Croatia uses tax and other incentives to attract investment and support policy goals including job creation and regional development. This chapter provides an overview of Croatia’s incentive regime, with a particular focus on tax incentives granted under the Investment Promotion Act. It analyses design features and how incentives intend to support their stated policy goals, offering suggested areas of reform. The chapter also highlights the importance of monitoring and evaluation of incentive policy to encourage more effective use of incentives.
FDI Qualities Review of Croatia
5. Towards more effective investment tax incentives
Abstract
Summary and policy recommendations
As Croatia develops and implements its National Plan on Investment Promotion, it could consider how the current investment incentive framework could be improved to best support investment policy goals. The new Plan could also serve as an opportunity and platform to better promote incentive policies to prospective investors. More broadly, incentives are only as attractive as the wider investment climate. They should be used to complement, not replace, policies to ensure a predictable and attractive investment framework, explored throughout this report.
Croatia offers investors a mix of tax incentives, grants, and in-kind benefits (including rent-free lease of land and buildings). The primary investment incentives are granted under the Investment Promotion Act, and include reduced corporate income tax (CIT) rates conditioned on investment amount and job creation, with higher caps on benefits in less developed regions. Reduced CIT rates lower the statutory rate substantially by 50-100% for up to ten years – though the total value of benefits investors can receive (including grants and other tax benefits) is capped.
Croatia has aligned incentives under the Investment Promotion Act with EU requirements on Regional Aid, with a positive effect on incentive design. Incentives are available to firms of any size, in a broad range of sectors, preventing opportunities for rent-seeking behaviour by favoured sectors. Eligibility conditions are clear and specific, and tied to positive development goals, notably, regional income convergence and job creation. Tax and financial benefits are capped with a ceiling per project as well as annual spending limits for the regime as a whole, proving a check on government expenditure. EU regulations also positively mandate thorough monitoring and reporting on incentive uptake and costs, an essential first step to evaluating the impact of incentives.
Tax and non-tax incentives under the Act are designed to support the growth of substantive private sector investment (domestic and foreign), job creation, regional development and technological upgrading. CIT incentives under the Act support these goals through eligibility conditions to receive benefits: investors must meet outcomes of job creation, modernisation of assets, or productivity increases, and can receive greater benefits if they invest more or locate in certain locations. Outcome conditions such as employment creation can promote positive spillovers of investment; however, they require careful monitoring to ensure that the outcome has been met. This necessitates resources, administrative capacity, and close coordination with other government agencies.
Looking forward, the government could consider revising some of its incentives to maximise positive spillovers and limit potentially excessive benefits to firms. Carefully designed and targeted incentives may help correct market failures and advance social and economic development. Positively, CIT rate reductions in Croatia are conditional on investment size and job creation, promoting a firm’s physical presence in the country. However, in general, income-based incentives (CIT exemptions and reduced rates) disproportionately benefit projects that are already profitable early in the tax relief period, and might have invested without the incentive, rendering the incentive redundant while potentially costing the state substantially in terms of revenue forgone.
Croatia could consider re-evaluating the design of its main tax incentives to adopt a stronger expenditure-based approach. Expenditure-based incentives (tax allowances or credits) could enable better targeting of incentives towards reducing specific costs, thereby encouraging spending that might not occur without the incentive, including costs of job creation and technological upgrading. These incentives might be more effective at attracting additional investment that would not have occurred otherwise. Furthermore, expenditure-based incentives are expected to be less affected by the new international tax agreement (OECD, 2022[1]). Under these rules, jurisdictions that grant large multinational enterprises (MNEs) effective tax rates below 15% may lose tax revenues as other jurisdictions start to impose top-up taxes on MNEs with low tax rates. Croatia is thus advised to consider the implications of these new rules for its tax incentives regime.
The MESD could use the upcoming reform of the Act to assess if tax incentives and grants seem to be incentivising their stated goals, including employment and regional development. Investment incentives of the Investment Promotion Act have primarily supported domestic industries that are already strong actors in the economy, including metal processing manufacturing and tourism. However, incentives may have helped grow the ICT sector. Foreign firms make up a quarter of beneficiaries of incentives over the past decade, with the number of foreign firms applying for incentives only slightly increasing. Most recipients are small firms, though a growing number of a large investments are receiving incentives.
In addition to investment tax incentives under the Investment Promotion Act, Croatia offers other incentives through multiple pieces of legislation that are governed by different public bodies at central and subnational levels. For example, R&D incentives are authorised in a separated act. Coordination between some agencies involved in incentives seems to work efficiently, for example between the Ministry of Finance and MESD’s Sector for Incentives and Entrepreneurial Infrastructure. However, information sharing could be strengthened across different bodies that grant incentives, including within departments of the MESD’s Directorate for Internationalisation, between different ministries, and with representatives at the local level to support policy coherence.
The effective use of investment incentives requires regular monitoring and evaluating the costs and benefits of incentives, including vis-à-vis public revenue mobilisation, investment attraction, and the respective policy objective. Croatia closely monitors compliance of beneficiaries with incentive conditions, and costs of different incentive schemes as per EU State Aid requirements. This provides a solid foundation for policy evaluation, and more could be done to assess if incentives seem to be generating additional investment and are best designed to support their policy goals, including related to sustainable development.
Policy recommendations
Assess whether tax incentives are best designed to support their stated objective. While eligibility requirements (on job creation or modernising assets) are one means to encourage the desired policy goals, they do not directly reduce the costs of meeting these goals, and require administrative resources to monitor if firms are complying with requirements. The government could consider whether targeted expenditure-based tax schemes (tax allowances or credits), could be more effective at promoting certain outcomes.
Explore what complementary policies are required (e.g., infrastructure, connectivity, regulations, education or labour market and broader-based personal income tax reforms) to best incentivise investment policy goals, including as part of the planned National Plan on Investment Promotion. Incentives should be used to complement, not replace, wider efforts to improve the investment climate. While tax and non-tax incentives can help promote certain investor behaviour, other policies might be more appropriate. For example, to ensure that tourism investment supports environmental conservation, regulatory changes may be more suitable.
Reinforce regular coordination at the national level, within departments of the MESD, and particularly within its Directorate for Internationalisation, as well as between different ministries, and with sub-national authorities at the local level to support policy coherence when designing and implementing incentive policies. For example, more formal data sharing could be established between MESD and other incentives-granting departments and ministries. Similarly, coordinating with the Croatian Employment Service, the Ministry of Labour, Pension System, Family and Social Policy and the Ministry of Regional Development could be beneficial to understand which type of support is required and to identify the most suitable policy response.
Enhance clarity of investment incentives by adding to the existing online investor guide more information on all available incentives programmes and relevant criteria. This could include information on incentives granted by sub-national authorities and English translations of all relevant laws and regulations in an online platform.
Croatia should continue its efforts to improve administrative and financial burdens and increase transparency of fees due. While Croatia has already progressed in recent years, investors still report lengthy procedures and unexpected fees. Continuing these efforts is crucial for boosting the competitiveness of its investment climate.
Implement a regular and structured evaluation mechanism to assess how incentives are used, if they are supporting their intended policy goals, and their costs. Embedding periodical evaluation processes in the law and clearly attributing responsibilities can support more effective evaluation mechanisms. The government already closely monitors compliance of beneficiaries with incentive conditions and costs (including tax expenditure) of each incentive programme as per EU State aid requirements. This could be leveraged to conduct specific studies to estimate forgone revenue from different programmes, and ideally, additional investment generated. An assessment could also be done to analyse the performance of firms with and without incentives. This could shed light on the behaviour of recipients of incentives and if they are supporting spillovers. The MESD could evaluate in coordination with subnational governments or other ministries the impact of incentives on stated policy goals, for example, whether investments are appropriately stimulating investment in different regions. Depending on the outcomes, the MESD should consider adjusting existing incentives and phasing out benefits that are no longer needed.
The tax system is only one of many factors for investment decisions
Statutory corporate income tax (CIT) rates are often the first reference point for investors when evaluating the tax competitiveness of a jurisdiction and provide the benchmark from which CIT incentives deviate. Croatia’s statutory CIT rate of 18% is in line with those of other CEE countries, and below the OECD average of 21.5% (Figure 5.1) (OECD, 2022[2]). Reforms in 2017 reduced the statutory CIT rate from 20% to 18% and introduced a 12% rate for small enterprises (up to EUR 400 000 or HRK 3 million annual revenue). In 2020, the government expanded its definition of small firms to all enterprises with up to EUR 1 million (HRK 7.5 million) annual revenue, followed by a reduction of the rate for small enterprises to 10% in 2021. Reflecting the important role SMEs play in the Croatian economy, around 90% of corporate income taxpayers pay the 10% CIT rate.1 Other CEE countries also have progressive CIT rates for small enterprises, ranging from 5% (Latvia) to 15% (Slovak Republic) (OECD, 2015[3]).
A country’s tax burden is one of many, and often not the most important factor considered by potential investors when making investment decisions. Macroeconomic and business conditions, market size, labour force, and the legal and regulatory framework are often as relevant for investors as tax considerations, and are explored throughout this report. The importance of taxation for investors depends in large part on these other factors. A higher tax burden can be acceptable to investors if the country’s overall framework for investment is attractive (OECD, 2015[4]).
Other features of the tax system, including its governance and administration, are also important for investors. In Croatia, investors have reported high administrative burdens when doing business, including time-consuming and lengthy processes with the Ministry of Finance(Box 5.1). The speed of responses related to CIT matters (e.g., distinction of taxable and non-taxable expenditures), is longer than in other CEE countries; however, some administrative relief efforts were recently undertaken by the Ministry of Finance and the government has made progress digitising many processes, which could improve speed of processes (Šonje, 2020[5]).2
In addition to statutory CIT rates and tax administration, investment incentives can form a key part of the policy framework for investment, and investment promotion strategies in particular. Investment tax incentives provide favourable deviations from the standard tax treatment for a specific group of corporate taxpayers, based on sector, activity, location or other investor- or project-related characteristics. The benefits and costs of granting tax incentives are not always clear. Tax incentives could attract investors that would not otherwise enter the market, help correct market failures and encourage positive spillovers from investment. Incentive policies can also be ineffective, providing windfall gains to projects that would have occurred without the incentive, with potential high and hidden costs, including to forgone government revenue, as well as from rent-seeking behaviour and economic distortions.
