Tax Policy as a Mechanism to Secure Kosovo’s Independence:
A Proposal to Reform the UNMIK Tax Regulations


By Melinda Bair[1]



            It is the dawn of independence in Kosovo: as the United Nations continues to discuss Kosovo’s final status, the presence of the thriving international community in Kosovo subsides.  Independence in Kosovo presents both an opportunity and a challenge.  The opportunity is to address the economic and financial ills suffered by Kosovo’s citizens.  The challenge is to build a stable and sustainable economy that attracts foreign investment, utilizes resources efficiently and maintains a fiscal budget that can afford to provide public services.  The solution requires the coordination of macroeconomic, fiscal and tax policies.  In particular, tax policy must be actively utilized to respond to Kosovo’s economic and fiscal needs.  Tax policy should be the tool used to build Kosovo’s financial future. 

            The current Kosovo Tax Code, written by the United Nations Mission in Kosovo (UNMIK), is not an effective response to Kosovo’s economic and fiscal needs for multiple reasons.  It does not provide Kosovo with a large enough tax base to ensure needed revenues.  It is not competitive enough to attract foreign investment.  It does not promote compliance but instead invites litigation.  It does not consider the nation’s regulatory and business culture.  At this critical juncture in its status, Kosovo should identify its economic goals and rewrite its tax code in order to achieve these goals.

            The purpose of this paper is to: (1) incite lawmakers to perceive tax policy as a mechanism to encourage behavior and (2) propose a viable method for implementing tax reform in Kosovo.  This paper will initially detail the importance of tax policy to stimulate a nation’s economy by analyzing the successes of such policies in Estonia, Latvia and Ireland in Section 1.  Section 2 of the paper will discuss the current economic environment in Kosovo and identify how tax policy can positively impact the development of Kosovo’s economy.  Section 3 will summarize the present legal and regulatory framework in Kosovo and how the legal and regulatory framework will change upon Kosovo’s obtainment of final status.  Section 4 will present a plan for implementing tax reform that will consist of three phases: (1) Tax Procedure; (2) Tax Planning; and (3) Substantive Tax Reform. 


Section 1: Tax policy as a means to stimulate economic development


            Taxation is a concept that elicits strong opinions from citizens in all countries. Yet, few people can substantiate their opinions because the majority of people do not understand tax policies and calculations.  It is therefore necessary to explain some basic taxation concepts.  There are three main components to a system of taxation levied by a government: (1) the type of tax; (2) the rates of taxation on each category of tax; and (3) the international method of taxation. 

The type of tax

            The type of tax describes either a class of persons taxed or the types of goods or services taxed.  Common types include: personal income taxes, corporate income taxes, excise taxes and consumption taxes.  Personal income taxes are levied on the income earned by individuals during a particular year while corporate income taxes are levied on a corporation’s net income.  Excise taxes are levied on the sale or importation of specific goods and therefore may serve to discourage specific behaviors, such as driving cars with poor gas mileage or smoking.[2]  Consumption taxes are levied on products consumed by individuals, thereby allowing individuals’ savings to accumulate tax-free if no personal income taxes are levied.[3]   

            Consumption taxes have been praised for their neutrality, meaning they do not “…alter spending habits or behavior patterns and thus [do] not distort the allocation of resources.”[4]  Two common types of consumption tax include the sales tax and the value-added tax (VAT).[5]  The sales tax is levied on the total value of a purchase while the VAT is levied on the value added from each exchange that occurs as the product is produced and brought to market.[6]  Under the VAT, the “…tax levied at each stage in the economic chain of supply is a constant fraction of the value added by a business to its products.”[7] 

The rates of taxation

            Tax rates are usually described as being progressive, regressive or flat.  A progressive tax rate occurs when the rate increases as the amount to which the rate is assigned increases.[8]  While progressive rates may be applied to any tax, they are often applied to income taxes.[9]  Progressive rates are used to achieve tax parity, on the theory that individuals with higher incomes can afford to pay more tax than people with lower incomes.[10]  As a result, progressive rates are a form of wealth redistribution.[11] 

            Conversely, taxes are regressive when the tax rate decreases as the amount to which the rate is assigned increases.[12]  In contrast to progressive tax rates, regressive rates result in a shift of tax liability from people with higher incomes to people with lower incomes.[13]  Flat taxes tend to be regressive because a country with a flat tax system typically taxes all income (personal and corporate) at the same rate in order to achieve greater tax simplicity and encourage higher compliance among taxpayers.[14]  Flat taxes may avoid being regressive if the nations that implement them adopt a dual rate on personal income, allowing taxpayers earning less than a specified income threshold to be exempt from taxation.[15]  One common implementation of a flat tax is to broaden the tax base by eliminating the exemptions available to taxpayers and additionally levying consumption and excise taxes.[16] 

The international method of taxation

             The international method of taxation identifies what constitutes a taxpayer’s taxable income and determines how it should be taxed.  There are two primary methods of taxation: (1) the territorial system and (2) the worldwide system, which is also referred to as the residence system.  The territorial system exempts any income that the taxpayer earns abroad from taxation in the taxpayer’s resident country.[17]  The territorial system instead taxes all income earned from investments made in the resident country, whether a resident taxpayer or foreign investor earned the income.[18]  The territorial system encourages foreign investment because it enables foreign and resident taxpayers to compete on the same tax basis.[19]

            In contrast, the worldwide system taxes all the income earned abroad by a resident taxpayer.[20]  This system attempts to discourage domestic taxpayers from investing abroad by taxing all of a resident’s return on investments made abroad as though it were earned domestically.[21]  This system often results in double taxation to a multi-national investor.[22]  Assume an investor invests in countries A and B, and country A employs a territorial system while country B uses a worldwide system.  Country A and B will both tax the return on investment earned by the taxpayer in each respective country.  If the laws of country B consider the investor a resident taxpayer, then country B will also tax the return on investment made by the taxpayer in country A.  This results in a double taxation of the income earned in country A unless country B has implemented tax policies to avoid this result.  Regardless, the multi-national investor is less likely to invest in country B.  



Case studies demonstrating the importance of tax policy

            An effective tax policy is defined by the taxes levied, the rates at which these taxes are levied and the international system of taxation.  Countries who achieve the optimal policy will obtain economic benefits.  Three such countries include Estonia, Latvia and Ireland. 

            Estonia and Latvia are two notable examples of nations with tax systems that have stimulated their economies.  Prior to 1991, Estonia and Latvia were satellite states of the former Soviet Union and therefore did not have independent economies.[23]  Upon asserting their independence, these Baltic nations inherited stifled economies in which industry had to be privatized and an influx of capital was needed.[24]  Estonia and Latvia adopted a flat tax regime, maintained balanced budgets, pegged their currencies to the Euro and established favorable laws for foreign investors.[25]  The results are stunning: as of December 2006, Estonia was the biggest recipient per head of foreign investment in Europe.[26]  Additionally, Estonia has enjoyed 11.6% growth in living standards over the last six years and the projected long-term economic growth rate is 7.8%.[27]  By adopting a similar tax system, Latvia experienced a 10.9% growth in living standards over the last six years and from January to October 2006, witnessed mortgage-lending rise by 90% and credit card lending double.[28]

            The degree to which the adoption of a flat tax system contributed to the economic growth of Estonia and Latvia cannot be fully quantified.  However, since Estonia established the first flat tax regime in 1994, many other nations in Central and Eastern Europe have followed suit.[29]  Whether these nations will achieve the same success as Estonia and Latvia may depend on how successful they are at creating a comprehensive plan of tax reform.  Studies conducted by the Economist Intelligence Unit indicate that flat taxes are most successful when adopted “…as part of a wider package of reforms, in an attempt to signal a move towards free-market economics by former communist countries, with the ultimate aim of bolstering their attractiveness to foreign investors.”[30]  As a result, a flat tax regime is not the right choice for every country.

