Viktor Gotovac
Saša Drezgić
Ulrich Schuh




   Analysis of the Severance
  Pay Scheme in the Republic
       of Croatia: current
  arrangements and changes
        to be considered


                      World Bank report prepared at the request of the
               Ministry of Labor and Pension System of the Republic of Croatia




                                       September 2013




                                                                                 1
Contents
Analysis of the severance pay scheme in the Republic of Croatia: current arrangements and
changes to be considered                                                                    4
0. Executive summary                                                                        4
1. Introduction                                                                             6
  1.1. Severance pay - the term                                                             6
  1.2 Function of Severance Pay                                                             7
  1.3 Severance pay - legal sources                                                        10
  1.4 Legal basis for the payment of severance pay                                         11
  1.5 The amount of severance pays                                                         13
  1.6 Financing severance pay                                                              14
  1.7 Taxation of severance pay                                                            14
2 Statutory regulation of the severance pay scheme in the Republic of Croatia              15
  2.1 The legislative history of the contemporary severance pay regulations in the Republic of
  Croatia                                                                                  16
  2.2. Regulation of severance pay in the provisions of the Labor Act                      17
  2.3 Regulation of severance pay in collective agreements and work regulations            20
  2.4. The status of severance pay in the provisions of tax regulations                    23
3. The economic characteristics of the severance pay scheme in the Republic of Croatia     25
  3.1 The characteristics of the Croatian severance pay scheme                             26
     3.1.1. Payment of severance pay in the public sector                                  27
     3.1.2. Payment of severance pay in the case of the bankruptcy of the employer         32
     3.1.3. Payment of severance pay in the private sector                                 35
4 Regulation of severance pay schemes in other states                                      36
  4.1 Regulation of the severance pay schemes in the EU member states                      36
     4.1.1. Regulation of severance pay in the EU member states                            36
     4.1.2. Economic effects of severance pay in the EU member states                      39
  4.2 Regulation of severance pay in the neighboring and other relevant states             41
5 Reform of the national severance pay scheme in the Republic of Austria                   42
  5.1 State before the reform of the national severance pay scheme in Austria, in 2003     42




                                                                                            2
  5.2 New Austrian national severance pay scheme after the reform of the national severance pay
  scheme in the Republic of Austria in 2003                                                    44
  5.3 Lessons from the new Austrian severance pay scheme after the reform of the national
  severance pay scheme in the Republic of Austria in 2003                                      46
     5.3.1. Coverage                                                                           46
     5.3.2. Labor mobility                                                                     47
     5.3.3. Capital accumulation and rate of return                                            49
     5.3.4. Conclusions on the new Austrian national severance pay scheme after the reform of the
     national severance pay scheme in Austria in 2003                                          51
  5.4 Acceptance of the new Austrian national severance pay scheme in other members states of
  the European Union after the reform of the scheme in the Republic of Austria in 2003         51
6 Comparison of relevant economic categories between the Republic of Croatia and the Republic
of Austria and reflections on the Croatian labor market                                        52
7 Simulation of the model                                                                      57
8 General open issues with respect to the reform and regulation of the severance pay scheme in the
Republic of Croatia and approaches to their resolution                                         61
9 Conclusion on strengths and weaknesses of introducing a new national severance pay scheme
model                                                                                          62
10 References                                                                                  67




                                                                                                3
Analysis of the severance pay scheme in the Republic of
Croatia: current arrangements and changes to be considered

0. Executive summary
The national severance pay scheme, its regulation in the law and in other sources, its practice and
practical application, and all the amendments of the statutory basis are the consequence of
considering individual and social implications of the termination of an employment contract or the
termination of employment, in one of the ways regulated by the Labor Act.

Each change in the national severance pay scheme is necessarily connected with redefining and
newly balancing worker's and employer's interests, with aspects of employment security and
flexibility and it requires processing and analyzing various aspects of the national severance pay
scheme. To this end, this report aims to present and analyze all the interconnected determinants of
the national severance pay scheme, such as:
(a) overview of theoretical qualifications and determinants within the national severance pay
      scheme;
(b) overview of arrangements within the national severance pay scheme through legal and other
      regulatory arrangements;
(c) overview of arrangements in different comparable national severance pay schemes;
(d) special overview of the current reforms of the severance pay scheme in the context of other
      relevant countries;
(e) presenting the plan for the amendments to legal and other regulatory arrangements;
(f) assessing the practical implications of the planned amendments to legal and regulatory
      arrangements and their effects on the national severance pay scheme; and
(g) final proposals and comments.

Both the legislator of the Labor Act and its amendments, and the discussions of social partners -
trade unions and employers' associations - are focused on considering the options and the
usefulness of establishing a severance pay fund in the Republic of Croatia, with designated
workers’ accounts, to which the employers would pay defined monthly contributions, as in the
“Austrian model”. With this, the current definitions and arrangements within the severance pay
scheme would be lost, and a new scheme would be set up, which is mostly based on the
characteristics of a globally innovative model for a reformed severance pay scheme as exists in the
Republic of Austria.

In the light of positive expectations from this scheme, and taking into account numerous obstacles
and economic difficulties in the Republic of Croatia, it is evident that an approach to such a reform
of the national severance pay scheme in the Republic of Croatia would be loaded with risks if it is
not based on information and analyses. The conclusions of this study point to the fact that there are
several key stages to this process and several issues to be considered before making a final
decision on approaching the changes to the national severance pay scheme in the Republic of
Croatia.



                                                                                                   4
1.   Factual conclusions based on the practice, but also the opinion of various authors point to the
     fact that the existing scheme is characterized by numerous problems and that it ought to be
     improved.
2.   Taking into account the above conclusion, the prerequisite for any kind of action is to start
     from a detailed analysis of the status quo in the national severance pay scheme.
3.   After the analysis of the status quo in the national severance pay scheme, it is necessary to
     define problems, which the reform ought to cover and the aim that the reform wishes to
     achieve.
4.   In the light of these aims, one of the possibilities is to reform the national severance pay
     scheme according to the Austrian model, but this decision would imply radical changes in
     the national severance pay scheme.
5.   There are alternatives to the reform of the national severance pay scheme according to the
     Austrian model – it is, for instance, possible to change individual parameters and to improve
     the outcomes of the existing severance pay scheme.
6.   There are no clear arguments that would definitely support the recommendation of any of the
     possible options – therefore, sustainability and implications of each proposed option should
     be tested, especially taking into account the problems, which the reform should cover and the
     aims to be achieved by the reform, and an evaluation of feasibility and economic
     reasonability of any such action should be made, particularly in the light of implementing
     this reform in the current situation of economic crisis.
7.   For the introduction of a new national severance pay scheme, it is necessary to achieve broad
     consensus of social players and stakeholders, and any hasty decisions should be avoided,
     especially if they lead to radical changes in the status quo.


Consequently, we have undertaken the following analysis of the severance pay scheme in the
Republic of Croatia, which is delivered as World Bank technical assistance to the Government of
the Republic of Croatia. Its systemic approach and analytical background, and its final proposals
and comments regarding various scenarios of amendments to the legal and other regulatory
arrangements should contribute to developing a discussion about possible reforms of this very
important segment of employment relations, labor law and life of any active employee.




                                                                                                  5
1. Introduction


1.1. Severance pay - the term

Severance pay (Engl. severance pay, severance allowance; Germ. Abfindung, Abfertigung; French
indemnité de résiliationducontratdutravail, indemnité de résiliation de licenciement), or the
severance pay scheme, is one of the most common and most widely represented, but also one of
the most controversial social schemes.1 It represents a guarantee of pecuniary prestation to the
worker after dismissal or after termination of the employment contract, and this guarantee exists in
almost all legal systems worldwide.2 However, the fact that severance pay is a common
phenomenon across the world does not mean that the terms or its functions, legal sources, legal
basis, amounts or ways it is funded are the same, on the contrary - there are systematic differences.
It is therefore difficult to introduce a uniform definition of the term severance pay, because such a
definition, in order to be valid, should cover all the globally different characteristics, which would
lead to its simplification. One such definition is the one where the term severance pay is connected
to the final payment from the employer to the worker, whose employment contract was
terminated3, from which definition no significant conclusion on the term 'severance pay' can be
made.

In view of this simplification, the definition of the term severance pay should - par excellence - be
sought in the national context, in this case in the Croatian legal system. After that, the report will
discuss some basic differences in the function, legal sources, legal basis, amount and way of
funding severance pays.

The term 'severance pay' in the Republic of Croatia is most often defined as the pecuniary amount,
which the employer pays to the worker, for whom it terminates the employment contract, besides
the worker's salary.4 This amount belongs to the worker after the expiry of the period of notice,
after the termination of the employment contract. Although it has be originally conceived as
reward to the workers for their loyalty to the employer, in essence the severance pay should
alleviate the negative consequences of the dismissal for the worker,5 and it is frequently considered
a means of ensuring an income, or a replacement income, so that it contains elements of social
security.6 In theory, severance pay is sometimes also understood as delayed payment of salary.7


1
  Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 2.
2
  Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 1.
3
  Please see: Entry “Severance pay”. Glossary of Labour Law And Industrial Relations (With Special Reference to the
European Union). Geneva: International Labour Office, 2005, p. 231
4
  Please see: Entry “Severance pay”. Pravni leksikon (Legal Lexicon). Zagreb: Leksikografski zavod Miroslav Krleža,
2007, p. 1013
5
  Please see: Bejaković, Predrag. Poteškoće oko mogućeg osnivanja posebnog fonda za otpremnine (Difficulties
related to possible establishment of a Severance Pay Fund) Radno pravo – Journal, 10, 2013, 5, p. 32
6
  Please see: Entry “Severance pay”. Pravni leksikon (Legal Lexicon). Zagreb: Leksikografski zavod Miroslav Krleža,
2007, p. 1013

                                                                                                                 6
Besides the legal definition of severance pay as the entitlement of the worker whose employment
contract was terminated after two years of uninterrupted employment, provided that the dismissal
was not caused by worker's conduct, the term severance pay in Croatia is also used to designate
any payment by the employer to the worker after the termination of employment, and as a
consequence of such termination, based on some source of entitlements related to labor or based on
a unilateral decision of the employer, for instance in case of retirement, consensual termination of
the employment contract or judicial termination of the employment contract8.9


1.2 Function of Severance Pay

Differentiating the definitions of the term severance pay as - on the one hand - reward to the
workers for their loyalty to the employer, and - on the other hand - as a means to alleviate the
negative consequences of dismissal, which some authors refer to as “the protective clause” 10,
points to the dualism of social functions of severance pay. This dualism can also be seen as
pluralism of functions: thus, severance pay can be identified through its "penalizing" function
towards the employers - because it makes dismissals more expensive and thus prevents employers
to dismiss workers without consideration and recklessly11, or through the function of increasing
workers' and their families' purchasing power, which contributes to workers' social security. 12
Pluralism of social functions of severance pay should be seen as a consequence of the dynamics of
its development, throughout which this entitlement was given several, even different functions,
depending on the time, place and purpose of its introduction and legal arrangements.

In a large number of countries severance pay and the entitlement to severance pay was first
introduced in the legal systems at the end of the 19th century, as a consequence of developing
industrial serial mass production, and it is also related to the development of the social state.
Thinking about the first industrial restructuring imposed the need to find systematic solutions,
which would alleviate the effects of mass dismissals on the social position of workers, and which
would be motivating for the remaining workers. Back then - at the time before any insurance
scheme, which would provide the unemployed with some minimum protected income during the
period of unemployment, the severance pay became the first instrument with such a social-



7
  See also: Potočnjak, Željko. Prestanak ugovora o radu (Termination of the Employm ent Contract), in: Radni odnosi u
Republici Hrvatskoj (Employment in the Republic of Croatia) (ed. Potočnjak, Željko). Zagreb: Faculty of Law Zagreb;
Organizer, 2007, p. 375-494
8
   Please see: Zuber, Marija. Plaće (Salaries), in: Babić, Vera et al. Veliki komentar novog Zakona o radu
(Comprehensive Commentary of the new Labor Act). Zagreb: Vaša knjiga, 2010, p. 132
9
  Please see: Entry “Severance pay”. Pravni leksikon (Legal Lexicon). Zagreb: Leksikografski zavod Miroslav Krleža,
2007, p. 1014
10
   Please: Crnić, Ivica. Otkaz ugovora o radu (Termination of the Employment Contract), Zagreb: Organizator, 2013, p.
213.
11
    Please see: Bejaković, Predrag. Poteškoće oko mogućeg osnivanja posebnog fonda za otpremnine (Difficulties
related to possible establishment of a Severance Pay Fund) Radno pravo – Journal, 10, 2013, 5, p. 32
12
    Please see: Zuber, Marija. Plaće (Salaries), in: Babić, Vera et al. Veliki komentar novog Zakona o radu
(Comprehensive Commentary of the new Labor Act). Zagreb: Vaša knjiga, 2010, p. 132

                                                                                                                   7
protective function13. In many developing countries, in which the social protection system is
underdeveloped, the severance pays still predominantly reflect such a social-protective function.14

In the context of legal arrangements regulating employment and protecting workers' rights with
respect to employers at the turn of the twentieth century, the severance pay was emphasized as an
important element among legal conditions to terminate employment contracts, and its role was to
guarantee indemnification for workers whose employments were terminated by their employers,
who have thus - in a way - "violated" (the purpose) of the employment contract. At that time, the
severance pay was often agreed ad-hoc between the employers and the trade unions, with the aim
to reduce workers' resistance towards restructuring implying significant reductions in the number
of jobs. At the same time, in some of the manufacturing industries, primarily those that require
higher qualifications and expertise, and higher investments into workers' skills, employers
themselves proposed that high severance pays be introduced, along with other workers' rights in
order to bind the employer to the workers and establish mutual trust. In this way, the employers
have increased the cost of dismissing workers, which provided the workers with a sense of security
and reduced the probability for them to transfer to another employer for a higher salary, which
would incur losses to the original employer. Thus, the severance pay became a protection
instrument, a reward to the workers for their loyalty to the employer and it thus had a role in
improving the efficient management of human resources.15

Finally, after the Second World War, through development of the social state16 in developed
welfare states, the severance pay was not abolished, regardless of the fact that a separate system of


13
   This is about severance pay as a pecuniary benefit for the workers during the period of unemployment and
indemnification for the total years of service with a single employer.
14
   Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 18-19 See also: Holzmann, Robert et al.
Severance Pay Programs around the World: History, Rationale, Status, and Reforms. Hirschegg; Marseille; Pretoria;
Washington: The World Bank; IZA, 2011, p. 5-6
15
   Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 19-20. Also see: Holzmann, Robert et al.
Severance Pay Programs around the World: History, Rationale, Status, and Reforms. Hirschegg; Marseille; Pretoria;
Washington: The World Bank; IZA, 2011, p. 6-8
16
   Most authors in the field of studying social policies equate the term “welfare state” with t he term "social state"
(Please see: Puljiz, Vlado. Socijalna politika: definicije i područja (Social Policy: Definitions and Areas), in: Puljiz,
Vlado et al. Socijalna politika (Social Policy). Zagreb: Pravni fakultet, 2005, p. 6). Please see: Entry “Socij alna
država” (Social state). Pravni leksikon (Legal Lexicon). Zagreb: Leksikografski zavod Miroslav Krleža, 2007, p. 1485
However, here I believe that in the legal and constitutional perspective, the term and concept of "social state" German
Sozialstaat; French état social) should be differentiated from the term and concept of “welfare state” German
Wohlfahrtstaat; French état-providence). Namely, welfare state is a term that designates the arrangements that were
introduced in almost all developed states in the course of the 20th century as a response to the functional need for a
modern capitalist economy, founded on market principles, whereas the term social state implies a leading normative
principle, which systematically regulates the obligations of a state in the sphere of social and economic policy. We can
therefore discuss the term social state as a legal form of organizing a form of welfare state, where the constitution
entrusts the state with a leading and visible role in ensuring social security and diminishing social differences.
Consequently, any social state is at the same time welfare state, but not necessarily vice versa. Please see: Katrougalos,
George S. The Implementation of Social Rights in Europe. Columbia Journal of European Law, 1996, 2, p. 277-278
See also: Mishra, Ramesh. The Welfare State in Crisis: Social Thought and Social Change. Brighton: Wheatsheaf
Books, 1984, p. 101; Ploug, Niels; Kvist, Jon. Social Security in Europe: Development or Dismantlement? The Hague;
London; Boston: Kluwer Law International, 1996, p. 51-53

                                                                                                                        8
social insurance started developing, which provided the unemployed - after the termination of their
employment - with a protected minimum income during the period of their unemployment. On the
contrary, the existing contractual or voluntary arrangements related to severance pay were
expanded to all employed persons, and they were anchored in legislation. By introducing legal
basis for the entitlement to the severance pay, the protective function of severance pay was
emphasized - i.e. its function of providing the workers with protective reward for their loyalty to
their employers.17

Through these three stages of severance pay development, several intended purposes of severance
pay can be identified as follows:
(a) a “primitive” form of social benefit, which preceded the introduction of unemployment
      insurance and pension insurance, which guarantees income replacement instead these forms
      of insurance;
(b) an instrument to increase the efficiency of human resource management, which - together
      with the components of providing a benefit, guarantees that interests of employers and
      workers will be balanced in knowledge-intensive forms of production; and
(c) an instrument to protect employment, as an unintended consequence of legal systems or an
      intended consequence of expanding the legal systems, all as a consequence of political
      economy, which cannot be changed.18

In view of the above, and bearing in mind the various intended purposes, severance pay can be
related to several social functions, which it should serve. Initially, this had to do with:
(a) rewarding the workers for their fidelity to their employers; and

In order to elaborate this division in greater detail, one ought to mention that the term "welfare" has been deducted
from the considerations of Pareto optimality or Pareto efficiency, according to which the equilibrium and efficiency
cannot be optimized by making any one individual better off without making at least one individual worse off (in other
words there is nothing, which would be "more optimal" than the "optimum"), which is one of the values or maybe
even the central value of the legal theory of law and economics, which is significantly represented in the United States,
not as a normative, but a positive law theory, which emphasizes formal and procedural and not material contents of the
rule of law, constitutional order and social action. In this context, the welfare or well-being imply the possibility to
achieve optimum social solutions, but not on the normative level, which would be done by conceptualizing or
constitutionalizing the obligations and the role of the state in that respect, but from the standpoint of positive law,
which make it possible to achieve welfare, though they do not guarantee it. In that sense, the well-being is inherent to
the tradition of a liberal state, which is focused on the individual and the market. And this is precisely what
differentiates the terms and the concepts behind the welfare state and the social state: the welfare state makes is
possible (though it does not guarantee) to achieve optimum social solutions, creating market and social conditions to
achieve this, but itself it does not take any active role in this; on the other hand the social state itself actively uses its
authorities and obligations to work towards achieving optimum social solutions.
We can find this same division in the conclusion that "between the social state and the welfare state there is a certain
difference in the first important element (duty of the state to equitably divide the national income), and for that reason
the former has more to do with social justice, whereas the latter is more connected with deserved justice." According
to: Ravnić, Anton. Socijalna država i država blagostanja (Social State and Welfare State), in: Hrvatska kao socijalna
država: Zadanosti i usmjerenja (Croatia as a Social State: Actualities and Directions) (ed. Bahtijari, Hašim). Zagreb:
Centar za industrijsku demokraciju SSSH, 1997, p. 72
17
   Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 20-22. Also see: Holzmann, Robert et al.
Severance Pay Programs around the World: History, Rationale, Status, and Reforms. Hirschegg; Marseille; Pretoria;
Washington: The World Bank; IZA, 2011, p. 8
18
   Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 9

                                                                                                                            9
(b)   help19 to mitigate the negative consequences that the termination of the employment contract
      has for the worker, in the form of securing income, or a replacement income, that is to ensure
      workers’ subsistence until they conclude a new employment contract or ensure a new source
      of income20,
however, through later stages of development, it became possible to identify some further,
comparatively more sophisticated functions of severance pay and national severance pay schemes
in the labor market, such as:
(c) indemnification for the termination of the employment contract that is for the loss of a job;
(d) stabilization of the employment and preventing unemployment by discouraging terminations
      of employment contracts21; and
(e) encouraging long-term employments, which keep valuable workers and reduce transaction
      costs resulting from turnover of labor force with a single employer.22


1.3 Severance pay - legal sources

There are several legal sources for regulating severance pay. At the national level, the legal source
for the payment of severance pay may be:
(a) the law - the obligation to pay severance pay regulated by the law;
(b) collective agreements - the obligation to pay severance pay regulated in collective
      agreements;
(c) unilateral voluntary arrangements by the employer (work regulations or employer’s decree) –
      the employer decides himself how he will pay severance pay even in cases when there is no
      legal obligation or collective agreement binding him and the decision on the payment of
      severance pay is based on encouraging voluntary character of employment terminations; and
(d) a combination of the above mentioned legal sources.