The effectiveness of tax incentives are context-specific, depending on the investor (and project sensitivity to incentives over other factors), the country and its investment climate, and the design of the incentive (OECD, 2022[1]). Certain types of investors may be more sensitive to tax burden and investment incentives than others. Economic studies and investor surveys suggest that market- or natural resource-seeking investors, which value the location-specific elements of a jurisdiction, are less swayed by tax incentives than efficiency-seeking investors that look for low-cost production sites (IMF, OECD, UN, World Bank, 2015[6]; James, 2014[7]; OECD, 2020[8]). But investor response varies by country. While lower effective tax rates are associated with higher FDI flows, this effect is significantly stronger in countries with good investment climates, and can have almost no effect in economies with weak investment climates (James, 2014[9]). Tax incentives – particularly reduced CIT rates and exemptions – are also often introduced due to competition with neighbouring countries. Most CEE countries offer numerous investment incentives, providing generous tax relief, adding to pressure on Croatia to offer similar or more advantageous benefits to investors (Schito, 2022[10]).
Box 5.1. Parafiscal fees increase business costs in Croatia
In Croatia, investors have reported high administrative burdens when doing business, including related to numerous parafiscal fees. Croatia collects more than 250 para-fiscal charges, e.g., for water sanitation, fire protection, preservation of monuments, in addition to other taxes and contributions. These parafiscal fees are managed in an uncoordinated way by different institutions, which may impede transparency regarding the extent investors are subject to these fees (OECD, 2019[11]). While the government has started to simplify administrative procedures and reduce parafiscal charges, consultations with private sector representatives suggest that these charges remain burdensome for businesses. The government is recommended to continue its efforts towards reducing administrative and financial burdens and increasing predictability of fees due.
Source: (OECD, 2019[11]).
Landscape of investment tax and non-tax incentives
Croatia offers a range of tax and non-tax incentives to domestic and foreign investors under various regimes (Figure 5.2). The main investment incentives are CIT benefits, grants and in-kind benefits introduced through the Investment Promotion Act (the Act) and are the focus of the chapter. Other tax incentives and grants are available to companies that engage in research and development (R&D), and firms in free zones or entrepreneurial zones can receive tax and in-kind benefits, as well as assistance from entrepreneurial support institutions. Sub-national governments provide additional non-tax incentives including financial grants, exemptions from fees, or in-kind benefits (e.g., land at reduced cost). A few other incentives are authorised in other legal acts, including the Profit Tax Act (CIT exemptions for investments in and around Vukovar city, accelerated depreciation for certain assets), and laws relevant to social security (grants and reductions to certain social security contributions). This section provides an overview of the main investment incentives and their governance; a more in-depth assessment of design of tax incentives under the Act follows.
Incentives are governed by EU State aid rules
Croatia introduced key reforms to its investment incentives before 2013 as it moved towards accession to the EU, revising the Investment Promotion Act to comply with EU State aid rules (Box 5.2). EU State aid rules set comprehensive requirements on how governments can grant incentives, the value of benefits, to which sectors, as well as reporting requirements. The regulations in many respects promote better incentives policy, meant to be less distortionary to competition, and encourage monitoring of incentives policies. Governments must ensure aid programmes are below an annual spending ceiling and investors are restricted in the amount of aid (tax and non-tax) they can receive per project. Incentives in the Promotion Act fall under the General Block Exemption Regulation (GBER) for Regional Aid, which has an annual state budget ceiling of EUR 150 million per year (Box 5.2). Tax and non-tax incentives for investors are capped at a certain percentage of eligible costs related to investment or job creation. These caps (“maximum aid intensity”) vary by region in Croatia, ranging from 35-60% of eligible project costs for large investors and can be increase for SMEs (more details on the Regional Aid Map below in Figure 5.5).3
Reforms to the Act over the past decade have made more firms eligible for incentives by reducing minimum investment and job creation requirements to receive benefits. This has expanded SME access to incentives. In 2015, minimum investment thresholds were lowered to support information and communications technology (ICT) sectors with potentially lower investments in fixed assets, while job creation thresholds were increased to encourage substantive investment in the country. This was done shortly after Romania introduced similar legislation. According to the government, these reforms led to a rise in incentive applications from SMEs and ICT enterprises in subsequent years. The latest amendment in 2022 introduced a new Regional Aid Map, with higher caps on benefits in less-developed areas. The reform also adjusted eligibility criteria for financial grants related to county unemployment rates, and changed certain provisions to respond to consequences of the COVID-19 pandemic.
Box 5.2. Incentive design is influenced by EU State Aid rules
State aid can be granted under certain conditions
EU competition policy generally prohibits State Aid, defined as action by a national, regional or local public authority, using public resources, to favour certain undertakings or the production of certain goods. A business that benefits from such aid has an advantage over its competitors. This can affect trade or distort competition, which is prohibited under Article 107 of the Treaty on the Functioning of the European Union. However, EU State Aid rules determine several exceptions to this general prohibition when State Aid is justified by reasons of economic development, including regional development.
In general, Member States are required to notify and receive authorisation from the European Commission (EC) prior to granting State Aid, with the exception of aid schemes conforming to sectoral block exemptions for agriculture and fisheries, certain de minimus aid, and the General Block Exemption Regulation (GBER). GBER sets parameters for aid in support of regional development, SMEs, R&D, environmental protection, infrastructure, and other areas of economic development. A recent amendment introduced new possibilities for aid measures that support the twin transition to a green and digital economy.
GBER sets parameters for regional aid schemes
Regional Aid under the GBER is meant to support horizontal development; it does not include aid that targets a limited number of specific sectors (defined as less than five sectoral classes under NACE Rev. 2). Aid to certain sectors, such as transportation, is also excluded (see Box 5.3 below).
Regional Aid aims to attract investment in disadvantaged locations. In areas where GDP per capita is lower than 75% of the EU average, aid caps are higher. Regional Aid can also be granted in sparely populated areas with less than 12.5 inhabitants per km2. Regional Aid rules set out the types of activities eligible for support, which costs relating to these activities may be covered, and the maximum aid intensity (aid cap) per beneficiary that may be granted for the various activities.
The annual State Aid budget of the scheme is capped at EUR 150 million per year. Otherwise, aid is subject to prior notification under general rules for State aid. For this reason, many countries, including Croatia, design their regional aid schemes to remain below this cap.
Maximum amount of aid depends on the region
Regional Aid rules also set a cap (maximum regional aid intensity) per beneficiary, expressed as a percentage of eligible investment costs, defined through Regional Aid Maps. The maps, set within the framework of the revised Regional Aid Guidelines, are proposed by the national government and approved and published by the EC, and are periodically reviewed. Eligible expenses are tangible or intangible assets (such as construction, acquiring or leasing of assets) or the estimated wage costs over 24 months of new jobs created for the investment project. A combination of investment costs and estimated costs for wages can be possible but must not exceed the amount of whichever category is higher. Costs related to previously built buildings, land or previously used equipment are not eligible. All types of benefits (e.g., tax incentives, financial grants) received must be accumulated when calculating maximum aid caps.
Annual reporting is required
Countries using State Aid schemes, including aid granted under the GBER, are subject to ex-post annual reporting to the EC. The EC then publishes the annual State Aid Scoreboard which provides a comprehensive overview of EU State Aid expenditure based on the reports provided by the Member States.
Notably, aid granted under the GBER can be challenged by other Member States, through a case in national court or a complaint to the Commission. The EC then verifies whether the aid has an incentive effect, its “appropriateness”, and if its benefits outweigh its costs. State Aid is appropriate when no other intervention can achieve the same results with less distortion of competition. The EC can determine that even though the aid fulfils the conditions set by the GBER, it may not be compatible with rules of the internal market. The EC has ruled in the past that distortion of competition was greater than potential benefits for regional development. It has also determined that aid was proportionally too great, even though it fell within the limits set by the GBER (OECD, forthcoming[12]).
Source: Commission Regulation (EU) No 651/2014 of 17 June 2014 declaring certain categories of aid compatible with the internal market in application of Articles 107 and 108 of the Treaty (OJ L 187 26.6.2014, p. 1).
The Investment Promotion Act grants tax and financial incentives to spur new investment, job creation and regional development
The Investment Promotion Act (63/22) sets the main incentives available to investors. The regime targets new investment or firms that invest in a new economic activity, with benefits rising with investment value. The regime also aims to enhance regional development – through higher caps on benefits in less developed areas – and encourage employment. CIT incentives are the core of the Investment Promotion Act and are complemented with financial grants as well as in-kind benefits in form of rent-free lease of state-owned land and buildings. Incentives are not available to several sectors on a negative list, set by the government and compliant with the GBER on Regional Aid (Box 5.3).
Accumulated aid from incentives (including tax relief and non-tax benefits governed by other laws) cannot exceed the maximum amount of State Aid per beneficiary, as determined by EU State Aid rules. The maximum amount is expressed as a percentage of eligible costs –expenses related to investment (tangible or intangible assets) or costs for newly created jobs (i.e., gross wage costs for 24 months). Costs related to previously built buildings, land or previously used equipment are not eligible. The cap varies depending on regions (defined under Regional Aid Maps); in Croatia as of 2022 the cap is higher in less developed and sparely populated regions. In addition to this cap, the Act states that the annual amount of aid cannot exceed EUR 7 million per beneficiary.