            Flat taxes are not the only tax reform measures that have been linked to economic success.  Ireland transformed itself from the “Sick Man of Europe” through the 1970s and 1980s to the “Celtic Tiger” during the 1990s.[31]  This transformation may be attributed primarily to Ireland’s reduction in its corporate income tax of 47.9%, to a mere 12.5% and only 10% on the income generated from manufacturing activities.[32]  This reduction in the corporate tax rate stimulated new investment, particularly in knowledge-based industries.[33]  From the period 1994 to 2001, Ireland accounted for 6% of all inward foreign direct investment flows to the European Union while only accounting for 1% of the European Union’s total GDP.[34]  During this period, fixed investment grew by an average of 14% per year.[35]  Additionally, Ireland’s GNP grew 62% in real terms between 1993 and 1999 while unemployment fell from more than 14% to 5.5%.[36]

            Also notable is the contribution the Industrial Development Agency (IDA) made to Ireland’s strong economic development.  The IDA actively pursued many foreign companies during the 1970s and 1980s to establish subsidiaries in Ireland by offering generous tax and economic incentives.[37]  One such example is the agreement executed between the Bausch & Lomb Corporation and the IDA in 1981.[38]  The IDA offered incentives to Bausch & Lomb that included capital grants of approximately 45% of the company’s initial investment in its subsidiary’s facilities and equipment, and grants to train Irish employees.[39]  The training grants provided for compensation and expenses for instructors as well as transportation and salaries for trainees.[40]  Additionally, the IDA negotiated to locate the plant in an impoverished region of Ireland to stimulate the local economy and generate jobs.[41]  The IDA’s efforts were enhanced by cooperative code provisions, particularly section 84 of the Irish Corporation Tax of 1976, which exempted Irish banks from paying tax on the receipt of interest on loans made to Irish companies.[42]  This further provided incentive for foreign parent companies to establish subsidiaries in Ireland that would qualify as Irish companies in order to obtain easy financing from Irish banks.[43]      


Section 2: The current economic environment in Kosovo

            Kosovo’s current economic situation is akin to Ireland when it was known as the “Sick Man of Europe”:[44] unemployment for the fiscal year July 2006 to July 2007 is estimated to be about 40% and approximately 37% of the population is considered impoverished.[45]  In 2005, among the persons aged fifteen or higher, more than 42% of the men and 69% of the women had not completed junior high school.[46]  And only roughly 10% of men and less than 5% of women, aged fifteen or higher, have completed a tertiary education: high school, university or graduate school.[47] 

            Kosovo’s economy is depressed because there is a lack of sustainable GDP growth.  Since 1999, real GDP has increased, declined, increased and declined again.  Real GDP initially increased 21% in the period 1999 to 2001.[48]  However, this growth was fueled mostly by external contributions in the form of remittances made by the Albanian Diaspora, procurements made by international donor agencies and expenses of those foreign employees living in Kosovo.[49]  In fact, 15% of the 21% GDP growth is attributed solely to remittances made by the Albanian Diaspora.[50] 

            The dependency of GDP growth on external contributions was demonstrated by the decline in real GDP growth of 0.1% in 2002 and 0.5% in 2003, when annual donor spending in Kosovo dramatically decreased.[51]  The main reason real GDP increased 2% in 2004 was because the Kosovo government increased its capital expenditures and its spending on the salaries of public employees.[52]  The decline in GDP growth of 1.5% in 2005 further demonstrated that the prior GDP growth was not sustainable.[53]  The repeated rise and decline in GDP indicate that the Kosovo government has not yet implemented viable economic policies or seriously considered economic reform proposals.

The World Bank’s economic reform proposals

            The World Bank made economic reform proposals to the Kosovo government in its Interim Strategy Note for Kosovo in March 2006.[54]  The World Bank identified the energy, mining and agriculture sectors as the potential pillars of growth, citing Kosovo’s “…abundant mineral deposits, low transport costs to Western European markets and fertile land” as the country’s best assets.[55]  The World Bank proposed a fiscal strategy that would reduce fiscal spending on the wages of public employees in the short-term.[56]  The long-term fiscal strategy is to generate new sources of revenue, “…some [of which] can come from further tax policy and administration changes, to cushion the impact of reduced international presence in an economy dependent on indirect taxation; [t]his includes strengthening VAT and property tax collection to broaden the tax base.”[57]

            The World Bank’s proposal to develop the energy, mining and agriculture sectors of the economy appears reasonable.  Kosovo possesses 45% of the total lignite (soft coal) deposits in Europe[58] and Kosovo’s energy supply could potentially assuage the Balkan energy crisis.[59]  However, the consequence of focusing on the energy, mining and agriculture sectors is the development of a primarily manufacturing and agrarian economy in Kosovo.  It is necessary to also devote funds and resources to the development of knowledge-based industries in order to create a more dynamic and stable economy less susceptible to crop failures or fluctuation in energy prices.  In a knowledge-based economy, “…firms seek to explore their markets.  Given that innovations are economic implementations of new ideas, then the exploration and understanding of markets, and the use of market information to shape the creation of new products, are central to innovation.”[60]  The development of a knowledge-based economy requires investment in the education of individuals and in the research and development of both private and public firms.[61]

            Tax policy is critical to the development of a knowledge-based economy.  The tax code should be used to create incentives for public and private firms to invest in research and development, such as offering a deduction for either a portion of or the total research and development expenses incurred.  Alternatively, a deduction for research and development expenses could be offered only for expenditures made in particular industries or for particular applications.  Additionally, the tax code could offer personal income deductions or credits to individuals who enroll at a university on a full or part-time basis.  Another possibility is to offer tax deductions or credits to employers who pay their employees’ tuition fees or reimburse their tuition fees. 

            Providing incentive for citizens to obtain an education is particularly important because unemployment among Kosovo’s youth is between 63% and 85%, which is much higher than the unemployment rate among all age groups and “…[g]iven that just about a third of the population is under the age of 14, the job crisis facing a future generation of Kosovans is even more alarming.”[62]  And while overall unemployment is steady, or slightly decreasing, the unemployment rate among youth increased 14.6% in 2003,[63] a statistic that reveals Kosovo’s economic frailty.  Utilizing the tax code to encourage businesses and individuals to invest in education will bolster government efforts and reduce its financial burden.

            Tax policy is also crucial to sound fiscal policy and should not be merely relegated to a long-term revenue stream, as suggested by the World Bank’s proposals.[64]  Concededly, a component of good tax policy is to generate revenues to fund the public fisc.  Currently, the Kosovo tax base is not broad enough to achieve this purpose because over 70% of tax revenues are attributable to customs, excise and VAT on imports and this is a tax base that will erode as more trade agreements with Kosovo’s neighboring countries are executed.[65]  However, tax policy is not a myopic exercise: policies need to be a direct response to the economic development goals in order to encourage specific business practices that will achieve those goals.  For instance, lowering the corporate income tax rate should result in an increase in foreign-direct investment inflows into Kosovo.[66]  Similarly, offering tax credits for multi-national companies who hire a certain percentage of Kosovo workers may decrease the unemployment rate and generate jobs for educated and skilled laborers, reducing the occurrence of brain drain.[67]


Section 3: Kosovo’s legal and regulatory framework

            Sections 1 and 2 of this paper have emphasized the importance of utilizing tax policy as a tool to stimulate Kosovo’s stagnant economy by citing examples of other nations that have effectively used tax policy to recharge their economies and by providing an overview of Kosovo’s current economic situation, which provides the canvas upon which tax policies must be drawn.  Similarly, Section 3 of this paper explains the regulatory and legal systems in Kosovo that must be considered when implementing tax policies.

The current legal and regulatory framework

            On June 10, 1999, the United Nations Security Council issued Resolution 1244 which authorized the Secretary-General to establish an international civil presence in Kosovo, which came to be known as the United Nations Mission in Kosovo (UNMIK).[68]  The Secretary-General subsequently promulgated Regulation 1999/1, which vested all the legislative and executive authority, including the administration of the judiciary, in the UNMIK, an authority that would be exercised by the Special Representative of the Secretary-General.[69] 

            Regulation 2001/9 established the Provisional Institutions of Self-Government (PISG), which constitute the branches of Kosovo’s local government.[70]  These PISG include the Kosovo Assembly, the president of Kosovo, the Government and the courts.[71]  This regulation also delineated powers that would be reserved by the Secretary-General and powers that would be transferred from the Secretary-General to the Provisional Self-Government of Kosovo.[72]  In the tax arena, substantive tax issues are reserved by the Secretary-General and procedural tax issues are transferred to the Provisional Self-Government of Kosovo.[73]  Therefore, the types of tax that are levied are decided by the UNMIK while tax collection procedures are established by the Provisional Self-Government.[74]

            Regulation 2005/17 approved the Provisional Self-Government’s Law No. 2004/48, which created the tax procedures in Kosovo.[75]  This law also established the Tax Administration of Kosovo (hereinafter TAK) as an agency within the Ministry of Finance and Economy.[76]  The TAK’s responsibility is to issue decisions on a taxpayer’s tax liability.[77]  Article 56 of Law No. 2004/48 enables the Director of the TAK to establish an Appeals Division within TAK.[78]  Article 57 of Law No. 2004/48 establishes an Independent Review Board to hear taxpayers’ appeals from the TAK’s Appeals Division.[79]  There are fourteen members and a Chief Member, all of whom are to be nominated by the Government and are appointed by the Kosovo Assembly.[80]  At least seven of these fifteen members shall be comprised of Kosovo business persons.[81]  These members are supposed to be independent of the Ministry of Finance and Economy.[82] 

            Article 58 of Law No. 2004/48 provides: “Decisions of the [Independent Review] Board may be appealed to a court of competent jurisdiction providing such appeals are initiated within 60 days of receiving notification of the decision of the Board.”[83]  The term “court of competent jurisdiction” is not defined in Law No. 2004/48.[84]  It is reasonable to interpret “court of competent jurisdiction” as referring to the Supreme Court of Kosovo because the Supreme Court has jurisdiction to hear and decide appeals from administrative decisions.[85]  However, the Supreme Court denied itself jurisdiction to hear appeals from the Independent Review Board’s decisions when the TAK is the plaintiff because the TAK does not possess the requisite legal standing under the Law on Administrative Disputes.[86]

