of tax forms that existed before independence, in 2007, the indirect income tax has in general prevailed.  From the shown data on table 1 for 2007, it can be seen that the policy and tax system that year relied on indirect tax basis as well. More than 74.62% of tax income was collected from border taxes, customs, VAT and excises. Despite many declarations of fiscal policy creators about the balancing of indirect and direct taxes, this seems far in the prospective, as only 25.3% of the income was collected from internal taxes, respectively from direct taxes. This was very clearly specified in the 2008 report 6 of the European Commission, which, referring to the tax system, says that there was lack of progress.  From the analysis of the structure of Kosovo's general public incomes, after the proclamation of the independence, it appears that before and after the proclamation of the independence, indirect taxes have dominated, as well as Customs and VAT. In the year 2011 and 2012 we had the same report of participation for direct and indirect taxes such as in previous years.
From the data in the table for the year 2012, it is shown that the policy and the tax system, also after the independence, continue to be based on indirect taxes. Almost 55% of incomes from taxes are gathered from border indirect taxes, customs, customs VAT and excise. From the data given for the level of income gathered from internal taxes (no border) in year 2012, which is 18% of general budget incomes, it results that declarations of creators for carrying tax burden from border to the inside, respectively for creating an internal tax system, still remains far away from achieved. Differently from the year 2012, in the year 2011, the incomes from indirect border taxes were even bigger, respectively they were taking part in general budget incomes with 64%, while tax incomes from the internal taxes were taking part in general budget incomes with 20%. Such structure, was impacted by the low level of incomes, not well consolidated tax administration, as well as the inherited aim from UNMIK, which was the accomplishment of fiscal functions, respectively gathering of foreseen funds, not taking in consideration other functions of fiscal policy, such as those economical, social, etc.

Tax reforms in selected Balkan countries -Kosovo Case
The Balkan countries, similar to the European countries (states) and other states of South-Eastern Europe constantly reformed their tax systems by reducing the rates, redefining the tax bases, and making amendments and clarifications of the existing laws interpretation. Parallel to the reduction of tax rates, the reduction of tax deductions and exemptions, as counterreimbursement for the tax rates reduction, was made. In this sense, in the following table we have presented the tax rates reformation in the selected Balkan countries and Kosovo. In the process of tax systems reformation, among other things, two trends should be distinguished -a) the trend of reduction of the main tax rates with a special emphasis on corporate income tax, and b) the aspiration and acts of all the Balkan countries for membership in EU, by adopting the EU rules. The Government of Kosova has since 1 st January 2009 changed only tax rates of main existing taxes, respectively has reduced tax rate of Corporate Income Tax (CIT) from 20% to 10 %, has reduced tax rate of Personal Income Tax (PIT) from 0%, 5%, 10% and 20% to 0%, 4%, 8% and 10%, which means that the highest rate of this tax will be 10% for taxpayers' and business activities. In contrast to above mentioned taxes, tax rate of VAT was increased from 15% to 16%. In this sense, in the following table we have presented the tax rates reformation in the selected Balkan countries and Kosovo.  Table number 3 shows that the main orientation of tax reforms in Balkan countries, was reduction of tax norms and that this was done mainly aimed at attracting foreign investors, respectively to create a competitive taxing system in Balkan region. The comparison of CIT norms of Serbia, Montenegro, Macedonia, Albania, Kosovo and Bosnia & Herzegovina, with average norms of EU CIT, we might say that Balkan countries have lower norms and that low norms of CIT can be qualified as tax incentive. Regarding Kosovo case, creators of tax policy in January of the year 2009 did a reduction of tax norms in two main forms of direct taxing, CIT from 20% to 10% and Personal Income Tax from 0%, 5%, 10% and 20% to 0%, 4%, 8% and 10%.
At CIT, creator's aim was that through reduction of tax norm, to increase the competition capacity of Kosovo vis-à-vis foreign direct investments, respectively CIT norm to be harmonized in the level of existing norms of CIT that were already existing in Balkan countries.
At the case of PIT creator's aim was to achieve another objective; that of fighting fiscal evasion, respectively attracting tax subjects so that by stimulating with tax burden they move from subjects of gray economy to subjects that manage to carry out their tax obligations.
Unlike two above-mentioned forms, by the increase of VAT norm from 15% to 16% creators had fiscal intentions, respectively the aim was to do the compensation of public incomes that would be lacking along with decreasing of tax norms of CIT and PIT.
Except decreasing of tax norms, Balkan countries have applied few numbers of tax incentives in order to simulate foreign investors, which we will address onwards.