Investors are required to carry out the planned investments, i.e., acquire new fixed assets or create new jobs, within three years from the project starting date. In addition, the Act requires a minimum period for maintaining investments, set at three years for MSMEs and five years for large enterprises (definitions on enterprise size set by EU regulations). This is enforced through annual reporting requirements by firms to the MESD’s Sector for Incentives and Entrepreneurial Infrastructure (referred to throughout as Sector for Incentives). If investors do not comply with this obligation, they are required to repay the full amount of State Aid received.
Box 5.3. Sectors not eligible for Regional Aid
GBER establish a negative list of sectors and activities which cannot be supported through Regional Aid schemes of EU Member States. These sectors are excluded from incentives in Croatia’s Investment Promotion Act and include:
agriculture, aquaculture and fishery production,
steel, coal, synthetic fibres, transport sector and related infrastructure,
energy production and distribution, energy infrastructure
development of broadband networks,
research infrastructures,
shipbuilding sector,
financial and insurance sector,
health sector, social care sector and education sector,
trade sector,
construction and real estate sector,
water management, waste management and environmental upgrading sectors,
mining and quarrying sectors,
transportation and storage sectors.
Other activities not eligible for aid under Croatia’s Investment Promotion Act and the GBER include subsidising costs of export activities to third countries or undertakings in difficulties or insolvency, conditioning aid upon the use of domestic goods over imported goods or other practices violating EU internal market law.
Source: Commission Regulation (EU) No 651/2014 of 17 June 2014 declaring certain categories of aid compatible with the internal market in application of Articles 107 and 108 of the Treaty (OJ L 187 26.6.2014, p. 1 ) and Investment Promotion Act (OG 63/22).
CIT incentives offer substantial reductions from statutory rates
According to MESD’s Sector for Incentives, tax benefits are the most used incentives provided by the Act. They are offered in the form of reduced CIT rates that lower the statutory rate by 50-100%, depending on the investment volume (tangible or intangible assets) and the number of new jobs created, and subject to caps as noted above.
Tax benefits are available to new investments or new economic activities in a range of manufacturing and service sectors (excluded sectors are listed in a negative list described in Box 5.3):
Manufacturing and processing activities,
Development and innovation activities, defined as activities affecting the development of new or significantly improving existing products, production series, production processes or production technologies,
Business support activities which include centres for product design, multi-media-contact, IT development, ICT system and software development, logistics and distribution or data centres,
High-added value activities, defined as including architecture, design, marketing or media communication, accommodation and activities related to tourism and industrial engineering.
Larger projects receive the greatest benefits; projects investing EUR 3 million that create at least 15 new jobs are eligible for 100% CIT reductions (Table 5.1). The duration of the reduced rates is 10 years (except for micro enterprises) – or until the cap (maximum aid intensity per beneficiary) is reached. The ten-year period begins at the starting date of the investment project as indicated in the application for incentives.
Table 5.1. CIT incentives are tied to investment and job creation conditions
CIT rate reduction |
Period (years) |
Investment amount (EUR) |
New jobs created |
Retention period, in years* |
---|---|---|---|---|
50% |
5 |
50.000+ (micro-enterprises) |
3 |
3 |
50% |
10 |
50.000 (ICT system and software development centres) |
10 |
3(SME) / 5(large) |
50% |
10 |
150.000 – 1 mln |
5 |
3(SME) / 5(large) |
75% |
10 |
1 mln - 3 mln |
10 |
3(SME) / 5(large) |
100% |
10 |
3+ mln |
15 |
3(SME) / 5(large) |
Note: *minimum period for maintaining the investment project and jobs after the completion of the investment.
Source: Art. 12f Investment Promotion Act (OG 63/22).
The government recently introduced CIT incentives to boost the transition to Industry 4.0. Benefits are available to firms in the manufacturing and processing industry that conduct automation, robotisation and digitalisation of production processes, and that meet minimum investment values. Instead of creating a minimum number of jobs, investors need to demonstrate a 10% productivity increase per employee after three years. This is measured as an increase in the value of the total income in relation to the number of employees on an annual basis (Table 5.2).
Table 5.2. Incentives seek to modernise business processes & increase productivity
CIT reduction |
Period (years) |
Investment amount (EUR) |
Productivity increase* (after 3 years) |
Retention period, in years** |
---|---|---|---|---|
50% |
10 |
500.000 – 1 mln |
> 10% |
3(SME) / 5(large) |
75% |
10 |
1 mln – 3 mln |
> 10% |
3(SME) / 5(large) |
100% |
10 |
3+ mln |
> 10% |
3(SME) / 5(large) |
Note: *expressed as an increase in the value of the total income of beneficiaries on an annual basis, in relation to the number of employees on an annual basis.
** minimum period for maintaining of the investment project and initial number of jobs after the completion of the investment.
Source: Art.19 Investment Promotion Act (OG 63/22).
Financial grants are available for job creation and training
Financial incentives are available to support job creation through investment projects across sectors. Depending on the level of the unemployment rate in one of the 20 counties or the city of Zagreb, non-refundable grants substitute 10-30% of wage costs incurred for new employees with certain characteristics. These criteria relate to age, disabilities, length of unemployment or in case their previous work contract was terminated due to bankruptcy proceedings. For employees that do not meet any of these criteria, aid is reduced to 40% of the amount eligible for employees with special characteristics (Table 5.3). Grants are also capped depending on the county unemployment rate.
Several top-ups related to the number of jobs created or the investment project’s business activity can be accumulated and may increase the employment grant by up to 150%. For example, labour-intensive investment projects with at least 100, 300 or 500 newly created jobs raise the generosity of the grant by 25%, 50% or 100%, respectively. Top-ups are also available for development and innovation activities (including development of new production processes or technologies), business support activities (primarily related to the ICT sector), and high value-added activities covering a range of professions including architecture, design, marketing or media communication, certain tourism activities, and industrial engineering. The definitions of the different activities are specific and defined in the Investment Promotion Act (Art. 16) and regulations.
Table 5.3. Grants support job creation costs in low employment regions & for high value-added activities
Employment incentive |
County unemployment rate |
Other conditions |
||
---|---|---|---|---|
< 10% |
10% - 15% |
> 15% |
||
Grant as a % of wage costs* |
||||
Grants for wage costs per new job ** |
4% (max. EUR 1,200) |
8% (max. EUR 2,400) |
12% (max. EUR3,600) |
Opening 5-15 new positions, Min. retention of employees for 3 (MSMEs) years or 5 (large) years* |
Grants for wage costs per new job for specified employees*** |
10% (max. EUR 3,000) |
20% (max. EUR 6,000) |
30% (max EUR 9,000) |
|
INCREASE (activity-based) |
||||
Development and Innovation activities |
+ 50% |
|||
Business support activities |
+ 25% |
|||
High added value activities |
+25% |
|||
INCREASE (labour-intense) |
||||
100+ new jobs |
+ 25% |
|||
300+ new jobs |
+50% |
|||
500+ new jobs |
+100% |
Note: *Wage costs refers to the estimated wage costs over 24-months per new job created
**Grants are a one-time payment.
***Special employee characteristics are determined by regulation and refer to persons registered as unemployed with the Croatian Employment Service (CES): (i) for at least 6 months, regardless of the length of the work experience and level of education, (ii) that are older than 50 years, (iii) without work experience or (iv) whose employment contract has been terminated due to the opening of bankruptcy proceedings.
Source: Article 14 Investment Promotion Act (OG 63/22)
Training grants are available for all sectors covered by the Act and bear up to 50% of costs incurred for training employees in newly created jobs. The benefit increases to 60% of costs for medium-sized enterprises and up to 70% for small enterprises or if the training is for workers with disabilities employed by SMEs. Eligible costs include training personnel and operating costs (e.g., supply of equipment, accommodation). While training grants can be used on top of employment grants, it cannot exceed 50% of the amount received from the job creation grant for the respective employee.
Financial grants target capital costs related to high-technology equipment
Financial grants also support upgrading machinery and equipment in capital-intensive investment projects in manufacturing and processing activities, again conditional on minimum investment and job creation. The aid is only available if the respective county unemployment rate is at least 10% and supports expenses related to the acquisition of new machinery and equipment or the construction of a new factory or industrial plant (Table 5.4). At least 40% of the total investment value must constitute investment in machinery and equipment, out of which 50% must be high-tech equipment. Investors are obliged to fulfil the minimum period of maintaining the investment project for five years (large investor) or three years (MSMEs) after the completion of the investment.
Table 5.4. Aid for capital costs requires a minimum share of high-technology equipment
Incentive for capital costs |
Grant for % of capital expenditure* |
Investment amount (million EUR) |
Other requirements |
---|---|---|---|
County unempl. rate: 10-15% |
10% (max. EUR 500.000) |
5 |
- Min. 40% invested in mach. & equip., - Min. 50% of mach.& equipment high-tech |
County unempl. rate > 15% |
20% (max. EUR 1 M) |
5 |
Note: *in long-term assets
Source: Article 17 Investment Promotion Act
Land and buildings can be leased rent-free under certain conditions
Land or buildings owned by the Republic of Croatia that are not in operation (“inactive”) can be leased rent-free for up to ten years. Investors are required to “activate” these state-owned assets by investing at least EUR 3 million in fixed assets and create at least 15 new jobs within three years. In less developed regions this incentive can be approved without a legal tender procedure. The application process is governed by regulations on the management of state assets owned by the Republic of Croatia and requires the conclusion of a leasing agreement between the Republic of Croatia and the beneficiary. After the end of the leasing period, the beneficiary may purchase the asset or continue to lease without aid.
Faster administrative procedures available for Strategic Investment Projects
The Act on Strategic Investment Projects (ASIP) (OG 29/18, 114/18) complements the Investment Promotion Act. It defines what constitutes “strategic investment projects”, using criteria linked to business activity, minimum capital investment thresholds (HRK 10 million, approximately EUR 1.3 million), and requires the project to comply with physical planning documents. The primary objective of the law is to provide quicker administrative processes by elevating procedures to the central government instead of the local level.