            The Law on Administrative Disputes was promulgated by the Socialist Federal Republic of Yugoslavia and continues to be applicable law in Kosovo.[87]  It is designed to serve a centralized administrative system and does not utilize independent review boards; the UNMIK introduced independent review boards to Kosovo’s administrative system.[88]  The Supreme Court’s denial of its own jurisdiction has created some confusion as to the proper interpretation of the concept of legal standing under the Law on Administrative Disputes, which proclaims that a plaintiff has proper legal standing when they can demonstrate that their rights as established by law have been adversely affected.[89]  According to the Supreme Court, a decision of the Independent Review Board that reverses a TAK decision does not affect the TAK’s legal rights.[90]  This conclusion contradicts the fact that Law No. 2004/48 gives the TAK legal standing to bring an appeals claim against the Independent Review Board.[91]  This inconsistency cannot be resolved through interpretation; resolution requires reform of Kosovo’s administrative appeals system, the court system and the Law on Administrative Disputes.[92]

            The Supreme Court’s reasoning in its decision to deny itself jurisdiction to hear appeals from the Independent Review Board only applied to the TAK as a plaintiff.  Additional problems arise if this decision is extended to deny individual taxpayers standing to file an appeal with the Supreme Court.  The authority to decide all cases disputing tax liability would subsequently be vested in only one branch of government.  A taxpayer’s initial appeal from the TAK’s assessment of liability is appealed to a division within TAK.  The taxpayer’s next appeal from the TAK appeals decision is made before the Independent Review Board, another administrative body.  Without jurisdiction to hear appeals from the Independent Review Board, the courts are not involved in the appeals process.  The legislative branch is also not adequately involved in the appeals process, as its role is limited to nominating and appointing members of the Independent Review Board. 

            Because the judiciary has no role in the tax appeals process, separation of powers are violated.  Under a government employing separation of powers, the role of the judiciary is to interpret the laws, while the executive branch is charged with enforcing the laws and the legislative branch promulgates the laws.  The collection of tax revenues is clearly a duty of the executive branch.  Assessing tax liability is also a duty of the executive branch.  However, if the assessment of tax liability is in dispute, it becomes a matter of which interpretation of the law is correct, a decision that must be made by the judiciary.

The future legal and regulatory framework

            The United Nation’s Ahtisaari Plan[93] for Kosovo’s final status replaces the Special Representative of the Secretary-General with an International Civilian Representative (ICR) who will supervise the implementation of the Ahtisaari settlement agreement.[94]  The ICR will be the final authority on the interpretation of the settlement agreement and will have the authority to repeal laws in violation of the settlement agreement.[95]  Additionally, the ICR must approve the appointment of international judges and prosecutors made by the European Security and Defense Policy (ESDP),[96] a body of the Common Foreign and Security Policy pillar of the European Union.[97]  The ICR must also approve the appointment of the Director of the TAK, the Director of the Treasury and the Managing Director of the Central Banking Authority of Kosovo.[98] 

            The implication is that the ICR will oversee the implementation of the settlement agreement by the Kosovo government and that the ICR will not possess any executive or legislative powers.  However, the ICR possesses an unfettered veto power: the Kosovo Assembly cannot overturn any veto issued by the ICR in response to Kosovo laws that the ICR deems are in violation of the settlement agreement.[99]  Coupled with the ICR’s broad authority to approve appointments, the ICR potentially has the ultimate ability to shape the development of Kosovo’s legal and economic system.

            The ICR’s appointment will be made by an International Steering Group (ISG), which is comprised of key international stakeholders, and approved by the United Nations Security Council.[100]  Interestingly, the ICR will be the same person as the European Union Special Representative (EUSR), who will be appointed by the Council of the European Union.[101]  The EUSR shall have the authority to exercise the powers of the ESDP Mission that will include the authority to ensure that cases of financial and economic crimes, war crimes and other cases of organized crime are properly investigated according to law.[102] 

            Because the ICR and the EUSR must be the same person, and they are individually appointed by the United Nations and the European Union, the success of Ahtisaari’s plan, and Kosovo’s subsequent status, depends on the cooperation of these two independent political bodies.  Furthermore, this bi-polar design forces the individual who comprises the role of the ICR and the EUSR to identify which role he is playing when making decisions, the role of the ICR or the role of the EUSR.  Each role is derived from different authorities shaped by different policies resulting from unique representations.  One key difference between the representations of the European Union and the United Nations is the involvement of Russia in the United Nations which is publicly and wholly opposed to the Ahtisaari plan.[103]  Assuming even that Ahtisaari’s plan is adopted by the United Nations, Russia could possibly stymie the abilities of the ICR to act, or instead encourage the ICR to exercise his veto power.[104]  It may therefore be a conflict of interest to have one person fulfill both roles of the ICR and the EUSR.

            As Section 3 details, Kosovo’s legal system is unresolved and requires reform.


Section Four: A proposed plan for implementing tax reform

            Currently, a Kosovo tax code does not exist.  Instead, among myriad UNMIK Regulations, organized by the date upon which they were promulgated, provisions that pertain to taxation are dispersed.  Upon final status, Kosovo will inherit these UNMIK Regulations and will have the authority to modify them, as all the previously reserved powers will be transferred to the Kosovo government.  Therefore, the first step to any meaningful tax reform is to organize and consolidate all the UNMIK tax regulations into one code, the current “Kosovo Tax Code,” thus facilitating and simplifying the reform process.  Appendix A provides a list of these tax regulations comprising the current Kosovo Tax Code.  This list is non-exhaustive; it is simply a reference for the creation of a more comprehensive list of needed tax provisions.  Furthermore, this list contains provisions that pertain to fiscal policy and foreign investment, laws that should include tax as a component.    

            Until final status is obtained, the current Kosovo Tax Code contains both Regulations, which are promulgated by the UNMIK pursuant to their reserved powers, and Laws, which are promulgated by the Kosovo Assembly pursuant to the transferred powers.[105]  Therefore, any substantive tax issues will be found in the Regulations while tax procedures and administration will be established in the Laws.[106]  When final status is achieved, the delineation of authority between Regulations and Laws will be abolished, as the Kosovo Assembly will have the ability to legislate both substantive and procedural tax issues.[107]  As a result, it is reasonable to implement tax reform in three phases: (1) Tax Procedure; (2) Tax Planning; and (3) Substantive Tax Reform.  Phase 1 may be implemented immediately, before final status is obtained, because it involves reform of procedures that have already been implemented by the PISG.  Phase 2 involves tax planning through the identification of the broad tax strategies the government would like to pursue.  Once final status has been obtained, Phase 3 may begin.  Phase 3 involves the actual manifestation of these tax strategies in the new Kosovo Tax Code through amendments made to the current Kosovo Tax Code.

Phase 1: Tax Procedure

            Phase 1 requires an efficiency analysis of the current tax administration that has been established by the PISG.  Kosovo utilizes a decentralized model of tax administration that consists of three administrative levels: (1) central, (2) regional and (3) municipal.  Most taxes are collected at the central level, with the notable exception of property taxes, which are collected by the municipalities. 

Property tax in Kosovo

            While municipalities are generally funded by the central government of Kosovo, municipalities may keep any property tax revenues they collect.[108]  Furthermore, the central government adopted the Incentive Grant for the Property Tax in 2005 that provides for additional monies from the central government to be distributed to those municipalities that reach their 2006 revenue targets.[109]  Despite the incentive grant provided by the central government, only one municipality, Lipjan, met its revenue target for the first six months of 2006.[110]  Lipjan’s revenue collections amounted to a 72% increase in its tax revenue collection over the same period in 2005.[111]  Total property tax collections for all 30 municipalities increased only 5%, or  186,599, from the period January to July 2005 to the same period in 2006.[112]  Thirteen municipalities collected less than one-half of their collection revenue targets, with the Novoberde municipality achieving only 2% of its collection target.[113]

            The poor collection of property taxes may be attributed to (1) a lack of a consistent and general method of collecting tax revenues and (2) high levels of corruption.[114]  There is no consistent and general method for collecting tax revenues as each municipality has its own set of tax goals and employs a different method of collecting tax revenues.[115]  Corruption is caused from the exploitation of the close relationships between public officials and the members of their communities.[116]  Thus, public officials may be lax in collecting tax revenues from their friends and family members.[117]  Public officials may also practice nepotism, which results in hiring unqualified tax officials.[118]

            The central government needs to encourage greater revenue collection by the municipalities by expanding its arsenal of incentives beyond the Incentive Grant for the Property Tax of 2005.  For example, the central government could adopt standard procedures for revenue collection and fine the municipalities that fail to implement the requisite procedures.  Additionally, the central government could more vigilantly monitor collections and prosecute corrupt municipal tax officials.  Another possibility is for the central government to withhold budgetary funds from those municipalities that substantially miss their revenue targets due to reckless or grossly negligent collection behaviors.