The World Bank Report “Severance Pay Programs Around the World” provides an overview of
183 states, according to which in hundred and fifty-two states - which accounts for 82 percent -
there is a legal obligation to pay severance pay in different situations when there is employment
termination. In further 18 states - 10 percent - the same obligation exists, only based on collective
agreements, whereas in thirteen states - seven percent - there is no obligation to pay severance
pay.23 In the same report, several other conclusions are stated. So, in a large number of developed
states, severance pay is regulated by a combination of legal provisions, collective agreements and
voluntary arrangements by the employers through their work regulations or unilateral decrees
issued by the employer. Further, in most states the obligation to pay severance pay covers all

19
   This is how the case law in the Republic of Croatia defines severance pay. Please see: Decision of the Supreme
Court of the Republic of Croatia, no. Revr-206/06 of 6 September 2007;
20
   Please see: Crnić, Ivica. Otkaz ugovora o radu (Termination of the Employment Contract). Zagreb: Organizator,
2013, p. 213.
21
   Please see: Bejaković, Predrag. Poteškoće oko mogućeg osnivanja posebnog fonda za otpremnine (Difficulties
related to possible establishment of a Severance Pay Fund) Radno pravo – Journal, 10, 2013, 5, p. 32
22
   Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 2
23
   Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 26

                                                                                                              10
employers, whereas in a smaller number of states, it depends on a minimum number of workers,
only affecting those employers who employ more than a certain number of workers, the threshold
ranging from five to twenty.24 Also, in some states the legal obligation to pay severance pay is just
focused on the private sector, whereas civil servants have a different regime, which achieves a
similar purpose.25 It is also evident in the fact that the best developed states most often have legal
arrangements, which regulate that severance pay is only binding for the private sector, whereas the
Eastern European states more often have the legal obligation for the severance pay to be paid to all.


1.4 Legal basis for the payment of severance pay

The legal basis for the payment of severance pay, that is its individual concretization, will answer
the question in which legal situations there is the obligation to pay severance pay. Thus, it becomes
evident that in most states, the obligation to pay severance pay exists as a consequence of the
termination of the employment contract by dismissal, after the worker was dismissed as
technological surplus. The key trigger for the payment of severance pay is thus the termination of
the employment contract for reasons, which were not conditional on worker’s conduct, which
corresponds to the mentioned definition of the term severance pay. This legal basis can thus be
either set up in a way that it is defined in connection with the termination of the employment
contract, which is a consequence of dismissing the worker as technological surplus, or other
dismissals not caused by workers’ conduct.

However, in some states the severance pay is paid even in the broadest scope of cases. Thus, there
are states where severance pay is paid in all cases of employment contract termination. Other states
are not focused on all forms of employment contract terminations, but only on those, based on
dismissals by the employer. However, in both these examples, some ways of terminating
employment contracts are most frequently excluded, e.g. if the termination of the employment
contract or the dismissal was caused by worker’s conduct, or if is the expression of the worker’s
will – where the workers themselves terminate their contracts.26

Along with the above mentioned, another legal basis for the payment of severance pay is also the
termination of the employment contract as the consequence of bankruptcy, old-age retirement or
disability.




24
   Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 28-29
25
   Here, I would like to mention examples where the right to pay severance pay is regulated for some groups of
workers with a single employer, i.e. for administrative workers or what is called called 'white collar workers'. Please
see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International Bank for
Reconstruction and Development; The World Bank, 2012, p. 23
26
   Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 23

                                                                                                                   11
Finally, the legal bases for the payment of severance pay can be divided as follows:
(a) dismissals from reasons not dependent on worker’s conduct;
(b) dismissals of technologically superfluous workers;                  Non-voluntary terminations
(c) termination of the contract due to bankruptcy;
(d) termination of the contract due to disability;
(e) retirement; and                                                     Voluntary terminations
(f) any (other) form of termination of the employment contract

Between the mentioned legal bases for the payment of severance pay it is quite evident that on the
one hand there are forms of severance pay, which are the consequence of employers’ decisions to
terminate employment contracts, where severance pay serves as a remuneration or reward to the
workers for their loyalty to the employer in cases of termination, which were not caused by
workers themselves, whereas on the other hand the payment of severance pay represents the final
payment by the employer to the worker, for whom the employment contract ceases, in any such
case of termination27. Looking at these two “extremes”, it is evident that the broader the range of
cases anchored in the legal basis regulating the payment of severance pays, the more the severance
pay loses the feature of being a reward to workers for their loyalty to the employer, which would
classify it exclusively as an instrument of the labor law, with only a marginal connection to certain
elements of the (social) security system28 after the termination of the employment contract not
caused by the worker, and they are actually more prominently characterized as a part of the system
of (public) savings funds29, which have a clear impact on employers’ costs related to employments
and dismissals. Naturally, in the latter case, the severance pay primarily serves to mitigate the
adverse consequences that the termination of the employment contract has on the worker, and it is
thus a means to ensure income, or a replacement income.30

Here, it needs to be mentioned that the way of terminating the employment contract itself does not
imply sufficient legal basis for the payment of severance pay, but it is combined with the factor of
fulfilling the minimum period of employment, meaning the years of service, which are necessary
for the employer to be obliged to pay severance pay to the workers. All this corresponds to the
definition of the term severance pay as it was presented earlier.31




27
   Please see: Entry “Severance pay”. Glossary of Labour Law and Industrial Relations (With Special Reference to the
European Union). Geneva: International Labour Office, 2005, p. 231
28
   Please see: Ravnić, Anton. Osnove radnog prava – domaćeg, usporednog i međunarodnog (Foundations of Labor
Law – Domestic, Comparative and International). Zagreb: Faculty of Law, 2004, p. 244-245
29
   Please see: Ravnić, Anton. Osnove radnog prava – domaćeg, usporednog i međunarodnog. (Foundations of Labor
Law – Domestic, Comparative and International). Zagreb: Faculty of Law, 2004, p. 245-247
30
   In case that severance pay fulfills this role, the workers have the right to withdraw the funds from their individual
savings accounts. Thus, the severance pay in this system becomes something completely different to the severance pay
as it is currently regulated in the Labor Act.
31
   Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 23

                                                                                                                     12
1.5 The amount of severance pays

The amount of severance pay that belongs directly to the worker is directly connected with the
legal basis for the severance pays. Namely, this amount is connected with the individual
concretization of the legal basis, the duration of employment, which is now terminated, whereas
the relevant variables are most often the following:
(a) duration of employment32; and
(b) the amount of salary33 of the concrete worker.

Based on these two variables, the amount of the severance pay, which is actually paid, is most
often defined by a formula, which multiplies the years of service with a single employer with the
amount or a part of the amount of the worker’s salary.34

In the vast majority of the national severance pay schemes, this formula is identically applied in all
cases of severance pay payment, however national severance pay schemes in some states define
different formulas for calculating the amount of severance pay, depending on the reason for the
termination of the employment, so that the way of terminating employment also plays a certain
role and influences the formula of calculating severance pay. On the other hand, the way of
terminating the employment contract, that is different situations and legal bases for the payment of
severance pay, in which the employer is obliged to pay it, may have the effect of just increasing (or
decreasing) the amount of the severance pay, which is defined according to a uniform formula.
Thus, for instance, in the Republic of Croatia, the amount of severance pay is increased for certain
protected categories, and a multiplying factor is applied to calculate the amount of severance pay.35

Along with the concrete way that the employment contract was terminated, other factors may also
have an impact on the formula of calculating the severance pay:
(a) age; and
(b) repeated, additional, duration of employment.




32
   Relevant duration of employment almost always refers to the duration of employment or years of service with a
concrete employer. According to available data, the only state where a formula is used, according to which the
employer would be obliged to calculate severance pay according to the full duration of all employments or the total
years of service is the Republic of Serbia.
33
   Most frequently the last salaries or salaries of some reference period towards the end of employment.
34
   The amount of legally regulated minimum severance pay is the highest in less developed states with lower salaries,
whereas in most developed states, with the highest salaries, the amount of legally prescribed minimum severance pay
is the lowest. This may at the first sight seem surprising, however, one has to bear in mind several facts. In the
developed states, the legal minimum is actually really treated as the minimum, whereas the collective agreements
regulate much higher amounts of severance pay. However, a more important reason is that in most less developed
states, the severance pay truly has a social and protective function, which compensates for the lack of legal insurance
systems, in that it provides replacement for unemployment benefits. Please see: Holzmann, Robert et al. Severance
Pay Programs around the World: History, Rationale, Status, and Reforms. Hirschegg; Marseille; Pretoria; Washington:
The World Bank; IZA, 2011, p. 16
35
   See also: Knežević, Nikola, Božina, Anja. Prestanak ugovora o radu (Termination of the Employment Contract), in:
Božina, Anja et al.Radni odnosi - Primjena Zakona o radu: RRiF plus d.o.o., 2010, p. 503-513

                                                                                                                    13
These two variables can sometimes be included or used in a way that – depending on the age and
the duration of employment, the variable of the amount of salary of a concrete worker is corrected,
most often entitling older workers or those who have worked longer for that employer to increased
amounts.36

Almost as a rule, the severance pay is paid as one-off amount, in full, although there is the
possibility to pay it in monthly installments. The latter would primarily be possible in those states,
where severance pay displays strong features of a social system of (public) savings funds or where
it has a prominent social protection function. Also, severance pay is paid after a case occurs, which
is an individual concretization of the legal basis for the payment of severance pay, whereas in
systems, which display more features of a social system of (public) savings funds, the funds can be
withdrawn from the individual accounts at the termination of employment, or this withdrawal of
funds may be postponed until the point of leaving the labor market, that is until retirement, after
which it is paid in monthly installments, serving basically as another pension insurance pillar.


1.6 Financing severance pay
Payment of severance pay may be financed:
(a) internally, or
(b) externally.

Internal financing is possible from the operating revenues of the employer at the time of payment,
and it is possible to make a provision for severance pay in the accounting. External financing
means that there are individual savings accounts for any individual worker in either public or
private funds to which contributions are paid, i.e. it is possible to finance them from general
centralized, mostly state funds to which the severance pay contributions were paid.

In practice, in most states severance pays are financed from the employers' operating revenues.


1.7 Taxation of severance pay

An important element in considering severance pay is also the issue of severance pay taxation.
Severance pay may be covered by various taxation regimes. It can be:
(a) tax privileged in a way that it is (a1) tax exempt; or (a2) that tax deductions, reliefs or
     incentives apply; or
(b) taxed as salaries or income.



36
  Also, the way of terminating employment contracts, differences between groups of workers with a single employer,
e.g. administrative workers or what is usually called “white collar workers”, as opposed to manual or “blue collar”
workers, or differentiations between open-ended and fixed-term employment contracts, as well as the differences
between workers covered by collective agreements and those who are not covered by collective bargaining, all this
may be the basis for differentiation. Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan).
Washington: The International Bank for Reconstruction and Development; The World Bank, 2012, p. 24

                                                                                                                14
It ought to be mentioned here that any differential tax procedure and treatment in comparison with
the salaries or income is actually an incentive for tax evasion and for using some concrete special
tax status.


2 Statutory regulation of the severance pay scheme in the
Republic of Croatia
On 4th December 2010, after long-term preparations and exhausting attempts to harmonize the
positions of social partners, the Croatian Parliament enacted the Labor Act, which was published in
the Official Gazette 149/09 of 15 December 2009, and which became the new source of labor law
regulations in the Republic of Croatia. With the entry into force of this Act, on 1 st January 2010,
the old law, which had been adopted on 17th May 1995 and published in the Official Gazette 38/95
of 8th June 1995, ceased being effective after fourteen years of application. The old Labor Act,
which came into force on 1st January 1996, was one of the more “longevous” Croatian acts, which
from today’s perspective, and despite several amendments, although not amendments of structural
type,37 can be said to have corresponded to the need of setting up modern interest-balanced labor
legislation both from the point of view of its contents, and its methodology, and provided the
general legal framework and regulated obligations in the individual and collective labor relations,
but also specific institutional structures, which are inherent to the social-market economy of the so
called Rhine model, which is something that the Republic of Croatia as a social state is aspiring to
achieve. The very fact that it was balanced, and particularly in view of the fact that this law was
the basic source of all labor law contracts, it has had a strong influence on the economy and social
reality in the Republic of Croatia.

Later on, the Labor Act38 was amended on several occasions, in a relatively short period of time.
Thus in 2011, the Amending Act to the Labor Act39 only managed to “correct” some of the
identified deficiencies with respect to regulating individual employments to a smaller extent. After
that, the Act on the Criteria to Participate in Tripartite Bodies and Representation for Collective
Bargaining40 made some changes with respect to regulating collective employment relations, and
primarily collective bargaining and collective agreements, by applying direct and indirect
derogations from the provisions of the Labor Act. Finally, the Amending Act to the Labor Act 41 of
June 2013 changed the contents of the Labor Act into what we have today.

The Labor Act of 2009 is really an iteration, only partially reshaped contents of the normative
solution from the 1995 Labor Act, with all the amendments made until the date of adopting the

37
   The Labor Act (Official Gazette 38/95); Correction to the Labor Act (Official Gazette 65/95); Amending Act to the
Labor Act (Official Gazette 17/01); Amending Act to the Labor Act (Official Gazette 82/01); Amending Act to the
Labor Act (Official Gazette 114/03); Correction to the Amending Act to the Labor Act (Official Gazette 142/03); and
the Decision of the Constitutional Court of the Republic of Croatia No. U-I-2766/2003, U-I-469/2004, U-I-1607/2004,
U-I-4768/2004, U-I-4513/2004 of 24th May 2005 (Official Gazette 68/05).
38
   Labor Act (Official Gazette 149/09).
39
   Amending Act to the Labor Act (Official Gazette 61/11).
40
   Act on the Criteria to Participate in Tripartite Bodies and Representation for Collective Bargaining (Official Gazette
82/12 and 88/12-correction).
41
   Amending Act to the Labor Act (Official Gazette 73/13).

                                                                                                                     15
new act, and the only additional contents stipulated in the negotiated Chapter 19 “Social Policy and
Employment”, that is the EU acquis in the field covered by labor legislation, as a necessary
prerequisite to achieve complete harmonization of the national labor legislation with the legislation
of the European Union. This also concerns the severance pay scheme in the Republic of Croatia.
From the legislative perspective, it is regulated by the provisions of the Labor Act. This means that
the current regulations actually date back to 2003, and the amendments adopted then, whereas
there are also connections to the original Labor Act of 1995.

2.1 The legislative history of the contemporary severance pay
regulations in the Republic of Croatia

The Labor Act of 1995 regulated severance pay in two provisions of Article 118. The right to
severance pay belonged to workers, then employees, who were parties to an employment contract
concluded for an indefinite period, where the employer terminated that contract after two years of
uninterrupted work, in every case of termination of an employment contract, except if it was
terminated for reasons caused by the employee's own conduct. Severance pay was regulated in
relation to the length of the previous uninterrupted length of the employment relationship with that
employer, and it was not permitted to agree, or establish it in an amount less than one half of an
average monthly salary, paid to the worker in the period of three months preceding the termination
of the employment contract, for each complete year of work with that employer.

In the Act on Amendments and Supplements to the Labor Act of 2001, according to the provisions
of Article 42, in addition to Article 118 paragraph 3, salaries paid on the basis of a management
contract cannot be taken as the base for definition of severance pay. The sense of this provision
has never been comprehensible and it leaves room for unequal interpretation of its content, so that
already in the next Act on Amendments and Supplements to the Labor Act, it was repealed.
Therefore, by this improvement, the Act on Amendments and Supplements to the Labor Act of
2003, the regulation of the severance pay scheme became what it is today. Along with repealing
the provisions on the base for determination of severance pay from a management contract, the key
amendments were that it was established in a completely straightforward and unambiguous manner
that the amount of severance pay is established from the worker’s gross salary42. At that time, the
link between the right to severance pay exclusively with the termination of an employment
contract for an indefinite period of time, was repealed, whereby the possibility was opened of
payment of severance pay upon termination of any employment contract, even a temporary one, of
course, under the condition that it had lasted uninterrupted for at least two years. By the same act,
the amount of the statutory minimum severance pay was redefined in that it could not be agreed or
set in an amount less than one third of the average monthly salary earned by the worker in the three
months before the termination of the employment contract, for each complete year of work with
that employer. The maximum was six average monthly salaries, which the worker earned in the
three months before the termination of the employment contract, if by a law, a collective



42
  This follows from the provisions of Article 83, paragraph 5, of the Labor Act added at that time: "Salary within the
meaning of this Act is the gross amount of the salary." This is now Article 84, paragraph of the Labor Act. "Salaries
and remuneration within the meaning of this Act are salaries and remuneration in the gross amount."

                                                                                                                   16
agreement, labor regulations or an employment contract it was not prescribed or prescribed or
regulated differently.

As has been said, when the Labor Act was passed in 2009, and the later relevant amendments and
supplements to the Labor Act, the legal regulation of the right to severance pay did not change.


2.2. Regulation of severance pay in the provisions of the Labor Act

The severance pay scheme, the right to severance pay and severance pay itself are regulated in the
Labor Act in Title XIV: "Termination of Employment Contracts" in the provisions of three
paragraphs of Article 119: "Severance Pay".

The first paragraph of Article 119 of the Labor Act prescribes the payment of severance pay to a
worker who is given notice by his employer after two years of uninterrupted work, unless the
employment contract is terminated for reasons caused by the worker's own conduct. So, the right to
severance pay belongs to workers who fulfill the prerequisite of two-year uninterrupted
employment, provided that their employment contract is terminated due to personal or business
reasons, but workers whose employment contract is terminated due to their own wrong conduct do
not have that right, and neither do workers, who by their own conduct, have committed a grave
violation of their obligations from their employment, and their employment contract has been
terminated as a result. Also, the workers whose employment contracts are terminated by a judicial
decision do not have this entitlement.43 As an argumento a contrario to the latter, the right to
severance pay would also belong to a worker whose employment contract has been terminated by
the employer due to: "some other especially important factors", when even "with respect for all the
circumstances and interests of both contracting parties, the continuation of the employment is not
possible". That is to say, when it is a case of circumstances outside the influence of the worker or
his responsibility, the right to severance pay is not excluded.

