Greece’s economic problems began long before the current debt crisis. In 2009, the Greek deficit was approaching the EU limit of 3% of GDP. Fearing economic sanctions by the EU, the Greek government passed taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. increases to reduce deficits. One of the tax increases was a 10% surtax on corporate income known as a special extraordinary contribution on corporate profits. The result was a mass exodus of businesses that continues today, even though the surtax was repealed in 2013.
The primary beneficiary of this corporate surtax was not the Greek government, but Bulgaria. After the surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. was implemented businesses, both corporate and non-corporate, started to seek a domicile with lower, more predictable tax regimes. Greek businesses found it just across the boarding in Bulgaria, where business taxes are low and tax policies are stable.
Like Greece, Bulgaria is no stranger to debt crises. In 1990 Bulgaria defaulted on its debt as it transitioned to a market economy and in 1997 flirted with bankruptcy after a systemic bank collapse. The lessons learned during this period, along with IMF imposed rules, has created one of the most fiscally disciplined member states in the EU, which boasts the lowest debt to GDP ratio in the EU as well as a stable, low corporate income tax rate.
120 large corporations originally expanded into Bulgaria in the 2000’s to take advantage of Bulgaria’s low wage and available resources. After the surtax was implemented in 2009, these corporations expanded their operations in Bulgaria while contracting their Greek holdings, preferring to export from Bulgaria rather than Greece.
Small and medium businesses followed suit, fearing they would be the next target of the Greek tax authorities. It has been estimated that 11,000 Greek business have left for Bulgaria since 2009.
The business exodus is obvious in the economic data from both Greece and Bulgaria. In 2009 both Greece’s and Bulgaria’s GDP contracted as the recession set in. In this year, the Greeks implemented a surtax while the Bulgarians held their corporate tax steady. By 2010 Bulgaria began showing positive economic growth while Greece continue to experience economic contraction. This trend continued until 2014 when both economies had positive growth. The reason for the positive growth should be no surprise. The Greek government lifted the surtax in 2013.
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Although the Greek government has removed one of the major causes of the business exodus, businesses are still relocating to Bulgaria to avoid being the target of future tax increases. Previous bailout proposals by the Greek government have included an additional tax on corporate and business income. These proposals signaled to the business community that the Greek government was willing to change the rules on businesses to keep their budget intact.
The instability in the Greek tax code is forcing businesses to consider Bulgaria as an alternative. As such, the migration of businesses is unlikely to subside anytime soon.
As businesses set up shop in Bulgaria to conduct business in Greece, the Greek government has become increasingly aware that business income is flowing out of the country. In an attempt to slowdown the outflow, the Greek government has proposed a transaction tax on payment by Greek companies for goods and services. These transactions taxes would largely fall on Bulgaria businesses.
The transaction tax will only exacerbate Greece’s business exodus. Greece needs to learn from the experience of its neighbor. Difficult reforms are not easy, but once completed, reforms create fertile ground for economic growth.
Greece and Bulgaria are a microcosm of tax competition. As the U.S. watches corporations move to Canada through inversions to stay competitive, U.S. lawmakers should keep Greece and Bulgaria in mind. Attempting to stop the problem through more rules will only complicate the matter. The only real answer is to lower the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate and compete for tax revenues. Reforms are difficult, but countries who have the political will to go through the process of tax reform are those who benefit from an increasingly connected world economy.
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