Ex-post Evaluation 2006 Advice on Developing Croatias Tax System, Croatia

Brief Report

Produced by: Forschungsstelle fr Internationale Agrarund Wirtschaftsentwicklung, Im Neuenheimer Feld 330, D-69120 Heidelberg This report was produced by independent external experts. It reflects only their opinion and assessment.

Published by: Deutsche Gesellschaft fr Technische Zusammenarbeit (GTZ) GmbH Evaluation Unit Dag-Hammarskjld-Weg 1-5 65760 Eschborn Germany Internet: http://www.gtz.de

Eschborn, December 15, 2006

Contents Page 1. 2. Tabular overview Description of the project/programme 2.1 2.2 2.3 3. Project/programme title, project objective, indicators, contribution to overarching objectives/ intended results Problem situation (sector), framework conditions in the country (political / economic / social / environmental) Concept and advisory approach of the project/programme (target groups, partners, levels, regions, modes of delivery) 2 3 3 3 4 5 5 5 6 7

Results of the evaluation 3.1 3.2 3.3 3.4 Overall rating Performance measurement in line with the 5 international evaluation criteria (with brief explanations) Performance measurement of MDG /poverty / gender Conclusions and recommendations

1.

Tabular overview Advice on Developing Croatias Tax System 1992.4817.0 01.09.1993 30.06.1999 German contribution: 1.233.706,-Partner contribution: provided by the Ministry of Finance (lead executing agency) with its general activities; there were no budget appropriations for the project; Contribution of a third party: there were no budget appropriations for the project input provided by the Ministry of Finance of Baden-Wrttemberg. Implementation of a working, market-economy oriented tax system in the fields of tax law and tax administration. Implementation of an academy of finance intended for the systematical professional training of the tax administrations staff. Ministry of Finance of the Republic of Croatia Tax department of the Ministry of Finance headed by the General Tax Director None

Project/programme title Project/programme number Overall term Overall costs

Objective of the project/programme

Lead executing agency Implementing organisations

Other organisations and donors involved Target groups

Target group of the project is the total population of Croatia Forschungsstelle fr Internationale Agrar- und Wirtschaftsentwicklung, Im Neuenheimer Feld 330, D69120 Heidelberg July 2006 to December 2006 1

Institute performing evaluation

Evaluation period Overall rating

On a scale of 1 (very good, significantly better than expected) to 6 (the project/program is useless, or the situation has deteriorated on balance)

Individual rating

Relevance: 1 Effectiveness: 1 Impact: 2 Efficiency: 1 Sustainability: 2

2. 2.1

Description of the project/programme Project/programme title, project objective, indicators, contribution to overarching objectives/ intended results

The advising activities on the introduction of a new tax system in Croatia aimed to implement an effective, market-economy oriented public financial system based on the three components of tax law, tax administration and institutionalized professional training in the form of an academy of finance. The target indicators named refer to the two components tax law and tax administration: Drafts have been submitted to Parliament. The description of tasks as well as the attribution of powers to the Ministry of Finance and the subordinate authorities have been defined in a binding and transparent manner on all levels. All functional levels of tax administrations staff are well informed on the objectives and contents of the reform measures. Information on the different taxes and taxation procedures is available.

The intended (indirect) results are described by the main objective according to which Croatias public financial system is to be geared to a system of social market-economy within a democratic state 1 . The social market-economy model is interpreted by the experts as defined by Ludwig Erhard, in other words positive social effects are expected from an effective and employment-generating economy, with the social security system playing a subsidiary part. 2.2 Problem situation (sector), framework conditions in the country (political / economic / social / environmental) In terms of the main objective, the tax system reform needed to be adapted specifically to the countrys constitution and its general economic constitution. In the latter basic and fundamental principles of the market-economy system, such as the right to private property and the freedom of trade, are enshrined in law. In fact, however, the transition process was discredited by serious irregularities concerning the privatization of former national enterprises.

The appraisers assume that democracy includes the rule of law.

The reform of tax law needed to satisfy the multi-functionality of tax systems in marketeconomy systems including more than the fiscal function (raising of revenues). In particular the specific features aimed at economic efficiency and income distribution. The main task of the tax administration reform consisted in avoiding division of the tax administration into two parts one for corporate bodies and one for private individuals and in building up a united tax administration. From a political and historical point of view, Croatias separation from multi-national Yugoslavia in 1991 led in a most decisive way to the development of the framework conditions existing at the start of the project and consequently to the transition of Croatia as former part of a socialist federal republic to an independent country adopting the Western model. Initially, Croatias economic conditions were characterized by the disastrous effects and consequences of the civil war, but also by regained monetary stability. 2.3 Concept and advisory approach of the project/programme (target groups, partners, levels, regions, modes of delivery) The project was not differentiated by target groups: Its target group was Croatias total population. The project was carried out by the following organizations: a) GTZ, b) Croatias Ministry of Finance (lead executing agency), c) Int-Fis Agency for International Fiscal Analyses GmbH, and d) Baden-Wrttembergs Ministry of Finance. The project as a whole was actually based on three key elements: tax law, tax administration, and an academy of finance. With regard to the projects overall term of nearly six years it should be emphasized that all advice was given by short-term experts. The procedure applied to perform their work can be characterized as the shuttle-principle 2 . The German contribution was directed by the GTZ headquarters and within this framework also by the German short-term experts themselves (delegated implementation on site) as well as by a GTZ coordination office in the Croatian Ministry of Finance. This project coordination office acted as a counterbalance, guaranteeing continuity of the project activities, to the advising activities of the short-term experts. The GTZ surveyed and effectively supported the project by using its planning and regulatory instruments. Three workshops (ZOPP system, i.e. Objectives-oriented Project Planning), one project success control, one project evaluation and one seminar discussing the results of the evaluation took place.