From the statutory regulation of the entitlement to severance pay, persons from the provision of
Article 2 paragraph 3 of the Labor Act are excluded. Namely, a natural person who is a

43
   In the case of judicial termination of an employment contract, the worker does not have the right to severance pay.
In the case of judicial termination of a worker's employment contract, instead of severance pay, the worker has the
right to compensation, in the amount of three to eighteen average monthly salaries, depending on the duration of the
worker’s employment relationship, age and number of dependants, but practically the courts could also consider, as an
additional criterion, the amount of the severance pay which the worker would have been entitled to, if the employer
had terminated his employment contract lawfully. Here, it is necessary to refer to the Decision of the Supreme Court of
the Republic of Croatia, nr. Revr-287/13 of 17 April 2013, and the Decision of the County Court in Zagreb no. Gžr -
1752/12 of 13 November 2012 and the Decision of the Municipal Labor Court in Zagreb no. Pr-1613/12 of 13 July
2013. In these decisions, the legal issue of whether a person is entitled to severance pay based on the termination of the
employment contract by a court decision, is answered affirmatively. However, in order to avoid any confusion, these
judicial decisions do not refer to all cases of judicial termination of employment contracts, but only to cases where
workers would be entitled to severance pay based on some autonomous source of law – here the collective agreement,
or in other cases prescribed by the Labor Act, so in the specific case also in case of judicial termination of the
employment contract, given that the right to severance pay from the collective agreement did not exclude judicial
termination. Per analogiam this relates also to the entitlement to severance pay in case of consensual termination of
the employment contract, if the ex lege conditions of age and years of service etc. are fulfilled.

                                                                                                                      17
Management Board member, a CEO or who performs any other office in accordance with a special
law, and who is individually and independently or jointly and severally authorized to conduct work
of the employer, may – but need not – perform this work for the employer as an employed worker,
and even if that person does perform these tasks as an employed worker, the provisions of the
Labor Act on the termination of employment contract do not apply, so that this person is not
entitled to severance pay.44 Consequently, for this category of workers – “managers” – the
entitlement to severance pay is a matter of their individual contracts, so that it is a part of the civil
obligations law.

Alongside establishing the reasons for termination of the employment contract, a requirement for
attaining the right to severance pay is also the previous uninterrupted duration of the specific
employment, for more than two years. This also determines the level or the amount of severance
pay, according to the length of the previous uninterrupted employment relationship. Article 119,
paragraph 2 of the Labor Act establishes the lowest amount of statutory severance pay, in that it
may not be agreed or set in an amount less than one third of the average monthly salary, which the
worker earned in the three months before the termination of the employment contract, for each
complete year of work with that employer.45 So, the lowest amount of severance pay according to
the Labor Act is calculated as one third of the worker's average monthly salary earned in the last
three months before the termination, and the number of complete years of uninterrupted pension
qualifying period served the worker with the specific employer.

Apart from establishing the lowest amount of severance pay, the Labor Act also establishes the
highest amount of severance pay. That is to say, if severance pay is only established on the basis
of the legal provisions, it may not be in an amount greater than six average monthly salaries which
the worker earned in the three months before the termination of the employment contract. This
provision of Article 119, paragraph 3 of the Labor Act is only relatively cogent in nature, since it
prescribes that by some other law, collective agreement, labor ordinance or employment contract,
severance pay may also be established differently. In the latter case, the severance pay may be
agreed, or established, under more favorable terms in an amount higher than according to the law.
When the right to severance pay is agreed or established for someone who is retiring, than it is not
deemed to be a right from the Labor Act, but a right from a collective agreement, work regulations
or an employment contract, since for that case, the Labor Act does not prescribe the right to
severance pay.

The Labor Act, in the provisions of Article 80, establishes, as an exception and under certain
conditions, the right to severance pay of at least double the amount of severance pay they would
otherwise be entitled to for especially protected groups of workers who have suffered an
occupational injury or who are suffering from an occupational disease. These are workers who,
after they have completed treatment and convalescence, cannot return to work with their employer,
or they cannot be offered an employment contract for some other work, so their employment


44
   Please see: Crnić, Ivica. Otkaz ugovora o radu (Termination of the Employment Contract). Zagreb: Organizator,
2013, p. 215-216.
45
    According to the Opinion of the Ministry of Labour and Social Welfare, Class: 110-01/97-01/61, reg. no: 524-02-
97-2 of 14 March 1997, if a worker was not paid a salary for the last three months, then the level of his salary is
established on the basis of the salary of a worker doing the same work.

                                                                                                                18
contract will be terminated by regular or conditional notice, after proceedings have been
conducted. 46

The right to severance pay may also be established by a program to take care of excess workers.
These workers may be granted the right to severance pay under more favorable terms and in a
higher amount than the amount established by the provisions of Article 119 of the Labor Act. A
program of care for excess workers (redundancy) is adopted as a unilateral act by the employer,
but workers’ representatives may take part in its adoption, so this program may also take the form
of a collective agreement or an agreement between the employer and the workers' council.

The employer's decision to terminate an employment contract may, but does not have to, establish
the right to severance pay or establish the amount of severance pay. 47 The obligation to pay
severance pay is due on the last day of the employment relationship. The fact that a worker would
stop work, at the request of or by a decision of his employer, before the expiry of the statutory or
agreed date of notice, does not affect the existence of the right to severance pay, and also when for
attaining or establishing the amount of severance pay the duration of the period of the previous
employment is important, that period also includes the period of notice, and the salaries earned
during the notice period.

The entitlement to severance pay is due on the day of termination of the employment contracts or
the employment, and in case when there is an entitlement to severance pay, this is most often the
date of expiration of the period of notice, unless the parties have agreed some other later due
date.48 This is also the relevant date for the expiry of the statute of limitations on the employer’s
obligation to pay severance pay to the worker, which is three years.

In relation to the earlier regulation of the right to severance pay, some questions and lack of clarity
have arisen in practice.

For instance the question arises of the right to severance pay with the use of the institution of
notice and an offer of an amended employment contract, or when workers who refuse to accept the
employer's offer for an amended employment contract, "accept" the termination of their
employment contract. This is a case of an attempt to amend the employment contract at the
proposal of the employer as a contracting party, and if this amendment is unacceptable for the
worker as the other party, then the possibility arises for the employer to terminate the employment
contract. Here the worker is protected in almost the identical way as in the case when notice is
given without offering to conclude an amended employment contract. Therefore, and due to the
express legal provisions about who has the right to severance pay, a worker, whose employment
contract is terminated because he refused an offer of an amended employment contract, also has
the right to severance pay. In the same way, if the worker accepts the offer of the amended
employment contract, he will not have the right to severance pay, because then the employment
contract is not terminated.

46
   See also: Crnić, Ivica. Otkaz ugovora o radu (Termination of the Employment Contract). Zagreb: Organizator, 2013,
p. 214-215.
47
   Please see: Decision by the Supreme Court of the Republic of Croatia, no. Rev-1368/01 of 23 October 2001.
48
   Please see: Legal understanding adopted at the fifth session of the Civil Division of the Supreme Court of the
Republic of Croatia (V/07) no. Su-IV 46/07 of 28 May 2007.

                                                                                                                 19
Further, even in the case when the employer’s business is undergoing reorganization, where the
existing employment contract is terminated by agreement between the worker and the employer,
and at the same time the worker concludes an employment contract with another employer, the
question arises of the existence of the right to severance pay. However, due to the fact that the
employment contract is not actually terminated, the worker does not have the right to severance
pay. Thereby, in our opinion, the general question of the right to severance pay is answered - the
right follows termination of an employment contract for reasons not caused by the worker's own
conduct, but it is also necessary for the employment relationship of the worker with a specific
employer effectively to end. In this sense, a worker will not have the right to severance pay if the
company or part of the company is transferred to a new employer, business operation or part of
another business operation, since in that case the existing employment relationship is also
transferred to the new employer, with unaltered content, and the employment relationship
continues, that is, it does not end.

It also needs to be mentioned that outside of the scope of the severance pay regulated by the Labor
Act, there is another severance pay sui generis in the Republic of Croatia.49 It is something that is
identified as “purchase of supplementary pension benefits”, in the form of severance pay, which is
paid in installments for life, through which the employer “indemnifies” workers who opted for
early retirement and compensates them for the amount, which is equal to difference of their
pension benefit based on early retirement and what would have been their full retirement benefit.
This role of this instrument is thus to ensure social security, because the pensioner, previously the
worker, receives the severance pay in installments together with the pension, each month for life,
and it is precisely calculated, equaling the amount of his early retirement “penalization”. This is a
form of reward to the worker, and it is an important message to new, young generations of how the
oldest workers should be treated and how to protect their dignity, and from the social and financial
standpoint it is more favorable than payment of one-off severance pay.50 The nature and the
characteristics of this type of severance pay are such that it won’t be elaborated further in this text,
but it can certainly represent one form of thinking about various functions of the severance pay
scheme in the Republic of Croatia.


2.3 Regulation of severance pay in collective agreements and work
regulations

We do not have any knowledge of any analysis of the regulation of the right to severance pay in
collective agreements, or alternatively in work regulations in the Republic of Croatia. In that sense
it is only possible to mention in passing here the possibility of a definition in more detail of the
right to severance pay, which we expect will be used in collective agreements.



49
   Please see: Opinion of the Ministry of Economy, Labor and Entrepreneurship, Class: 140-01/10-01/156 filing
number: 526-08-01/1-10-2, of 16. December 2009.
50
   Also see: Bulaš, Ivo. Dokup mirovine – vrsta otpremnine (Purchase of Supplementary Pension Benefits – a Type of
Severance Pay). Radno pravo – journal, 8, 2013., 4., p. 44-52.

                                                                                                               20
Article 119, paragraph 3 of the Labor Act allows severance pay to be regulated differently by
another act, collective agreement, work regulation or employment contract, in an amount higher
than that in the Labor Act. Here lies the authority for bilateral agreements based on free will of
both parties, on severance pay through collective agreements, or for voluntary unilateral regulation
by the employer, but only in a way that is more favorable for the worker, that is in a higher amount
than the regulations in the Labor Act.51 At the mention of free will, it also has to be mentioned that
in case an agreement about the termination of the employment contract is reached between the
worker and the employer, or per analogiam even in cases of employment terminations where there
is no obligation to pay severance pay, the employer may independently introduce a right to
severance pay, and it can even exceed the mandatory amount.52

So for example, in the Basic Collective Agreement for Civil Servants and Employees in Public
Services 53 the right to severance pay is regulated in the provisions of Article 47, paragraphs 2 to 5.
Every "employee" in public services, "civil servant" and "employee" who is given notice by the
employer, and the reason for notice is not the conduct of the employee, has the right to severance
pay pursuant to the Labor Act. Article 47, paragraph 3 of the Basic Collective Agreement for Civil
Servants and Employees in Public Services prescribes exceptions to the general regulation of the
right to severance pay in the public services, in that an "employee" with thirty years or more of
pension qualifying period with the same employer, is paid a privileged severance pay in the
amount of at least sixty per cent of the average gross monthly salary paid to the employee in the
three months before the termination of the employment contract, for each complete year of work.
Here, the pension qualifying period with the same employer, pursuant to the provisions of Article
49 of the Basic Collective Agreement for Civil Servants and Employees in Public Services, is
counted as uninterrupted work in public services, regardless of a change in employer.54

Therefore, in public services the pension qualifying period with an employer is taken to be
uninterrupted work in public services, regardless of a change of employer, which makes it possible
to accumulate pension qualifying period realized with different employers or institutions in the
same or different public services. Regarding the level of severance pay, for a person who has
thirty or more years of pension qualifying period in the public services with the same employer,
payment is prescribed of a privileged severance pay, in the amount of no less than sixty per cent of
the average gross salary, paid to the employee in the three months before the termination of the
employment contract, for each complete year of pension qualifying period. 55 Thereby in these two
elements the right to severance pay in the public services has been "enhanced".56


51
   Also see: Decision of the Supreme Court of the Republic of Croatia, nr. Gzz-110/03 of 17 September 2003.
52
    Please see: Decision of the Supreme Court of the Republic of Croatia, nr. Revr-536/07 of 23 December 2008;
Decision of the Supreme Court of the Republic of Croatia, nr. Gzz-110/03 of 17 September 2003.
53
   The Basic Collective Agreement for Civil Servants and Employees in Public Services (Official Gazette 141/12)
54
   The exception to this is in the calculation of severance pay of "employees" who, during their work in public services
and upon the termination of their employment relationship, have already realized the right to severance pay, since in
that case the uninterrupted pension qualifying period will not include the period for which severance pay has already
been realized. The vagueness of the general meaning of this provision, and the possibility of working for several
employers part time at the same time, indicate the questionable implementation of this limitation in the application of
the calculation of the total pension qualifying period in public services as the pension qualifying period with a single
employer.
55
    Pursuant to Article 47, paragraph 5 of the Basic Collective Agreement for Civil Servants and Employees in Public
Services severance pay is due and paid no later than 30 days from the end of the employment relationship. The same

                                                                                                                    21
Alongside this severance pay, which in a regulatory sense is equivalent to severance pay from the
Labor Act, Article 61 of the Basic Collective Agreement for Civil Servants and Employees in
Public Services also regulates severance pay upon retirement, whereby an "employee" in public
services, who is retiring, is entitled to the right to severance pay of three bases for calculation.

From a review of other collective agreements in the Republic of Croatia, primarily those in state
and public services, and those with employers in "majority ownership of the Republic of Croatia",
it may be established that the question of the right to severance pay is regulated in them in many
different ways, or in relation to many different factors.

In some collective agreements the amount or level of severance pay is determined in that the
number of years of pension qualifying period with an employer determines an amount of severance
pay higher than in the Labor Act - one third of the average monthly salary which the worker earned
in the three months before the termination of the employment contract - whether as a percentage or
a proportion of the average salary, or as an absolute number, in cash.

Also, the highest amount of severance pay is established differently in some collective agreements,
as a higher amount, whether by setting a higher number of monthly salaries for that amount, in
comparison to the six average monthly salaries from the Labor Act, or by setting the highest
amount of severance pay as an absolute amount.

It may also be established that for some categories of workers, older workers or workers with more
pension qualifying period with an employer, incentives are sometimes prescribed in the formula
for calculation of severance pay, so that the severance pay is increased by those sums. Also, in
some collective agreements, the elements of the formula for calculation of severance pay differ
between workers who do different jobs.

Already in the presentation of the possibility of different ways of regulating the right to severance
pay in collective agreements, or alternatively in work regulations, it was noticed in a review of
collective agreements and work regulations in the Republic of Croatia, which, since there has been
no more detailed or systematic analysis of the regulation of the right to severance pay, is
practically the only way to encompass this subject matter, that in this country various corrective
elements have been introduced in many different ways, which have acted to increase the amount of
severance pay, for all or some workers.

It is also necessary to mention that since it is possible to regulate the right to severance pay
differently in both collective agreements and work regulations, under more favorable terms or in


Article 47, paragraph 4 of the Basic Collective Agreement for Civil Servants and Employees in Public Services states
that if the "employee" has not been paid a salary in the last three months before the termination of the employment
contract, but rather remuneration pursuant to separate regulations, or part was paid as a salary and part as
remuneration, pursuant to separate regulations, then for calculation of the severance pay to which he is entitled, the
salary will be taken which would have been paid if that person had worked full time.
56
   Pursuant to the provisions of Article 48 of the Basic Collective Agreement for Civil Servants and Employees in
Public Services, the provisions of Article 47 on severance pay do not relate to the heads of institutions in the system of
public services.

                                                                                                                      22
higher amounts than in the Labor Act, there are still certain differences between the possibilities of
these two choices, although everything that has been said here regarding collective agreements is
also applicable to the regulation of the right to severance pay in work regulations, still the key fact
is that the extent of the regulation by work regulations is must smaller, due to the fact that these are
unilateral (self) regulations by the employer, who in their work regulations most often merely
repeat the regulations from the Labor Act, with only minimal alterations. An exception may be
mentioned here in relation to reconstruction by employers, whereby employers sometimes,
unilaterally and voluntarily, raise the amount of severance pay, according to the years of pension
qualifying period with that employer, to motivate workers to "accept" termination of their
employment contract57, or to accept an offer to conclude an agreement on termination of the
employment contract.


2.4. The status of severance pay in the provisions of tax regulations

The Labor Act contains cogent provisions on severance pay, which guarantee the lowest level of
rights regarding severance pay. Tax regulations deal with the status of severance pay regarding the
part that is taxable and the part which is non-taxable.

The non-taxable amount of severance pay which an employee may pay his workers, and the
requirements for payment of a certain amount of non-taxable income, are prescribed by the
provisions of Article 13, paragraphs 1 and 2 of the Ordinance on Income Tax58, and in the light of
the provisions of Article 14, paragraph 1, point 1, subsection 1.2 of the Act on Income Tax 59. If the
requirements are not met for payment of the non-taxable part of severance pay, the entire amount
paid, for tax purposes, is deemed to be salary and is subject to tax, surtax and insurance
contributions. Also, in the amount above the non-taxable amount, the difference above the non-
taxable amount is equivalent to payment of a salary for tax purposes.

Therefore, pursuant to the provisions of Article 13, paragraph 2, point 21 of the Ordinance on
Income Tax, severance pay for termination of an employment contract for business or personal
reasons, as established by the Labor Act, is not subject to tax up to HRK 6,400.00 for each
complete year of work with the employer. In the same way, severance pay is also not subject to
tax paid that follows the termination of an employment contract due to an occupational injury or
disease, up to the amount of HRK 8,000.00 for each complete year of work with the employer.
The tax regulations also deem work with the same employer to be a period of work with a previous
employer, if, pursuant to the provisions of the Labor Act, the workers’ employment contracts were
transferred to the new employer for work in a company or part of a company, which by change of



57
   The termination of an employment contract is a case of a unilateral form of termination of an employment contract,
and in that sense, the worker's acceptance is not legally either necessary or relevant, but in fact it may be relevant in
that it means that the worker himself does not dispute the termination of employment contract, whether with the
employer or in court.
58
    Ordinance on Income Tax (Official Gazette 95/05, 96/06, 68/07, 146/08, 2/09, 9/09 - correction, 146/09, 123/10,
137/11, 61/12 and 79/13).
59
   Act on Income Tax (Official Gazette177/04, 73/08, 80/10, 114/11, 22/12 and 144/12).

                                                                                                                     23
status or legal transfer was transferred to a new employer. These provisions are also applied
mutatis mutandis to institutions and other legal persons.

There are several open questions in this form of regulation. First of all, the terminology of the
provisions of the Ordinance on Income Tax is not quite clear. That is to say, it states: "severance
pay due to termination for business or personal reasons according to the Labor Act", whereby it is
not completely clear whether this means that severance pay following termination of an
employment contract for business or personal reasons, is non-taxable pursuant to the Labor Act,
which is well known, or it means that severance pay is non-taxable if it is given according to the
parameters and calculation formulas from the Labor Act, or that any severance pay is non-taxable
that is given whether it is according to the parameters and calculations formulas in the Labor Act,
or according to some other parameters from another law, collective agreement, work regulation or
employment contract, which pursuant to the provisions of Article 119, paragraph 3 of the Labor
Act, regulate severance pay differently, under more favorable terms or in a higher amount than
under the Labor Act. The fact that the tax regulations do not limit the highest amount of the non-
taxable part of severance pay does not help here.60

Also in relation to establishing the amount of severance pay, it is not completely clear if severance
pay established in an amount higher than the non-taxable amount belongs to the worker as a net
sum or if it is a gross sum, from which contributions from the salary and income tax need to be
deducted. Since the latter is a significant expense, the parties to this agreement (the employers, the
unions and the workers) and decision making (the employers) should prevent disputes over this
through ensuring clarity in the content of regulations stating the amount of severance pay and the
extent of the obligation to bear all further burdens.

The provisions of Article 13, paragraph 2, point 20 of the Ordinance on Income Tax also treat as
non-taxable severance pay given on retirement up to the amount of HRK 8,000.00.

