A well-planned tax policy provides the necessary incentives to promote economic growth. This chapter, along with two sub-dimensions, explores the effectiveness of tax policy and tax administration. The first sub‑dimension, tax policy framework, assesses the soundness and efficaciousness of the legal framework, the tax system, and the incentives for investment in promoting steady economic growth. The second sub‑dimension, tax administration, focuses on the efficiency and transparency of the tax administration organisation while also reflecting upon the tax filing and payment procedures and taxpayer services.
Western Balkans Competitiveness Outlook 2024: Montenegro
Competitiveness and Private Sector Development
5. Tax policy
Abstract
Key findings
Montenegro has continued to improve its overall tax policy score since the previous Competitiveness Outlook (Table 5.1), nearly matching the Western Balkan average. The economy in particular improved its tax policy framework due to a number of new tax reforms as part of the 2022 Europe Now package.
Table 5.1. Montenegro’s scores for tax policy
The key findings are:
The 2022 Europe Now reform package engendered substantial change to Montenegro’s tax system, namely through the introduction of progressive corporate income tax (CIT) and personal income tax (PIT) regimes. These changes are expected to foster formal employment, reduce labour costs for businesses and create new jobs, thereby broadening the economy’s tax base.
Given the effects of long-term demographic trends, such as population ageing and high levels of emigration, expanding and financing social protections will be an increasing challenge for Montenegro. This necessitates the restructuring of PIT and social security contributions (SSCs) systems to effectively address the challenge.
Montenegro will need to ramp up its efforts on international co-operation in tax matters, as it does not yet exchange information under the OECD Automatic Exchange, adhere to Global Anti-Base Erosion (GloBE) rules, or implement international VAT/GST (value added tax/goods and services tax) Guidelines.
The economy boasts widespread availability of electronic tax filing; in 2022, over 99.6% of VAT returns, 98% of CIT returns, and 96% of PIT returns were filed on line. Additionally, tax filing and payment procedures are regularly reviewed by the State Audit Institution to ensure their clarity and transparency.
Thanks to Montenegro’s ongoing co-operation with the International Monetary Fund (IMF), the economy has developed a strategy to improve tax regulation and compliance management. However, broader advances in this domain were limited by the absence of a legal framework that ensures procedural justice in decisions on tax compliance rulings.
State of play and key developments
Sub-dimension 4.1: Tax policy framework
Montenegro’s tax revenues are relatively high compared to the rest of the region; despite the decrease in the tax-to-GDP ratio from 35.7% in 2019 to 31.8% in 2021, this ratio remains above the WB6 average (28.5%) but close to the OECD area average of 33.6%. Montenegro’s tax mix, however, is relatively unbalanced and very dependent on revenues from taxes on goods and services, which accounted for 62.6% of total tax revenues. For comparison, taxes on goods and services on average make up 49.2% and 32.1% in WB6 economies and OECD member countries, respectively. As a share of GDP, VAT revenues account for 19.9%, which is almost twice as much as the OECD average of 10.6%. Revenues from SSCs were similar to the OECD average both as a share of GDP (8.0%) and as a share of total tax revenues (25.1%). Tax revenues from personal and corporate income taxes, on the other hand, are relatively low and make up only 1.4% and 1.6% of GDP, respectively (Table 5.2). To some extent, the outsized share of VAT revenues in Montenegro’s tax mix is driven by the size of the tourism industry.
Table 5.2. Montenegro’s tax revenues composition (2022)
Tax revenues are expressed as a percentage of GDP
Note: Information on Montenegro is from 2022 and information from the OECD is from 2020.
Sources: Data from the Directorate for State Budget of the Ministry of Finance provided for the Competitiveness Outlook assessment and (OECD, 2024[1])
The 2022 Europe Now (Box 5.1) corporate income tax (CIT) reform in Montenegro is a significant step toward improving the balance of its revenue structure, which will have a positive impact on labour market outcomes. As part of the reform, Montenegro replaced its 9% flat CIT rate with a progressive CIT rate schedule of 9% on profits below EUR 100 000, 12% on profits between EUR 100 000 and EUR 1 500 000, and 15% on profits above EUR 1 500 000. A 15% withholding tax is levied on both corporate capital gains and dividend distributions.