            A more radical approach may be to abandon the decentralized model of tax administration altogether and make the collection of all tax revenues the responsibility of the central government.  This approach is not optimal because a decentralized model of tax administration provides many benefits.  A decentralized model enables the central government to strengthen the municipal governments by training tax officials and prosecuting corrupt officials.[119]  The decentralized model of tax administration fosters innovation in tax collection.[120]  Giving municipalities the freedom to try various methods of tax collection may enable a municipality to find a tax collection method that maximizes their resources.[121]  It is also easier and less expensive to test new technologies for tax collection at the municipal level rather than at the centralized level.[122]  

            The appropriate solution may be to modify the current decentralized system of tax administration with a top-to-bottom approach.  Under this approach, the central government would establish the property tax collection procedures and impose these procedures on the municipalities.  This approach would permit the central government to test new technologies and collection methods in the municipalities who have the appropriate resources for implementation.  The top-to-bottom approach would involve continuous training of municipal tax officials to enable them to adopt their own revenue procedures.  The central government could authorize the municipalities to implement collection procedures on the condition that they meet their revenue targets by a certain percentage.

Effectiveness in levying taxes

            The success of a top-to-bottom modification of the current decentralized system of tax administration depends on the effectiveness of the central government to levy taxes.  The central government’s effectiveness in levying taxes is measured by the amount of tax revenues actually collected.  While the amount of tax revenues has increased from 2001 to 2005, tax revenues as a percentage of the total Kosovo Consolidated Budget inflows decreased during this same period.[123]  Also notable is the shift from collecting tax revenues at Kosovo’s borders to domestic collections, an indication that the central government’s ability to levy taxes domestically is crucial to Kosovo’s future fiscal vitality.[124] 

            Revenue collection increases when a government understands the nation’s fiscal culture and demonstrates aptitude for managing taxpayers’ expectations and actions.  According to Drs. Isa Mustafa and Ymer Havolli and Venera Demokaj-Bislimi, M.Sc., of the Kolegji Universitar Vikctory and Economic Faculty Prishtinë, “…[f]iscal culture describes a system of behavior in the relationship between [the] taxpayer and the tax authorities and includes the system of communication between them, as well as the sphere of reasoning.”[125]  An important aspect of fiscal culture is tax mentality, which is defined in terms of “tax moral” and “tax discipline.”[126]  Tax moral is the “…measure of willingness to pay taxes, as a result of feeling obligations towards the government and the community as a whole” and tax discipline “…is a measure of taxpayers’ attitude toward tax obligations.”[127] 

              Opinion polls conducted by the Riinvest Institute reveal that tax moral in Kosovo is high.[128]  The two main reasons taxpayers comply with the tax code are because they feel responsibility toward the government (44.7%) and they want to avoid problems with the tax authorities (36.2%).[129]  These opinion polls also suggest that the willingness to pay tax increases with the level of education and depends on certain tax discipline indicators, such as whether the taxpayer: (1) is a business or an individual; (2) is satisfied with the quality and diversity of public services; and (3) perceives the tax rates levied by the government as fair.[130]  Only 50 percent of those polled who have no education paid taxes whereas 93.3% of those with a high school education and 100% of those with a graduate degree paid taxes.[131]  Of those taxpayers with a “high willingness” to pay taxes, only 8.9% were businesses compared to 11.8% of individuals and of those taxpayers with a “middle willingness” to pay taxes, 45.8% were businesses while 57.7% were individuals.[132] 

            The Riinvest Opinion Poll for Early Warning System conducted in 2005 on 1,200 households revealed that taxpayers are satisfied with education, healthcare, public television and services provided by local administrations.[133]  Approximately half of the taxpayers were not satisfied with electricity, local infrastructure and public hygiene.[134]  In another Riinvest survey, 66.7% of the respondents thought the level of taxes were unbearable and businesses were particularly concerned with the perceived high level of customs duties and taxes.[135]

            These Riinvest opinion polls are very instructive in understanding the relationship between the government and its taxpayers.  The government must exploit these relationships to increase taxpayer compliance and tax revenues.  The poll results emphasize the importance of investing in the general education of Kosovo’s citizens.  Additionally, individuals and, more importantly, businesses need to be educated about taxes. 

            One business owner interviewed by this author complained about paying the VAT, calling it “a tax on the brain.”  He did not understand that the VAT is a consumption tax whose liability is supposed to be borne by the consumers in the form of higher product prices and not by the businesses that actually pay it.  Because his business paid the tax without raising its prices, it generated less profit.  If this practice is rampant among the Kosovo business community, there is a smaller pool of corporate profits upon which to levy the corporate income tax.  If this business owner had been educated in the various types of taxes and each tax’s intended payee, his opinion of the Kosovo Tax Code, and his trust in the government, would likely improve.  

Remedies for taxpayer non-compliance

            The fact that 36.2% of taxpayers pay taxes as to avoid problems with tax authorities demonstrates the need for proper legal authority to prosecute non-compliant taxpayers and appropriate remedies that serve as a deterrent for engaging in tax evasion.[136]  Law No. 2004/48 on Tax Administration and Procedures outlines the rights and remedies available to the government when taxpayers fail to pay their taxes.[137]  In general, if a taxpayer fails to pay their tax liability, the government may impose a lien or place a levy on the taxpayer’s property.[138]  Article 26 gives the Director of the TAK the right to sue in a court of competent jurisdiction to recover any tax that has not been paid when due.[139]  Article 27 gives the TAK Director the right to file a civil action in a court of competent jurisdiction to enforce any lien imposed on the taxpayer’s property.[140]  Article 29 mandates that any person who refuses to surrender any property subject to a levy on the demand of the designated officer shall become personally liable to the government for the value of the tax liability, interest incurred and penalties imposed on the taxpayer.[141]  If the Director believes that collection of the tax due is in jeopardy because a person is about to evade taxation by fleeing Kosovo, transferring assets or ceasing business, Article 20 enables the Director to demand immediate payment of the tax and proceed with immediate enforced collection.[142]        

            Law No. 2004/48 limits the remedies available to the government in the case of taxpayer non-compliance to the seizure of the taxpayer’s property, which may or may not be enforced by the courts.  While the actual deterrent effect of these remedies is unknown, the fact that 50% of uneducated taxpayers did not pay taxes in 2005 indicates that these remedies may not serve as powerful deterrents to tax evasion.  Changing the nature of the legal remedies available to the government may increase taxpayer compliance.  The legal remedies are currently civil in nature and criminalizing tax evasion may serve as a greater deterrent, as citizens may choose to aovid incarceration for failure to pay their taxes.  An opinion poll could be conducted to determine whether length of incarceration affects taxpayer compliance.

Phase 2: Tax Planning

            Tax policy must be actively utilized to respond to Kosovo’s economic and fiscal needs.  Proper tax planning can attract foreign investment, utilize resources efficiently and fund the public fisc.  Likewise, poor tax planning could adversely affect the success of Kosovo’s economic development.  Phase 2 involves an evaluation of the current Kosovo Tax Code and the corresponding proposals for reform.  This paper focuses on three areas of substantive tax policy: (1) method of international taxation; (2) corporate income taxation; and (3) personal income taxation.


Evaluation of the method of international taxation

            The Kosovo Ministry of Trade and Industry touts Regulation No. 2006/28 and Law On Foreign Investments No. 02/L-33 as providing for the same investment regime for Kosovo’s residents and foreign investors.[143]  However, this favorable outcome for foreign investors is undermined by Regulation No. 2004/51 On Corporate Income Tax, which treats resident and non-resident taxpayers differently.[144]  Section 3.1 proclaims that “…[t]he object of taxation for a resident taxpayer shall be taxable income from Kosovo source income and foreign source income” while Section 3.2 reads “…[t]he object of taxation for a non-resident taxpayer shall be taxable income from Kosovo source income.”[145] 

            Sections 3.1 and 3.2 place resident and non-resident taxpayers in tax disparity.[146]  The effect of these sections is an adoption of the worldwide, or residence, system of taxation, the method of taxation that is utilized by the United States to discourage United States taxpayers from investing abroad.[147]  Under Section 1(q) of Regulation No. 2004/51, a “resident” is defined as “…a person or group of persons that is established in Kosovo or that has its place of effective management in Kosovo.”[148]  While a “resident” is equated to a “place of effective management,” under Section 1(l), a “non-resident” does business in Kosovo through a “permanent establishment” which includes, but is not limited to: plants, representative offices, branch offices, construction sites, factories and workshops.[149] 

            These distinctions discourage a foreign investor from establishing their “place of effective management” in Kosovo for fear of being classified as a resident taxpayer.[150]  Because the meaning of “place of effective management” is still unclear, a foreign investor will likely avoid the establishment of any level of management in Kosovo.  By sanctioning branch offices, plants and factories, Regulation No. 2004/51 encourages foreign investors to establish subsidiaries in Kosovo, rather than headquarters.  A long-term consequence of this regulation may be to stifle the development of the Kosovo workforce by promoting expansion of manufacturing and other blue-collar industries rather than fostering the growth of knowledge-based industries.[151]

            The TAK further obfuscates this distinction between resident and non-resident taxpayers by requiring investors to register any business activity conducted in Kosovo, including activities as minor as electronic commerce.[152]  Once a business is registered, it is considered a resident for purposes of Regulation No. 2004/51, thereby subjecting foreign investors to taxation of all of their income, whether derived in Kosovo or abroad.[153] The TAK’s interpretation of this Regulation discourages the development of any foreign investment in Kosovo.