Given that the statutory regulations on severance pay indirectly exclude natural persons who are
Management Board members, CEOs or who perform any other office in accordance with a special
law, and who are individually and independently or jointly and severally authorized to conduct
work of the employer61, who – even if they perform this work as employed workers, are excluded
from the provisions of the Labor Act regulating employment termination and even if such persons
perform these tasks as employed workers, the provisions of the Labor Act on the termination of


60
   It has to be pointed out here that the justice and social justification are questionable of the interpretation of these
provisions, where any severance pay would be non-taxable, which is given either according to the parameters and
calculation formula from the Labor Act, or according to some other parameters from another law, collective
agreement, work regulation or employment contract, which pursuant to the provisions of Article 119, paragraph 3 of
the Labor Act, regulate severance pay differently, under more favorable terms or in a higher amount than under the
Labor Act. That is to say, it is doubtful whether the employer should be permitted to pay out severance pay on the
basis of an agreement or a unilateral decision, that is non-taxable and not burdened by insurance contributions, and in
that way more acceptable and more favorable to him, and for it to be an incentive to evade paying tax and to use some
other specific special tax status as opposed to a salary. Thereby it also stands in contrast to the Constitutional principle
of participating in the defrayment of public expenses, in accordance with one's economic possibilities.
61
   Based on the provisions of Article 2 paragraph 3 of the Labor Act these persons may – but need not – perform these
tasks for the employer as employed workers, but even if they perform they work as employed workers, the provisions
on the termination of employment and provisions on severance pay from the Labor Act do not apply to them.

                                                                                                                        24
employment contract do not apply to them, including the provisions on severance pay, so that these
persons, even if they have some civil-law agreement on severance pay, will be excluded from the
privilege of non-taxable amounts of severance pay from the Ordinance on Income Tax, which
means that the full amount of their severance pay will be taxable.



3. The economic characteristics of the severance pay scheme
in the Republic of Croatia
Regarding the severance pay scheme in the Republic of Croatia, we can differentiate three
segments of the labor market. The first segment relates to workers in the public sector, who are
mostly covered by collective agreements which offer more than generous severance pay. Within
that system, a large amount of manipulation has been noticed62.

The second segment relates to workers of employers that are bankrupt, who receive part of their
payment of severance pay, in the amount of half the sum established by the Labor Act, through the
Agency for Insurance of Workers' Claims in the Case of the Bankruptcy of the Employer.63
However, they most often never receive the remaining amount of severance pay which they are
entitled to because the bankrupt employer rarely leaves sufficient funds in the bankruptcy estate to
settle those claims.

The third segment relates to workers in the private sector who are not entitled to severance pay,
whether because the employers do not respect their obligations established by law, or because the
employers try to manipulate the way they terminate their workers' employment contracts. In view
of the fact that the right to severance pay is only realized in the case of the termination of an
employment contract by the employer, the employer either makes them conclude a temporary
employment contract, or he terminates employment contracts before the right to severance pay is
attained after two years of an uninterrupted employment relationship with the employer, or, in the
case of a long-term contract, the employment contract is not terminated, thereby reducing labor
mobility. Therefore, from this it is clear that a problem that occurs in practice in the Republic of
Croatia is that workers in the private sector most often do not realize the right to severance pay, the
severance pay to which they are entitled is not paid or that payment is made difficult or reduced.

It must be pointed out here that there is no centralized data base recording claims on the basis of
the right to severance pay, or which records severance pay paid out in the public and private
sectors. The Agency for Insurance of Workers' Claims in the Case of the Bankruptcy of the
Employer is an exception to this, in view of the fact that it is possible to monitor the results of its
work analytically. Therefore it is only possible to reach any conclusions on the basis of data from

62
   These manipulations range from introducing instruments, which greatly differ from the purpose of the law and the
regulations on severance pay to plain illegal conduct, either in the form of distorting facts, on the basis of which the
severance pay is calculated or in the form of introducing fake reasons or fake dismissals with the aim of paying
severance pay, which would otherwise not be due, or to increase its amount or to abuse the non-taxable amount of
severance pay.
63
   According to Article 3 of the Act on Insurance of Workers' Claims in the Case of the Bankruptcy of the Employer
(Official Gazette 86/08 and 80/13).

                                                                                                                    25
several sources and by establishing presumptions based on an estimate of employment and labor
mobility. In any case, it may be said that the burden of implementing the current system is to a
large extent borne by the State Budget of the Republic of Croatia, and workers, who are denied
their statutory rights.

In view of this, it may be said that the existing mechanism of payment of severance pay is
inappropriate, that is, that there are practical hindrances to realization of the statutory aims and
parameters of the severance pay scheme, which indicate the importance of removing or improving
these weaknesses, whether through the partial or complete reform of the system. Here, the aims of
the reform would be:
(a) a reduction in the burden of payment of severance pay on the employers
(b) ensuring payment of severance pay to workers to provide income during a period of
      unemployment
(c) increased labor force mobility; and
(d) a reduction in the burden on the State Budget of the Republic of Croatia.


3.1 The characteristics of the Croatian severance pay scheme

The system of regulation of the Croatian national severance pay scheme is described here.
Severance pay, as regulated by the Labor Act, if the worker has been in an uninterrupted
employment relationship with the same employer for longer than two years, is calculated as the
amount of one third of the salary for each complete year of employment with that employer, and
no more than six salaries, but may also be regulated more favorably by a collective agreement,
work regulation or an individual employment contract. Mainly these more favorable amounts
relate to workers in the public sector.

Regarding the criterion of the reason for the termination of the employment contract, in practice
the following types of severance pay are paid out:
(a) severance pay for termination of an employment contract for business or personal reasons
(b) severance pay for the uncontested termination of an employment relationship
(c) incentive severance pay, which is paid on the basis of the termination of an employment
      contract for business reasons, or the uncontested termination of an employment contract, and
(d) severance pay upon retirement.

It is important to differentiate three sectors in the analysis of the scheme. The first relates to the
public sector, which is well protected by collective agreements and where severance pay is
generous. Then there is the system of insurance of protection of claims by workers in the case of
bankruptcy, conducted by the Agency for Insurance of Workers' Claims in the Case of the
Bankruptcy of the Employer. The third part is the most comprehensive, relating to workers in the
private sector, whose rights to severance pay are regulated by the general provisions of the Labor
Act, or individual collective agreements for each branch. This part of the system is least
transparent and reform is possible, precisely aimed at resolving the problems involved in insurance
of protection of payment of severance pay to workers in this sector. Unfortunately, although the
statutory requirements exist for creation of a centralized data base, to provide an insight into the
status of claims on the basis of the right to payment of severance pay and severance pay paid out,

                                                                                                   26
this base does not exist. Data exist on the amount of severance pay paid out in the public sector
and these same data within the Agency for Insurance of Workers' Claims in the Case of the
Bankruptcy of the Employer.

Although there is no centralized data base, it should be pointed out that, in the existing regulatory
and institutional framework, all the requirements exist for registering claims and payments on the
basis of the right to severance pay. That is to say, pursuant to the Labor Act, in the provisions of
Article 85, an employer who does not pay a salary, remuneration or severance pay on the day they
are due, or does not pay them in full, is obliged to send the worker a calculation of the sum he is
obliged to pay by the end of the month in which the salary, remuneration or severance pay is due
(the calculation is an enforcement document). Therefore, on the basis of the documentation sent
by workers who have not been paid severance pay, the tax administration would be able to keep
complete records of the status of claims of workers on the basis of payment of severance pay.
Currently only severance pay that has been paid through an OTP form is recorded, which the
employer sends to the tax administration when paying the severance pay.64


3.1.1. Payment of severance pay in the public sector

Regarding the public sector, a detailed review of the question of payment of severance pay and the
important elements of the position of income on the basis of the right to severance pay within the
tax system has been provided by Marija Zuber65. As has been said, the rights of workers within the
public sector are protected by collective agreements and they are in a significantly better position
than the private sector.

Tables 1 and 2 show the values of severance pay paid for budget beneficiaries in central
government since 2009. It may be seen that the amount of severance pay paid fell significantly
from 2009, and stabilized at the level of about 60.0 million HRK a year. The highest amounts of
severance pay paid relate to the Ministry of Defense, the Ministry of Education, Science and Sport,
and the Ministry of the Interior.




64
   Pursuant to the provisions of the Ordinance on the Content of Calculation of Salaries, Remuneration or Severance
Pay (Official Gazette 81/10).
65
   Please see: Zuber, Marija. Otpremnine – pravoradnika i poreznoodređenje. (Severance pay- workers' rights and tax
definition) Zagreb: Računovodstvo i financije, 2012, pp. 100 -106.


                                                                                                                27
Table 1: Severance pay paid on the level of central government from 2012 to June 2013 (in million
HRK)

                                                                   2012              2013
                          TOTAL                                    63,17             29,64
                CROATIAN PARLIAMENT                                 0,07              0,00
  OFFICE OF THE PRESIDENT OF THE REPUBLIC OF
                         CROATIA                                    0,04              0,00
   GOVERNMENT OF THE REPUBLIC OF CROATIA                            0,11              0,02
                 MINISTRY OF FINANCE                                1,29              0,65
                 MINISTRY OF DEFENSE                               20,23              5,67
STATE OFFICE FOR CROATS LIVING OUTSIDE OF THE
                 REPUBLIC OF CROATIA                                0,01              0,04
                 MINISTRY OF INTERIOR                               3,61              7,28
            MINISTRY OF WAR VETERANS                                0,09              0,02
  MINISTRY OF FOREIGN AND EUROPEAN AFFAIRS                          0,15              0,16
                MINISTRY OF ECONOMY                                 0,14              0,03
  MINISTRY OF ENTREPRENEURSHIP AND CRAFTS                           0,19              0,04
                 MINISTRY OF CULTURE                                0,31              0,28
             MINISTRY OF AGRICULTURE                                0,25              0,23
  MINISTRY OF REGIONAL DEVELOPMENT AND EU
                          FUNDS                                     0,14              0,03
MINISTRY OF MARITIME AFFAIRS, TRANSPORT AND
                    INFRASTRUCTURE                                  0,24              0,18
    MINISTRY OF CONSTRUCTION AND SPATIAL
                        PLANNING                                    0,39              0,22
   MINISTRY OF ENVIRONMENTAL AND NATURE
                       PROTECTION                                   0,12              0,09
  MINISTRY OF SCIENCE, EDUCATION AND SPORTS                        26,14              6,87
    MINISTRY OF LABOR AND PENSION SYSTEM                            1,59              0,57
                 MINISTRY OF TOURISM                                0,00              0,01
       MINISTRY OF PUBLIC ADMINISTRATION                            0,71              0,56
                  MINISTRY OF HEALTH                                0,91              0,58
     MINISTRY OF SOCIAL POLICY AND YOUTH                            1,51              0,71
    CROATIAN ACADEMY OF ARTS AND SCIENCE                            0,11              0,04
                  MINISTRY OF JUSTICE                               4,28              5,26
             OFFICE OF THE OMBUDSMAN                                0,00              0,01
          GENDER EQUALITY OMBUDSMAN                                 0,02              0,00
          CENTRAL BUREAU OF STATISTICS                              0,28              0,04
                  STATE AUDIT OFFICE                                0,08              0,00
                 STATE INSPECTORATE                                 0,17              0,03
Source: Ministry of Finance



                                                                                              28
Table 2: Severance pay paid on the level of central government from 2009 to 2011 (in million
HRK)
                                                                 2009     2010       2011
                           TOTAL                               245,01    128,27     67,84
                 CROATIAN PARLIAMENT                             0,02      0,11      0,11
    OFFICE OF THE PRESIDENT OF THE REPUBLIC OF
                         CROATIA                                 0,05      0,00      0,05
    CONSTITUTIONAL COURT OF THE REPUBLIC OF
                         CROATIA                                 0,00      0,00      0,01
            CROATIAN COMPETITION AGENCY                          0,00      0,02      0,00
     GOVERNMENT OF THE REPUBLIC OF CROATIA                       0,13      0,21      0,09
        CENTRAL STATE OFFICE FOR E-CROATIA                       0,00      0,01      0,00
  STATE PROPERTY MANAGEMENT ADMINISTRATION                       0,00      0,02      0,00
                  MINISTRY OF FINANCE                            1,10      1,52      1,17
                  MINISTRY OF DEFENSE                          179,49     43,68     21,38
                 MINISTRY OF INTERIOR                           10,69      9,59      6,88
      MINISTRY OF FAMILY, WAR VETERANS AND
           INTERGENERATIONAL SOLIDARITY                          0,12      0,05      0,00
   MINISTRY OF FOREIGN AFFAIRS AND EUROPEAN
                      INTEGRATION                                0,23      0,11      0,18
          MINISTRY OF ECONOMY, LABOR AND
                   ENTREPRENEURSHIP                              1,17      1,32      1,07
                 MINISTRY OF CULTURE                             0,20      0,30      0,33
 MINISTRY OF AGRICULTURE, FISHERIES AND RURAL
                      DEVELOPMENT                                0,08      0,54      0,22
 MINISTRY OF REGIONAL DEVELOPMENT, FORESTRY
               AND WATER MANAGEMENT                              0,06      0,03      0,08
  MINISTRY OF MARITIME AFFAIRS, TRANSPORT AND
                    INFRASTRUCTURE                               0,14      0,10      0,18
     MINISTRY OF ENVIRONMENTAL PROTECTION,
        SPATIAL PLANNING AND CONSTRUCTION                        0,47      0,57      0,34
   MINISTRY OF SCIENCE, EDUCATION AND SPORTS                    40,72     59,74     25,15
                  MINISTRY OF TOURISM                            0,02      0,00      0,00
         MINISTRY OF PUBLIC ADMINISTRATION                       0,63      0,82      0,55
     MINISTRY OF HEALTH AND SOCIAL WELFARE                       2,17      3,56      2,21
     CROATIAN ACADEMY OF ARTS AND SCIENCE                        0,06      0,06      0,05
                  MINISTRY OF JUSTICE                            6,90      5,35      7,18
              OFFICE OF THE OMBUDSMAN                            0,00      0,00      0,02
            GENDER EQUALITY OMBUDSMAN                            0,00      0,01      0,00
            CENTRAL BUREAU OF STATISTICS                         0,11      0,25      0,18
                   STATE AUDIT OFFICE                            0,00      0,00      0,05
                  STATE INSPECTORATE                             0,43      0,28      0,31
    COMMISSION FOR RELATIONS WITH RELIGIOUS
                      COMMUNITIES                                0,00      0,00      0,02

                                                                                         29
                        PERSONAL DATA PROTECTION AGENCY                                                                         0,00        0,01            0,00
                Source: Ministry of Finance

                Given that one third of all persons employed in the Croatian public sector are working in bodies of
                local and regional government and in public companies, it can be assumed that the amount of
                severance pay benefits is proportionate to the below mentioned number (Table 3).

                Table 3: Total number of persons employed in the Croatian public sector
                                                                                                                                                            Index
                                                                                                    2005        2006          2007         2008
                                                                                                                                                          2008/2006
                                Central state




                                                               Budgetary users
                                                 (public and state officials, civil servants and
                                                                                                    234,309      235,976      246,833        248,949             105.5
                                                                  employees)
                General state
PUBLIC SECTOR




                                                Extrabudgetary funds and users *                     10,731       10,930        3,961             1,510            13.8

                                                Local and regional level                                   nn     62,362       64,621         66,806             107.1

                                                Public companies                                           nn     68,438       68,845         70,957             103.7

                                                                                            Total          nn    377,706      384,310        388,222             102.8

                in % of the total number of persons employed in the Croatian public sector

                                                Budgetary users (civil servants and employees)              -          62.5      64.2              64.1            63.6
PUBLIC SECTOR




                                                                Extrabudgetary funds and users              -           2.9          1.0            0.4               1.4

                                                                        Local and regional level            -          16.5      16.8              17.2            16.8

                                                                           Public companies **              -          18.1      17.9              18.3            18.1

                                                                                            Total                  100.0        100.0             100.0          100.0

                Source: Institute of Public Finance

                However, the Republic of Croatia has a relatively significant number of persons employed in non-
                financial public companies, which are expected to be restructured in foreseeable future, which
                means a potentially higher number of severance pay claims. Also, workers employed at state
                companies are protected by collective agreements, so that the payments are significantly higher
                (Table 4). In addition, some claims can be expected within the process of planned privatization of
                financial public companies66. However, it is very likely that the financial burden of these claims
                will be compensated for within the privatization process, and that it won’t be financed from the
                state budget.

                Finally, it needs to be mentioned that most manipulations with severance pay were identified with
                employers in the public sector, regardless if they were public and state agencies or companies “in
                majority state ownership”, introducing elements, which ranged from significant divergence from



                66
                  Such as the Hrvatska poštanska banka d.d. (Croatian Post Bank) and Croatia osiguranje d.d. (state-owned insurance
                company).

                                                                                                                                                                   30
the purpose of the law and the regulations on severance pay67 to plain illegal conduct68, with the
aim of either paying severance pay, which was not due, increasing its amount or abusing the non-
taxable amount of severance pay by paying high amounts, which were largely non-taxable. The
burden of such conduct was mostly born by the employer and the state budget of the Republic of
Croatia, which thus lost some of its tax revenue, and the severance pays were often even financed
from the state budget. Collective agreements, which open room for moral hazards (agreement
between the employer and the worker at the cost of the state) and generous tax treatment have
encouraged numerous workers to use this possibility at the expense of the state budget. This
situation was also enhanced by the lack of transparency and records of payment and lack of
control.

Table 4: Number of persons employed in non-financial public companies




Source: Institute of Public Finance




67
   For instance, calculating pension qualifying periods with different employers in one or several public agencies or a
uniform pension qualifying period, which is taken into account in calculating severance pay, then significant increase
(as much as double) of individual elements in the formula for calculating severance pay, or regulations, according to
which the severance pay belongs to the worker in any case of employment contract termination – even when the
contract is terminated by the employee himself, as was the case in the collective agreement of the Croatian
Privatization Fund.
68
   For instance, distorting facts, on the basis of which severance pay is calculated, faking reasons for dismissal and
dismissal procedures, introducing the element of “voluntary” terminations and workers’ “acceptance” of the
employer’s decision on notice, which was most often caused by personal or business reasons.

                                                                                                                    31
3.1.2. Payment of severance pay in the case of the bankruptcy of the
employer

With respect to workers, whose employment contracts were terminated after the employer’s
bankruptcy, it was already mentioned that their claims are guaranteed by the Agency for Insurance
of Workers' Claims in the Case of the Bankruptcy of the Employer.

The Agency for Insurance of Workers' Claims in the Case of the Bankruptcy of the Employer was
established by the Act on Insurance of Workers' Claims in the Case of the Bankruptcy of the
Employer. It was founded by the Republic of Croatia, and the founding rights and obligations
pertain to the Government of the Republic of Croatia. Within the Act on Insurance of Workers'
Claims in the Case of the Bankruptcy of the Employer, the Agency for Insurance of Workers'
Claims in the Case of the Bankruptcy of the Employer:
     issues first instance rulings on material rights of workers in the case of bankruptcy of the
      employer and makes payments based on these rulings to the designated earmarked account of
      the bankruptcy debtor, exclusively for the payment of workers’ claims;
     makes sure that the proceedings to ensure workers’ rights are conducted in accordance with
      the law;
     provides expert assistance to workers in exercising their rights as defined by the Act on
      Insurance of Workers' Claims in the Case of the Bankruptcy of the Employer;
     directs and manages the funds provided for this purpose based on the Act on Insurance of
      Workers' Claims in the Case of the Bankruptcy of the Employer;
     exercises procedural rights of the bankruptcy creditor in the bankruptcy proceedings for the
      claims that it settled;
     exchanges relevant information with competent bodies or guarantee agencies of other
      countries in case that business activities were conducted in two or more states of the
      European Economic Area;
     exercises the right to recovery for the payments made to the workers in case of bankruptcy of
      a foreign employer; and
     performs other tasks as established by the Act, the Statute and the acts of the Agency for
      Insurance of Workers' Claims in the Case of the Bankruptcy of the Employer.