Furthermore, Montenegro offers standard cost-based investment tax incentives that are in line with OECD best practices and only a limited number of profit-based tax incentives.1 The most generous profit‑based tax incentive is only available to companies that invest in designated underdeveloped areas and whose total tax liability, without the incentive, would not exceed EUR 200 000. Companies that meet these criteria are eligible for an 8-year CIT exemption.
Despite its recent CIT reform, Montenegro may face certain implications from international tax developments that require additional assessment. For example, the Global Anti-Base Erosion (GloBE) Rules ensure large multinational enterprises (MNEs) pay a minimum level of tax on the income arising in each of the jurisdictions where they operate. While countries are not required to adopt the GloBE Rules, jurisdictions that adopt them will apply an effective tax rate test using a common tax base and a common definition of covered taxes to determine whether an MNE is subject to an effective tax rate of at least the agreed minimum rate of 15% in any jurisdiction where it operates (OECD, 2022[2]). For Montenegro, this means that in-scope Ultimate Parent Entities of MNE Groups – that have their headquarters in a jurisdiction that has implemented the GloBE Rules and that operate a subsidiary (or Constituent Entity) in Montenegro – may be subject to a top-up tax in the residence jurisdiction, if the profits earned in the subsidiary are taxed at an effective rate below 15%. To avoid forgoing tax revenues in the short run, Montenegro is the only WB6 economy that is planning to introduce a qualified domestic minimum top-up tax (QDMTT).
Box 5.1. 2022 Europe Now reform
The Europe Now tax reform came into effect on 1 January 2022. The programme was designed to serve as a concrete measure toward achieving the economy’s long-term development goals, particularly in the aftermath of the COVID-19 pandemic. Its main objectives are to: i) increase the standard of living; ii) raise employment; iii) reduce informality in the labour market; and iv) improve the business and investment environment.
Before the programme was formally implemented, the Chamber of Commerce of Montenegro, in co‑operation with the programme’s co-ordination body, organised a roundtable to discuss the reform’s potential challenges and explain its implementation guidelines.
Main changes in the reform package
The Europe Now reform introduced several changes across the main types of taxes:
Corporate income tax – Amendments to the Law on Corporate Income Tax abolished the flat rate of 9% and introduced a progressive system. Businesses that make less than EUR 100 000 are taxed at 9%; those that make between EUR 100 000 and EUR 1.5 million must pay EUR 9 000 plus a 12% rate on earnings above the EUR 100 000 threshold; and those making over EUR 1.5 million must pay EUR 177 000 plus a 15% rate on earnings above EUR 1.5 million.
Personal income tax – Under the Law on Personal Income Tax, a new progressive PIT schedule was introduced. The law introduced a non-taxable portion of income (up to EUR 700 per month), followed by a progressive scheme: earnings from EUR 700 to EUR 1 000 are taxed at a 9% rate, while income exceeding EUR 1 000 per month is subjected to a 15% rate. These brackets apply to both employees and self-employed individuals.
Social security contributions – Under the Law on Contributions for Compulsory Social Insurance, the contribution for health insurance for all types of income has been abolished. As such, contributions are required solely for pension and disability insurance (15% by the insured individual and 5.5% by the payer) as well as unemployment insurance (0.5% by both the insured individual and the payer).
Additionally, in 2021, prior to the programme’s implementation, the Montenegrin Government worked with the IMF to develop a novel micro-simulation model to assess the likely effects of the Europe Now reform on wages, taxes, and contributions.
Further examining Montenegro’s international co-operation in tax policy, the economy does not yet exchange tax information through the OECD Automatic Exchange of Information (AEOI) framework. However, Montenegro has fully implemented the AEOI legal framework in accordance with the terms of reference, and the government has committed to start exchanging information in 2024. One remaining challenge is that the economy has not yet acquired a software solution that will facilitate the automatic exchange of information.
In addition to CIT, governments have the option to implement presumptive tax regimes when taxing firms. However, Montenegro does not have a presumptive tax regime that targets small businesses. Presumptive tax regimes, also known as simplified tax regimes, simplify the tax compliance process for micro and small businesses (Mas-Montserrat et al., 2023[5]). By reducing tax compliance costs and levying lower tax rates compared to the standard tax system, these regimes aim at encouraging business formalisation and compliance. They are particularly useful when actual taxable income is difficult to quantify. A taxpayer’s tax base is determined using alternative indicators.
