The Croatian Profit Tax: An ACE in Practice

Abstract

In a series of reforms between 1994 and 1998, Croatia assembled a uniquely interesting tax structure. It is a rare example-perhaps the only one-of a system built systematically on the principle that tax be levied on consumption rather than income. The system had - and the reason for the past tense will become clear shortly - three main components: a broad based value-added tax; a personal income tax from which dividends, interest and capital gains were explicitly exempt; and a profit tax charged only on equity income in excess of some imputed ‘normal’ return (called the rate of ‘protective interest’ (PI)). The profit tax was thus essentially an ‘Allowance for Corporate Equity’ (ACE) system of the kind advocated by the IFS Capital Taxes Group (1991) and Devereux and Freeman (1991), so that the Croatian experience provides a unique opportunity to evaluate an ACE in practice.

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