Additionally, the ASIP outlines the terms for the sale of state-owned property, awarding concessions, and issuing administrative licenses. It applies to private, public, and private-public investments. Strategic investment projects are governed by the Sector for Competitiveness within the MESD’s Directorate for Internationalization.
R&D activities incentivised through tax benefits and financial grants
The regime for R&D incentives is separate from other investment incentives in Croatia. It has been in place since 2019 and is governed by the Law on State aid for Research and Development Projects (OG, 64/18) and the ordinance on State aid for research and development projects (OG, 9/19). The MESD is the responsible authority for setting the incentive policy, although the Croatian Agency for SMEs, Innovation and Investments (HAMAG BICRO) is the implementing body.
The regime targets basic research, industrial research, experimental development, and feasibility studies. It is thus eligible for projects at different stages, ranging from the early research phase to further development of already existing products. Investors have three years to implement the project, starting from the announcement of the positive incentive decision.
Depending on the type of research project, 125-200% of eligible R&D expenses can be deducted from the taxable base, with the total amount of support reaching up to EUR 300 000 per entrepreneur and project. Eligible expenses include current expenditure (including wages and salaries) and certain capital expenditure (e.g., equipment). The regime is also regulated by the GBER (under provisions related to R&D aid rather than the Regional Aid scheme), which sets a ceiling for maximum State aid intensity per beneficiary and determines the amount deductible. For basic research projects, an additional 100% of eligible project costs are deductible, whereas for other types of research projects (e.g., feasibility studies) the ceiling is lower. This enhanced tax allowance enables investors to deduct up to twice the amount of the actual expenses incurred.
Croatia, like most OECD countries, uses a mix of tax relief and direct funding to encourage R&D and innovation. This helps to support different R&D policy objectives. Studies suggest that R&D tax incentives are more effective to support projects that are closer to market, while direct funding appears more important for longer research (such as for pharmaceuticals) (Appelt et al., 2020[13]). In Croatia, 97% of R&D incentives awarded are grants (Government of Croatia, 2022[14]). Even though most applications for tax incentives are approved, the number of applications is relatively low (around 70 projects received R&D tax incentives in the period 2019-2021 out of around 100 applications) (Figure 5.3). Additional analysis is required to understand why this is the case (see Monitoring and Evaluation for a discussion on take-up of the incentives under the Investment Promotion Act). Relatively low take-up of R&D tax allowances could be due in part to complex application procedures or a lack of awareness about the incentive regime among SMEs. Compared to other CEE countries and the OECD and EU28 average, funding and tax support of company R&D expenditure is significantly lower in Croatia (Figure 5.3). The MESD is aware of these challenges and plans to reform R&D tax incentives and respective application and granting procedures until 2025.
Economic zones offer other tax and non-tax benefits and business support services
Croatia also offers benefits and services associated with locating in special economic zones. There are two zone regimes in Croatia: free zones and entrepreneurial zones. The objective of free zones is to build the industrial infrastructure for the production of goods aimed for export, while the goal of entrepreneurial zones is enhancing regional development. In 2022, Croatia operated six free zones and 313 entrepreneurial zones. Benefits for companies in free zones – which can be established at seaports, airports, river piers or along international roads – include an exemption of customs duties or certain taxes, including VAT, levied on goods stored in the zone and unlimited time for storing goods in the zone. The zone users can also benefit from forwarding and logistics services and consultations. The founders of free zones can be regional authorities, institutions, public or private companies and zones are governed by the Free Zones Act (OG 44/96, 58/20).
Entrepreneurial zones target companies and entrepreneurs operating in manufacturing, processing, logistics, distribution activities and selected services. While they do not provide special tax incentives, a key benefit of operating in one of the zones is that they are equipped with infrastructure (i.e., energy, transport, ICT and municipal infrastructure) and that related costs can be lower due to multiple users in the zone. Zones can also provide lower land prices, reduced parafiscal charges (e.g., lower utility charges) and assistance and consultation services. Local and regional authorities can be the founding bodies and the MESD grants financial and planning assistance to these bodies when creating the zones. These zones are governed by the Entrepreneurial Infrastructure Improvement Act (OG 93/13, 138/21). The act also sets the framework for entrepreneurial support institutions. These local institutions can take different forms, including development agencies, entrepreneurship centres, business incubators, business parks or competence centres. They are intended to strengthen entrepreneurial competences by offering services to existing and future entrepreneurs. The main services of these institutions are counselling, assisting and educating entrepreneurs. In September 2022, the number of entrepreneurial support institutions in the country amounted to 214, ranging from two to 33 per county.
Sub-national governments grant additional incentives
Sub-national governments and county development agencies offer various types of incentives (see Chapter 4 for more on regional development). These can include in-kind incentives such as easy access to industrial sites, utility connections, reduced price of land and exemptions from local taxes and administrative fees. There is no complete overview of all incentives granted at the local level. Some of the local incentives are displayed in the catalogue of regional and local grants, provided on the homepage of the Croatian Employment Service (Croatian Employment Service, 2022[15]).
A special case is the incentives regime for the city of Vukovar, which was significantly damaged during the homeland war in 1991. The incentive was introduced at the national level through the Income Tax Law (article 43) and the Profit Tax Act (article 28.a). To encourage rebuilding and reestablishment, investors operating in the city of Vukovar are fully exempt from paying Personal Income Tax (PIT) or CIT if they employ five or more workers and if at least half of their employees are residents of the city or surrounding assisted areas. Additionally, if taxpayers perform activities in the areas of the local self-government units (categorised as group 1, as defined per regulation on regional development), half of their taxable income is CIT or PIT exempt.
Incentives are governed by different institutions and under various legal acts
While most incentives for investors are authorised in the Investment Promotion Act, the governance of investment incentives is split across different institutions and legal frameworks. This is not unique to Croatia; however, it raises the importance of coordination to ensure that incentive programmes complement each other.
Incentives granted under the Investment Promotion Act are governed by the Sector for Incentives and Entrepreneurship (referred to throughout as Sector for Incentives), a department under the Directorate for Internationalisation in the MESD. The Sector is responsible for implementing incentives granted by the Act, monitoring the compliance of beneficiaries, and is also involved in proposing policy changes and amendments of the Act. The Sector is divided into the Investment Incentives Service and the Entrepreneurial Infrastructure Service. The Investment Incentives Service is in charge of the operational aspects of incentives for investment projects. It receives applications, checks project eligibility, and meets with applicants prior to approval. It coordinates with the Ministry of Finance (MoF) before granting incentives, to request information about potential tax arrears, it receives MoF approval and shares which investors have been granted beneficiary status with the MoF.
Other incentives are governed by different units or institutions under separate legislation. The Entrepreneurial Infrastructure Service is involved in the creation of zones and business support institutions and maintains a register of existing zones and support institutions. It also evaluates requests of local authorities for donating state-owned land from the national to the local level for the establishment of new zones. Free zones are governed by the Free Zones Act (OG 44/96, 58/20) and entrepreneurial zones and support institutions by the Entrepreneurial Infrastructure Improvement Act (OG 93/13, 138/21), although not the MESD but the zones’ founding bodies (e.g., regional authorities) determine the concrete benefits.
Another unit in the MESD’s Directorate for Internationalisation (Sector for Innovation) is responsible for R&D incentives, regulated under the Act on State aid for Research and Development Projects (OG 64/18) and related ordinance (OG 9/19). The Sector is solely responsible for the implementation of R&D incentives though according to representatives from the MESD it coordinates with other units when designing incentive policies. Lastly, other (mostly non-tax) incentives are granted at the local level by sub-national governments or local development agencies and may vary in each of the 20 counties and the city of Zagreb. There appears to be no formal coordination between national institutions in charge of incentives and sub-national governments or local development agencies.
Split governance frameworks can result in challenges for coordination on design and implementation of incentive policy, and can make it more difficult for the government and investors to understand the scope of incentives offered. Some agencies seem to coordinate more than others. Both the Sector for Incentives (responsible for the main incentives granted in the Act) and the MoF reported a well-functioning coordination process to share information on potential tax arrears of applicants and which investors receive incentives. However, coordination between all incentive-granting sectors within the MESD, other ministries and different incentive-granting authorities at the local level appears to be limited. The MESD’s Entrepreneurial Infrastructure Service is responsible for zone policy and monitors the development of entrepreneurial zones. It appears, however, that there is no central oversight or coordinating body at the central government level that coordinates zone activities (OECD, 2019[16]).
Many countries grant tax and other incentives in a variety of laws, including investment laws, administered by different agencies (Celani, Dressler and Wermelinger, 2022[17]). Investment laws can add transparency to the investment regime and are more often used in developing and emerging economies than in OECD countries. However, investment policymakers tend to be inclined to offer fiscal benefits to attract investment, perhaps without full consideration of the state’s fiscal needs. Close coordination with the Ministry of Finance is therefore key to ensure that incentives are cost-effective. Moreover, without mechanisms to share information between incentive-granting authorities, incentives may overlap, be inconsistent, or work at cross-purposes (OECD, 2013[18]). This is particularly a risk if different ministries offer CIT incentives. While the Sector for Incentives is responsible for granting most CIT benefits, it does not oversee R&D incentives and incentives for investors in Vukovar city, and coordination could become a greater challenge if tax incentives for tourism move under the remit of the Ministry of Tourism and Sports. Sharing information across levels and bodies of government on beneficiaries of incentives is important to curb potential redundancies in granting benefits to the same investors (Jedlicka and Sabha, 2017[19]).
Croatia could consider how to improve coordination in its reform efforts, both at the national level (within sectors of the MESD and between different ministries) and with representatives from the local level. This is important to counteract the risk of operating in silos when designing both tax and non-tax incentive policies independently, particularly between the national and sub-national level.