In the 2022 Europe Now reform, Montenegro replaced its flat personal income tax (PIT) regime, which previously offered no allowances, with a new progressive PIT (see Box 5.1). This reform represents a substantial effort toward diversifying the tax mix and increasing tax revenues, while shielding low-income workers from additional tax burdens. Though the augmented top PIT rate is a welcome reform, it is worth noting that most OECD countries have significantly higher top rates, with all members exceeding 15% and most averaging above 45% (as shown in Figure 5.1).
Figure 5.1. Personal income tax rates, Montenegro and OECD member countries (2022)
Source: OECD (2024[1]).
With respect to modelling and forecasting, one major development was the creation of a micro-simulation model as part of the PIT reform under the Europe Now programme. Developed in 2021 with the technical assistance of the IMF, this model was used to calculate the effects of the Europe Now reform on taxes, contributions and wages. Although existing micro-simulation models only analyse PIT and SSCs, the Montenegrin Government has been developing plans to create a model that covers corporate income tax. Montenegro also has an aggregated forecasting model used for all the main types of taxes that makes projections on tax revenue twice annually.
As Montenegro implements new tax reforms, it is essential to consider their potential effects on labour market dynamics. One potential change is bringing more employees into the formal sector, which could expand the coverage of social protection. Since the last Competitiveness Outlook, Montenegro has decreased its total SSCs rate.2 The sum of employee and employer SSC rates is 20.5% (in 2020 it was 32.3%). Employers pay 5.5% of gross income and employees pay 15%. Additionally, employers and employees each pay 0.5% toward unemployment insurance. Meanwhile, the SSC rate for the self‑employed is 20.5% and 1% for unemployment insurance. The maximum annual base for SSCs was EUR 55 249 in 2022.
The need to expand and finance social protection is intensified by long-term demographic trends of ageing and emigration. Between 2013 and 2023, the share of population aged 65 years or over has increased by 3.3 percentage points in Montenegro (Statistical Office of Montenegro, 2024[6]). Additionally, the average life expectancy in the economy has risen from 73.98 years in 2000 to 77.78 years in 2023 (UN Population Division, 2022[7]). If these trends continue, they are likely to put pressure on PIT and SSC revenues. Although VAT revenues are relatively robust with regard to population ageing, Montenegro may still wish to protect its PIT base by, for example, stimulating labour force participation. Since the last Competitiveness Outlook in 2021, Montenegro has made substantial progress in analysing and simulating the effect of potential reforms on informality and labour force participation. However, the economy currently does not have any plans or initiatives aimed at changing the PIT or SSC systems to estimate and prepare for the impacts of an ageing population and emigration.
Regarding the design and structure of the VAT system, the standard VAT rate in Montenegro is 21%, which is similar to the OECD average of 19.2% and significantly above the EU minimum rate of 15%. The VAT registration threshold in Montenegro is EUR 30 000. For comparison, the average VAT registration threshold in OECD countries is around EUR 53 000 (OECD, 2022[8]). Montenegro applies a reduced rate of 7% on, among other things, basic nutrition, medicine, and magazines. Exported goods and a limited list of specific goods and services are taxed at a 0% rate. In response to high inflation, Montenegro temporarily applied a 0% VAT rate on bread, flour, and sunflower oil until the end of 2022 and permanently included biomass fuel, compressed wood bricks, menstrual hygiene products, baby diapers, and solar panels in the list of goods for which the reduced (7%) rate applies. Overall, the VAT rules also generally follow the principles of EU VAT directives, and the fairly limited list of goods and services that are exempt from VAT – or for which a reduced rate applies – is in line with the OECD VAT guidelines (OECD, 2017[9]).
In terms of digital taxation, Montenegro has levied VAT on cross-border digital services since 2014. The rules determining the place of taxation follow the destination principle, but Montenegro has not yet implemented all the international VAT/GST guidelines (OECD, 2017[9]). Further progress in this area is crucial, given the exponential increase in online transactions for services and digital goods. These developments necessitate frequent revision of regulations to guarantee effective VAT collection. Including digital platforms in the process of VAT collection and remittance can reduce administrative costs and improve efficiency.
