# **I. Introduction**

Serbia’s economic reform agenda aims to accelerate economic growth and boost convergence in living standards with the European Union. To support that process, macroeconomic sustainability and fiscal policy for inclusive growth are an important part.<sup>2</sup> Serbia achieved notable fiscal consolidation efforts in 2015-2019 to bring down high public debt and stabilize its macroeconomic foundations, and economic growth and labor market improvements during this period benefitted the population. Yet more structural reforms are needed to boost private sector dynamism and jobs, improve welfare of citizens, and strengthen the middle class in Serbia. In 2019, 23.2 percent of Serbia’s population was still considered at risk of poverty, defined as living below 60 percent of the median per-adult-equivalent income. The COVID-19 pandemic and economic crisis brought earlier progress to a halt and underscored the need for a green, resilient, and inclusive recovery.

In this context, understanding the impact of the fiscal system on inequality and poverty is key to inform policy choices. To better understand how the government redistributes resources and the potential equity and distributional impacts of any future fiscal reform, it is useful to have a comprehensive assessment of the redistributive effect of the current tax-benefit system. The equity impacts should be considered along with other goals of fiscal policy, such as efficiency and sustainability.

This paper’s key research question is to analyze the incidence of fiscal policy in Serbia, that is, the impact of government spending and tax collection on households and on poverty and inequality. The results will shed light on the extent to which the government redistributes resources, which can serve as an input into the public policy debate about whether a tax or a benefit, or what combination, is desirable. To our knowledge, this is the first paper that analyzes and presents a comprehensive assessment of how the distribution of household income is affected by each type of tax or social transfer and by the whole system in Serbia. The paper advances on the previous literature as follows. Earlier work has looked at the impact of direct taxes and direct transfers using SRMOD, a version of the EUROMOD model (Randjelovic and Zarkovic, 2013) and estimated the effects of fiscal instruments on income inequality using a decomposition approach (Krstic and Zarkovic, 2017). However, these studies did not include indirect taxes, which are a major source of revenue collection, and did not look at poverty impacts. This paper incorporates these aspects and, in addition, includes inkind transfers such as education and health, which are major components of social spending, in assessing impacts on inequality.

This paper follows the Commitment to Equity Assessment (CEQ) approach<sup>3</sup> and, to our knowledge, is the first to apply the methodology and generate new findings for Serbia. Compared to other approaches, using the CEQ has the benefits of assessing the comprehensive fiscal system as a whole, assessing impacts for various types of households, and comparison with the many countries where this same approach has been applied. The paper uses the household survey data available at the time of analysis, namely the 2017 Survey of Income and

> 2 World Bank (2020). Serbia Systematic Country Diagnostic Update.

> 3 The Commitment to Equity Assessment (CEQ) toolkit provides a solid methodological framework for answering these questions; see <u>https://commitmentoequity.org/publications-ceq-handbook. This approach has been</u> implemented in many countries across different regions of the world. For methodological details, see Lustig, Nora (editor). 2018. _Commitment to Equity Handbook. A Guide to Estimating the Impact of Fiscal Policy on Inequality and Poverty_ . Brookings Institution Press.

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