Assessing design of investment tax incentives
The forthcoming National Plan on Investment Promotion provides an opportunity to assess Croatia’s investment incentive policies, including their design, goals and use, whether incentives are supporting policy goals. Of the incentives outlined, according to the MESD, CIT incentives granted through the Investment Promotion Act are the primary incentives used by investors (83% of incentive spending via the Act is on tax benefits, compared to 17% on grants) (Government of Croatia, 2022[14]). This section assesses the implications of the design of these tax incentives for their policy goals, suggesting potential areas for reform. It also considers the implications of the international tax agreement on incentive policies.
Empirical evidence on the benefits of tax incentives is limited but confirms that in addition to context and framework conditions of the jurisdiction, incentive design is critical for their success (see OECD (2022[1]) for a literature review on effectiveness of incentives). Incentive design relates to the type of incentive (how the incentive reduces taxation, including qualifying income or expenditures), eligibility conditions (which investors and projects qualify to receive the incentive), and governance (how the incentives is awarded to investors) (Celani, Dressler and Wermelinger, 2022[17]). These aspects affect incentive uptake and investor behaviour, and thus are key to assessing if incentives seem to be contributing to stated policy goals, and at what costs.
As detailed above, Croatia has aligned incentives under the Investment Promotion Act with EU regulations on Regional Aid, with a positive effect on incentive design. Incentives are available to firms of any size, in a broad range of sectors, preventing unfair distortions to competition or opportunities for rent seeking behaviour by favoured sectors. Eligibility conditions are clear and specific, and tied to positive development goals, notably, regional convergence and job creation. Tax and financial benefits are capped with a ceiling per project as well as annual spending limits for the regime as a whole, proving a check on government expenditure. As will be explored in the following section, EU regulations also positively mandate thorough monitoring and reporting on incentive uptake and costs, an essential first step to evaluating the impact of incentives.
Looking forward, the government could consider revising some of its incentives to maximise positive spillovers, limit potentially excessive benefits to firms, and ensure incentives are in line with broader investment policy goals. Moreover, though not covered in this chapter, as the government elaborates its investment promotion plan and goals, it should also evaluate if other policy instruments – including regulations – may be more appropriate for certain economic and sustainable development objectives.
Consider moving from income-based to expenditure-based tax incentives
The key design features of investment tax incentives determine how the incentive provides tax relief. The four most frequently used CIT incentive instruments and their main design features are summarised in Box 5.4. Income-based tax incentives (CIT exemptions, reduced CIT rates) reduce the rate applied to generated income and generally attract investments that are already profitable early in the tax relief period. These firms may not be most in need of government support; profitable firms are arguably more likely to have undertaken the investment even without incentives (IMF, OECD, UN, World Bank, 2015[6]). CIT reductions and exemptions can lower effective tax rates substantially, even to 0%, with potential significant costs in terms of revenue forgone (Celani, Dressler and Hanappi, 2022[20]).
Box 5.4. Tax incentive instruments
The most commonly observed CIT incentives can be categorised as income-based tax incentives (CIT exemptions and reduced CIT rates), which reduce the rate applied to generated income, and expenditure-based tax incentives (tax allowances and tax credits), which relate to the capital or current expenditure of firms.
Tax exemptions provide a full or partial exemption of qualifying taxable income and apply on a temporary or permanent basis.
Reduced rates are CIT rates set below the standard rate for a sector or firm type and apply on a temporary or permanent basis.
Tax allowances are deducted from taxable income (i.e., income subject to taxes) and may target current expenditure (e.g., operation expenses) or capital expenditures. Tax allowances may allow for a faster write-off of value of capital expenditure from taxable income up to 100% of incurred costs (i.e., acceleration) or can go beyond 100% of acquisition cost (i.e., enhancement). This could include, for example, allowing firms to deduct 150% of the value of a new machine. Tax allowances for current expenditure are always enhancing (i.e., deductible expenditures are higher than actual costs incurred).
Tax credits are deductions from the amount of taxes due (i.e., tax liability) that may relate to capital expenditures or current expenditures.
Note: Additional information on how the key design features affect tax relief is discussed in Celani, Dressler and Hanappi (Celani, Dressler and Hanappi, 2022[20]).
Investment tax incentives in Croatia take the form of reduced CIT rates (income-based). Positively, reduced rates are conditional on substantive investment in the country, with minimum investment value and employment requirements. Investors are required to retain fixed assets and jobs for three to five years. Tax incentives in Croatia are also capped as a share of the investment value, which can limit excessive costs in terms of revenues forgone. Tax incentive caps are set in Croatia’s regional aid map for 2022-2027, with higher caps in regions with lower levels of GDP per capita.
In many cases, it seems income-based incentives are used primarily because of tax competition with other economies, making it difficult for countries to unilaterally remove such benefits (Klemm and Van Parys, 2012[21]). Czechia and the Slovak Republic also offer income-based incentives under Regional Aid schemes, with similar tax relief as Croatia for up to ten years, also conditioned on minimum investments and capped at a percentage of eligible costs. Countries with higher levels of GDP, including Austria and Slovenia, as most countries in the EU, primarily use expenditure-based tax incentives (targeted for R&D) and enhanced allowances for the acquisition of certain new assets.
Looking forward, especially as GDP levels in Croatia rise and allowances of incentives under EU Regional Aid changes, Croatia could consider phasing out the use of income-based in favour of expenditure-based incentives, such as accelerated depreciation and tax allowances or credits. While the effects of policies depend on the individual country context, there is evidence suggesting that accelerated depreciation and immediate expensing have been effective at increasing investment in OECD countries (Maffini, Xing and Devereux, 2019[22]; Zwick and Mahon, 2017[23]; House and Shapiro, 2008[24]; Cohen and Cummins, 2006[25]). Similarly, among developed countries, evidence of the effectiveness of expenditure-based R&D tax incentives is much more conclusive than for income-based tax incentives (OECD, 2022[1]; Hall, 2019[26]; Appelt, González Cabral and Hanappi, 2022[27]; Guceri and Liu, 2017[28]; Gaessler, Hall and Harhoff, 2018[29]). However, expenditure-based incentives still have costs, necessitating regular monitoring and analysis. Tax revenues are a key source of public finances, crucial for delivering public goods and services, such as infrastructure, education and skills development – factors that also affect the country’s investment climate.
Expenditure-based incentives could enable better targeting of incentives towards reducing specific costs, thereby encouraging spending that might not occur without the incentive. While income-based incentives in Croatia are conditioned on expenditure, the definition of eligible investment costs is broad (assets or wages); transforming the reduced rate into a tax allowance could allow to support specific policy objectives through targeting of relevant qualifying expenditure, for example, high-tech machinery. Because expenditure-based incentives directly target investment expenses, they reduce the cost of capital, making investments more profitable at the margin (IMF, OECD, UN, World Bank, 2015[6]). The benefit for the company depends on the size of the investment it undertakes and can also be linked to specific activities and policy objectives (e.g., R&D, skills development etc.).
Expenditure-based incentives are also likely to be less affected by the recently agreed Global Minimum Tax for large MNEs (Box 5.5). The agreement, by more than 135 jurisdictions, requires large MNEs (with revenues above USD 750 million) to pay a 15% minimum effective tax rate in all jurisdictions in which they operate. If in-scope MNEs in Croatia are subject to ETRs below 15% (for example through reduced CIT rates) Croatia could potentially forgo revenues that could be collected by other jurisdictions through a top-up tax, in the absence of tax reform or other policy actions.
As more countries are moving to implement the global minimum tax, it is important for Croatia to analyse the implications for its domestic tax system. In December 2022, EU Member States unanimously adopted a directive to implement the minimum tax for large MNEs and large domestic groups. OECD analysis shows that income-based incentives for in-scope MNEs will be strongly affected, whereas expenditure-based incentives are less likely to be affected. The current design of income-based incentives in Croatia ties tax support to creating economic substance in the country. The minimum tax rules allow a carve-out for profits associated with economic substance (OECD, 2022[1]).4 This means that if incentives in Croatia are successful at attracting investment and generating employment, they should be better protected from the minimum tax. In consultations, the MESD noted that developments related to the minimum tax are being closely observed and that incentives for MNEs will be adjusted in close cooperation with the Ministry of Finance. It will be important to ensure coordination across ministries on this issue given the fast pace of action of reform in this area.
Box 5.5. Tax incentives and the global minimum tax for MNEs
A global minimum effective taxation level for large MNEs
Pillar Two of the new international tax agreement establishes a global minimum effective corporate tax rate of 15% for large multinational enterprises (MNEs). Where an MNE’s effective tax rate (ETR) in a jurisdiction falls below 15%, the MNE would potentially be subject to top-up taxes under the Global Anti-Base Erosion (GloBE) Rules, a core component of Pillar Two. The GloBE Rules establish the minimum corporate tax and are complemented by the subject-to-tax rule which will allow developing economies to tax certain base-eroding payments (such as interest and royalties) when they are not taxed up to the minimum rate of 9%. The GloBE Rules apply top-up taxes to profits in excess of a substance-based income exclusion (SBIE), which allows some profits based on economic substance (tangible assets and payroll) to be deducted from the GloBE base.
A recent OECD report prepared under the request of the G20 Indonesian Presidency explores the impact of GloBE Rules on tax incentive use (OECD, 2022[1]). This report draws on the OECD Investment Tax Incentives Database (ITID) to provide evidence on tax incentives use in developing countries; outlines key provisions of the GloBE Rules; analyses the impact of GloBE on different common tax instruments and outlines some options for policymakers to explore.
Impact on the use of tax incentives
The GloBE Rules will not affect all jurisdictions, MNEs and tax incentives in the same manner. The impact of the GloBE Rules on tax incentives will depend on their design, on the jurisdiction’s tax system (its baseline tax system and its use of base narrowing provisions), and on the characteristics of MNEs and the activities they perform in the jurisdiction. For example, existing tax incentives may continue to be used by MNEs below the EUR 750 million revenue threshold, without them being affected by the GloBE Rules.