Along with the Agency for Insurance of Workers' Claims in the Case of the Bankruptcy of the
Employer, the administrative work related to receiving requests to insure claims is also performed
by the Croatian Employment Service.


In case of the employer’s bankruptcy, the Agency for Insurance of Workers' Claims in the Case of
the Bankruptcy of the Employer makes sure that the workers exercise their right to:
     unpaid salary for the last three months before initiating bankruptcy, or before the termination
      of their employment, if the employment was terminated within three months before initiating




                                                                                                  32
      bankruptcy – the maximum amount being the amount of minimum salary in the Republic of
      Croatia for each month, in which the worker did not receive salary69;
     unpaid amount of the compensation for sick leave, which the employer was responsible for
      paying in the last three months prior to initiating bankruptcy or before terminating
      employment, if the employment was terminated within three months before initiating
      bankruptcy – the maximum amount being the amount of minimum salary in the Republic of
      Croatia for each month, in which the worker did not receive salary;
     the compensation for the unused annual leave that the worker was entitled to in the calendar
      year, in which the employment was terminated, that is in which bankruptcy was initiated –
      the maximum amount being half the amount of minimum salary in the Republic of Croatia;
     severance pay under the conditions established by the law – half of the legally prescribed
      maximum amount of severance pay. The highest amount of severance pay is established by
      the Labor Act, and it amounts to six average monthly salaries, which the worker received
      within three months before the termination of the employment contract; and
     payment of the compensation of damages for injury at work or an occupational disease,
      based on a final court decision – the maximum amount being one third of the damages
      awarded by a final court decision.


Table 5 shows an overview of payments to workers employed by companies in bankruptcy
proceedings within the above mentioned categories in the remit of the Agency for Insurance of
Workers' Claims in the Case of the Bankruptcy of the Employer. It ought to be mentioned that up
until the 1st January 2010, the insurance of worker’s claims in the case of the bankruptcy of the
employer was in the remit of the Development and Employment Fund. Based on the insight into
the data, two important conclusions can be drawn:
      insurance of workers’ claims during the entire time that this system has been in place are
       mostly financed from the state budget of the Republic of Croatia, which means that
       employers’ unsettled liabilities are mostly financed from the general taxes; and
      the economic and financial crisis has increasingly contributed to the increase of bankruptcy-
       related claims – since 2009, there has been a significant increase in the number of claims and
       the amount of payments based on the exercise of workers’ rights.




69
  Minimum salary for the period from 1 June 2012 until 31 May 2013 in the Republic of Croatia amounted to HRK
2,814.00 according to the publications of the Central Bureau of Statistics (Official Gazette 60/12).

                                                                                                          33
Table 5: Overview of payments based on workers’ claims and recovery of funds to the state budget
of the Republic of Croatia within the operations of the Agency for Insurance of Workers' Claims in
the Case of the Bankruptcy of the Employer
                   Number of               Total           Total         Share of recovered funds
                payments based on       payments         recovery              (percentage)
                     claims              (million        (million
                                          HRK)            HRK)
    2003               142                  0.41            0.00                    0.00
    2004              4,982                32.70            4.38                   13.41
    2005              1,886                28.96            6.99                   24.13
    2006              1,710                20.81            5.81                   27.91
    2007              1038                 11.36            3.00                   26.39
    2008              2,585                11.84            2.80                   23.67
    2009              2,734                42.93           11.90                   27.72
    2010              6,789                84.16           10.37                   12.32
    2011              4,229                64.32            7.48                   11.64
    2012              4,031                65.80           15.05                   22.87
  TOTAL:             30,126               363.29           67.78                   19.01
Source: Agency for Insurance of Workers' Claims in the Case of the Bankruptcy of the Employer

The above data point to pro-cyclic nature of the existing severance pay scheme, which is not being
sufficiently highlighted. Namely, at the time of economic and financial crisis, when employers
have financial problems because of reduced demand and reduced operational revenues, one of the
ways out of this situation is to reduce the number of employees. However, if it is necessary to lay
off a significant number of workers, employers might find themselves in a situation that they are
forced to declare bankruptcy because of significant severance pay claims by the workers or they
might have serious liquidity problems.

Besides the fact that workers’ claims from employers impose a significant burden to the state
budget of the Republic of Croatia, it needs to be said that this system for insurance of workers’
claims does not provide for maximum protection. Namely, the Act on Insurance of Workers'
Claims in the Case of the Bankruptcy of the Employer stipulates that the Agency for Insurance of
Workers' Claims in the Case of the Bankruptcy of the Employer provides compensation just for
one part of workers’ rights, and the rest is paid in regular proceedings in line with the Bankruptcy
Act70, from the bankruptcy estate. Naturally, settlement of workers’ claims thus depends on the
state of the individual employer and on the bankruptcy proceedings, and it is thus possible that
workers loose an important share of the claims that they are entitled to. It can therefore be said that
the major share of the financial burden of this system is shared by the state budget of the Republic
of Croatia and the workers. Also, mentioned procedures take time and they do not make sure that
the workers will be compensated for their share in the lost profit at the moment when they lose
their jobs. Therefore, the function of the severance pay as an instrument of sustaining workers’
standard of living during the period of unemployment, as it is envisaged in theory, is thus not
fulfilled.

70
     The Bankruptcy Act (Official Gazette 44/96, 29/99, 129/00, 123/03, 82/06, 116/10, 25/12 and 133/12).

                                                                                                            34
3.1.3. Payment of severance pay in the private sector

As for the third group of workers employed in the private sector, who are regularly employed,
there seems to be most uncertainties. Namely, although there is a legal obligation to record
severance pays, there are no public data, on the basis of which the amount of severance-pay-based
claims could be determined. It is assessed that – at the annual level – the number of workers who
are entitled to severance pay ranges between twenty-five and sixty-seven thousand workers.71 The
number of workers who are entitled to severance pay is significantly higher at the time of
economic and financial crisis, which poses an additional burden to the private sector. Also, the
majority of workers in the private sector are not “covered” by collective agreements, so that they
are entitled to severance pay only by the standards of the Labor Act. It is assessed that this
amounts between HRK 1,150.20 and HRK 3,082.20 billion annually.72

A question imposed by this situation is to what extent such high financial burden for the employers
influences their decisions with respect to the employment policy. On the one hand, the employers
lack the incentive to dismiss existing workers during crisis and thus they tend to reduce their
salaries, whereas on the other hand, they also lack the incentive to employ new workers, even if the
business conditions improve. In any case, it is difficult to assess the proportions of social and
economic effects of the existing system within the private sector. Data also show that the number
of labor disputes within the system amounts to approximately 100,000.73 This points to the fact
that a large number of workers in the private sector are unable to timely collect their claims as
prescribed by the law.

When it comes to the severance pay scheme, tax treatment of severance pay plays an important
role. Namely, the Ordinance on Income Tax stipulates that the tax-free amount of severance pay
for terminations of employment contracts caused by business or personal reasons amounts to HRK
6,400.00, and for terminations of employment contracts for persons with occupational disability
after returning from treatment for a work-related injury or an occupational disease, to whom the
employer did not offer adequate work, it amounts to HRK 8,000.00 for each completed year of
work for the employer, who terminates the employer contract, and the tax regulations do not define
any ceiling for the tax-free severance pay, so that a worker with thirty years of service with the
same employer can be entitled to tax-free severance pay amounting to HRK 192,000.00 in the
former case, and to as much as HRK 240,000.00 in the latter case.74

The issue here is to what extent this system is just, because in a way the payment of one form of
income is exempt from the progressive income tax rate, which is based on the ability-to-pay


71
   Please see: Krištof, Marko. Potiču li neoporezive otpremnine prerano umirovljenje? (Does Severance Pay Encourage
Early Retirement?), Banka, 2011 (available at: www.banka.hr/UserDocsImages/.../AMS_Kristof_2011-03_17.ppt).
72
   Please see: Bejaković, Predrag. Poteškoće oko mogućeg osnivanja posebnog fonda za otpremnine (Difficulties
related to possible establishment of a Severance Pay Fund) Radno pravo – Journal, 10, 2013, 5, p. 33
73
   Please see: Zuber, Marija. Kakva je veza između uplaćenog doprinosa i mirovine? (What Is the Relationship
between Paid Contributions and the Retirement Benefit?), Banka, 2011 (available at: www.banka.hr).
74
    Please see: Zuber, Marija. Plaće (Salaries), in: Babić, Vera et al. Veliki komentar novog Zakona o radu
(Comprehensive Commentary of the new Labor Act). Zagreb: Vaša knjiga, 2010, p. 135

                                                                                                                35
taxation. Additionally, it has to be mentioned that workers who are entitled to smaller amounts of
severance pay due to low income are as a rule less mobile and have smaller chances of re-
employment than workers with higher income, especially of older age. This system opens the
possibility of moral hazard because it may be suspected that employers and employees will be
prone to make mutual agreements in order to avoid the payment of taxes and contributions. This
possibility is even more pronounced as there are no records on the payment of severance pays and
re-employment of workers who received such severance pay based on the fact that they were
dismissed by their employer: the same workers may be employed at a different job with the same
or a related employer.


4 Regulation of severance pay schemes in other states
In most countries in the world there are severance pay schemes.75 They mostly provide for lump-
sum payments to workers after the termination of their employment contracts. In almost every EU
member state there is some form of a comprehensive approach to severance pay: a national
severance pay scheme. They differ greatly in scope and generosity from state to state. Besides, it
can be noted that – along with the legally imposed and regulated severance pay scheme – there are
also severance pay schemes that are based on voluntary principle, most often with concrete
individual employers.


4.1 Regulation of the severance pay schemes in the EU member states


4.1.1. Regulation of severance pay in the EU member states

It is rather difficult to precisely systematize, classify and compare national severance pay schemes,
given that various states inherited different traditions and attitudes towards payments to workers
after the termination of their employment contracts. As we have already mentioned, if we compare
national systems, they seem to serve different purposes: for instance, as compensation to workers
in case of the termination of the employment contract, depending on special reasons, ways of
termination or depending on the number of workers, or they provide compensation regardless of
the way that the employment contract was terminated, and even in cases when it is the worker who
terminated employment. Therefore, any systematization and classification may be based on the
legal source of the entitlement to severance pay. In that sense, Table 6 contains an overview of the
legal basis, i.e. of legal sources of the entitlement to severance pay in the EU member states.

In the EU, most members states, or rather 21 of them, base their national severance pay schemes
on statutory regulations. In six EU member states, the entitlement to severance pay is regulated by
collective agreements, and there are not any EU member states, which have no comprehensive
severance pay scheme across the entire economy.

75
  Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012, p. 17-67

                                                                                                          36
However, it needs to be mentioned that any attempt at systematization and classification is rather
arbitrary. For instance, German labor legislation in principle does not guarantee the right to
severance pay or to any workers’ claims on this basis. However, the law that regu lates safeguards
related to the termination of employment contracts, Kündigungsschutzgesetz, introduced and
regulated the right to a lump sum in case that the employment contract is terminated for economic
reasons.

Table 6: Legal basis for the right to severance pay in the EU member states
 Entitlement to severance pay regulated by the law        Entitlement to severance pay regulated by
                                                                   collective agreements
                  Republic Austria                                         Belgium
                      Bulgaria                                              Cyprus
                Republic of Croatia                                        Finland
                  Check Republic                                         Netherlands
                     Denmark                                                Poland
                      Estonia                                              Romania
                       France                                              Sweden
                     Germany
                       Greece
                      Hungary
                       Ireland
                         Italy
                       Latvia
                     Lithuania
                   Luxembourg
                      Portugal
                 Republic Slovakia
                      Slovenia
                        Spain
                  United Kingdom
Source: World Bank, ILO

An important characteristic of any national severance pay scheme is a formula or a defined type
and level of the benefit, or prestation, which represents the severance pay. There is a traditional
connection or interdependence between severance pay and the years of service that a worker
accumulated with a single employer, duration of employment, and dependence on the reason for
the termination of the employment contract.

Most countries, which regulate the right to severance pay in their legislation make the right to
severance pay and the payment of severance pay conditional on a minimum number of years of
service, that is they regulate what is the minimum years of service with a single employer in order
to qualify for severance pay. In most cases, this motivates the employers or provides an incentive
to them to distort factual and legal situations regarding employment and terminations of
employment contracts with the aim of avoiding the financial burden caused by the payment of
severance pay. Besides this conditionality, the level of generosity of severance pay is proportionate
with the years of service with a single employer.

                                                                                                  37
Financing severance pays represents an additional aspect, which characterizes the national
severance pay scheme. So, in general, the national severance pay schemes are financed by the
employer, and this can pose a liquidity challenge in case that a larger number of workers has to be
taken care of after the termination of their employment contracts, that is in cases where there is a
collective surplus of workers, and this particularly applies to small and micro employers. In some
countries, this leads to excluding workers employed with such employers from the otherwise
mandatory national severance pay schemes, which means that in such situations there is no
obligation to pay severance pay. However, in some countries, including the Republic of Austria,
national severance pay schemes are funded through earmarked contributions. Here, the level of
generosity of the severance pay would depend on accumulated contributions and the accrued
interest rate, and funding is conducted through financial institutions, which are in charge of
managing individual accounts, with the deposits being invested in capital markets.

Table 7 provides a good overview of the characteristics of the national severance pay schemes in
the European Union. In two countries, in the Republic of Austria and Italy, these schemes are
reformed in the direction of financing through earmarked contributions. In most EU member
states, the minimum number of years of service at a single employer represents the basis for
qualifying for severance pay. In six EU member states, small employers are excluded from
mandatory arrangements of the national severance pay schemes.

Table 7: Characteristics of the national severance pay schemes in the European Union
          State                  Earmarked            Minimum years of         Small and micro
                                contribution         service with a single   employers excluded
                                                           employer
   Republic Austria                  yes                      no                     no
       Bulgaria                      no                       no                     yes
  Republic of Croatia                no                       yes                    no
   Check Republic                    no                       no                     yes
       Denmark                       no                       yes                    yes
        Estonia                      no                       no                     no
         France                      no                       yes                    no
       Germany                       no                       yes                    yes
        Greece                       no                       yes                    no
       Hungary                       no                       yes                    yes
        Ireland                      no                       yes                    no
          Italy                      yes                      no                     no
         Latvia                      no                       no                     no
       Lithuania                     no                       no                     no
     Luxembourg                      no                       yes                    no
       Portugal                      no                       yes                    no
  Republic Slovakia                  no                       no                     no
       Slovenia                      no                       yes                    yes
         Spain                       no                       no                     no
   United Kingdom                    no                       yes                    no
Source: ILO, World Bank

                                                                                                 38
In order to achieve effectiveness and efficiency of the national severance pay scheme, the
generosity of severance pay is of key importance. Figure 1 shows severance pay generosity or the
level, expressed as a number of monthly salaries paid after ten years of working with the same
employer. What was taken into account here is the total amounts of severance pay paid, based on
all sources of entitlement, including the amounts that the employer paid voluntarily in order to
“stimulate” employment termination. Here, for example, it is revealed that the Republic of Croatia
is at the sixth place among this group of countries, so among those EU member states, which are at
the top in terms of severance pay generosity. Although the Republic of Austria and Germany have
higher severance pays after ten years of service with a single employer in comparison to the
Republic of Croatia, it is important to notice that the Republic of Austria has a scheme with an
earmarked contribution, and in Germany there is a significant share of workers, who are exempt
from the scheme (small employers, termination of the employment contract without an economic
reason).

Figure 1: Generosity of the national severance pay schemes




Source: ILO, World Bank, own calculations


4.1.2. Economic effects of severance pay in the EU member states

There are several comprehensive studies of the national severance pay schemes.76 A combination
of a comprehensive empirical analysis and research of the literature on severance pay makes it


76
  Please see: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012; Holzmann, Robert et al. Severance Pay Programs

                                                                                                          39
possible to draw certain general conclusions. First, it can be established that there is a stable and
significant negative relationship between economic effects measured in terms of GDP per
inhabitant and the generosity of the severance pay – “richer” countries display a tendency towards
relatively lower amounts of severance pay in comparison to the “poorer” ones. In addition, it is
possible to establish that the probability of mandatory outcomes of the national severance pay
schemes is significantly lower in the countries with highly developed economies. This result is in
line with the historic development of the national severance pay schemes, as a precursor of broader
social policy interventions. Second, there is a consistent negative relationship between the
generosity of the severance pay scheme and the unemployment benefit. This result shows that in
the historic perspective, unemployment insurance absorbed the role of the national severance pay
schemes in protecting the worker from the consequences of losing work. This invites us to
critically re-examine the existing national severance pay schemes with respect to their adequacy.
Third, the results show a consistently positive and mostly significant effect of the generosity of
pension benefits on the level of the national severance pay schemes. It seems that – in this area –
there is a complementary function of the national severance pay schemes and public pension
schemes.

In relation to the effects of severance pays to the economic well-being, scientific research focuses
on their interaction with the labor market. There is a large number of studies, which assess the
effects of the employment protection legislation (EPL) on the outcomes on the labor market and on
economic efficiency.77 Although the findings are not always compatible, a clear picture emerges,
showing the negative effects of the EPL on various economic variables. It has been proven that the
EPL has the tendency to reduce the number of those who become unemployed or who exit
unemployment, which prolongs the duration of their unemployment. This, on the other hand, may
discourage fast adaptation of the labor market to changed economic conditions, and result in lower
productivity growth.78 Recent studies also confirm the assumption that the EPL reduces the
division between workers and creation of new jobs, having negative consequences on the level of
revenue and economic growth.79

There is an increasing amount of evidence about the negative effects of the EPL on the results
achieved by the labor market, and this has to be clearly differentiated from the effects of the
national severance pay systems. The existing studies cast doubts on some significant quantitative
effects of the national severance pay schemes on labor market outcomes. Thus, it is considered that
the effect on workers’ separation or the average level of employment is small. He provides an
argument that severance pay schemes have to be assessed in the context of the broader concept of
labor legislation on the labor market and in interaction with this concept.80 National severance pay
schemes usually only provide a marginal contribution to the existing incentives, and they therefore


around the World: History, Rationale, Status, and Reforms. Hirschegg; Marseille; Pretoria; Washington: The World
Bank; IZA, 2011
77
   Please see: Organisation for Economic Co-operation and Development. Employment Outlook. Paris: Organisation
for Economic Co-operation and Development, 2004
78
   Please see: Davis, Steven J.; Haltiwanger, John. Sectoral Job Creation and Destruction Responses to Oil Price
Changes (NBER Working Papers 7095).Cambridge: National Bureau of Economic Research Inc., 1999
79
   Please see: Boeri, Tito; Garibaldi, Pietro. Beyond Euro sclerosis. Economic Policy, 24, 2009, 7, p. 409-461
80
   Please see: Parsons, Donald O. Mandated Severance Pay and Firing Cost Distortions: A Critical Review of the
Evidence, in: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International
Bank for Reconstruction and Development; The World Bank, 2012., p. 121-157

                                                                                                             40
only have a minor effect on the outcomes. The empirical analysis of the Austrian severance pay
scheme is in line with this general conclusion.81


4.2 Regulation of severance pay in the neighboring and other relevant
states

In Germany, the national severance pay scheme is for the most part not anchored in the law.
However, its existence results from the regulations on the termination of the employment contract,
which are such that they encourage employers to terminate employment contracts based on mutual
agreement in order to avoid court disputes. Consequently, a part of the agreement to terminate the
employment contract is the entitlement to severance pay. In defining the amount of severance pay,
the most relevant aspects are the duration of employment with a specific employer and the risk of
losing the court dispute. As a rule, a worker whose employment contract is terminated based on
business circumstances is entitled to a severance pay amounting to one half of salary for each year
of service with that employer. Each severance pay in Germany is taxable and social security
contributions have to be paid.

