Bosnia and Herzegovina: Revisiting the Tax Wedge in BiH
The tax wedge in Bosnia and Herzegovina (BiH) is a significant driver of labor market outcomes, distorting economic incentives by creating a wedge between what employers pay for labor and what employees receive. This report revisits the tax wedge in BiH, providing estimates of average and income-specific labor tax wedges in both the Federation of BiH (FBiH) and Republika Srpska (RS), considering specific characteristics of the labor legislation.
Key findings include:
- FBiH and RS have different labor tax systems with varying rates and bases. PIT rates are among the lowest in the region, while SSC rates are among the highest. This results in a low share of PIT in total revenues but a significant contribution from SSC.
- The effective tax wedge is lower than suggested by conventional measures, particularly in FBiH. This is due to non-taxable employment benefits and preferential income tax treatments that encourage tax-saving arbitrage.
- The tax system displays limited progressivity. Both entities have flat PIT and SSC rates, with progressivity coming from PIT deductions, which have a higher percentage share in lower incomes. RS has higher progressivity due to a larger personal deduction.
- Recent policy changes in FBiH, including a minimum wage hike and SSC rate reduction, have a limited impact on overall tax progressivity. The SSC rate reduction will lower the tax wedge for most employees, but the minimum wage increase will offset some of these gains.
- Reforms toward a more efficient, progressive, and transparent system are necessary to boost fiscal and growth outcomes. This includes simplifying the system, removing preferential treatment for certain categories of work, broadening the tax base, and potentially introducing a second marginal PIT tax bracket at a higher rate for higher earners.
The Real Estate Market in Bosnia and Herzegovina
Housing prices in BiH have been rising rapidly, mirroring trends in the broader region. While the House Price Index (HPI) and private credit growth have increased significantly, financial stability risks remain contained due to the relatively low share of mortgage lending in banks' portfolios and modest levels of household indebtedness.
Key findings include:
- Housing has become less affordable in BiH. The faster increase in housing prices compared to the rise in average net wages has made apartments less affordable. This trend has been consistent in both RS and FBiH.
- Construction of new housing units has been increasing, but this trend is slowing. The increase in the number of new apartments planned for construction appears to have stabilized in 2024, reflecting developers' perception of market saturation.
- Construction costs have increased significantly, negatively impacting supply. This is due to inflationary pressures, supply chain disruptions, a shortage of construction labor, and a burdensome regulatory framework.
- Credit growth in the mortgage segment has increased, but risks appear to be contained. Mortgage lending represents only a small part of the total loan portfolio of banks, and household indebtedness is low.
- Low interest rates and limited alternative investment options make real estate an attractive investment. This could pose future risks for lenders if households become too leveraged and financing conditions become too loose.
Overall, authorities should remain vigilant and systematically monitor housing market and credit indicators to detect potential vulnerabilities early. Accelerating the implementation of borrower- and capital-based tools, such as loan-to-value (LTV) and debt-service-to-income (DSTI) limits, and the countercyclical capital buffer (CCyB), is crucial to ensure a timely and effective policy response.
