Low Deficit Without Doing Anything: A Problem for Squaring the Circle

The Ministry of Finance, after another postponement, finally presented a draft budget for 2025, and in less than a day it was questioned by the ruling parties themselves. This means that we do not yet know what the final agreement in the coalition will be, what the government will submit to the National Assembly, and even less – what the final parameters will be after a second vote. Still, we see a political request to adhere to the existing fiscal rules and the convergence criterion related to public finances. Judging by Minister Petkova’s public statement, Bulgaria will request extraordinary convergence reports from the EC and the ECB, which suggests that the submitted draft budget will have a deficit of up to 3% of GDP, and there seems to be some preliminary unofficial agreement with the EC that the parameters in the medium-term fiscal-structural plan until 2028 will be acceptable. However, there are two questions – first, to what extent even the timid proposals for budget consolidation of the Ministry of Finance will be supported, and second, whether the members of parliament will not organize ad hoc majorities for decisions that increase spending or reduce revenue. On top of that, some of the assumptions and revenue forecasts used raise strong doubts, to put it mildly. The draft currently envisages an increase in spending by 18.5 billion, or 23.8% compared to 2024. – with 6.8% nominal GDP growth and 2.4% average annual inflation. This is a huge expansion of the state's redistributive role to 44.9% of GDP, or over 6 percentage points per year. Half of this increase is due to the expected increase in capital expenditures, the other is due to an increase in current expenditures.

However, the current team of the Ministry of Finance is proposing a total amount of expenditures 2.2 billion lower than the request of the caretaker cabinet. Of these, however, just over 400 million leva were added back in the first hours – this is the idea of ​​​​updating pensions by 5% instead of 8.5%, which does not seem to be accepted by the coalition. Thus, total expenditures again exceed 45% of GDP. In structural terms, the capital program has been reduced minimally by 150 million leva, and the rest of the measures affect current expenditures.

The cost of living is nearly 900 million leva less than the caretaker government's project - but even so, the growth is nearly 25%, and with low inflation expected. However, there is clearly no will to limit the growth of salaries. The rulers do not question at all the increase in the "Security and Defense" sector, which "weighs" over 2.1 billion leva for 2025 alone, and separately with the adopted automatic indexation mechanisms, it will accumulate pressure in each of the following years. There is also a lack of courage to terminate or at least significantly reformulate the program for generous compensations to non-household consumers of electricity. It weighs on both energy producers and now directly on the tax authorities.

When there is no will to limit the growth of expenses, the reduction of the deficit depends on the increase in revenues. However, the political promise not to increase taxes cannot be kept with such an inflated expenditure. We have already commented more than once that even with measures to increase collection, the current basic taxes cannot be maintained with expenditures significantly exceeding 40% of GDP.

And in fact, this is starting to be seen in the proposal of the Ministry of Finance. There are several sources of increase in the revenue side. One is an effective increase in the tax burden, the second is closing "loopholes", fighting the shadow economy or eliminating inexplicable preferences, and the third, unfortunately, is purely wishful thinking. All this adds up to an expected increase in revenues by 18.3 billion leva or by over 25% compared to 2024. Even if we subtract 3.8 billion leva higher planned revenues from the EU budget, the increase is still startling. Tax revenues are expected to increase by 20.6% with projected low inflation and against the background of about 12% growth for last year.

The tax burden is clearly increasing through higher excise rates, the return of a lower threshold for VAT registration, and an increase in the maximum social security income. Excise duties on tobacco products in our country are indeed relatively low compared to other EU countries and there will obviously be convergence; however, the automatic reaction to fill budget holes by “adjusting” higher taxation renders the so-called excise calendar and the idea of ​​predictability in general meaningless. For now, the proposed framework relies on the elimination of the preferential VAT rate for restaurants and bread, although it is not known whether there will be parliamentary reversals in 12 to 5. On the other hand, the return of a lower threshold for VAT registration removes one of the meaningful measures for reducing the administrative burden on small and start-up businesses. Over 700 million leva is the estimate for the set of measures to combat the shadow economy. The long-overdue increase in the amount of tolls, which were consistently reduced from the long-term set values ​​needed to cover the costs of maintaining the road infrastructure, is also reasonable - another populism paid by everyone in favor of large Bulgarian and many more foreign carriers.

But even if all this were to be realized, it would not be enough to cover the huge inflation of costs, which could even be expanded with new decisions of the National Assembly. And that is why the "residual" appears as an arithmetic difference, supplementing the necessary revenues. Revenues from value-added tax in the forecast are nearly 6.3 billion leva or 34% higher than in 2024. This is nothing more than wishful thinking – VAT revenues have traditionally been at 9.0-9.5% of GDP, and now they should jump to 11.5% of GDP, and that without any significant changes in the rate or tax base.

The combination of unrealistic optimism and the risk of another “loosening” through spending populism or new preferences in parliament will quickly show that the deficit cannot remain within 3% of GDP. And the reflex – before reaching the inevitable consolidation through spending cuts and the search for higher efficiency through structural reforms – will be to increase tax rates or introduce extraordinary taxation. The medium-term framework already openly envisages an increase in the social security burden by 3 percentage points by 2028, which effectively reduces the disposable income of all working Bulgarians – in 2028 alone, the state will take an additional 2 billion leva from workers in the form of increased pension contributions. But we can expect new impulses to seize excess profits – whether from mining companies or banks. Adding an additional corporate tax for large multinational groups has already set a precedent – ​​if it can be done for them, why not take more from others as well. Reality always wins – such a growth in spending leads to a significant increase in the deficit and a large increase in government debt, or to an increase in taxes for the economically active, working and successful.

But it seems that these issues will be postponed for later – now on the agenda is the first test of the majority in the new ruling coalition and a decent-looking fiscal framework that will be acceptable in the process of assessing the fulfillment of the convergence criteria on the way to the eurozone.