As for environmentally related taxes, Montenegro levies a specific excise tax on motor fuels. The specific excise on gas oils is EUR 440 per 1 000 litres. While such policies represent positive steps, there is scope for additional carbon pricing and increased excise taxes. For example, Montenegro does not currently levy a carbon tax, nor are there any imminent plans to introduce one. Furthermore, the economy has not yet implemented an emissions trading system or assessed the potential impact of the EU Carbon Border Adjustment Mechanism (CBAM),3 scheduled to take effect in 2026. The EU CBAM will impose taxes on carbon-intensive imports, such as fossil fuel-powered electricity generation. Thus, given Montenegro’s current absence of carbon pricing initiatives and the significance of aligning with EU climate policy, it is imperative that policy makers undertake a comprehensive effort to use the tax system to better prepare for future challenges related to climate change mitigation and adaptation.
While environmentally related taxes are levied on activities considered harmful to the environment, health taxes are those levied on goods that adversely affect health. Montenegro levies excise taxes on tobacco and alcohol products, although it does not use its health tax system to full potential; there is scope to further increase health taxes. Montenegro levies specific tax on alcohol products and both an ad valorem and specific tax on tobacco,4 which is a common approach among OECD countries. Combining specific and ad valorem taxes for tobacco products discourages consumption of both high- and low-priced tobacco products (OECD, 2020[10]). Aligned with the EU Directive on Tobacco Taxation, there is a minimum specific excise tax of EUR 83.50 per kilogramme of tobacco (World Bank Group, 2018[11]). Nevertheless, there is still significant scope to further induce smokers to quit smoking, as the prevalence of smokers in Montenegro is more than 14 percentage points higher than the EU average (40.7% versus 26%, respectively) (Cizmovic et al., 2022[12]).
Although Montenegro offers various tax reliefs and incentives, there is room for improvement in its tax expenditure reporting. Currently, Montenegro only calculates the aggregate tax revenue forgone and does not systematically estimate the revenue forgone for each tax expenditure. Expanding and regularising public tax expenditure reporting increases transparency and improves efficiency. Indeed, making this process public and calculating the tax expenditures of separate incentive schemes can assist policy makers in evaluating the efficiency and effectiveness of tax incentives through cost-benefit analysis.
Sub-dimension 4.2: Tax administration
With respect to tax administration functions and organisation, Montenegro operates a unified tax administration system responsible for the collection of all types of taxes, except for VAT on imports, which is managed by the Customs Administration. As is common practice, tax fraud investigations are handled by the prosecutor’s office and the police department. The Montenegro Tax Administration (MTA) falls under the supervision of the State Audit Institution (SAI), which annually assesses the MTA and, based on the results of this monitoring exercise, issues public recommendations.
The Audit Plan is informed by a risk-based approach by the Division for Risk Analysis. With support from its eight regional offices, the MTA oversees compliance assessment and risk management. Montenegro is presently collaborating with the IMF to devise a strategy for tax regulation and compliance management. However, currently Montenegro does not have a legal framework in place to ensure procedural justice in decisions for tax compliance rulings, despite procedural justice’s positive linkage to improved compliance with tax rules and regulations.
When it comes to independence and transparency, Montenegro made progress in January 2019 when the MTA transitioned to an independent entity. The MTA's head is now appointed for five years and reports directly to the Minister of Finance. Nevertheless, its budget is still the responsibility of the Ministry of Finance. Montenegro’s efforts toward improving independence and transparency are significant, but certain aspects require improvement. For example, the MTA needs an independent operational budget, separate from the annual budget process, as well as procedural protections to ensure its recent independence. Additionally, the OECD recommends that the staff of a tax administration is clearly and directly under the control of the chief executive and separate from the normal civil service system.
Access to electronic tax filing is extensive and available for every major tax type. It is compulsory for income taxes and optional for others. In 2022, 99.6% of all VAT and 98.3% of all CIT declarations were e-filed. However, only taxpayers who buy a digital certificate at a cost of EUR 110 can access the e-filing software.