The Hungarian national system of severance pay is anchored in the law. The amount of severance
pay is related to the duration of the employment with the employer. So, a worker who has worked
for more than three years with a single employer is entitled to severance pay amounting to one
salary. For working for more than five years for the same employer, the legal minimum increases
to two salaries, and for more than ten years it is minimum three salaries, four salaries for more than
fifteen years, and five salaries for more than twenty years, whereas for more than twenty-five years
it is a minimum of six salaries. So it is evident that there is a correlation between the years of
service and the severance pay, the relevant intervals being five years, which lead to proportionate
increases by one salary amount. The only exception is the first interval, which begins with more
than three years of service. Correction of severance pay is also evident in two more instances:
workers who reach the retirement age (62) are not entitled to severance pay, but workers whose
employment ceases at the age between 57 and 62 are entitled to three additional salaries in addition
to the legally prescribed minimum. The amount of salary means net monthly salary, which belongs
to the worker.

In Slovenia, the entitlement to severance pay is anchored in the labor legislation and it is connected
to dismissals based on business reasons. The severance pay for workers who have worked with the
employer between one and five years amounts to one fifth of the salary per year of service with the
employer. For workers who have worked between five and fifteen years for the same employer, the
severance pay is calculated as one fourth of the salary for each year of service. For workers who
have worked for more than fifteen years, the minimum severance pay is the most generous, it is
calculated as one third of the salary for each year of service with the employer. The mentioned
amounts point to the fact that the amounts of severance pay are conditional on the years of service
with the employer, but in a way that longer work is rewarded double – the base increases with the


81
  Please see: Hofer, Helmut; Schuh, Ulrik; Walch, Dominik. Effects of the Austrian Severance Pay Reform, in:
Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International Bank for
Reconstruction and Development; The World Bank, 2012, p. 177-209

                                                                                                         41
duration of employment and it is multiplied with a higher number of years. The maximum
severance pay is ten salaries, except in cases when it is regulated differently by collective
agreements. The base is the average monthly salary in the past three months.

In Serbia, the obligation to pay severance pay results from the Labor Act, both in cases of
dismissals based on business reasons and for retirements. In the latter case, three monthly salaries
are paid, whereas with the termination of the employment contract, it is one third of the monthly
salary for each of the first ten years of the total years of service, and one fourth of the monthly
salary for each following year. Here, we can see that the growth is not proportionate, but that it
drops after the tenth year. Severance pays are paid as a one-off benefit, before the employment
contract is terminated. The greatest problem in Serbia is the legal provision, which stipulates that
the employer is obliged to pay severance pay for each year of the total years of service of that
person, and not just for the years of service with that specific employer.


5 Reform of the national severance pay scheme in the
Republic of Austria
In 2003, the Austrian government implemented a widely acknowledged reform of the Austrian
national severance pay scheme as it was regulated by the law. The former scheme was organized at
the level of the employers and it was based on the years of service that the worker accumulated
with a specific individual employer. The current national scheme is based on the mandatory
savings account for all workers and on that account, the deposits are managed by investing them in
capital markets.

Reform of the national severance pay scheme in the Republic Austria was implemented based on
the following assumptions:
     development of the national severance pay scheme, which guarantees access to severance
      pay to all workers in the Republic of Austria, regardless of the length of service with a
      specific employer;
     avoiding negative effects of the legislation of the national severance pay scheme on market
      mobility and economic efficiency;
     introducing mandatory individual savings accounts, which guarantee that workers’ claims are
      settled in due time; and
     using the savings as a potential core for developing the insufficiently developed capital-
      funded pillar of the Austrian pension scheme.


5.1 State before the reform of the national severance pay scheme in
Austria, in 2003

Until 2002, Austrian labor legislation determined how severance pay is to be paid to workers in the
private sector in case of termination of the employment contract by the employer or by mutual
consent of both parties, provided that the worker worked with the employer for at least three years.
Starting with two monthly salaries after three years of working for a specific employer, the


                                                                                                 42
payments increased depending on the duration of the employment up to the maximum amount of
one annual salary after twenty-five years of service with the same employer.

The old scheme defined the right to severance pay at the following levels of gross monthly
salaries, depending on the worker’s years of service with the employer:
     after two years of service:           two salaries;
     after five years of service:          three salaries;
     after ten years of service:           four salaries;
     after fifteen years of service:       six salaries;
     after twenty years of service:        nine salaries; and
     after twenty-five years of service:   twelve salaries.

In terms of bookkeeping, the severance pay was recorded as regular salary increase. The employers
were obliged to keep at least half of the amount of due severance pay on their bank accounts.

Reforming the severance pay scheme in the Republic of Austria was debated for a long time.82 The
earlier scheme was questioned for three main reasons.

The first important problem, which resulted from the former statutory severance pay scheme was
differentiation of the entitlement to severance pay among workers. The Austrian trade union
federation requested that the entitlement to severance pay is expanded in a way that not only
terminations of employment contract by the employer are covered, but also terminations by the
employee and situations that involve seasonal work or seasonal employment. This is what was
requested in negotiations. According to some assessments, only one third of all workers really
exercised their right to severance pay.83

Secondly, the scheme was exposed to criticism due to its effects in terms of preventing mobility on
the labor market and limitations with respect to the entitlement to severance pay. The former
statutory scheme reduced the incentives for workers to change the employer, as they would lose
the right to severance pay in cases they themselves would initiate the termination of their
employment agreement.

Thirdly, the former scheme also had some disadvantages for the employers, particularly the
SMEs.84 They could have liquidity problems if they were obliged to make severance pay payments
to a larger number of workers at some point.




82
   Please see: Abfertigungen im Spannungsfeld der Wirtschaftspolitik - Eine interdisziplinäre Analyse (ed. Genser,
Bernd). Vienna: Manz, 1987; Europan Industral Relations Observatory. Reform of Severance Pay under Discussion.
Dublin: Europan Industral Relations Observatory, 2001 (available at:
www.eiro.eurofound.ie/2001/06/inbrief/at0106220n.html); Klec, Gerald. Flexicurity and the Reform of the Austrian
Severance-pay System. Brussels: ETUI-REHS, 2007.
83
    Please see: Kristen, Sabine; Pinggera, Winfried; Schön, Rosemarie. Abfertigung Neu: Überblick über die
Neuregelungen durch das Betriebliche Mitarbeitervorsorgegesetz. Recht der Wirtschaft 2002, 7.
84
    Please see: Kristen, Sabine; Pinggera, Winfried; Schön, Rosemarie. Abfertigung Neu: Überblick über die
Neuregelungen durch da sBetriebliche Mitarbeitervorsorgegesetz. Recht der Wirtschaft 2002, 7.

                                                                                                               43
In 2002, the Government highlighted another issue. In their coalition program, they emphasized
the intention to develop the pension scheme, which consists of three pillars: the existing pay-as-
you-go pillar, the second pillar with mandatory capital-funding, and the third pillar with voluntary
funding. The government aimed at transforming the system of mandatory severance pay into a
program of new professional pensions, which would also work as the second pillar of the pension
scheme.


5.2 New Austrian national severance pay scheme after the reform of the
national severance pay scheme in the Republic of Austria in 2003

After extensive negotiations with the social partners an agreement on the new severance pay
scheme was reached in summer 2002. The reform extends the entitlement to severance pay
considerably. Entitlement now starts from the first day of employment and does not depend on the
way of termination of the contract. Employers have to pay a contribution of 1.5377 percent of the
payroll into a fund, specified by an agreement of employer and work council, from the first day on.
Existing severance pay entitlements under the old scheme remain unchanged.

In the case of dismissal by the employer after three years of job tenure the employee can choose
between receiving her severance payment from the central funds at once, or saving her entitlement
toward a future pension. The amount will not be paid out if the employee gives notice herself or
job tenure is shorter than three years. The acquired claim, however, remains.

Figure 2 shows the evolution of severance pay claims in terms of the individual’s last monthly
wage in the old vs. the new scheme. While in the old scheme severance pay increased in stages and
the maximum level of severance payment was reached after 25 years of employment with the same
employer, in the new scheme the severance pay will rise continuously and reach the maximum
value of the old scheme after 37 years (under the assumption of a rather high rate of return of 6
percent per annum). Under the new scheme, severance pay contributions are paid to a fund. In the
existing scheme, the severance pay contributions are paid to a fund, and the money is invested on
private capital markets.




                                                                                                 44
Figure 2: Comparing the result of the previous and the existing severance pay scheme in the
Republic of Austria
                                Severance pay reform in Austria
                                              Old vs. new scheme
    15
    12
     9
     6
     2 3 4




             0      3   5          10          15      20        25              30              37     40
                                                 Years of Service

                                         New Scheme*                      Old Scheme
             *Calculation based on the assumption of 3% real wage growth and 6% real return on assets


The dotted line – new scheme, full line – the old scheme, the y axes shows severance pay in
relation to the salary in the past month
Source: Koman, Reinhard; Schuh. Ulrich; Weber, Andrea. The Austrian Severance Pay Reform:
Toward a Funded Pension Pillar, Empirica. 2005, 32, p. 255-274

The contributions are invested into private funds. As soon as the duration of the employment
contract exceeds one month, the employer is obliged to pay a contribution to the body that
manages this fund, and there are ten such funds at the moment. These funds are strictly regulated,
and their investments are limited to:

        bank deposits (maximum twenty-five percent per institution);
        credits and loans;
        bonds;
        shares (maximum forty percent of the total capital);
        certificates on the share in the funds; and
        maximum fifty percent in foreign currency.

At the end of October 2012, the ten funds managed the capital amounting to 5 billion EUR, that is
1.6 percent of the GDP.




                                                                                                             45
5.3 Lessons from the new Austrian severance pay scheme after the
reform of the national severance pay scheme in the Republic of Austria
in 2003
5.3.1. Coverage

After the reform, the Austrian model has quite a broad and comprehensive base. Namely, each
worker has the option to exercise his/her right to severance pay, whereas in the former system
approximately one third of all workers exercised their right to severance pay during their career on
the labor market. This is related to the fact that the Austrian labor market is marked by a high level
of labor force mobility. In 2012, more than one million and seven hundred thousand new
employment contracts were concluded. This is one half of the total number of workers who were
earning income from dependent employment in 2012, so approximately three and a half million.
Approximately the same number of contracts were terminated in 2012. Average duration of
employment, which was terminated amounted to 598 days. This implies that an “average”
employment spell would have been far too short to qualify for severance pay in the old Austrian
scheme. The average duration of employment spells is also very unevenly distributed among
economic sectors. In the energy sector and in banking & insurance employment spells lasted for on
average 1.600 days. On the other end of the spectrum average employment in agriculture amounted
to 128 days, 235 days in tourism or 450 days in construction. The high turnover at the labour
market and the heterogeneity of the length of job spells in economic sectors corresponds to the
structure of the Austrian labour market. Important sectors of the Austrian economy, namely
tourism and construction inhibit a very high degree of seasonal fluctuations which lead to high
rates of job creation and destruction.

The implementation of the new severance pay scheme has resulted in a continuous and impressive
increase of coverage. The number new entrants to the severance pay scheme increased from
143.000 persons in 2003 to 1 Mio. persons in the year 2012. In the meantime 2,8 Mio. persons are
covered by the Austrian severance pay scheme. This corresponds to 80% of total dependent
employment in Austria.

Figure 3: Coverage of Severance Pay in the Republic of Austria




Source: Plattform der Betriebliche Vorsorgekassen




                                                                                                   46
In line with the increase of coverage of the new scheme it can be observed that the number of
beneficiaries is expanding at high speed. In 2004 only 2.000 persons withdrew their claims from
the system. With increasing coverage and more persons reaching the employment duration that
allows for taking out funds from the system the number of persons that withdrew funds has
increased substantially. In 2009 more than 250.000 persons withdrew funds for 2012 it is estimated
that significantly more than 400.000 persons took out their claims from the system. The amount of
capital that was withdrawn increased from 7 Mio. Euro in 2004 to nearly 300 Mio. Euro (around
0,1 % of GDP) in the year 2012.

Figures 4 and 5: Withdrawal of funds from the national severance pay schemes in the Republic of
Austria




Source: Plattform der betrieblichenVorsorgekassen


5.3.2. Labor mobility

The former Austrian severance pay scheme has been under suspicion of distorting the labour
market behaviour of economic agents.85 The discrete increase in entitlements led to incentives on
the part of employers to dismiss employees just before additional claims could arise. From the
perspective of employees the severance pay scheme has reduced the attractiveness of changing
jobs with increasing duration of the employment spell.

Theoretical considerations give reason to assume that the reform of the Austrian severance pay law
should have increased labour mobility significantly. As a consequence beneficial effects on labour
productivity should arise as the quality of matches between workers and firms would increase. In
addition to that economic growth may be supported as workers move faster to innovative sectors of
the economy. There are estimates that the reform “will raise the annual TFP growth in EPL-
binding industries by about 0.25 percentage points, which translates into an average estimated
growth rate of at least 0.1 percentage points for the whole economy.” 86 Precondition for these
effects to materialize is, however, the assumed impact of the reform on labour mobility in Austria.


85
   See also: Organisation for Economic Co-operation and Development. Employment Outlook. Paris: Organisation for
Economic Co-operation and Development, 2004
86
   According to: Bassanini, Anarea; Nunziata, Luca; Venn, Danniele. Job Protection Legislation and Productivity
Growth in OECD Countries. Economic Policy, 2009., 58, p. 351-402

                                                                                                             47
An empirical study investigated the impact of the introduction of the severance pay reform on
labour mobility in the Republic of Austria.87 It identified the impact of the reform by applying a
difference in difference estimator on the probability of job termination for two separate groups of
job spells immediately before and after the introduction of the severance pay reform. The analysis
tests the hypothesis whether job mobility was enhanced by the reform. It can be inferred from
Figure 2 the old severance pay scheme introduced a significant incentive for employees to avoid
quits after three years of job tenure. Consequently it was expected to observe a significant increase
in relative job mobility after three years of tenure for the group of job spells after the introduction
of the reform.

The analysis found indeed a significant positive impact of the reform on job mobility. Job mobility
was 0,9 percentage points (or 5,8%) higher for females and 0,2 percentage points (or 1,1%) higher
for males. Robustness checks of the results – i.e. by restricting the analysis to direct job to job
moves - revealed however, that the impact of the reform on job mobility may be substantially
lower than initially expected.

Figure 6: Job mobility after four years of tenure, comparison of before and after reform




The y axes shows the probability of terminating employment in the fourth year of tenure, the left
side shows women, the right side men, and red is the impact of the reform.
Source: Hofer, Helmut; Schuh, Ulrik; Walch, Dominik. 2012 Effects of the Austrian Severance
Pay Reform, in: Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan).
Washington: The International Bank for Reconstruction and Development; The World Bank, 2012;
own calculations

Other factors like economic conditions seem to play a much bigger role in affecting job changes in
Austria. The results indicate that the adverse financial incentives of the old severance pay scheme
have been – at least for job spells lasting no longer than five years – too small to have more
prominent effects on labour mobility in Austria. This result is in accordance with the literature that



87
  Please see: Hofer, Helmut; Schuh, Ulrik; Walch, Dominik. 2012 Effects of the Austrian Severance Pay Reform, in:
Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The International Bank for
Reconstruction and Development; The World Bank, 2012.

                                                                                                              48
points to the importance of the interaction of severance pay with general provisions for
employment protection legislation.


5.3.3. Capital accumulation and rate of return

One original objective of the Austrian reform has been to contribute to the expansion of the
underdeveloped second pillar of the Austrian pension system. In 2005 only 11% of all Austrian
employees had claims to a funded pension scheme on the enterprise level compared to an average
value of 27 % in all EU-member states. The total savings in the funded pillar amounted to 4.7% of
GDP in 2005 compared to the average value of 87.6% for all OECD member states.88 The structure
of savings for old age benefits in Austria may be explained by the rather generous public pay-as-
you-go pension system. However, recent pension reforms imply a significant gradual reduction in
replacement rates89 in the pay-as-you-go system by 25% in the coming decades. In this respect the
savings from the severance pay system could serve as an option to fill the gap left from the pension
reforms. By replacing the former defined-benefit, final salary severance payments scheme by a
contribution-defined, fully funded system, the reform may be considered as a first step in this
direction. The essential condition for establishing an instrument to increase savings for pension
benefits is, however, not fulfilled: after 36 months of contribution to the system employees may
withdraw their claims from the system. The legislator additionally provided tax incentives to
motivate employees to leave their savings within the severance pay funds. Benefits from the new
severance pay scheme are tax-exempt if they are transformed into a pension annuity otherwise a
reduced income tax rate of 6% of benefits applies.

Consequently the decision of employees whether to withdraw their claims from the system
depends on the return of the severance pay funds. The returns of the new scheme have been,
however, not very promising in recent years. At the outset of the reform it was assumed that in the
long term the rate of return should be at 6 percent per annum. As can be seen from Figure 7 the
rate of return in the new system turned out to be well below this very optimistic target level.
Returns of the Betrieblichen Vorsorgekassen (BVK) continuously declined from 5½% in 2005 to
only 2% in the year 2008. On average the rate of return amounted to 2.8% for the period 2004 to
2012.




88
   Please see: Felderer, Bernhard et al. Perspektiven der betrieblichen Altersvorsorge in Österreich – Studie im Auftrag
der Wirtschaftskammer Wien. Wien: Institute for Advanced Studies, 2008.
89
   Replacement rate is the share of average salary in the average pension.

                                                                                                                    49
Figure 7: annual rate of return on savings in the severance pay scheme




Source: Oesterreichische Kontrollbank

The rate of return has to be qualified as very poor. This hypothesis is confirmed by comparing the
performance with the corresponding development of the private funded pillar in the Republic of
Austria. The private pensions funds in Austria achieved a rate of return of 4.2% in the period 2004-
2012, thus 1.5 percentage points higher compared to the BVK. It thus comes as no surprise that
withdrawals from the system have been the rule rather than the exception. In 2006 it became
possible for the first time for those entering the system during 2003 to withdraw their claims. As a
consequence withdrawals have increased sharply. The data for 2011 reveal that 95 percent of all
participants that had the option to take out their claims from the system did so. Given the
foreseeable decline in replacement rates in the public pay-as-you-go pension system it may be
desirable to achieve higher rates of savings for old age income via this channel in the future.

From the perspective of the BVK there are two reasons – that are not independent from each other
– that seem to explain the poor performance of the severance pay funds. First the BVK are obliged
to guarantee the value of the capital corresponding to the contributions. This implies a costly
insurance of the funds that reduces the potential rate of return. Second the participants in the
system may withdraw their claims as soon as they have contributed at least for three years to the
system. Therefore the BVK have to provide for sufficient liquidity to pay out potential claims. This
implies that the BVK are forced to have large shares of their portfolio to be invested in short term
assets, which also reduces the potential rate of return. As these two obligations reduce the potential
rate of return – which can be seen from the current performance – the incentives of employees to
actually withdraw their claims from the system increases which again has negative impact on the
performance of the funds.

Consequently the BVK argue for modifications of the legal provisions in order to improve their
performance. They propose to allow employees to opt out of the capital guarantee and to raise the
minimum contribution period into the system to five years. Another possibility would be to stick to
the original intention and to restrict withdrawals until the time of retirement.