            Regulation No. 2004/51 should be rewritten to adopt the territorial system of taxation in place of the worldwide system.  The rewritten regulation would not tax the resident taxpayer on income earned abroad and thus place the resident and non-resident taxpayer in tax parity.  The territorial system of taxation is utilized by the European Union and its adoption by Kosovo would be consistent with the Ministry of Trade and Industry’s vision of fully integrating Kosovo into “…the regional cooperation initiatives and ultimately into the European Union.”[154]  Because of Kosovo’s desire to be regarded as a regional player by the European Union, protectionism has no place in its tax code. 

            A territorial system of taxation serves as a unilateral approach to the elimination of international double taxation, thereby alleviating sole reliance on double taxation treaties.[155]  Double taxation treaties require diplomacy and sound relations with other countries.  Kosovo is still in the primitive stages of developing its international relations and has executed only one double taxation treaty, with Albania.[156]  Section 4.1 of this treaty defines a “resident of [either Kosovo or Albania]” as “…any person who, under the laws of [Kosovo or Albania], is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature.”[157]  The next sentence of this section reads: “…[t]his term, however, does not include any person who is liable to tax in [either Kosovo or Albania] in respect only of income from sources in [either Kosovo or Albania] or capital situated therein.”[158]  This telling statement concedes that this agreement arises from the need to address the income of a resident whose foreign-source income is being taxed by his resident country, a result that may be avoided with the adoption of a territorial system of taxation.

            Establishing tax parity between resident and non-resident taxpayers is but one method to increase foreign investment in Kosovo.  Another approach is to use tax as a negotiation tool for attracting foreign investors.  Article 19 of Law No. 02/L-33 On Foreign Investment establishes the Investment Promotion Agency as an agency under the Ministry of Trade and Industry, which is responsible for facilitating the relationship between foreign investors and the Kosovo government.[159]  The Investment Promotion Agency is given many functions under Article 20, including making “…policy recommendations to the Government of Kosovo for the purpose of promoting the creation of a favorable investment climate in Kosovo.”[160]  And under Section 20.2, “…[a]ll public authorities of Kosovo shall cooperate with the Agency in the furtherance of its objectives and the objectives of the present law.”[161]

            The combined effect of these provisions is to entrust the Investment Protection Agency with a tremendous task and then limit its ability to achieve its designated purpose to facilitate the foreign investment process and provide comfort to foreign investors.  Although the Investment Protection Agency is best suited to represent investors’ needs, the agency may only make policy recommendations.  And while all public authorities must cooperate with the Investment Protection Agency, the level of required cooperation is unknown and subject to interpretation.  In response to the taxation issues that may arise, the Investment Protection Agency can only make recommendations to the Kosovo Assembly in the hope that the tax code will be amended to better suit investors’ needs, a process that could prove lengthy and tedious.  

            A better approach would be to make the Investment Protection Agency a joint agency of the Ministry of Trade and Industry and the Ministry of Finance and Economy.  This would enable the Investment Protection Agency to work closely with the TAK to properly consider the tax issues that arise from foreign investment transactions.  Furthermore, the Investment Protection Agency should be given the authority to use the tax code to negotiate with foreign investors who are considering privatizing a company or establishing a subsidiary or headquarters for their multi-national company in Kosovo.  With appropriate restrictions, this would enable the Investment Protection Agency to offer tax holidays to foreign investors or tax credits for multi-nationals who employ a certain level of local workers.[162]  This would effectively make the Investment Protection Agency akin to the Investment Development Agency (IDA) of Ireland, thus giving Kosovo a chance to capitalize on the foreign investment success visible in Ireland today.[163]

Corporate income taxation

            Section 5 of Regulation No. 2004/51 sets the corporate income tax rate at 20% of taxable income.[164]  At present, this is one of the highest corporate income tax rates in the Balkans region and is 11% higher than the lowest corporate tax rate in the region, that of Montenegro, Kosovo’s neighbor to the west (see Appendix B).[165] 

            A high corporate tax rate has many adverse effects, and substantially affects the ability to attract foreign investment.  With continued globalization, multi-national companies are increasingly sensitive to corporate income tax rates in all countries.[166]  In fact, multi-national companies were twice as sensitive to corporate income tax rates in 1994 as they were just a decade earlier and this effect has only magnified since 1994.[167]  In countries with open trade regimes, a lower tax rate that increases the after-tax return to capital for businesses by 1% is associated with about 3% more real capital invested by those businesses.[168]  Additionally, a 10% corporate income rate reduction by a European Union member state can reap a 60% short-run increase in investment by a United States multi-national company,[169] a statistic that becomes relevant if Kosovo integrates into the European Union.

            Recommendations to decrease the corporate income tax rate in Kosovo were made by the American Chamber of Commerce in Kosovo (hereinafter Chamber) at the Tax Reform Conference on December 5, 2006.[170]  The Chamber determined that a lower corporate income tax rate would enable Kosovo to maintain its competitiveness for attracting foreign investors among the other Balkan countries.[171]  The Chamber recommended decreasing the corporate income tax rate from 20% to 7%.[172]

            The Chamber stated that the short-term impact of a lower corporate income tax rate would result in a decrease in corporate income tax revenues by €28 million.[173]  They did not explain the formula they used to calculate this number, resulting in a confusing calculation that lacks credibility.[174]  The Chamber assumed that by lowering the corporate income tax rate, taxpayer compliance would increase collected revenues by 20%, thus reducing the resulting loss of corporate income tax revenues to €24.97 million.[175]  The assumption that taxpayer compliance would increase revenues by 20% was unsubstantiated, as the Chamber did not cite supporting data or expert opinions.[176]

            Additionally, lowering the corporate tax rate does not necessarily reduce revenues.  In a recent OECD study of 13 nations with above-average corporate tax rates, it was found that 9 of these nations had below-average collections.[177]  Conversely, of the 15 nations with below-average corporate tax rates surveyed, 6 were found to collect above-average corporate tax revenues.[178]  Included among these 6 nations was Ireland, which has the lowest corporate income tax among all the OECD member countries.[179]  The Chamber acknowledged this possibility in referencing the Laffer Curve, stating:

            The Laffer Curve suggests that tax revenue increases more steeply at low levels of taxation.  As the tax rate further increases, the revenue increases at a decreasing rate, until the point at which the government collects the maximum amount of tax revenue point T*—after this point, any increase in the tax rate prompts people to work less, or do more to avoid the tax, thereby reducing total revenue.[180]


            The Chamber referenced the Laffer Curve to postulate that effective fiscal reform can be achieved by determining whether the current tax rate is higher or lower than the optimal rate T.[181]  The Chamber stated that “…if the current tax rate is higher than the optimal rate T*, then reducing the tax rate would increase revenue by increasing the tax base.”[182]  Similarly, if the current tax rate is lower than the optimal rate, increasing the tax rate would increase revenue although the tax base is decreased.[183]  However, the Chamber did not indicate whether the current tax rate is below or above the optimal rate when they calculated that the loss of corporate income tax revenues would be €28 million.[184]  Conversely, the report stated that the “…[p]roponents of lower tax rates…believe that taxes are higher than the optimal tax rate T* described by the Laffer analysis, and that a moderately low rate would increase tax revenue.”[185]  It is unclear whether “proponents of lower tax rates” include the Chamber but the inclusion of this statement in their report contradicts their conclusion that lowering the corporate tax rate would result in a loss of revenues.[186]

            The Chamber does not provide valid reasons that explain why 7% was chosen as the appropriate corporate income tax rate.  If the sole aim is to maintain regional competitiveness to attract more foreign investment vis-à-vis the other Balkan nations, then the lowest corporate income tax rate in the region—Montenegro’s 9%—should be adopted.  If Kosovo wants to offer the lowest corporate income tax rate in the region, then an 8% rate would suffice.  A more insightful analysis would include a comparison of the amount of collected revenues at a 7%, 8% and 9% corporate income tax rate.  Additionally, the Chamber would benefit from conducting a sensitivity analysis of taxpayers’ increased compliance at each tax rate.  For instance, lowering the corporate income tax rate to 9% may increase taxpayer compliance by 20%, but it may also result in increased taxpayer compliance of 15% under a worse-case scenario or 25% in a better-case scenario.  The resulting net increase or decrease in corporate income tax revenues at each rate and each taxpayer compliance scenario should be calculated and compared.  The rate that produces the greatest average revenue collections among the three different taxpayer compliance scenarios would be the optimal rate.