Here one could also speak of intermittent missions.

3. 3.1

Results of the evaluation Overall rating

As far as the projects overall rating is concerned, the five evaluation criteria are of different significance. Sustainability is of comparatively high significance because it exerts a decisive influence on the amount of the present value of future project benefits as an indicator of success. As effectiveness together with sustainability is a critical factor for impact, this criterion is also of higher than average significance. Efficiency, on the contrary, is relatively insignificant, because, compared to the considerable effects of the tax system reform on the total economy, the mere efficiency of the project is of minor importance. Based on the different results the overall rating of the project and its achievement of the development goals is very good. 3.2 Performance measurement in line with the 5 international evaluation criteria (with brief explanations) The performance measurement in line with the 5 international evaluation criteria leads to a very positive impression of the projects success in the achievement of the development goals. Relevance The project objectives correspond to a high, or extraordinarily high, degree with the needs of the target group, the policies of the cooperating country and its institutions, the global development goals as well as the donors principles of development policy. This is therefore definitely a very good result. It is important to emphasize that this reform project and its underlying model were given high priority by the cooperating country and that it was of high relevance, especially to the poor population groups. Effectiveness The complete achievement of all project objectives resulted in the grade very good. The project is not responsible for some directly negative effects (for instance: contradictions between implementing regulations and substantive tax law); the reasons for these negative effects are not due to the project itself.

Impact Together with the high effectiveness of the project its convincing models in the fields of tax administration and tax law (the latter being exemplary) contributed significantly to the achievement of chief development goals; thus, the grade good is awarded. An aggravation of the situation after the implementation of the reform is not in contradiction with this assessment; but of course this needs to be taken into consideration when assessing sustainability. Efficiency The project realized a) a high efficiency on the technical and organizational level, b) a sufficient input level, and c) a high project output per invested DM. Because of these results the grade very good is awarded. Sustainability It should have been possible to work against the observed, though not neutrally classified system deteriorations after the implementation of the reform by starting project activities such as information and communication campaigns. These negative effects, which result only marginally from the project itself, did not alter the established and very important fundamental structure in the fields of tax administration and tax law. In addition, system deteriorations can be easily corrected within the solid fundamental structures. Therefore it seems appropriate to award the grade good. 3.3 Performance measurement of MDG /poverty / gender

With regard to poverty reduction two facts should be emphasized: Firstly, with the tax system generating fiscal abundance, conditions were given to finance numerous social projects. Secondly, it seems to be obvious that the whole system encouraged efficiency and investments thus weakening other significant factors which exerted a negative influence on labor demand. The architects of the tax reform project vehemently rejected the use of different value-added tax rates in order to correct distortions of the social system. It seems at least understandable that the initiators of the tax reform followed a conception implying optimum division of tasks between the fiscal and the social system, so that the system transition is not charged a priori with a faulty design. At the beginning the tax exempt amount of the income tax system did not sufficiently take into consideration the subsistence level. It was no problem, however, to 6

realize improvements on the technical level within the framework of the reform model later on. MDG From the results obtained we may conclude that the reform project can be expected to contribute directly and substantially to the solution of problems and/or higher abilities to find solutions to problems in the following areas 3 : economic growth and increased active participation of the poor (MDG 1,8); reduction of the fiscal deficit development finance (MDG 1,8); guaranteeing basic social services strengthening social security (MDG 1-6 and 8).

Gender The project is neither gender differentiated nor was any gender analysis carried out. The project was considered gender neutral from the outset. Due to the lack of previous sociostructural analyses it was not possible to carry out any gender analysis during the evaluation of the project. 3.4 Conclusions and recommendations

Two results that differ significally from each other characterize the project and the changes accomplished by Croatia subsequently. These results are: on the one hand, the unusually high project success, and on the other hand, system deteriorations in tax law and decreasing performance of tax administration after conclusion of the project. The changes introduced after the project was concluded and that were mainly criticized in a negative way, were primarily the result of a normal political process. Donor institutions such as the GTZ or the World Bank are in a dilemma: On the one hand it is possible to achieve a considerable degree of transition, that cannot be achieved otherwise, by introducing a good tax system and implementing it well, on the other hand tax law especially tends to be susceptible to discretionary political influences. Nevertheless it should be noted that the Croatian tax reform was not established on a broad political basis. In addition, according to the project scheme, popular communication and information campaigns were not planned within the projects framework. Both can be regarded as missed opportunities to stabilize the tax system.

On this, cf. the ten priority areas of the German Governments Programme of Action (see German Governments 12th Development Policy Report).

The donor institution should at least try to find ways to lead a broad political dialogue with the partner country. It does not seem possible, however, to stabilize the tax system without finding compromises as far as concrete measures are concerned. In the case of Croatia, it would have been worthwile to take steps symbolizing distribution justice (for instance, reduced value-added tax rates on basic food), because distribution problems dominated the political tax discussion. A choice has to be made between limited economic inefficencies that need to be accepted, on the one hand, and enormous potential stabilization effects, on the other. The experience gained from this project shows that all projects dealing with the implementation of complex system reforms and, in addition, directly touching the interests of most members of a society, should include information and communication campaigns.