Regarding taxpayer services, the MTA provides online access to information, electronic communication, and face-to-face inquiries. Additionally, every two years the MTA conducts a taxpayer and employee satisfaction survey to identify areas of improvement. One shortcoming in this area is the absence of customer segmentation models, which would allow the MTA to differentiate between different groups of taxpayers and thus better meet the needs of these individuals and firms.
Overview of implementation of Competitiveness Outlook 2021 recommendations
Montenegro’s progress on implementing past CO Recommendations has been mixed: in some areas, such as instituting a progressive PIT schedule or strengthening international co-operation, the economy has made strong advances since the CO 2021. Conversely, its progress has stagnated in domains such as expanding its VAT base. Table 5.3 shows the economy’s progress on implementing past recommendations for tax policy.
Table 5.3. Montenegro’s progress on past recommendations for tax policy
The way forward for tax policy
Considering the level of the previous recommendations’ implementation, there are still areas in which Montenegro could enhance the tax policy framework and further improve the functioning of the tax administration. As such, policy makers may wish to:
Consider further broadening and diversifying the tax base by improving the design of personal and corporate income taxes in addition to increasing health and environmentally related taxes. Diversifying the tax mix can raise revenues and make them more resilient to shocks as well as long-term trends. While the recent Europe Now reform programme constituted a notable step forward in rebalancing the sources of the economy’s tax revenue, its relatively limited use of health and environmentally related taxes represents an opportunity to further raise tax revenues for the government.
Assess the impact of GloBE Rules on large in-scope MNEs operating in Montenegro. Montenegro may face certain implications from the GloBE Rules. As such, policy makers should examine the influence of these rules, particularly their effects on subsidiaries of multinational enterprises within Montenegro’s jurisdiction, through an impact assessment that will enable the economy to evaluate different policy options in response to these developments. Depending on this assessment's outcome, Montenegro may want to consider revising some of its tax incentives and main CIT rates. In particular, profit-based tax incentives, such as rate cuts and exemptions, are more likely to be impacted by the GloBE Rules.
Prepare to start exchanging information through the OECD AEOI standards. The implementation of these standards has implications for Montenegro’s domestic tax policies as well as its international co-operation, particularly given the economy’s EU accession ambitions. This exchange of information can provide timely information on non-compliance where tax has been evaded either on an investment return or the underlying capital sum. Additional steps include implementing the Country-by-Country (CbC) Reporting Package as set out in base erosion and profit shifting (BEPS) Action 13 (OECD, 2015[13]), as well as updating the reporting requirements to incorporate the OECD Crypto Asset Reporting Framework (CARF) (OECD, 2023[14]). Strengthening its capacity in this area will help Montenegro improve its technical and IT capacity, which is likely to become increasingly important for tax co-operation with the European Union and other key trading partners. Furthermore, automatically exchanging information with other countries will also assist Montenegro in more effectively taxing capital income from its top earners (OECD, 2017[15]).
Consider the benefits of introducing a presumptive tax regime following best practices to reduce the size of the relatively large informal sector. Well-designed presumptive tax regimes can reduce compliance costs for businesses and promote business formalisation. Specifically, policy makers may wish to consider the benefits of introducing a regime that follows the best practices outlined in Mas-Montserrat et al. (2023[5]).
Assess the impact of future demographic changes on revenue and the functioning of the SSC system. Given the changing population structure of Montenegro, this assessment is an important step towards developing a plan to make Montenegro’s public finances more resilient. Specifically, policy makers may want to estimate the impact of a drop in the number of people active in the labour market on tax revenues and the functioning of the SSC system.
Continue to expand the usage of micro-simulation models. While Montenegro made substantial progress with the development of its new model as part of the Europe Now reform, there is still room to broaden the applications of such simulations. Namely, given the gap between the top PIT rates in Montenegro and most OECD member countries, Montenegro may want to use these micro-simulation models to analyse the potential impact of a top PIT rate increase. Moreover, it might be beneficial for Montenegro to continue to examine the potential development of micro-simulation models for CIT, which could explore firm-level or sector-specific CIT revenues.