The impact of the GloBE Rules will strongly depend on the design of tax incentives. Certain types of tax incentives will be strongly affected, particularly certain income-based tax incentives such as full exemptions or significantly reduced CIT rates, which as shown above are widely used across the world. Others may not be affected at all, such as accelerated depreciation for tangible assets. Understanding the degree to which tax incentives may be affected by the rules requires careful consideration of the detailed design of tax incentives.
Targeted tax incentives, incentives with economic substance requirements and expenditure-based tax incentives targeted at tangible assets may be less affected. The targeting of tax incentives to certain categories of income or expenditure or limitations to tax benefits will impact which tax incentives might be affected. Expenditure-based tax incentives targeted to payroll tangible assets or tax incentives with substantive economic substance requirements may be less likely to be affected by the GloBE Rules due to the SBIE. However, the value of providing strongly reduced CIT rates or CIT exemptions to in-scope firms might merit a reassessment of the use of these tax incentives.
The GloBE rules should prompt jurisdictions to review the use of tax incentives and consider tax incentive reform. This is particularly the case for tax incentives that may become inefficient due to the operation of the GloBE rules.
Source: (OECD, 2022[1])
Consider if eligibility conditions best support policy goals
Many countries design investment incentives not only to attract investment but also to advance certain economic, social, environmental and other goals. Carefully designed and targeted incentives may help correct market failures and advance social and economic development (OECD, 2022[30]; IMF, OECD, UN, World Bank, 2015[6]). This can be done through eligibility conditions that require investors to meet certain project or outcome requirements (e.g., investment size, job creation) to receive the incentive, or operate in certain sectors (e.g., renewable energy), or by designing the incentive to reduce certain expenditures (e.g., tax credits for R&D, infrastructure) or taxes on certain income (e.g., revenue from exports) (Celani, Dressler and Wermelinger, 2022[31]).
Tax and non-tax incentives under the Investment Promotion Act are designed to support the growth of substantive private sector investment (domestic and foreign), job creation, regional development and technological upgrading. CIT incentives under the Act (most used by investors) support these goals through eligibility conditions to receive benefits: projects must meet outcomes of job creation, modernisation of assets, or productivity increases, and can receive greater benefits if they invest more or locate in certain locations. Outcome conditions such as employment creation can promote positive spillovers of investment; however, they require careful monitoring to ensure that the outcome has been met. This necessitates resources, administrative capacity, and often coordination with other government agencies (e.g., cross-checking with social security information on number of jobs created or salary) (Celani, Dressler and Wermelinger, 2022[31]). The government is encouraged to critically evaluate if incentives are contributing to their goals, and if some policies could be adjusted to better target their aims.
Incentives could further support costs of job creation and skills development
Tax incentives promote job creation through an employment requirement (between three and 15 new jobs depending on the size of the firm) to receive reduced CIT rates. Investors are also encouraged to invest in areas with low employment, where caps for maximum State Aid per project are higher. Employment is also incentivised through grants, supporting costs of job creation and training employees in new jobs. The Investment Promotion Act further encourages employers towards more inclusive practices; grants are higher for disabled or older employees, and long-term unemployed people. Separate subsidies (not detailed in this chapter) are available through the Croatian Employment Services and other bodies, including reductions on social security contributions for hiring young employees (Government of Croatia, 2022[14]).
According to MESD’s figures, since 2013 investment incentives under the Act have supported around 800 projects, which have created an estimated 27 000 new jobs (planned to be created from projects). That is approximately 5.4 jobs per USD million invested, higher than estimated job creation intensity of foreign investment in Croatia overall (3.5 jobs per USD million, see Chapter 1). This suggests that incentives could be supporting investment with greater employment potential. However, it is not clear how many jobs would have been created in the absence of the incentive. Results could also be linked to the sectors that most apply and benefit from incentives, notably metal processing, tourism, and ICT according to MESD.
It is also not clear how effectively a job creation requirement for reduced CIT rates incentivises new jobs. It requires close monitoring that the firm adheres to this requirement, and administrative costs to remove the incentive if firms are not complying. Income-based incentives also do not directly decrease the cost of employment. Social security contributions (SSC) in Croatia, as is in many countries in Central and Eastern Europe, are above the OECD average (OECD, 2019[11]). In consultations, investors frequently cited high employment costs as a constraint on growth.
Moving from income-based to expenditure-based tax incentives, for example, could directly reduce hiring or social security costs for employers, incentivising job creation. There is evidence that a well-designed tax credit in France, which was temporary and targeted at jobs with rigid wages, had a clear positive affect on employment for small firms. Box 5.6 provides several examples of such policies in peer countries. However, CIT incentives cost the state revenue; taxing corporate incomes could allow the state to lower the labour tax burden, which could also support employment. Notably, other incentives in Croatia do seek to directly reduce the costs of employment, including grants in the Investment Promotion Act as well as other grants and reductions to SSC set in different legal acts (not covered in this chapter). It would be pertinent to explore if investors are using these benefits and if they are contributing to reducing employment costs.
More broadly, the government could consider other barriers to job creation, and other labour market goals. Job quality – including wage and non-wage working conditions – and skills development are key for inclusive labour markets (OECD, 2022[32]). Consultations with private sector associations revealed that investors are in many cases ready to employ but face constraints due to a lack of workers and skills mismatches of the available workforce. Consultations with the Croatian Employment Service and the Ministry of Labour, Pension System, Family and Social Policy supported these findings. The institutions emphasised on the need for up-skilling the Croatian population and mentioned that emigration trends of highly skilled Croatians are contributing to the low supply of workers. The government recently established tools as a base for a skills prediction system, such as the Labour Market Portal for monitoring labour supply and skills potential and labour demand on a county level. Further upskilling and educational programmes are planned. The MESD could use the upcoming reform of the Investment Promotion Act to assess if tax incentives and grants seem to be incentivising employment and skills development. Coordinating with the Ministry of Labour or the Croatian Employment Service might be insightful for discussing how to support up-skilling or re-skilling of the workforce and securing quality jobs.
Box 5.6. Targeting employment and skills development through tax incentives
Many governments use tax incentives to target employment and skills development, for example through CIT allowances or credits, or through reductions or exemptions to other taxes such as social security contributions. CIT incentives can address employment outcomes by linking benefits to qualifying expenditure (e.g., wages or payroll expenses) or outcome conditions (e.g., creating a minimum number of new jobs). By using dedicated eligibility conditions and design features, incentives can support existing jobs, or encourage beneficiaries to create new jobs or invest in training opportunities of staff. Sometimes these goals overlap with other priorities; many countries that support employment costs via incentives also encourage skills development or promote R&D.
Reducing employment costs through tax credits
France has offered different tax credits to target employment costs. The Competitiveness and Employment Tax Credit (CICE) amounted to 6% of annual payroll charges paid and could be claimed for salaries that are up to 2.5 times the amount of the French minimum wage. It thereby significantly decreased the costs of medium and low wages. In 2019, a reform permanently decreased employers’ social contributions and phased-out the credit.
France introduced a hiring credit to counter the effects of the 2008 recession. The credit relieved firms from paying social contributions for new employees hired between December 2008 until the end of 2009. It targeted small firms with less than ten employees and low-wage jobs. An econometric assessment of the credit found that it had a statistically positive effect on job creation (Cahuc, Carcillo and Le Barbanchon, 2019[33]). The success of the measure was due to certain design features: the credit was temporary, targeted at jobs with rigid wages and not anticipated by the labour market.
Targeting employment and innovation
In the Netherlands, investors can benefit from an employment incentive if their business is engaged in R&D activities. The country offers a payroll withholding tax credit (also known as the WBSO R&D credit scheme) that reduces wage costs of R&D employees. Such an incentive has the potential to boost employment and could generate knowledge spillovers, if researchers acquire skills on the job that they can transfer to other jobs. The incentive may also attract innovative companies. The benefit amounts to 32% for the first EUR 350.000 of R&D costs and 16% if expenses (wages or other expenses) exceed the threshold.
Tax allowances can support skills development
Italy offers a tax allowance for companies investing in training of staff for Industry 4.0. The goal is to support the up-skilling of staff related to the technological and digital transformation of businesses. Large companies can deduct 30% and medium-sized companies additional 50% of training costs from their taxable base, caped at max. EUR 250,000. For small companies, these thresholds increase to 70% of respective costs, caped at EUR 300,000.
Assess if changes to tax incentives are supporting regional development
Many governments design incentives to promote regional development, often through eligibility conditions that require investors operate in certain locations to receive benefits. In Croatia, investors in under-developed regions or regions with higher unemployment rates can receive greater benefits: larger grants to support job creation and equipment upgrades, and as of 2022, higher caps on incentives. The government recently revised its Regional Aid Map, which sets caps – as a percentage of eligible investment costs (assets or wages) – on the total amount of tax and non-tax incentives an investor can receive over the project lifecycle. The 2022-2027 map sets caps between 35-60% of eligible costs for large investors, with higher ceilings in less developed regions, notably in Pannonian and Northern Croatia (Figure 5.5). The government recently increased the cap to 60% for the county of Sisak-Moslavina, one of the least developed areas in Pannonian Croatia. These changes revised the previous map, which capped benefits at 25% of costs regardless of project location. Regional Aid Maps are proposed by the government and approved by the European Commission (Box 5.2). For SMEs, the caps can be increased to up to 75% of eligible project costs (see note in Figure 5.5).
According to Croatian government officials, incentives have thus far not had the desired effect on promoting investment in less developed locations, and it is too soon to evaluate if the new Map will change this. However, since the differentiating caps were introduced, the Sector for Incentives reported receiving a rising number of applications for projects in some of the affected locations. Officials also noted that caps are among the highest across the EU, which it hopes might attract more investors to Croatia overall and these regions in particular.