Tax incentives -the Kosovo Case
In function of accomplishing such intentions, Balkan countries in their tax systems have applied various mitigating measures that in tax theory 7 are known as tax incentives. Taxing incentives are included in various forms, which are presented as tax relief, tax holidays, and reduction of tax base, or relief from tax obligation. Tax incentives are instruments with which countries are served aiming at favoring specific categories of tax payers (specific sector, enterprise or individual) and in function of simulating specific economic activities.
Through tax incentives, the state intentionally accords for reduction of public incomes which will have in disposition. This for the fact that state achieves the same effect if it would gather this portion of taxes, and which later through budgeting costs in indirect manner it would share through subventions for sectors and specific activities. The incentives' application causes decrease of budgeting incomes and this phenomenon in tax theory is called tax expenditure. In tax theory, single and accepted definition related to tax expenditures doesn't exist. In this context, most proper definition would be that tax expenditures include all the measures, which are undertaken in the existing tax form with which losses of budgeting income are caused due to decreasing of taxing base or tax obligation. In this case a portion of incomes isn't calculated at all, as it flows from specific tax form.
This part of incomes that is not calculated and isn't gathered from this specific taxing represents what is called tax expenditure.
While, according to the classic tax theory, tax incentives do not have any important role in simulating investments and economic developing, in contemporary tax theory, tax incentives are seen as very important and influential in this direction. More specifically, in old tax theory there is a conclusion that role of tax incentives in relation with foreign investments is secondary compared to basic determinants, such as the size of a state, approach in unwrought materials and availability of a qualified working force.
Investors, in general, attempt to adapt two-steps process in the case of evaluation of one state, as a country for investments. In the first phase, they analyze country based on its basic determinants.
Only those states that have been through these criteria are taken into consideration in the future phase of evaluation, where tax norms, grants and other incentives can be important. Therefore, tax incentives in relation with foreign investments only have the secondary importance.
Different from classical theory, contemporary theory 8 sees tax incentives as a very important factor and decidive in this direction. As a base of such stance is the fact that in globalization area, all the countries have undertaken the same measures,as states with full investments, as well as also for economical-regional intentions they have undertaken same measures with those of European Union, where the process of tax harmonization and mutual economical politics are more intensive than ever.
In tax systems of Balkan countries since the beginning of the process of tax reforms, an important number of tax incentives are applied and are still being applied with added intensity.
In this context, tax incentives mainly are related to Corporate Income Tax (CIT).
Relevant literature about tax incentives to CIT, have grouped the tax incentives in few groups such as: reduced norms of CIT, taxes decreasing, incentives for investments in a wide concept, which covers tax incentives as an accelerated amortization, tax credits in disposition for investments, decrease for qualified expenditures, decrease or zero norm, amortization based on employment, etc.
The role of tax incentives of CIT at the foreign direct investments promotion has been the object of various studies, but their disadvantages and advantages never have been clearly defined. In practice, spectacular successes have Another issue that needs to be stated is lacking of proper analysis and reports for tax expenditures that Balkan countries have in the moment of application of tax incentives. While analysis and reporting of tax incentives in developed countries is done regularly in budget process, this doesn't happen in developing countries. And even if Balkan countries do this, these analysis and reports are not adequate and are not described in details.
In the context of this analysis for comparison of Kosovo case the main emphasiz will be put just upon tax incentives to CIT. A great number of tax incentives are applied inside of this tax form in contemporary tax systems of the world, excluding Kosovo that still applies them very poorly (Table no. 2) In the given table, it can be seen that Kosovo in comparison to the compared countries, applies tax incentives very little, by making that policy and tax system in this segment not being in function of economical development.
From the study done by the American Chamber of Trade through surveying companies which have invested in Western Balkan and Southeast Europe it shows up that one of the main causes of hesitations to invest in Kosovo is the non-existence of enough tax incentives, respectively disadvantaged tax environment 9 .

Conclusions
In the year 1999 in Kosovo was installed Temporary Mission of United States (UNMIK) which until the proclamation of Independence of Kosovo in February of the year 2008 was creator of fiscal policy. Kosovo's fiscal policy that was created in year 1999 by UNMIK had just few fiscal functions and wasn't in function of simulation of economic development. This due to the fact that the main objective of the policy and tax system was gathering of funds for foreseen public expenditure financing, by not giving an importance to economic and social functions which could be achieved through policy and tax system.
After the proclamation of independence in 2008, it's of a high importance the fact that Kosovo was approached to the reformatting policy and tax system, making Kosovo economy more competitive. In this context creators of tax policy in January of the year 2009 did a reduction only of tax norms for two main forms of direct taxing, CIT from 20% to 10% and Personal Income Tax from 0%, 5%, 10% and 20% to 0%, 4%, 8% and 10%, and increasing VAT norms from 15% to 16%, as indirect tax.
Tax incentives are instruments with which countries are served aimed at favoring specific categories of tax payers (specific sector, enterprise or individual) and in function of simulating specific economic activities. Kosovo compared with other countries is the last, regarding the application of tax incentives of CIT.
Tax evasion is in high proportions. Reduction of tax rates on PIT is not producing the expected results.
In the following, for each finding we have given adequate recommendation:

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-Even though tax reform of the year 2009 has made Kosovo economy more competitive, policy and tax system in Kosovo should be also reformed in many other segments. This due to the fact that the main aim of fiscal policy still remains realization of fiscal functions, respectively gathering of foreseen funds without taking into consideration economical functions of tax policy, with a tax structure where majority of tax incomes come from indirect taxes and where few tax incentives are applied. Kosovo should make dynamic activities for achieving the balance between direct and indirect taxes and creating a tax system that would have neutral approach on competition and trade economy.
-Due to the fact that Kosovo compared with other countries is the last, regarding the application of tax incentives of CIT, creators by using the experiences of other countries must apply more tax incentives (Tax holidays, Accelerated depreciation, Investment allowance, Social security reductions, Import duty exemptions) in order that tax policy to be more in function economic development.
-Creators must as soon as possible create a strategy for combating tax evasion, where legislative and institutional measures must be introduced, in contrary tax evasion will continue to reduce its tax base, which is already small. As combating tax evasion can be efficiently implemented only by synergizing the legislative actions in all the areas of taxation, such as commercial, financial, and criminal law, this strategy must include institutional measures that interfere in all of those areas. So at the same time, institutions as the Ministries of Finance (Tax Administration), Justice and Interior must cooperate to effectively address the issue of tax evasion in a wide range of areas. Therefore it is important not only to take unilateral actions, but also to encourage wider cooperation among all stakeholders and raise awareness of the whole society to participate. Particular significance in the context of these multidimensional measures of strategy must be paid to increasing tax education of citizens through awareness on the role that tax payments have for public benefit.