Implement a vendor collection regime supported by streamlined registration and collection procedures. The regime would help collect VAT on business-to-consumer (B2C) services and intangibles supplied by non-resident providers (OECD, 2019[16]). This approach to digital taxation can simplify the VAT compliance process for consumers, particularly in cases of cross-border transactions.
Assess the impact of the EU CBAM on the export economy and consider increasing carbon pricing accordingly. In order to tackle climate change, Montenegro should introduce a carbon tax or implement carbon pricing that is sufficiently high. Pricing carbon domestically or through a regional or EU-wide Emissions Trading System comes with the added benefit of generating revenues that can be mobilised to further accelerate the green transition and meet other social and political priorities (OECD, 2022[17]). In Montenegro for example, these revenues could be used to mitigate some of the impacts of the transition, such as reduced energy and food affordability.
Induce smokers to quit smoking through tobacco tax reform. Doing so would also raise additional tax revenue to finance the public healthcare system. Montenegro could move toward implementing the World Health Organisation’s guidelines on the taxation of tobacco products, which include the abolition of taxes that differentiate based on tobacco product characteristics, and ensuring specific excise taxes are automatically adjusted for inflation (WHO, 2021[18]). Finland offers a good practice example of how tobacco taxation can increase government revenue while also discouraging consumption among the population (Box 5.2).
Box 5.2. Successful taxation of tobacco: The case of Finland
As the first country globally to establish a goal for ending all use of tobacco products (and by the deadline of 2030), Finland has undertaken a series of ambitious measures aimed at reducing – and ultimately eliminating – the use of tobacco and nicotine.
A substantial component of this plan has included increasing the tax rate and broadening the base of taxes on tobacco products. Since 2016, the Finnish Government has increased taxes on tobacco products every six months. As a result of these constant increases, Finland levied the third-highest excise duties on cigarettes in the European Union as of July 2023. The excise duty on a 20-pack of cigarettes was approximately EUR 6.76. Moreover, the total tax (composed of the excise duty and VAT) as a share of the final retail selling price amounted to 91.5% – well above the EU average (81.1%) and the World Health Organisation’s recommended 75%.
The positive effects of this steadily increasing taxation are already evident. The prevalence of both daily and occasional smoking has been declining in recent years, and the average prevalence of smoking in Finland is significantly below the EU average (11% versus 20%, respectively). In terms of revenue for the government, in 2021 the tax revenue from tobacco products was EUR 1.03 billion.
Sources: OECD (2021[19]) WHO (2021[18]); Finnish Ministry of Social Affairs and Health (2023[20]).
Make the tax expenditure reporting process public and calculate the tax revenue forgone of all tax expenditures and incentives. This can assist policy makers in evaluating the efficiency and effectiveness of tax incentives through cost-benefit analysis. The economy would also benefit from the implementation of regular and systematic tax expenditure reporting.
References
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Notes
← 1. Profit-based incentives generally reduce the tax rate applicable on taxable income, while cost-based incentives lower the cost of an investment and increase with the size of the investment.
← 2. Law on Contributions for Compulsory Social Insurance, Official Gazette of Montenegro, (OG MNE Nos. 145/2021 and 146/2021).
← 3. The EU Carbon Border Adjustment Mechanism (CBAM) is the policy instrument designed to reduce the likelihood of carbon leakage by instituting a carbon price on imported goods. This tool reflects EU commitments to reducing its greenhouse gas emissions under the “Fit for 55” package while still ensuring a level playing field between EU and non-EU businesses. The CBAM transitional period, which started on 1 October 2023 and continues until the end of 2025, exclusively involves reporting obligations; however, from 1 January 2025, carbon pricing will also be implemented.
← 4. According to the Law on Excise Tax, the specific excise duties per kilogramme for different tobacco products are as follows: cigars and cigarillos, EUR 25; fine-cut tobacco, EUR 60; other tobacco for smoking, EUR 25; smokeless tobacco products, EUR 190, starting from 1 January 2024. Cigarettes are subject to both specific excise taxes (set to increase from EUR 50.50 in January 2024 to EUR 53.50 in January 2025) and ad valorem excise taxes (EUR 24.40, starting from 1 January 2024) per 1 000 pieces.