earned income. For example, for a family with two children falling within the subsidy range, the credit can represent a substantial increase in their income, which increases with the number of children. Therefore, for some individuals who were previously not in the workforce, the earnings subsidy provided by the tax credit can create a financial incentive substantial enough to motivate them to join the labor force or work more hours. This increase in earnings, combined with the child tax credit amount, amplifies the povertyreduction impact of the initial income boost. Consequently, it can sometimes lift a family's income above the poverty line. If the policy creates a disincentive effect, the poverty effect goes in the other direction. International evidence on the disincentive effect of such policies is mixed and varies based on the specific policies and context.<sup>16</sup>

# IV.Main Results

What is the net impact of fiscal policy on overall poverty and inequality in 2020? Has the impact changed from 2018 to 2020?

**Despite facing the challenges posed by the COVID-19 crisis, Bulgaria's fiscal system demonstrated limited impact to reduce the at-risk-of-poverty rate; however, it has the potential to mitigate poverty among lower income deciles, as measured by the lower poverty lines. The fiscal system has shown the capacity to reduce inequality, albeit direct taxes and transfers have a lower ability to reduce inequality compared to other EU countries.** Results from this updated CEQ for the year 2020 are consistent with the previous CEQ fiscal analysis conducted for the year 2018.  Regrettably, the country's fiscal policies still do not significantly contribute to reducing relative poverty. Despite various tax and transfer mechanisms in place, the level of relative poverty persists and fails to be substantially reduced with the fiscal system. On the positive side, the system can improve welfare levels among the bottom deciles, as shown by its ability to reduce poverty when using a lower poverty line ($ 6.85 a day).  Fiscal policy in Bulgaria effectively diminishes overall inequality, surpassing countries with comparable income levels. This proves pivotal in fostering social cohesion and sustainable economic growth. Despite this, the redistributive effects of direct taxes and transfers remain comparatively minimal within Europe.

**The fiscal system continues to be poverty-increasing when measuring poverty using the at-risk-ofpoverty (AROP) poverty line, the measure used throughout the EU, primarily due to the limited redistributive role of direct taxes and transfers, as this population at risk of poverty** **<mark>pays more in taxes than what they receive in transfers</mark> .** The impact of fiscal policy on poverty will depend on the size and incidence of government spending and revenues along the income distribution. The fiscal system raises poverty (using the AROP<sup>17</sup> poverty line) by 3.8 percentage points, from 25.3 percent to 29.1 percent (Figure 3, panel a). The largest increase in poverty is due to changes between disposable and consumable income due to indirect taxes, which are not fully compensated by transfers. Indirect taxes and transfers increase poverty by 6.9 percentage points, while direct taxes and transfers reduce it by only 3.1 percentage points. Compared to 2018 (the year the previous CEQ was available), the subsidies to market

> 16 Brandon et al (2023) and Baker and Messacar (2021) observed no labor supply response to child tax benefits in the US and Canada, respectively. Kayser (1999) found no impact on labor force participation from tax deductions for single-parent households in Germany. Tamm (2009) discovered that a child benefit reform in Germany led to reduced working hours for certain groups of mothers but didn't affect participation rates. On the other hand, Bettendorf (2011) noted that an earned income tax credit for single parents in the Netherlands increased participation rates and hours worked. Overall, the evidence is mixed. 17 The AROP poverty line was equivalent to US$20.5 in 2017 PPP per day in 2020.

19