Personal income taxation

            The Chamber also suggested a 7% rate for personal income tax, which would establish a flat tax in Kosovo.[187]  Currently, personal income taxes are progressive and are levied at 0% (taxpayers under a certain income threshold are exempt), 5%, 10% and 20%.[188]  The Chamber advocates the flat tax because it: (1) is simpler for employees to administer; (2) harmonizes personal and corporate income taxes; and (3) is good propaganda for attracting foreign investment.[189]  They concede that some lower-paid taxpayers will see a slight increase in their tax liabilities.[190]  They also determine that applying a flat tax to personal incomes will result in an increase of revenues of €16.5 million, assuming that the average personal income tax rate levied under the current progressive structure is 4%.[191]

            While a flat tax structure has undisputedly provided benefit to the economies of Latvia and Estonia,[192] the degree to which these flat taxes have contributed to their respective economies is debatable.[193]  For instance, “…a second view points to the statistics that the rising public revenues [in Estonia] were caused also by a superproportionally rising value added tax.”[194]  An additional factor contributing to increased public revenues in Estonia may include the high social contributions, which are pegged to wage levels.[195]  The continued use of flat taxes in Estonia is uncertain; the former chairman of Estonia’s parliamentary budget committee proclaimed in September 2005 that “…income disparities are rising and calls for a progressive system of taxation are getting louder—this could put an end to the flat tax after the next election.”[196]  

            Before Kosovo jumps on the flat tax bandwagon,[197] a detailed and cogent analysis of a flat tax’s merits and negative externalities should occur (see Appendix C for the arguments made in favor of and against a flat tax).  It is important to consider the arguments for and against the flat tax discerningly as the flat tax regimes adopted by other nations differ fundamentally, and empirical evidence of their consequences is limited.[198] 

            The conclusions made by the International Monetary Fund from its analysis of the implications of adopting a flat tax regime should also be considered:

            [S]everal lessons emerge: there is no sign of Laffer-type behavioral responses generating revenue increases from the tax cut elements of these reforms; their impact on compliance is theoretically ambiguous, but there is evidence for Russia that compliance did improve; the distributional effects of the flat taxes are not unambiguously regressive, and in some cases they may have increased progressivity, including through the impact on compliance; adoption of the flat tax has not resolved common challenges in taxing capital income; and it may have strengthened, not weakened, the automatic stabilizers.  Looking forward, the question is not so much whether more countries will adopt a flat tax as whether those that have will move away from it.[199]


            Along with the discussion of the merits of the flat tax, the type of flat tax variation that would be implemented in Kosovo must be considered.  The Chamber does not specify the type of flat tax to implement.  There is the basic flat tax without any variations.[200]  One possible variation is a flat tax with deductions, which would give the government flexibility in encouraging certain behaviors or investments among taxpayers.[201]  It appears that the Chamber may support this particular implementation, as evidenced from their suggestion of “…a 7% flat tax with annual allowance of maximum €1000.” [202] This insinuates that the American Chamber of Commerce would adopt a dual-income approach, exempting taxpayers with an annual income of under €1000 from taxation.

            Another variation of the flat tax is a negative income tax, as advanced by Milton Friedman.[203]  The negative income tax (NIT) is similar to a flat tax with deductions, except that it enables taxpayers to receive money from the government for the amount of their deductions in excess of their taxable income liability.[204]  This type of flat tax could be used to replace the welfare benefits received by the poor class from the government.[205]  It is designed to avoid the “welfare trap,” which results in higher effective marginal rates on the needy from the decrease in their welfare benefits as their incomes rise.[206]

Phase 3: Substantive Tax Reform

            Phase 3 involves the implementation of all the tax policies developed during Phase 2 planning that are a direct response to Kosovo’s fiscal and macroeconomic goals.  Phase 3 begins upon the obtainment of final status, when the authority to amend all the UNMIK Regulations is transferred to the Kosovo Assembly.  Phase 3 requires amendments to be made to the existing UNMIK Regulations or entirely new legislation to be promulgated.  In particular, Regulation No. 2004/51 On Corporate Income Tax should be amended to abolish the worldwide system of taxation in favor of a territorial system of taxation and to adopt a reduced corporate income tax rate.  

Modification of investment literature

            Before any Regulations can be modified or abrogated, the discrepancy between the information the Kosovo government provides to potential investors and the realities of the business climate in Kosovo must be addressed.  Existing investment literature given to potential investors includes the following statement: “The business environment in Kosovo is in many respects becoming the most competitive in the region.  For instance, Kosovo’s tax system is excellent in both its simplicity of compliance and the low level of burden on enterprises.”[207]  This is a gross misstatement.  The current Kosovo Tax Code is not as simple as a system utilizing a flat tax.  The current Kosovo Tax Code is not as simple as adopting a territorial system of taxation that would reduce the dependency on double taxation agreements.  The current Kosovo Tax Code has a higher level of burden on enterprises than many of its neighboring countries; a fact that is evidenced by Kosovo’s high corporate income tax rate. 

Personal income tax reform

            Kosovo should adopt a flat tax regime only to the extent that it enables the government to retain its ability to use the tax code as a tool to reshape the economy by attracting foreign investors and encouraging investment behaviors among resident taxpayers.  

            Regardless of whether Kosovo adopts a flat tax or retains the progressive personal income tax structure, Section 7 of the current Regulation No. 2004/52 On Personal Income Tax needs to be amended.[208]  Section 7 sets forth the categories of income that are exempt from taxation.[209]  Subsections (a) through (e) exempt income earned by foreign nationals working in Kosovo.[210]  For instance, subsection (a) exempts the wages of foreign diplomatic and consular representatives and foreign personnel of the Liaison Offices in Kosovo; subsection (b) exempts the “…wages of foreign representatives, foreign officials and foreign employees of international governmental organizations, and international non-governmental organizations that have received and maintained public benefit status;” subsection (c) exempts wages of foreign representatives, officials and employees of donor agencies, or their contractors or grantees, who carry out “…humanitarian aid, reconstruction work, civil administration or technical assistance within in Kosovo;” subsection (d) exempts the “…wages received by foreign and locally recruited officials of the United Nations and its specialized Agencies, and the International Atomic Energy Agency;” and subsection (e) exempts the wages received by the foreign KFOR employees.[211] 

            Because UNMIK drafted and promulgated Regulation 2004/52 On Personal Income Tax, it is difficult to ascertain for whose benefit the United Nations included Section 7 subsections (a) through (e).  Employees of UNMIK clearly benefit from these subsections because their incomes are not subject to taxation in Kosovo.  In fact, the European UNMIK employees receive a double taxation benefit because their respective nations do not tax the income they earn abroad, as they utilize territorial systems of taxation.  As a result, their wages earned in Kosovo from their work with UNMIK are 100% untaxed. 

            It is possible that UNMIK included these subsections (a) through (e) after concluding that they enable Kosovo to attract and maintain a foreign workforce.  However, without a review of the legislative history to this Regulation, it is impossible to draw this conclusion.  Kosovo should remove the tax-exempting subsections (a) through (e) of Section 7.  Although the number of United Nations employees, and that of other international organizations, will decrease upon final status, the remaining employees provide an additional tax base upon which to levy personal income tax.  If Kosovo seeks to provide incentives to foreign employees to continue to work in Kosovo, personal income tax deductions or credits would prove effective.






            This paper has proposed many reforms to the current Kosovo Tax Code:

Ø      Modify the current decentralized system of tax administration with a top-to-bottom approach


Ø      Criminalize tax evasion


Ø      Use the tax code to create incentives for public and private firms to invest in research and development


Ø      Use the tax code to create incentives for businesses and individuals to invest in education


Ø      Abandon the worldwide system of taxation for a territorial system more akin to the European Union


Ø      Give the Investment Protection Agency (IPA) the ability to negotiate tax terms with potential investors


Ø      Lower the corporate income tax rate


Ø      Adopt a flat tax regime in Kosovo only if all of its resulting advantages and disadvantages have been considered


Ø      Tax the personal income of internationals working in Kosovo


            This paper focused on reform of Kosovo’s personal and corporate income taxes, and did not consider reform of Kosovo’s presumptive tax, profits tax or the VAT.  An interesting debate on the merits of the presumptive tax, and whether utilizing a withholding system would make it unnecessary, would also prove valuable.  This author believes that these proposed reforms would provide Kosovo with a sustainable economic and fiscal framework upon which Kosovo may assert and maintain its status as an independent nation.  