Studies suggest that in Europe, financial, in-kind and tax incentives have helped encourage investors to locate to less favoured regions, particularly for efficiency-seeking investors when this support helps offset disadvantages related to a more peripheral region. However, these concessions have in general been far more generous than what is necessary to compensate for extra costs of investors to locate in these areas (Amin et al., 1994[36]). Overly generous incentives in certain locations can increase the risk of aggressive tax planning by firms (for example, shifting profits to areas with lower taxation while keeping operations elsewhere), and a race to the bottom among regions (OECD, 2021[37]; IMF-OECD-UN-World Bank, 2015[38]). Case studies also highlight the importance of other complementary policies in attracting investors to under-served regions, including investment in infrastructure (Amin et al., 1994[36]).
If well designed, incentives can nonetheless help to offset certain costs or risks of investing in less developed regions, and the Croatian government could consider adopting a more targeted approach to location-based benefits. For example, tax allowances or credits could reduce costs related to infrastructure and utilities. Incentives could also be used to increase the positive impact of investment across regions. Firms generally locate in less developed regions for cost advantages, including low wages. Incentives that support training costs and labour productivity through equipment upgrades (also discussed below) can help promote positive FDI effects (Amin et al., 1994[36]; OECD, 2022[30]). Grants for job creation costs could be further tailored towards training.
Designing incentives to attract additional investment in particular regions requires clear understanding of the challenges and opportunities for investors in these locations. MESD should ensure close coordination with subnational self-governments and agencies, who also grant their own incentives, to ensure that place-based incentives are relevant and coherent (Chapter 4). For example, some local authorities already grant in-kind incentives such as utilities and reduced price of land. The national government should consider the effectiveness of these measures. Overall, more evaluation is required to determine how investors are responding to existing incentives, and if these benefits can be revised to overcome costs of locating in less developed areas.
Expenditure-based incentives could support technology upgrading
One of the more specific goals of the Investment Promotion Act is supporting modernisation of business equipment via grants for equipment, requiring a minimum share of high-tech machinery (Table 5.4) and the transition to Industry 4.0, via CIT reductions for firms operating in the manufacturing and processing (Table 5.2). In 2015, the government also adjusted requirements to benefit from reduced CIT rates for the service-intensive ICT sector, by decreasing minimum investment thresholds in assets and increasing minimum job creation requirements. According to the government, the change led to a clear rise in incentives applications from ICT enterprises. Analysis of FDI trends confirms an increase in ICT investment; stock of greenfield FDI in ICT (manufacturing and services) grew by 22% more in the years after 2015 than during years prior to the policy change. Half of this increase was in ICT and internet infrastructure – essential to boosting the enabling environment for the digital economy – and around 40% in software and ICT services (Chapter 2). These figures do not imply a causal link between the incentives and rise in investments, which could also be due to a general growth in ICT sector in Croatia in recent years, particularly since the COVID-19 pandemic. Incentive policies, however, can also have an important signalling effect to alert investors to opportunities.
As outlined above, the government could consider adopting expenditure-based incentives rather than income-based benefits to better target relevant qualifying expenditure, and more directly support the policy objective. Tax allowances and credits are more likely to be effective at reducing the cost of technology upgrading, as opposed to equipment modernisation requirements. While reduced CIT rates in Croatia are tied to expenditure, eligible costs (assets or wages) go beyond investing in high-tech equipment and could be less effective in encouraging this purchase compared to more targeted expenditure-based incentives. Grants can also be useful to support technological upgrading, and it would be worthwhile for the government to explore why these are not used more widely by firms.
Croatia could consider examples from other countries that provide targeted support to firms specifically to pursue digital transformations (across sectors), using a mix of tax and financial support, as well as business advisory services (e.g., consulting and technical support). For example, Australia recently introduced a temporary tax credit to support digital upgrades in small firms (Box 5.7). Many countries in Central and Eastern Europe (CEE) are trying to position themselves as front runners in ICT services, innovation and high-tech industries (McKinsey, 2022[39]). Improving local digital skills is important in this regard, particularly for strengthening local linkages with SMEs. When SMEs have some digital tools, they are more appealing as domestic suppliers, which in turn supports their entry into global value chains. SMEs with basic digital skills are also more likely to benefit from more advanced technology transfers from international firms (OECD, 2022[32]).
Box 5.7. Investment for digital upgrades and skills training in Australia
Australia has introduced a comprehensive package of investment incentives for digital upgrades across firms. Under the Technology Innovation Boost programme, small businesses with annual turnover of less than USD $50 million can claim a 20% enhanced deduction (120% tax deduction) for cost of expenditures and depreciating assets up to a threshold. Eligible expenditure includes digital solutions such as portable payment devices, cyber security systems and subscriptions to cloud-based services. The policy is notable in using specifically, targeting relevant expenditure for digital upgrades, and in that it is time-bound, the boost applies only to expenditure incurred between March 2022 and June 2023. Time limits on incentives can facilitate policy evolution. The Skills and Training Boost programme provides similar tax benefits (enhanced tax deduction/allowance) for training courses to employees..
Source: (Government of Australia, 2022[40]).
Assess tourism incentives ahead of planned reforms
In addition to the areas mentioned above, tourism seems to be a priority for the government. The incentives of the Investment Promotion Act target “sustainable high value-added tourism services”, which include accommodations with at least four stars, related services (e.g. congress, sports-recreational, entertainment, health, tourist-ecological, nautical) and amusement theme parks. The tourism industry has been rapidly growing and upscaling towards more high-end establishments in the last recent years but it is unclear to what extent incentives helped support this growth.
Croatia’s current reform plans include creating a new legal act to grant specific incentives for the tourism sector that will be governed by the Ministry of Tourism and Sports. The tourism sector is one of the top recipients of incentives under the Investment Promotion Act, according to MESD. MESD noted in consultations that one rationale for this move is to create an incentives programme that is more adapted to the tourism industry. The reform would also allow more projects to receive incentives (and greater government spending) under the Investment Promotion Act, subject to a EUR 150 million cap under EU Regional Aid rules, if tourism projects fall under a different aid scheme (Box 5.2). While there are clear benefits for countries to keep incentives under GBER thresholds (not least to avoid lengthy approval procedures), introducing several aid schemes involves costs to the government.
Tourism already contributes to 20% of Croatia’s GDP. It also received up to 25% of total regional investment aid granted between 2013 to 2021. Tourism is in many ways location-specific, raising questions about whether investors are likely to enter Croatia’s tourism market regardless of incentives. This underscores questions around whether the type of incentives currently in place are generating additional investment in the country that would not have entered without the incentive. Before implementing the new tourism incentives programme, more studies on the impact and need for tourism incentives would be beneficial.
Transparency can increase take up of incentives
Many countries face difficulties enhancing the transparency of their incentive regimes to investors. Transparency concerns the legal basis (e.g., clear criteria stated in law) but also relates to the governance of incentives (e.g. administrative burden of application, discretion during granting process) and promotion (accessibility of incentive legislation and available incentives) (OECD, 2023[41]). From the perspective of investment facilitation – i.e., improving practical procedures for investors entering and operating in a market – greater transparency on available incentives and conditions for receiving them could help countries to attract untapped investment sources, by levelling the playing field among investors. SMEs have fewer resources to navigate the often complex legal framework governing incentives, and may be deterred by incentives that require lengthy or complex approval processes. Foreign investors that are less familiar with the local market may not be aware of potential assistance to support new investment; greater transparency could help overcome information asymmetries (Jedlicka and Sabha, 2017[19]).
Croatia has taken successful measures to enhance transparency on incentives for investors. The “Invest Croatia” homepage features an incentives calculator that allows investors to calculate the total value of benefits they can receive, depending on their project characteristics and investment costs. Furthermore, Incentives are granted based on clear and measurable criteria outlined in the law. This is positive compared to many other countries, including in CEE, where governments have more discretion in granting decisions. In consultations, investors noted that they consider requirements for receiving incentives clear and did not experience unpleasant surprises during the granting procedure. Based on information shared by the MESD, the Ministry did not approve around one-third of applications for incentives received in 2021. The most common reasons for the rejection were that applicants had already started the investment project prior to the application, which is not in line with EU requirements or indebtedness of applicants.
The availability of information on incentives is in line with other CEE countries. The MESD’s Sector for Investments maintains an up-to-date guide on the incentives offered under the Investment Promotion Act on the “Invest Croatia” website. The guide provides details on eligibility criteria and the different categories of aid available, as well as an English translation of the law. This is good practice to ensure that investors are aware of incentives and their requirements. The homepage also features the Investment Promotion Act, relevant regulations and the application form translated in English. These documents are important as they detail the application process and full incentive requirements.
However, additional efforts could further support investors in understanding the incentives regime. As outlined, incentives in Croatia are governed by several pieces of legislation and authorities which may create challenges for investors to understand the full system. While MESD’s Sector for Investments has made strides in providing information on various regimes (beyond the Investment Promotion Act) on its “Invest Croatia” website, a comprehensive guide that highlights all available schemes – including at the local level – and relevant legislation could provide investors with a more complete picture of the scope of benefits available. This could be further enhanced through an interactive online tool that provides information on how a given investor can benefit from incentives. One example is in Spain, where the Investment Promotion Agency features an “Incentives and Aids Search Engine” on its website that lists different grants per region and sector. Croatia could also consider translating guides, websites and promotion material in the languages of its main investors (e.g., German or Italian). In consultations the MESD noted that administrative costs of keeping this information up to date were high; promoting information should be balanced with the administrative costs of doing so.
