Guy Norton in Zagreb -

The recently elected centre-left coalition government in Croatia has sparked controversy with its proposed measures to address the country's economic weaknesses, which could result in its economy shrinking again this year and its credit rating downgraded to junk status.

Having secured a comfortable working majority of 80 seats in Croatia's 151-seat parliament, the Sabor, the so-called Kukuriku coalition is currently working on a series of measures for a new budget, which should be voted on in February. Among the headline proposals by Finance Minister Slavko Linic are a hike in the country's value-added tax rate, from 23% at present to at least 25%, which would be one of the highest levels in the EU, which Croatia is on track to join on July 1, 2013.

The proposed consumption tax hike quickly provoked widespread opposition in Croatia, with even members of the government coalition questioning the wisdom of the move, which it is claimed could raise around an extra HRK3bn (€400m) a year for the state. Damir Kajin, a leading member of the Istrian Democratic Assembly, one of the junior factions in the four-party Kukuriku coalition, told state broadcaster HRT that the tax hike would hit the poorest members of society hardest and would merely encourage growing numbers of his constituents in Istria to do their grocery shopping in neighbouring Italy, where the VAT levied on food is only 4%-10%. "VAT of 25% would be a failure," claimed Kajin.

He has also attacked another of Linic's proposals - the introduction of property tax, a first for Croatia, saying that the proposed levy would hit cash-strapped pensioners particularly hard. Although the VAT increase could be introduced as early as March, the introduction of any property tax would likely be delayed until at least 2013, as the country's property and land ownership records would need to be comprehensively updated.

Predictably, there's also been opposition to the proposed reintroduction of a 6% levy on mobile telephony services from the country's three leading operators, Hrvatske Telecom, Vipnet and Tele2, which have argued that the tax hike will reduce the funds available for investment in new infrastructure and services. The previous right-wing government introduced the tax as a temporary measure in 2009 and it ceased to apply at the end of last year. Economy Minister Radimir Cacic told state press agency Hina that the levy would apply until Croatia joined the EU in July 1, 2013 and generate revenues of HRK300m (€40m) a year. The extra revenue would help the government cope with the growing burden of employment, which at the end of 2011 stood at around 315,000, the highest level since 2003. Cacic added that the phone companies would benefit from a proposed tax exemption on re-invested profits, which would allow them to implement their planned investments.

Tax collection

Rather than increase taxes for both individual and companies, some commentators say that the new government would be better off spending more time and effort on collecting taxes already due to it. According to Mihaela Bronic, an analyst at the Instituta za javne financije (Institute of Public Finance), unpaid taxes and contributions totaled HRK14bn at the end of 2010 - equivalent to the country's budget deficit at the time and double the level three years earlier. According to the IJF, unpaid taxes are likely to have climbed further to HRK17bn by the end of last year.

Natasa Srdoc, co-head of the Adriatic Institute for Public Policy, an independent economic think-tank, believes the proposed tax increases, which also include new taxes on capital gains and dividend payments, will prove to be counter-productive. "These new taxes and fees will result in lower tax revenues, tax avoidance, tax evasion and increase the already large grey economy," she says. "The government should focus on reducing government expenditures and allowing the economy to grow. The new taxes will deal a heavy blow to the economy on the brink of disaster and directly hurt businesses and consumers. It is time to slash Croatia's bloated government budgets and not slay Croatia's burdened taxpayer."

Unsurprisingly, there's been a warmer welcome for the proposal that VAT levels for hotels and restaurant services should be cut to 8-10% in a bid to make the Croatian tourist industry more competitive in the face of increased competition for tourists from Mediterranean competitors such as Greece, Italy and Spain. However, tourism minister Veljko Ostojic says in return for the tax cut he expects hoteliers and restaurateurs to cut prices, maintain current levels of employment and to invest more in upgrading their facilities and services.

Finally, Finance Minister Linic's proposal to privatise the government's stakes in insurer Croatia Osiguranje and lender Hrvatska Postanska Banka has also met with mixed reviews. Economic commentator Damir Novotny believes that both companies have been poorly managed under state ownership and so should be privatisation candidates. However, Zeljko Lovrincevic, a professor at the Institute of Economics in Zagreb, says that with financial sector assets attracting miserly valuations at present, the new government would be better off improving the efficiency of the public sector and state companies. "As long as there is tremendous scope for reducing costs in certain public sector undertakings, local government and local monopolies... it is very difficult to convince people that the sale of state assets at discounted prices is the right move," he told Croatian daily Vecernji List.