Appendix A: Current Kosovo Tax Code


Regulation/Law Number



Regulation 1999/3

On the establishment of customs


Regulation 2000/2

On excise taxes in Kosovo


Regulation 2001/11

On value added tax in Kosovo


Regulation 2002/04

On personal income tax in Kosovo


Regulation 2003/02

Amending 2002/4


Regulation 2003/07

On the promulgation of the law adopted by the Assembly of Kosovo on liquidation and reorganization of legal persons in bankruptcy


Regulation 2003/15

On the promulgation of a law adopted by the Assembly of Kosovo on external trade activity


Regulation 2003/17

On the promulgation of a law adopted by the Assembly of Kosovo on public financial management and accountability


Regulation 2004/30

On the promulgation of the law on international financial agreements adopted by the Assembly of Kosovo


Regulation 2004/35

Amending UNMIK Regulation No. 2001/11, as amended, on value added tax in Kosovo


Regulation 2004/43

On the promulgation of the law on internal trade adopted by the Assembly of Kosovo


Regulation 2004/44

On the promulgation of the law on competition adopted by the Assembly of Kosovo


Regulation 2004/51

On corporate income tax


Regulation 2004/52

On personal income tax


Regulation 2005/27

On the promulgation to Law No. 2003/2 and 2003/21 on public financial management and accountability adopted by the Assembly of Kosovo


Regulation 2005/39

Amending UNMIK Regulation 1999/3 on the establishment of the customs and other related services in Kosovo


Regulation 2005/40

Amending UNMIK Regulation No. 2001/11 on value added tax in Kosovo


Regulation 2006/28

On foreign investments


Law 02/L-16

On an Amendment to Law No. 2003/02 and 2003/21 on Public Financial Management and Accountability




Official Gazette (UNMIK ed., 2007),












Appendix B: Corporate Income Tax Rates of Balkans Region (Effective 2008)


Corporate Income Tax Rate

Bosnia and Herzegovina














Republic of Macedonia









Tax rates around the world (Wikipedia ed., 2007), rates_around_ the_world.











Appendix C Arguments For and Against the Flat Tax

Arguments for the Flat Tax

Ø      Simplicity

Ø      Economic efficiency

o       As achieved from removing the economic distortion, which results in a distortion that is proportional to the square of the tax rate (this means that a 20% tax rate does not cause twice the deadweight loss of a 10% tax, but four times the deadweight loss)

Ø      Removal of the dividend tax and thus removal of double taxation with respect to corporations

Ø      Substitute for, or reduction in, other taxes

Ø      Increased tax revenues, through the removal of many loopholes corporations and affluent taxpayers use to achieve an overall smaller tax liability

Ø      Decreased governmental costs to process tax returns and prosecute non-compliant taxpayers


Arguments against the Flat Tax

Ø      Results in a regressive overall tax structure, which is exacerbated by the loss of deductions available to the middle class

Ø      Simplicity can be achieved while keeping the rate structure progressive

Ø      Difficult to maintain simplicity over time

Ø      Use of the tax code to influence particular investments or modify taxpayers’ behaviors is lost

Ø      Inequality results from removing the redistributive effect of progressive taxation




Flat tax (Wikipedia ed., 2007),




[1] Candidate for Juris Doctor, Spring 2007, Chicago-Kent College of Law, Illinois Institute of Technology. This author spent a week in Kosovo in March 2007 working with Management & Development Associates (MDA) and conducting interviews and gathering information for this paper. She wishes to thank Professor Hank Perritt for his continued support. She would like to thank Robert Muharremi for his patience and his contributions to this paper.  She would also like to thank Ardian Jashari, Driton Dalipi, Luan Dalipi and the staff at MDA for their guidance and friendship. Additionally, she thanks the Rafuna family for their hospitality and friendship.

[2] Excise (Wikipedia ed., 2007),

[3] Consumption tax (Wikipedia ed., 2007),

[4] Al Ehrbar, (The Concise Encyclopedia of Economics ed., 2007), Consumption Tax.html.

[5] Consumption tax, supra note 3, at

[6] Value added tax (Wikipedia ed., 2007),

[7] Id. at

[8] Progressive tax (Wikipedia ed., 2007),

[9] Id. at

[10] See Joel B. Slemrod, The Concise Encyclopedia of Economics (2007), library/Enc/ProgressiveTaxes.html.

[11] See id. at

[12] Regressive tax (Wikipedia ed., 2007),

[13] Id. at

[14] Flat tax (Wikipedia ed., 2007),

[15] Flat taxes, The Economist Intelligence Unit Views Wire, Jan. 18, 2007, at /agenda/displaystory.cfm?story_id=E1_RVQSPQP.

[16] Id. at

[17] J.D. Foster, Ph.D., U.S. Int’l Tax Policy: Tax Neutrality or Investment Protectionism (Tax Foundation ed., 1994),

[18] Id. at

[19] Id. at

[20] See id. at

[21] See id. at

[22] See Hearing on the Impact of Int’l Tax Reform on U.S. Competitiveness Before the Subcomm. on Select Revenue Measures, 109th Cong. (2006) [hereinafter Hearing] (statement of United States Council for Int’l Bus.),

[23] See Riga and Tallinn, The Dynamic Duo, The Economist. Dec. 13, 2006, at


[24] See id. at

[25] Id. at

[26] Id. at

[27] Id. at

[28] Id. at

[29] These nations include: Lithuania, Latvia, Russia, Serbia, Ukraine, Slovakia, Georgia, Macedonia, Czech Republic. Iceland, Kyrgyzstan, Mongolia, Hong Kong, Saudi Arabia, The United Arab Emirates, Bahrain, Somalia, Nigeria, Rwanda, Uruguay, Guyana, The Bahamas and Tonga are implementing flat taxes and Greece and Croatia are seriously considering adopting a flat tax. Flat tax (Wikipedia ed., 2007),

[30] Flat taxes (The Economist Intelligence Unit ed., 2007), /displaystory.cfm?story_id=E1_RVQSPQP.

[31] Economic history of the Republic of Ireland (Wikipedia ed., 2007), Economic_history_of_the_Republic_of_Ireland.

[32] Chris Atkins & Scott A. Hodge, U.S. Lagging Behind OECD Corp. Tax Trends, Tax Foundation, May 5, 2006, at

[33] Scott A. Hodge, It’s Not the Luck of the Irish—It’s Their Low Corp. Taxes, Tax Foundation, May 15, 2006, at; For a more in-depth discussion on the definition of knowledge-based industries, please refer to Section 2: The current economic environment in Kosovo, infra.

[34] Id. at

[35] Id. at

[36] Id. at

[37] See Bausch & Lomb v. Comm’r, 92 T.C. 525, 561 (1989).

[38] Id. at 562.

[39] Id.

[40] Id.

[41] Id. at 561.

[42] Id. at 564.

[43] See id.

[44] The Economist declared Portugal “A new sick man of Europe” and cited Portugal’s GDP growth in 2006 of 1.3% as the lowest in all of Europe; The Economist attributed Portugal’s economic demise to an expansionary fiscal policy. A new sick man in Europe, The Economist, Apr. 12, 2007, at In recent years, Kosovo has also adopted an expansionary fiscal policy and should heed Portugal’s experience as a lesson to tighten spending.

[45] Interim Strategy Note for Kosovo 3 (The World Bank ed., 2007), INTKOSOVO/ Data%20and%20Reference/20963962/Kosovo_ISN_(Final).pdf.

[46] 5 Labour Market Statistics 2005 15 (Statistical Office of Kosovo ed., 2006), esk/esk/pdf/english/social/labour_mark_stat_05.pdf.

[47] Id. at 15,

[48] Interim Strategy Note supra note 45, at 3, INTKOSOVO/Data% 0and%20Reference/20963962/Kosovo_ISN_(Final).pdf.

[49] Id.

[50] Id.

[51] See id. at 3-4.

[52] Id.

[53] Id. at 3.

[54] Id.

[55] Id. at 8.

[56] Id. at 12.

[57] Id.

[58] Rucker: Kosovo sits on 45% of overall lignite deposits in Europe, Kosov@News, Oct. 12, 2006, at

[59] The Economist reported that two Chernobyl-era units at Bulgaria’s Kozloduy nuclear power plant were closed down in January as a condition of Bulgaria’s accession to the European Union and as a result, power outages have increased in frequency in duration, and have been as long as 20 hours in Albania’s countryside. Albania’s energy problem. Switching on the lights, The Economist, Feb. 8, 2007, at

[60] Keith Smith, What is the ‘knowledge economy’? Knowledge-intensive industries and distributed knowledge bases (STEP Group ed., 2000),

[61] Id.

[62] 7 Governance and Competition in Higher Education (Kosovar Institute for Policy Research and Development ed., 2007), competition%20%20higher%20education(1).pdf.

[63] The Rise of the Citizen: Challenges and Choices (United Nations Development Programme ed., 2004), Kosovo/Kosovo_2004_en.pdf.

[64] Interim Strategy Note for Kosovo, supra note 45, at 12.

[65] Id.

[66] See Hodge, Irish, supra note 33, at

[67] See Bausch, 92 T.C. at 561.

[68] At a Glance (UNMIK ed., 2007),

[69] On the Authority of the Interim Administration in Kosovo, No. 1 (1999) (UNMIK), http://www.unmikonline. org/regulations/1999/re99_01.pdf.

[70] On a Constitutional Framework for Provisional Self-Government, No. 9 (2001) (UNMIK),

[71] Id. at

[72] Id. at

[73] Interview with Robert Muharremi, Lawyer, Kosovo Assembly, in Pristina, Kosovo (Mar. 9, 2007).

[74] Id.