Monitoring and evaluation
Better understanding whether incentives contribute to policy goals, and at what costs, requires careful monitoring and evaluation. Monitoring can include tracking investor compliance with qualifying conditions and audits to detect potential fraud or abuse. Monitoring should also involve collecting data on tax incentives expenditure (direct or revenue forgone), which supports evaluation on costs of policies. Regular reporting of tax expenditures also creates accountability and better control over the use of public funds (OECD, 2021[37]; Redonda, von Haldenwang and Aliu, 2022[42]). Croatia already conducts extensive monitoring of its incentive policies, including on incentive uptake and compliance, as well as on costs to verify incentive caps per investor and for the Regional Aid programme as a whole. The EU also mandates annual reporting on expenditure on all incentives and descriptive details on aid recipients. The government could use its comprehensive set of data to inform evaluations on the impact of incentive policies, including if incentives seem to be effectively supporting stated policy goals, and if benefits outweigh costs.
Croatia monitors incentive take-up and compliance
The Sector for Incentives closely monitors compliance of incentive beneficiaries with the conditions set in the Investment Promotion Act and to ensure that the amount of aid received does not exceed the maximum amount of state aid, as per EU GBER reporting requirements. This includes tracking whether investors comply with minimum investment and job creation requirements. Companies are required to submit annual reports to the MESD that show this information, as well as the amount of benefits already received. The Sector for Incentives reported that it closely coordinates with the Croatian Employment Service to ensure that newly created jobs are maintained for the required period. Another component of monitoring compliance is surprise audits of one to four companies per year. Out of nearly 800 companies that have received tax and non-tax incentives under the Investment Promotion Act since 2013, the Sector has identified 15 companies that did not comply with the requirements and consequently had to repay the amount of incentives received.
As a result of this reporting, the Sector for Incentives compiles detailed information on projects and companies benefiting from incentives, including enterprise size, sector, if foreign- or domestic-owned, project location, and other descriptive firm information. Based on data shared with the OECD, applications for incentives rose notably after 2015 amendments to the Investment Promotion Act but have remained fairly steady in terms of yearly requests since 2017 (Figure 5.6A). The ratio of approved projects to applications has been increasing in recent years, though overall the number of new projects supported (around 100 per year) is relatively low in absolute terms. Most incentive recipients operate in metal industry, wood processing, tourism and ICT sectors. While most of these sectors are well established in Croatia, the ICT sector has seen notable recent growth (Chapter 2). Incentives are predominantly used by SMEs (roughly two-thirds of recipients) and investment volumes commonly exceed EUR 3 million (Figure 5.6B and C). Most recipients are also domestic firms, one-fourth of supported firms are foreign owned.
The Sector for Incentives also collects detailed information on incentive costs. The Sector and the Ministry of Finance conduct some analysis on costs of incentives, though the methodology was not shared with the OECD. Data provided (on costs of CIT incentives in terms of revenue forgone as a share of overall tax revenue) suggests revenue lost on CIT incentives is relatively low (Figure 5.6D). However, full analysis would require better understanding on how tax expenditures are calculated. There are different methods to estimating revenue forgone from tax incentives, the most straightforward of which uses simple accounting to capture a static measure of revenue forgone as the difference in tax revenue under a scenario in which the tax incentive applies relative to the benchmark tax scenario, and when the tax incentive is removed. Such a measure does not consider changes in the behaviour of taxpayers owing to the removal of the incentive (OECD, 2021[37]) (IMF, OECD, UN, World Bank, 2015[6]).
Efforts to evaluate incentive polices could be strengthened
The data collected through the monitoring process and for EU reporting could inform assessments of how incentives are used, if they are supporting their intended policy goals, and their costs. The data is already being used to inform amendments of the Investment Promotion Act. For example, the annual amount of aid granted under the Investment Promotion Act was EUR 122 million in 2019, just under the maximum limit of EUR 150 million for Regional Aid set by GBER. The Sector for Incentives consequently initiated discussions to move incentives for tourism – which received up to 25% of total regional investment aid granted per year in the period from 2012 to 2021 – under a separate aid programme, also determined by GBER parameters, governed by the Ministry of Tourism and Sports. Croatia’s spending on incentives under the GBER is relatively high; double as a percent of GDP than the EU average (Figure 5.7). According to the draft 2021 State Aid report prepared by the Ministry of Finance, State Aid overall (including all programmes of support beyond incentives described in this chapter), made up almost 12% of state expenditure (Government of Croatia, 2022[14]). This spending might be justified if it leads to increased investment with postive spillovers on the economy, which additional evaluations could help assess.
It would be pertinent to assess whether incentives generate additional investment, in support of different policies. Regular and structured evaluations of policies provide crucial insights on a measure’s impact and allow governments to consider adjusting, phasing out or continuing a policy. Ideally, this is done through an econometric study that seeks to isolate impact of a specific policy. For example, the Slovak republic recently evaluated that their Regional State Aid scheme has been effective in reducing unemployment rates in economically lagging regions of the Slovak Republic (Box 5.8). However, evidence from an evaluation of the direct and indirect effects of the scheme on FDI suggests that FDI inflows to the Slovak Republic have been significantly and positively influenced more by the grants and wage subsidies than tax relief, which was found to have a negative impact on inward FDI (Bobenič Hintošová, Sudzina and Barlašová, 2021[44]).
The MESD could consider engaging in (or commissioning) an empirical assessment to compare firms that have benefited from incentives with those that have not, in terms of performance and other firm characteristics (e.g., share of innovative or loss-making firms). This could be envisaged by matching the list of firms that have benefited from incentives with census data from the Financial Agency (FINA) of Croatia, including detailed financial and performance information on all active firms in Croatia. While the concrete effect of incentives cannot be determined in such an evaluation, these data could nevertheless be used to assess whether incentives are supporting investment with positive effects on productivity, exports, jobs, wages, skills and other outcomes in different regions. Similarly, Italy’s Ministry of Economy and Finance recently evaluated the impact of its hyper-depreciation for Industry 4.0 investments and results suggested the measure to be effective in supporting Italy’s digital technology transformation (Bratta et al., 2020[45]).
An intermediary step that might require fewer resources would be to periodically compare selected indicators of beneficiaries with a sample of non-benefiting firms, e.g., SMEs vs. large firms, share of innovative firms, temporary loss-making firms. Such analysis can provide first insights into the take-up of incentives and can inform future policy amendments while moving towards more sophisticated, regular evaluation methods.
Box 5.8. Findings from an empirical evaluation of the Slovak Republic’s Regional Investment Aid Scheme
In 2022, the Slovak Ministry of Labour, Social Affairs and Family Policy concluded an empirical evaluation of the Regional Investment Aid scheme, which explored the impact of investment incentives on the unemployment rates in districts to which these incentives were targeted as well as potential spatial spillover effects into other districts. The study relies on the assumption that, while the incentives target only a single firm, the extra spending on wages or contractors will be absorbed into the district economy and, through its multiplier effect, will contribute to district-wide economic performance, in particular in economically lagging regions. The assumption invites a hypothesis that if there are fewer possibilities to affect growth and employment in economically lagging regions directly, the next best option might be to invest in districts with which these have the strongest ties and stimulate the local economies and employment rates by leveraging spatial spillover effects and inter-regional interdependencies.
By comparing districts, in which a firm has successfully applied for investment incentives to those which had no successful applicants, the study found that the effect of these incentives on regional unemployment varies by the level of development of the recipient district. While no significant effects were found in most Slovak districts, investment incentives directed into one of the twelve “least developed districts” (LLDs) shows significant improvements in unemployment within the treated LDDs compared to the treated non-LDDs. Investing in non-LDDs has not been shown to be effective in reducing unemployment in those districts and there do not seem to be spillover effects into other linked (non-treated) districts. These findings are consistent with the economic intuition of diminishing marginal returns, which would indicate that investing into districts that had enjoyed more investment and development in the past will not be as impactful as investing into districts with less investment in the past.
Source: (OECD, 2022[46]) (ISP, 2022[47])
The government has conducted evaluations on some incentive policies in the past, though not to the incentives provided under the Investment Promotion Act. The government commissioned the Institute of Economics in Zagreb (EIZ) to assess the effectiveness of entrepreneurial zones over the years 2003-2014. The study aimed to examine whether entrepreneurial zones stimulate economic development. While the results did not draw a clear causal relationship between the zones and local economic outcomes, the findings suggest positive effects of entrepreneurial zones on economic activity. Local self-government units with entrepreneurial zones were more successful than units without entrepreneurial zones. However, local units with zones also had a younger population, higher average income and lower unemployment (Alibegović, Bakarić and Slijepčević, 2019[48]) (Eknomski instititut zagreb, 2018[49]).
Finally, to support evaluation of policies as well as policy coherence, the government could enhance data sharing across departments working on investment. The Sector for Incentives could share data on applications and approvals, and data collection methodology, with other Sectors and Directorates of the MESD, and could consider making some of the data publicly available. Czechia, for example, provides detailed information on incentive uptake on the investment promotion homepage “Czech Invest”. The website features a tool that highlights in which regions and to what extent incentives are used, including information on the business sector, the origin country of investors and number of new jobs created. Greater transparency on the benefits of incentives can help governments promote incentive policies to investors and ensure to the public prudent spending of public funds.
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Notes
← 1. Based on data from the Ministry of Finance provided by MESD.
← 2. The government, including the Ministry of Finance, have addressed administrative issues with the Action Plan for administrative relief of the economy for 2018 and relieved the economy by EUR 76 million (or 11.8%) in administrative costs out of the total measured EUR 650 million in administrative costs. Through the Action Plan for administrative relief of the economy for 2019, business costs were reduced by EUR 30.6 million (or 18.7%) out of the total measured EUR 136.6 million.
← 3. This chapter focuses on the maximum aid intensity caps for large investors (60%). However, maximum aid caps can be increased by 10% for investments made by medium-sized enterprises and by 20% (except in Sisak-Moslavina, where the increase is limited to 15%) for investments made by small enterprises.
← 4. The substance-based income exclusion (SBIE) allows 5% of the value of tangible assets and payroll to be subtracted from the profits to which the top-up tax applies. For more, see OECD 2022.