Determinants of the Capital Demand in Macedonia: Do Low Tax Rates Really Play an Important Role for Domestic Investment

Abstract

It is very hard to find strong arguments and dispute the distortionary essence of taxes. They built schools and hospitals but also disrupt the economic efficiency. Ever since the first independence days, the officials in the Republic of Macedonia have tried to solve this “dilemma” in tax policy, initially balancing from higher taxes during the 90-ties to “zero” taxes marking the last decade. Generally, in the focus of the biggest tax reform undertaken in 2006 was the economic efficiency and investment, analogically followed by a period with lower tax rates. Now that we are standing in front of another challenge, since the government announced the new course in tax policy in which higher and progressive taxes are the basic attributes, it is time to answer the question whether the previous “era” of low tax rates have earned the justification of its purpose. Intending to answer this and many other questions, as well as to explore and specify the mechanism of capital formation in the domestic economy, the goal of this paper is to identify and evaluate the factors of capital demand in the Republic of Macedonia, as well as to explore: if the low tax rate policy had any significant role for domestic investment?  Based on the concept of the cost of capital from the methodological frame of METR, developed by Devereux & Griffith, the tax component was separately examined from the non-tax (economic) component of the cost of capital, in order to quantify their individual contribution on capital stock.

Considering the results from the analysis, a critical assessment is given on the current set of policy measures as well as recommendations for new investigations in the field of fiscal and tax policy. At the end, who knows to answer the question: are taxes “necessary evil” or “blessing in disguise”?