[75] On the Promulgation of the Law on Tax Administration and Procedures Adopted by the Assembly of Kosovo, No. 17 (2005) (UNMIK),

[76] Id. at

[77] Id. at

[78] On Tax Administration and Procedures, No. 48 (2004) (Kos.), /regulations/2005/RE2005_17_ALE2004_48.pdf.

[79] Id. at

[80] Id. at

[81] Id. at

[82] Id. at

[83] Id. at

[84] Id. at

[85] Interview with Robert Muharremi, supra note 73.

[86] Id.

[87] Id.

[88] Id.

[89] Id.

[90] Id.

[91] Id.

[92] Id.

[93] On February 2, 2007, UN special envoy Martti Ahtisaari, a former Finnish president, presented his plan for Kosovo’s final status to the United Nations Security Council. Prime Minister Agim Ceku of Kosovo supported the plan as an advancement of Kosovo’s independence. Serbia’s president, Boris Tadic refused to recognize Kosovo as independent.  Tomislav Nikolic, the leader of the nationalist Radical Party in Serbia, claimed that any independence enjoyed by Kosovo would be short-lived. Ahtisaari plan welcomed in Pristina, rejected in Belgrade, Southeast European Times, Feb. 4, 2007, at cocoon/setimes/xhtml/en_GB/features/setimes/newsbriefs/2007/02/04/nb-01.

[94] Comprehensive Proposal for the Kosovo Status Settlement art. 11, Feb. 2, 2007, [hereinafter Status Settlement].

[95] Status Settlement, supra note 94, at %20for%20the%20Kosovo%20Settlement.pdf.

[96] Status Settlement, supra note 94, at %20for%20the%20Kosovo%20Settlement.pdf.

[97] European Security and Defence Policy (Wikipedia ed., 2007), Security_and_Defence_Policy.

[98] Status Settlement, supra note 94, at %20for%20the%20Kosovo%20Settlement.pdf.

[99] See Status Settlement, supra note 94, at %20for%20the%20Kosovo%20Settlement.pdf.

[100] Status Settlement, supra note 94, at %20for%20the%20Kosovo%20Settlement.pdf.

[101] Status Settlement, supra note 94, %20for%20the%20Kosovo%20Settlement.pdf.

[102] Status Settlement, supra note 94, at annex IX art. 2 %20Proposal%20for%20the%20Kosovo%20Settlement.pdf.

[103] See Ahtisaari plan an attempt to impose one-sided solution—Lavrov, Russian News & Information Agency, April 20, 2007, at

[104] See id. at (stating “As a veto-wielding UN Security Council member and long-time Serb ally, Russia is opposed to the proposal.”)

[105] Interview with Robert Muharremi, supra note 73.

[106] Id.

[107] Id.

[108] New MEF Figures Show Slight Increase in Property Tax Collections over Same Period Last Year, Ministry of Finance & Economy, Sept. 1, 2006, at kompermedtatpr6mujori1shtator.html.

[109] Id. at

[110] Id. at

[111] Id. at

[112] Id. at

[113] Id. at

[114] See Tefta Kelmendi, Centralized vs. Decentralized Tax Administration in Kosovo, Public Finance Course of Dr. Besnik Bislimi at American University in Kosovo, Feb. 19, 2007, at 4-5.

[115] Id.

[116] Id. at 5.

[117] Id.

[118] See Id.

[119] See id.

[120] See id.

[121] See id.

[122] See id.

[123] Venera Demukaj-Bislimi, M.Sc., Dr. Ymer Havolli & Dr. Isa Mustafa. Fiscal Exchange and Budget Development in Kosova, Ifimes, Feb. 19, 2007, at =09&ID=298.

[124] Id. at =09&ID=298.

[125] Id. at =09&ID=298.

[126] Id. at =09&ID=298.

[127] Id. at =09&ID=298.

[128] Id. at =09&ID=298.

[129] Id. at =09&ID=298.

[130] See id. at =09&ID=298.

[131] Id. at =09&ID=298.

[132] Id. at =09&ID=298.

[133] Id. at =09&ID=298.

[134] Id. at =09&ID=298.

[135] Id. at =09&ID=298.

[136] Id. at =09&ID=298.

[137] On Tax Administration and Procedures, No. 48 (2004) (Kos.), /mefwww/atatimore/files/adminproced/R_E_2005_17_ALE2004_48.pdf.

[138] Id. at 17_ALE2004_48.pdf.

[139] Id. at 17_ALE2004_48.pdf.

[140] Id. at 17_ALE2004_48.pdf.

[141] Id. at 17_ALE2004_48.pdf.

[142] Id. at 17_ALE2004_48.pdf.

[143] Invest in Kosovo (Ministry of Trade and Industry of Kosova ed., 2007), /?cid=2,13.

[144] On Corporate Income Tax, No. 51 (2004) (UNMIK), 2004/re2004_51.pdf.

[145] Id. at

[146] Id. at

[147] See Hearing, supra note 21, at

[148] On Corporate Income Tax, at /2004/re2004_51.pdf.

[149] Id. at /2004/re2004_51.pdf.

[150] Foster, supra note 17, at

[151] See Smith, supra note 59, at

[152] Policy Recommendations on Tax Reforms 12 (American Chamber of Commerce in Kosovo ed., 2006).

[153] Id.

[154] Invest in Kosovo, supra note 113, at,13.

[155] See Hearing, supra note 21, at =5198.

[156] Interview with Robert Muharremi, supra note 73.

[157] Agreement for the Avoidance of Double Taxation with Respect to Taxes on Income and Capital and the Prevention of Fiscal Evasion, Alb.-Kos., 2004 [hereinafter Agreement].

[158] Agreement, supra note 157.

[159] On Foreign Investment, No. 02/L-33 (2005) (Kos.),,5&date=2005-00-00.

[160] Id. at,5&date=2005-00-00.

[161] Id. at,5&date=2005-00-00.

[162] See Bausch, 93 T.C. at 562.

[163] See id.

[164] On Corporate Income Tax, No. 51 (2004) (UNMIK), /2004/re2004_51.pdf.

[165] Tax rates around the world (Wikipedia ed., 2007), _around_ the _world.

[166] Roseanne Altshuler, Harrby Grubert & T. Scott Newlon, Has U.S. Investment Abroad Become More Sensitive to Tax Rates?, NBER, Jan. 1998, at

[167] Id. at

[168] The Economics of International Taxation (Tax Foundation ed., 2002), research/show/153.html.

[169] Michael Devereux & Ben Lockwood, Taxes and the Size of the Foreign-Owned Capital Stock: Which Tax Rates Matter?, University of Warwick, Apr. 2006, at /etpf_lockwood.pdf.

[170] Policy Recommendations on Tax Reforms (American Chamber of Commerce in Kosovo ed., 2006) [hereinafter Policy].

[171] Id. at 5.

[172] Id. at 6.

[173] Id. at 6-7.

[174] The Chamber stated: “Total income tax for the year 2007 is projected to be €90 million. Corporate tax, using previous years’ ratios is 48% or €42.2 million. Lowering the rate to 7% would mean a loss of revenues of 43.2*7/15=15.2 (€28m).” This author believes that 48% of €90 million is €43.2 million, and not €42.2 million.  This author also believes that the formula incorrectly used 7/15 and should have used 7/20, and should result in corporate tax revenues of €15.12. This results in a €28.08 loss of revenues.  Id. at 6-7.

[175] Id. at 7.

[176] Id. at 7.

[177] Chris Atkins & Scott A. Hodge, U.S. Lagging Behind OECD Corporate Tax Trends, Tax Foundation,  May 5, 2006, at

[178] Id. at

[179] Id. at

[180] Policy, supra note 170, at 13.

[181] Id. at 13.

[182] Id.

[183] Id.

[184] Id. at 6-7.

[185] Id. at 13.

[186] Id. at 13.

[187] Id. at 8.

[188] Id.

[189] Id.

[190] Id.

[191] Id.

[192] Riga, supra note 23, at id=E1_RQTSJJV.

[193] Flat taxes, supra note 30, at id=E1_RVQSPQP.

[194] Christian Tenbrock, Low tax for all: Eastern Europe: Some Countries have the standard tax. But it is disputed, Wirtschaft, Jan. 9, 2005, at

[195] Id. at

[196] The case for flat taxes, The Economist. Apr. 14, 2005, at displaystory.cfm?story_id=E1_PRGDSPT.

[197] Flat tax, supra note 30, at

[198] Michael Kenn, Yitae Kim & Ricardo Varsano. The “Flat Tax(es)”: Principles and Evidence. The IMF Working Paper. Sept. 2006, at

[199] Id. at

[200] Flat tax, supra note 30, at

[201] Id.

[202] Policy, supra note 170, at 7.

[203] Flat tax, supra note 30, at

[204] Id. at

[205] Id. at

[206] Id. at


[207] E.g., Invest in Kosovo, supra note 113, at,13.

[208] On Personal Income Tax, No. 52 (2004) (UNMIK), re2004_52.pdf.

[209] Id. at

[210] Id. at

[211] Id. at