                                                                                                   50
5.3.4. Conclusions on the new Austrian national severance pay scheme after
the reform of the national severance pay scheme in Austria in 2003

Ten years after the implementation of the new Austrian severance pay legislation the following
conclusions may be drawn:
    The new scheme extended coverage to all employees and seems to have broad acceptance
       among the economically active population
    The reform reduced potential liquidity problems especially for small firms
    Coverage increased fast and continuous, currently 80 % of all employees are already in the
       new scheme
    A modest increase in labour mobility has been identified, the impact seems to be, however,
       less important than initially expected
    The new severance pay scheme is in principle a mandatory savings account for employees.
       Data reveal that in fact nearly everybody who may withdraw funds from the system does
       so.
    Withdrawals from the system are induced by the very poor performance of the
       Betrieblichen Vorsorgekassen (BVK). The legal provisions that force BVK to guarantee for
       the value of capital and that allow persons to withdraw funds after 3 years of employment
       has a substantial negative impact on returns. In this respect future modifications of the
       legislation seem reasonable.



5.4 Acceptance of the new Austrian national severance pay scheme in
other members states of the European Union after the reform of the
scheme in the Republic of Austria in 2003

The new Austrian national severance pay scheme after the reform, which took place in 2003, is
still rather unique and other member states of the European Union are rather at the stage of still
studying it than adopting it. The acceptance of the new scheme has advanced furthest in Italy.

The Italian severance pay scheme is quite specific, although it might be said that in Italy there is no
severance pay model in the conventional sense. There are namely two schemes. The first scheme
serves to provide compensation to persons, whose employment contracts were terminated with no
fault of their own, which differentiates between employers with fifteen or fewer employed workers
and those with sixteen and more workers. In those cases, if the court establishes that the
termination of the employment contract was unfounded, the worker receives compensation
(smaller employers), i.e. they can choose between the compensation or returning to work (larger
employers). The second scheme is where the entitlement is exercised after the work is terminated.
Here, the employer pays a contribution amounting to 1/13,5 of the worker’s gross annual salary for
each year of service to the worker’s personal account. The funds on the account are indexed
annually by a fixed factor of 1.5 percent increased by 75% value of the consumer price index as an
inflation ratio versus a year earlier. If the worker accumulates at least eight years of tenure with the


                                                                                                     51
employer, and if the employer agrees, these funds may be used to cover the health care cost for the
worker, purchase of a house or a flat or as remuneration for a certain period of unpaid leave.
Actually, this is worker’s credit to the employer until the termination of employment, but the
accumulated funds may be used even earlier for specific purposes.

Changes of the public policies in the past decade were focused on strengthening the pension
component, which reduced the level of severance pays. Therefore, in 2004, the state provided the
workers with the possibility to choose whether they want to enroll the complementary pension
insurance scheme (something similar to the Croatian third pillar), in exchange for giving up the
personal accounts. Both newly employed and older workers were encouraged to do so. Once a
person opted for the new scheme, the decision was irreversible, while the workers who remained in
the old scheme could transfer to the new scheme at any moment. In order to encourage the transfer
to the new scheme and to encourage development of complementary pension insurance, numerous
new solutions have been offered since 2004: it was made possible to consider participation in
complementary insurance as justified avoidance of the severance pay scheme, favorable tax
treatment was offered for the benefits, regardless if they were paid as a lump sum or in annuities,
there were changes in the way of paying contributions, benefits, advance payments, exemptions
from payments and determining the transferability. Until 2007, the Italian government decided that
the employers with fifteen or more workers would have to transfer to the state all future severance
pay contributions, with the state making direct payments regardless of the scheme that the workers
have chosen. So far, fiscal and other incentives have produced only limited effects. Until the end of
2008, only 26 percent of workers who are entitled to do so have opted for the complementary
pension insurance scheme. Possible explanations for the low rate of interest for this transfer range
from pre-mature effects of the financial crisis to systemic problems, including quite a low level of
credibility of complementary insurance and workers’ preferences with respect to liquidity.
Numerous experts are concerned about the liquidity of this system and about broader economic
effects on small and medium-sized entrepreneurs who have lost access to cheap forms of internal
funding.


6 Comparison of relevant economic categories between the
Republic of Croatia and the Republic of Austria and
reflections on the Croatian labor market
Considering that the Austrian model is proposed as a possible solution for the deficiencies of the
existing national severance pay scheme in the Republic of Croatia, it would be useful to compare
the most important categories, which are relevant for the direction and the scope of effects if this
model is applied.

The application of the identical model in states, which are characterized by significantly different
parameters, may produce significantly different effects. Table 6 shows the relevant categories,
which lead to the main conclusions about the state of the labor market in the Republic of Austria
and the Republic of Croatia. It can be noted that the labor markets of compared countries are
significantly different. The Republic of Austria is characterized by a much higher level of
development and labor market mobility at the level of full employment. On the other hand,
Republic of Croatia shows unfavorable long-term unemployment indicators. It can therefore be

                                                                                                  52
concluded that the labor market dynamics, which depends on the economic structure of any
individual country, is in this case significantly different, and clearly unfavorable for Croatia.

Table 6: Comparison between relevant indicators in the Republic of Croatia and the Republic of
Austria
               Real GDP   Employment Unemployment            Long-term          Employment
              growth rate      rate             rate       unemployment           duration
             RoC RoA RoC            RoA    RoC      RoA    RoC      RoA       RoC        RoA
   2003       5.4    0.9  53.4      68.9   14.3      4.8    59.6    29.1       30.5       34.1
   2004       4.1    2.6  54.7      67.8   14.1      5.3    54.1    24.7       30.6       34.2
   2005       4.3    2.4   55       68.6    13       5.2    57.9    25.4       31.4       33.6
   2006       4.9    3.7  55.6      70.2   11.5      4.8    62.1    27.3       31.4       34.6
   2007       5.1    3.7  57.1      71.4    9.8      4.5    60.9    25.3       31.2       35.3
   2008       2.1    1.4  57.8      72.1    8.6      3.9    62.2    23.4       31.4        36
   2009       -6.9 -3.8   56.6      71.6    9.3      4.9     52     24.2       31.5       36.2
   2010       -2.3 2.1     54       71.7   12.1      4.5    58.8    26.7       31.5       36.4
   2011         0    2.7  52.4      72.1   13.8      4.2    63.5    26.6       31.3       36.3
   2012        -2    0.8  50.7      72.5   16.3      4.4    63.7    24.2       31.1       36.6
AVERAGE 1.47 1.65 54.73 70.69 12.28 4.65 59.48 25.69                          31.19      35.33
Source: Eurostat

Given that the Republic of Austria had a higher average rate of economic growth, applied to a
higher base, it is clear that the tax pressure in the Republic of Austria poses a significantly smaller
burden. Therefore, when analyzing the severance pay scheme in the context of the Austrian model,
it is necessary to consider the burden of the labor costs as one of the important foundations for
competitiveness. Table 7 compares social security contribution rates of the OECD countries and
the Republic of Croatia.




                                                                                                    53
Table 7: Social security contribution rates of the OECD countries and the Republic of Croatia,
expressed as a percentage of gross salary
                                                      Social security contributions
               State
                                            By worker          By the employer         Total
            Australia                           0.0                    5.6               5.6
         Republic Austria                      14.0                   22.6              36.6
             Belgium                           10.8                   23.2              34.0
             Canada                             6.6                   10.6              17.2
               Chile                            7.0                    0.0               7.0
         Czech Republic                         8.2                   25.4              33.4
            Denmark                             2.7                    0.0               2.7
             Estonia                            2.1                   25.6              27.7
             Finland                            6.2                   18.6              24.8
              France                            9.5                   30.6              40.1
            Germany                            17.3                   16.4              33.7
              Greece                           12.8                   22.2              35.0
             Hungary                           14.4                   22.2              36.6
              Iceland                           0.4                    7.2               7.6
              Ireland                           2.9                    9.7              12.6
               Israel                           7.3                    4.4              11.7
                Italy                           7.2                   24.3              31.5
               Japan                           12.0                   12.6              24.6
               Korea                            7.4                    9.2              16.6
           Luxembourg                          11.0                   11.0              22.0
             Mexico                             1.2                   10.5              11.7
           Netherlands                         13.9                    9.7              23.6
          New Zealand                           0.0                    0.0               0.0
             Norway                             6.9                   11.6              18.5
              Poland                           15.3                   14.4              29.7
             Portugal                           8.9                   19.2              28.1
             Slovakia                          10.5                   21.8              32.3
             Slovenia                          19.0                   13.9              32.9
               Spain                            4.9                   23.0              27.9
             Sweden                             5.3                   23.9              29.2
           Switzerland                          5.9                    5.9              11.8
              Turkey                           12.9                   14.2              27.1
         United Kingdom                         8.5                    9.8              18.3
               USA                              5.1                    8.9              14.0
            Ø OECD                              8.2                  14.36             22.56
             Ø EU 15                           9.06                  17.61             26.67
             Ø EU 21                           9.78                  18.45             28.23
       Republic of Croatia                     20.0                   15.2              35.2


                                                                                                 54
Source: Organisation for Economic Co-operation and Development Taxing Wages 2011-2012
Paris: Organisation for Economic Co-operation and Development, 2012, p. 16

It can be noted that the workers in the Republic of Croatia are burdened by almost the highest
social security contribution rate in comparison to the developed countries. In terms of the total
burden, France and the Republic of Austria are heading the list. The Republic of Croatia has made
some progress on this issue through the past twenty years, slowly reducing the contribution rates
for both workers and employers. Thus, the health insurance contribution was reduced on 1st May
2012 from fifteen to thirteen percent. In any case, any further increase of the burden of
contributions in the Republic of Croatia would have very unfavorable effects in the context of the
desire to increase competitiveness. In that sense, it is proposed to abolish a part of the contribution
for insurance against injuries at work, the employment contribution and the special contribution for
the employment of disabled persons. However, eliminating the mentioned contributions would
only imply transferring these costs from the gross salary to the “invisible” costs, which would have
to be borne by the employers, workers and the state budget of the Republic of Croatia. It would
therefore be interesting to establish the social cost of such replacements in contributions.

One of the important goals of the reform would be to increase labor force mobility, however the
analysis of the effects of this reform in the Republic of Austria did not show significant effects to
this end. Table 8 shows that the lack of labor force mobility in the Republic of Croatia is still
caused by specific features of the economic structure and its lacking power to create jobs – looking
at the duration of the period of seeking work among the unemployed, long-term unemployed
persons remain the prevalent group.

Table 8: Unemployed persons categorized by the duration of seeking employment
                     Total (in thousands)                       Total (in percentages)
 in months    2009      2010      2011       2012      2009       2010       2011      2012
    Total      160       206       232        272       100        100        100       100
     <1          4         6         5                   2.5       3.0        2.1
     1-5        35        42        43         51       22.2      20.3       18.5      18.9
    6-11        26        38        34         36       16.6      18.3       14.6      13.3
   12-23        26        44        55         59       16.1      21.3       23.6      21.8
    24>         66        75        95        119       41.2      36.5       40.9      43.7
Source: CBS Labor Force Survey

In the light of the above, the question that surfaces is to what extent the severance pay scheme
influences labor force mobility in the Republic of Croatia. Based on Figures 8 and 9, it can be
concluded that severance pay does not represent an important factor in deciding whether to retire
or change a job. We can therefore conclude that it is not very likely that any changes in the
severance pay scheme would produce significant effects on the labor market in the Republic of
Croatia.




                                                                                                    55
Figure 8: Retired persons (between 50 and 69 years of age), categorized by reasons for retirement

            Ostali razlozi
               Obiteljski razlozi ili
                  skrb o drugim
                     osobama                                                                 Zdravstveni razlozi,
                                                                                                  invalidnost
                   Ostali razlozi
                                                                               Ispunili uvjete za
                 povezani s poslom
                                                                                    mirovinu
                                                                                  (dobrovoljni
                  Dosegnuli dob            Ostali bez posla, ne                     odlazak)
                                            mogu naći drugi,
                                             otkaz, stečaj ili
                      Povoljni financijski
                                                likvidacija
                            uvjeti
                                               poslodavca
Source: CBS Labor Force Survey
       (reasons, in the order of appearance in the above Figure)
       Other reasons
       Family reasons or care for other persons
       Health reasons, disability
       Other job-related reasons
       Conditions for retirement fulfilled (voluntary retirement)
       Reached the retirement age
       Lost their jobs, cannot find another job, bankruptcy or liquidation of the employer
       Favorable financial conditions

Figure 9: Workers (between 50 and 69 years of age) who would accept early retirement, by reasons

                                                 Teški uvjeti rada na
                                                        poslu
                             Smanjenje iznosa
                               mirovine s
                               vremenom
                                                                          Uvjeti za odlazak u
                                                                          mirovinu mogli bi
                                                                           biti nepovoljniji
                                                  Ostvarivanje prava
                                                   na otpremninu
                                            Strah od gubitka
                                          posla i nemogućnost
                                           dobivanja novoga
                                                                                                Osobni, obiteljski
                                                                                                    razlozi

Source: CBS Labor Force Survey
        (reasons, in the order of appearance in the above Figure)
       Difficult conditions of work
       Reduced amount of the pension because of early retirement
       Conditions for retirement might be more unfavorable
       Exercising the right to severance pay
       Fear of losing job and not being able to find a new job
       Personal, family reasons



                                                                                                                     56
It ought to be mentioned that the Republic of Croatia has by far lower labor force productivity than
the Republic of Austria. This means that average Croatian employer has lower added value per
worker. Therefore, any increase in costs would now pose a relatively higher burden to employers
than it is the case in the Republic of Austria. Naturally, this rule also applies across industries, in
the sense that industries that create higher added value will be less burdened, unlike those with
lower productivity, which would carry a higher burden. Such burden is also higher in absolute
terms, because the lack of productivity increases the need for a higher number of workers. On the
other hand, their dismissal would result in a higher burden of severance pay payments.



7 Simulation of the model
The current severance pay regulations and the way that the amount of severance pay is determined
are based on the years of service with the same employer, the average monthly gross salary in the
last three months and the tax treatment of this kind of income. The model that is proposed to
replace this scheme would determine the amount of severance pay based on the total years of
service, that is of continued employment, gross salary contributions, tax treatment of severance
pay, but also the rate of return achieved by managing the accumulated funds. Given such a diverse
base of regulating the entitlement to severance pay and determining the amount, it is important to
make projections concerning the amounts of claims based on the entitlement to severance pay.

The following simulations were developed based on the assumed average amount of the gross
salary and years of service, 18% surtax, gross salary contribution of 1.5% and the return rate of
five percent. Table 9 shows the amounts of severance pay, which would be paid under the current
scheme. As it was mentioned, the current national severance pay scheme in the Republic of Croatia
is opposite to the principle of vertical equity, which is otherwise applied in Croatia in standard
income taxation. Namely, while the income tax is significantly progressive, the severance pay
scheme shows minimum progression.90




90
  Please see: Urban, Ivica. Što porez na dohodak u Hrvatskoj čini progresivnim? (Why can income tax in Croatia be
considered progressive?) Newsletter of the Institute of Public Finance, 2006, 23. (available at:
www.ijf.hr/newsletter/23.pdf); Urban, Ivica. Raspodjela poreznog opterećenja u Hrvatskoj (Distribution of the Tax
Burden in Croatia). Newsletter of the Institute of Public Finance, 2011, 58. (available at:
www.ijf.hr/newsletter/58.pdf).

                                                                                                              57
Table 9: Amounts of severance pay claims based on average gross monthly salary and years of
service (the current national severance pay scheme)
                                                   Years of service
  Monthly gross
  salary amount
      (HRK)           1         2          5         10             15      20       30
     3,000.00         -     2,000.0     5,000.0   10,000.0      15,000.0 20,000.0 30,000.0
     5,000.00         -     3,333.3     8,333.3   16,666.7      25,000.0 30,000.0 30,000.0
    10,000.00         -     6,666.7    16,666.7   33,333.3      50,000.0 60,000.0 60,000.0
    15,000.00         -    10,000.0 25,000.0      50,000.0      75,000.0 90,000.0 90,000.0
    20000.00          -     13333.3     33333.3    66666.7      100000.0 120000.0 120000.0
    30000.00          -     20000.0     50000.0   100000.0      150000.0 180000.0 180000.0
Source: Calculations by the author

Table 10 shows the amounts of severance pay claims within the new scheme. It can be noted that
the amounts paid by the employer are significantly smaller in comparison to the existing scheme.
The new scheme also allows for continuity with respect to this entitlement, regardless of the years
of service with any individual employer, but also irrespective of any limitations in the total
duration of worker’s employment. In this way, seasonal and other workers, whose employment
contracts are shorter than two years are still entitled to severance pay.

It ought to be said that within the new scheme, in the given example, the amount of severance pay
exceeds the amount of non-taxable income only for workers with the average monthly salary of
HRK 20,000.00 and the total of thirty years of employment, and for workers with the average
monthly salary amounting to HRK 30,000.00 after the tenth year of employment. It is important to
mention that the given example only provides a frame for considerations and analyses. Namely, in
practice, severance pay under the current scheme would be much smaller, since the workers in the
private sector are much less bound to the same employer in the longer term. In other words, the
amount of paid severance pay would be much smaller, and most workers would be entitled to
severance pay based on shorter periods of service with the same employer.

Table 10: The amounts of severance pay claims based on the average monthly gross        salary and
years of service (the new model)
                                               Years of service
    Monthly
   amount of
  gross salary
     (HRK)             1         2        5         10           15       20                 30
    3,000.00         540.0    1,162.4  3,133.0   7,131.7      12,235.0 18,748.4           37,670.8
    5,000.00         900.0    1,890.0  5,167.0 11,816.3 20,302.6 31,133.6                 62,599.5
   10,000.00        1,800.0   3,780.0 10,334.0 23,632.6 40,605.3 62,267.2                125,199.0
   15,000.00        2,700.0   5,670.0 15,501.1 35,448.9 60,907.9 93,400.8                187,798.5
   20,000.00        3,600.0   7,560.0 20,668.1 47,265.2 81,210.6 124,534.5               216,667.3
   30,000.00        5,400.0 11340.0 31,002.1 66,913.6 106,904.6 152,837.8                269,551.3
Source: Calculations by the author

                                                                                                58
Table 11 shows differences in the amounts of severance pay claims produced by the existing and
the new model. It can be noted that the new model increases payments to workers only in case the
severance pay is paid based on thirty years of service (in practice, due to shorter periods of
employment at the same employer, the payments in the new system would still be significantly
more favorable than the example shows – especially in case of frequent change of employer). It
can also be concluded that this system of capitalizing the contributions is more favorable for
workers with a higher monthly income, because the return rate is applied to a higher base.

Table 11: Difference in the amounts of severance pay claims based on average monthly gross
salary and years of service between the current national severance pay scheme and the new model
                                                   Years of service
    Monthly
   amount of
  gross salary
     (HRK)           1           2           5           10           15          20         30
    3,000.00       540.0      -837.7     -1867.0      -2,868.3     -2,765.0   -1,251.6    7,670.8
    5,000.00       900.0     -1,443.3    -3,166.3     -4,850.4     -4,697.4    1,133.6   32,599.5
   10,000.00      1,800.0 -2,886.7       -6,332.6     -9,700.7     -9,394.7    2,267.2   65,199.0
   15,000.00      2,700.0 -4,330.0       -9,498.9 -14,551.1 -14,092.1          3,400.8   97,798.5
   20,000.00      3,600.0 -5,773.3 -12,665.2 -19,401.5 -18,789.4               45,34.5   96,667.3
   30,000.00      5,400.0 -8,660.0 -18,997.9 -33,086.4 -43,095.4 -27,162.2 89,551.3
Source: Calculations by the author

Finally, it is necessary to point to the relevance of adequate return rates on severance pay
contributions. Figure 10 compares the amount of severance pay claims under the existing scheme
(flat line – HRK 100.000,00), based on thirty years of service and an average monthly gross salary
of HRK 10.000,00. On the same basis, the Figure shows the development of revenue from paid
contributions based on different rates of return – ranging from 1-5%. In this example, the 4%
return rate is the minimum rate, which sustains the amount of paid severance pay at the same level.
In practice, the contribution rate has to be even higher because of the negative influence on the
return rate caused by the need to reserve a significant share of the capital for current payments and
a share of the amount that belongs to the fund that manages the revenue from severance pay
contributions.




