Improving work incentives in Serbia: evaluation of a tax policy reform using SRMOD

Inactivity and unemployment rates as well as informal employment rates in Serbia are particularly high among low-paid workers. Several studies argued that one of main reasons for high entry costs in the labour market in Serbia is the existence of the mandatory minimum base for social security contributions (SSC). Our paper is the first one to provide empirical evidence about the incentive and distributional effects of the abolishment of the mandatory minimum SSC base. Using the tax and benefit micro-simulation model for Serbia (SRMOD), which is based on EUROMOD platform, we found that this policy reform would reduce effective average tax rates by more than it would reduce effective marginal tax rate. This implies a larger participation response than hours-of-work response. A decrease in both of these indicators is most pronounced for lower income groups. At the same time, the reform would trigger positive distributional effects since the number of individuals in low-income groups, whose disposable income would increase after the reform by more than 2%, is ranging from 3.3% to 5.8%. However, the impact of the reform on the overall level of inequality, measured by the Gini coefficient, would be small.