                                                                                                  59
Figure 10: Impact of the return rate on the amount of severance pay in the new scheme




                                                                                                      30god10000
                                                                                                      30godst10000




Source: Calculations by the author

Figure 11 shows the average annual return of mandatory pension insurance funds (for the past five
years), and during 2013. It can be noted that the nominal rates of return are relatively low. It is
therefore not realistic to expect significant rates of return on capital from future contributions.

Figure 11: Rates of return achieved by mandatory pension insurance funds

              PGP, AZ, 5.22            PGP, Erste plavi, 5.2                                     PGP, Raiffeisen OMF,
                                                                                                         4.81
                                                                      PGP, PBZ CO, 4.32



                                                                                                                  2013
      2013, AZ, 2.62
                                                                                                                  PGP
                                                               2013, PBZ CO, 2.1
                              2013, Erste plavi, 1.76
                                                                                          2013, Raiffeisen OMF,
                                                                                                  0.93




Source: www.in-fin.info




                                                                                                                     60
8 General open issues with respect to the reform and
regulation of the severance pay scheme in the Republic of
Croatia and approaches to their resolution
Analysis of the provisions of the Labor Act, the practice resulting from the severance pay scheme
in the Republic of Croatia and placing this scheme in the global context of how national severance
pay schemes are regulated, it is possible to identify some key open issues that determine the
significance and the character of that national scheme.

The main issue that surfaces with respect to the reform and the regulation of the severance pay
scheme in the Republic of Croatia is identifying the need to approach a systematic reform, which
would thoroughly change the existing scheme in a way that it is based on the elements of the
reformed Austrian severance pay system, which would be one of the options for a “systematic”
reform of the scheme. Alternatively, there is a possibility to consider amending and supplementing
the existing legal scheme with respect to some of its elements of legal and practical arrangements,
which would mean changing some elements or parameters of the existing scheme, but not touching
the whole arrangement. The third approach would be to keep the existing state as it is. Although
possible, the latter solution is not realistic and it will not be considered here.

The first, systematic approach to reform and regulation of the severance pay scheme in the
Republic of Croatia, would lead to comprehensive changes in the current situation, with a
completely new system, which requires consideration and analyses of various solutions with
respect to all elements of the system, as it was done in this analysis.

The second approach that would only deal with certain parameters of the scheme would make it
possible to influence different elements of the system, to reposition them and thus to rearrange the
existing scheme. Possible points that could be influenced are the following:
     eligibility conditions for the entitlement to severance pay (duration of the employment, the
      manner of terminating the employment contract etc.);
     amounts of severance pay per year of service with a particular employer;
     maximum amount of severance pay per worker;
     possibility of different, more favorable regulation of the entitlement to severance pay in other
      sources of labor law (collective agreements, work regulations, employment contracts etc.);
      and
     the tax status of the right to severance pay, particularly when it comes to more favorable
      regulation of the entitlement to severance pay in other sources of labor law.

When it comes to opting between the first and the second approach and to designing the elements
of the scheme within the selected option, a valid informed conclusion and choice between possible
options can only be made if one has access to comprehensive economic and other indicators of the
existing system, and to a thorough analysis of the outcomes based on these indicators. It is none
the less important to clarify the intended outcomes and to consider whether there are more simple
ways to achieve them, without introducing systemic changes. One thing that always has to be taken
into account is that – due to various functions of severance pay – the decisions on the approach to
the national severance pay scheme and its outcomes are directly related to the decisions regarding


                                                                                                   61
the labor market policy, tax policy, economic and social policy in general, so that in making this
decision, all considerations have to be analyzed in view of these policies as well.

It is none the less important to understand that in deliberating all the open issues, one has to take
into account that these issues are of particular significance for the trade unions and employers, and
without a high level of their support for the selected approach and for concrete elements of the
selected approach, it is difficult to expect that the legislative changes will be accepted. Besides,
given that the existing national severance pay scheme is not just a reflection of statutory
regulations but also of more favorable schemes presented primarily in collective agreements and
work regulations, and given that there is already a practice in applying these schemes, all
significant changes imply a change of approach in the practice of collective bargaining and the
unilateral self-regulation by the employers in work regulations. Consequently, all of the above
points to the necessity to have a very thorough analytical approach to any changes in the existing
scheme, and to reach a high level of consensus in the process.


9 Conclusion on strengths and weaknesses of introducing a
new national severance pay scheme model
Legally and practically, virtually all countries value the protection of workers in case of their
employment contract termination. To that end, the countries establish a scheme of rights and duties
of workers and employers. One of the systems which is being built legislatively or in practice to
take on that role is a national severance pay scheme, which rests upon the right to severance pay as
a consequence of an employment contract termination. There are different mechanisms by which
the scheme operates, ranging from compulsory contributions for the purpose of severance pay to
obliging the employers to make a one-off severance pay in case of an employment contract
termination. The very foundations of the scheme can vary as well, and can range from statutory or
legislative arrangement of the scheme or a liberalised scheme, whose features are actually
determined by collective agreements. One thing unique to the system is the fact that any national
severance pay scheme has important roles to play and outcomes to reach, both from the perspective
of individuals – the workers and the employers, and the society or economy alike. On the grounds
of such importance and value, such a scheme is virtually omnipresent, even when its roles and
outcomes are being accomplished in different ways. This is confirmed by sizable differences
between, for instance, the European Union member-states: the differences in terms of persons and
scope of persons exercising the right to severance pay, the conditions for exercising the right to
severance pay, the severance pay amount and its tax status.

An unusual matter is that the entitlement to severance pay, the severance pay itself and the national
severance pay schemes have been quite neglected as a subject of scientific or specialist discussions
and research. However, this topic is being opened as well in a contemporary environment, which
attributes a great deal of attention to labour market efficiency, the fact that there is a connection
between the right to severance pay and the labour market rigidities or flexibilities, its impact to
employment and employability that may be also expressed in terms of an EPL index. This is where
specificities of individual national schemes, certain elements of the schemes, the correlation
between economic and demographic indicators, labour market properties, the conditions of
employment and the activities of active population, institutional and regulatory properties of the

                                                                                                  62
social security and the tax systems, the degree of legislative and tax evasion combined, become a
framework for reflection.

The need for rationalisation and flexibility in the labour market, including by way of providing for
it through labour law, opens up space in the Republic of Croatia for reflection on the right to
severance pay and the national system as a vehicle for exercising such a right. Therefore, one of
such reflections has been presented via this analysis. To the greatest extent, it is founded upon the
comparison between the Croatian and Austrian severance pay scheme properties, and some other
solutions to a lesser extent. From this angle, the possibility of the implementation of a new
severance pay model that would primarily rest upon the properties of the reformed Austrian
national severance pay scheme is being analysed. Some room was devoted to an analytical
overview of the existing arrangements and a possibility for changed outcomes within such an
arrangement.

As the foundation of methodical reflection, the analysis itself has some limitations. These are first
of all reflected in a lack of data. However, even on the basis of quite a limited insight into data and
analysis of relevant labour market indicators in the Republic of Croatia, it is possible to establish
and arrive at conclusions on positive and negative aspects of the existing systems. Table 12 below
presents a summary of strength and weaknesses of the existing severance pay scheme model.

One may immediately say that a new national severance pay scheme model that would be built
around elements that were purposed in the Republic of Austria for reforming the scheme was not
chosen by chance. The similarity between the existing state-of-play in the Republic of Croatia
against what existed in the Republic of Austria before the reform, coupled with closely matching
conclusions on the weaknesses of the arrangements in both cases, justifies the reference to the
Austrian reform model as a new model to be applied in the Republic of Croatia. It is, therefore,
easy to explain a matter that could otherwise be interpreted as an interesting coincidence: The
reform oriented following the properties of the Austrian severance pay scheme relatively simply
overrides weaknesses and problems characterising the existing scheme in the Republic of Croatia.
This may also be seen from Table 12 below. Thus, one of the most important results of the reform
in the Republic of Austria deals with securing the disbursement of severance pay to the greatest
portion of private sector workers. Such an effect would be even more important in the Republic of
Croatia. However, since there are no relevant data at hand that would enable an assessment of a
broader spectrum of the reform impact, the first step towards improving the system should surely
involve making a complete database available that would be the foundation for conducting a
relevant analysis of this projection.




                                                                                                    63
Table 12: Summary of strengths and weaknesses of the current national severance pay scheme and
the new model
                            Current national severance pay                 New model
                                         scheme
     Positive aspects     high level of severance pay            ensures the right to severance
                          suitable         for      successful    pay for all workers
                             companies        with       greater  a     reduced     burden     of
                             productivity of workers               terminating an employment
                          ensures disbursement of a               contract for severance paying
                             portion of severance pay to           employers
                             workers of an employer under  assumes the creation of a
                             bankruptcy                            central database
                                                                  impetus to capital market
                                                                  relaxes the state budget of the
                                                                   Republic of Croatia
     Negative aspects     it is founded on an inadequate  tax wedge (likely adverse
                             institutional and regulatory          impact on competitiveness)
                             framework (which is rigid, and  no impact on labour force
                             does not guarantee the payment        mobility
                             of severance pay to all workers  reduces the amount of
                             and in the defined amounts, and       disbursed severance pay to
                             it allows for manipulations)          workers
                          labour market disruption               dependence                   on
                          inadequate tax treatment                macroeconomic        indicators
                          does not secure right to                and management of a
                             workers’       severance       pay,   competent fund
                             especially in the private sector     takes up a sizable working
                          procyclical          impact        on   capital from employers
                             employers, weakening them
                             during economic and financial
                             crisis, making it impossible to
                             terminate employment contracts
                             in case of financial difficulties
                          especially jeopardises labour
                             intensive sectors
                          burden transferred from a
                             portion of employers to the state
                             budget of the Republic of
                             Croatia and workers
          Risks            economic and financial trends  yield rate
                                                                  tax treatment

Based on the previously conducted analysis of the scheme in the Republic of Croatia and the
options for improving the scheme following the Austrian model, coupled with the strengths and
weaknesses of the current national severance pay scheme and the new model presented in the table
above, one may arrive at a number of conclusions, as follows.

                                                                                               64
CONCLUSION 1: The existing scheme is characterised by numerous problems and requires
improvement.

The relatively easy-to-detect problems stem from the fact that there is a sizable level of
unexercised or partially exercised rights to workers’ severance pay predominantly in the private
sector, which in a way derogates the protective role of and the sense of the entitlement to severance
pay; further, the existing scheme virtually enables abuses in the public sector, thereby transferring
the burden of severance pay to the state budget of the Republic of Croatia; moreover, the existing
scheme is burdensome for workers, the state budget of the Republic of Croatia and some
employers who comply with the relevant arrangements; and it is questionable whether or not the
tax treatment of severance pay is adequate. All these problems necessitate action-taking.

CONCLUSION 2: A detailed analysis of the existing severance pay scheme is a precondition for
taking any action.

Without an analytical background, it is impossible to identify the actual state-of-play, problems
and critical points, as well as their actual relevance by which they prevent target outcomes from
being achieved. Against such a backdrop, a detailed analysis of the current state-of-play at the
level of individual employers, by sectors and economy-wide stands as a conditio sine qua non. All
the more so, strengths and weaknesses are dependent not only of theoretical properties of the
models being compared or the legislative arrangements, rather they also depend on their
application in practice. And such a disparity between the regulatory and the practical is
problematic in its own right for the rule of law in the Republic of Croatia.

A significant practical problem surfaces along with the need for making an analysis of the existing
scheme. To a large extent, the analysis is currently hindered due to the non-existence of a
centralised and a comprehensive database on claims and disbursements by way of the right to
severance pay. Therefore, the creation of such a database would be the first step towards the
improvement and enabling an analysis of the existing scheme.

CONCLUSION 3: Reform goals should be defined

The direction of any reform depends on what is it intended to achieve. After the development of an
analytical background, therefore, the next assumption for taking statutory action deals with the
definition of goals to be achieved via the reform. Without that, any action would boil down to mere
“takeover” of models and “copy and paste” of legal solutions, without any serious assessment of
how, in which period and what results it could yield. In terms of severance pay, and given that this
analysis at its very beginning stated that severance pay may have different functions and that the
dynamics and trends of such functions could be monitored over time, the definition of the reform
goals becomes all the more so important.

CONCLUSION 4: A reform following the Austrian severance pay scheme model implies more
sizable changes.

To conduct a reform following the Austrian scheme model, it is important not only to define
adequate reform goals, but it is also necessary to establish the way in which the Austrian model

                                                                                                  65
could be applied within the framework of the Croatian institutional and regulatory arrangements,
i.e. it requires an adaptation of the model to the framework of such arrangements.

Moreover, since a reform following the Austrian model attributes a broader meaning to severance
pay and it no longer is just a consequence of an employment contract termination, one must take
account of the position and the role of the new right to severance pay in a broader context of the
social protection system in the Republic of Croatia.

CONCLUSION 5: The application of the Austrian model is not necessarily the outcome of the
reform – it is possible to take different actions into the national severance pay scheme.

In addition to conducting a reform following the Austrian model, it would also be possible to apply
different scenarios or different reform goals, comprehensive to a greater or lesser degree, as would
be to focus actions beyond the labour law framework. For instance, this may entail revisiting all
the parameters of the existing national severance pay scheme – eligibility requirements, amounts,
etc. – and even regardless of the reforms within the framework of the Labour Law, we maintain it
would be needed to explore modes for changing the severance pay tax treatment towards aligning
it with the properties of the tax system (progressivity) and providing stimulus to savings. Even the
latter action alone could be a significant intervention into the national severance pay scheme.

CONCLUSION 6: Sustainability and implication of each proposed action should be tested.

Once the parameters for taking action are defined, it is necessary to further explore the extent to
which such a course of action would burden individual employers, how would this burden be
allocated sector-wise and what would be the impact on the economy overall, and what would be
the level of workers’ rights given that this stands as an important element in the evaluation of
sustainability of any proposal.

CONCLUSION 7: Consensus between social actors and stakeholders should be achieved to the
greatest extent for the purpose of introducing a new national severance pay system.

Given the content of the actions, the introduction of a new national severance pay scheme should
be previously empowered by reaching a consensus between all actors and stakeholders – the
Government of the Republic of Croatia, unions and employers’ as parties to tripartite social
relations – in order to satisfy the interest of economic sustainability and labour force protection. If
a full consensus cannot be reached, it would be worthwhile to reach an agreement between all the
parties on the proposed solution to the greatest extent.

Based on these conclusions, actions towards arranging the right to severance pay should
undoubtedly be taken. However, an answer to whether or not such a course of action should
critically be oriented following the properties and outcomes of the Austrian severance pay scheme
should be given in a professional and a detached manner, taking account of all the arguments
presented.

As arguments in favour of this solution, one may indicate the need for equalising the requirements,
rights and duties of all workers, as a response to polarisations existing in the Croatian society and
the Croatian labour market. One such polarisation exists between employees with open-ended full-

                                                                                                    66
time employment contracts and the others: the unemployed, the workers with fixed-term
employment contracts, those hired part-time, seasonally, etc. Another polarisation is between
employers: the successful ones who pay generous severance pays and the less successful ones
facing bankruptcy and liquidation, where workers not only fail to receive any severance pay but
also frequently do not receive the unpaid salaries. This could improve the social image, which in
turn may improve the elements of security and equity in the labour market, especially in the light
of the announced introduction of flexibility.

One must simultaneously bear in mind certain weaknesses to such a path. This would result in an
additional rise in labour cost, and the difference between the employer’s cost and a worker’s net
wage (tax wage). The fact that the employment contract termination cost would no longer rest with
the employers could lead to a situation where such a severance pay scheme loses its preventative
role in employment contract termination. There is also an issue of a transitional period during
which the severance pay fund should be supported by contribution, while guaranteeing for the
disbursement of the reached severance pay levels, as the scheme would otherwise hardly be
acceptable to the unions.

The utilisation of the severance pay fund also appears as an important question. How much and
how would employers contribute to the severance pay fund under illiquidity is a question that may
be solved. However, the outcome of the fund’s operation during an economic crisis, the investment
and yields, this is an issue without a fully clear and certain answer or evaluation.

All of the above points to the need for a balanced and well thought approach. As per the proposed
flow of conclusions, such an approach should be used as a vehicle for analysing the existing state-
of-play and relevant elements, examining all available experiences and models and avoiding any
rushed decisions on drastic changes to the existing status.


10 References

Abfertigungen im Spannungsfeld der Wirtschaftspolitik – Eine interdisziplinäre Analyse (ed.
Genser, Bernd). Vienna: Manz, 1987
Babić, Vera et al. Veliki komentar novog Zakona o radu (Comprehensive Commentary of the new
Labor Act). Zagreb: Vaša knjiga, 2010
Bassanini, Anarea; Nunziata, Luca; Venn, Danniele. Job Protection Legislation and Productivity
Growth in OECD Countries. Economic Policy, 2009, 58.
Bejaković, Predrag. Poteškoće oko mogućeg osnivanja posebnog fonda za otpremnine (Difficulties
related to possible establishment of a Severance Pay Fund) Radno pravo – Journal, 10, 2013, 5,
Boeri, Tito; Garibaldi, Pietro. Beyond Eurosclerosis. EconomicPolicy, 24, 2009, 7.
Božina, Anja et al. Radni odnosi - Primjena Zakona o radu (Employment Relations – Application
of the Labor Act): RRiF plus d.o.o., 2010
Bulaš, Ivo. Dokup mirovine – vrsta otpremnine (Purchase of Supplementary Pension Benefits – a
Type of Severance Pay). Radno pravo – journal, 8, 2013, 4.
Davis, Steven J.; Haltiwanger, John. Sectoral Job Creation and Destruction Responses to Oil Price
Changes (NBER WorkingPapers 7095). Cambridge: National Bureau of Economic Research Inc.,
1999

                                                                                                67
Crnić, Ivica. Otkaz ugovora o radu (Termination of the Employment Contract). Zagreb:
Organizator, 2013.
Europan Industral Relations Observatory. Reform of Severance Pay under Discussion. Dublin:
Europan          Industral      Relations         Observatory,        2001        (available     at:
www.eiro.eurofound.ie/2001/06/inbrief/at0106220n.html).
Felderer, Bernhardet al. Perspektiven der betrieblichen Altersvorsorge in Österreich – Studie im
Auftrag der Wirtschaftskammer Wien. Wien: Institute for Advanced Studies, 2008
Glossary of Labor Law And Industrial Relations (With Special Reference to the European Union).
Geneva: International Labour Office, 2005
Holzmann, Robert et al. Severance Pay Programs around the World: History, Rationale, Status,
and Reforms. Hirschegg; Marseille; Pretoria; Washington: The World Bank; IZA, 2011
Katrougalos, George S. The Implementation of Social Rights in Europe. Columbia Journal of
European Law, 1996, 2, Mishra, Ramesh. The Welfare State in Crisis: Social Thought and Social
Change. Brighton: Wheatsheaf Books, 1984
Klec, Gerald. Flexicurity and the Reform of the Austrian Severance-pay System. Brussels: ETUI-
REHS, 2007
Kristen, Sabine; Pinggera, Winfried; Schön, Rosemarie. Abfertigung Neu: Überblick über die
Neuregelungen durch das Betriebliche Mitarbeitervorsorgegesetz. Recht der Wirtschaft 2002, 7.
Krištof, Marko. Potiču li neoporezive otpremnine prerano umirovljenje? (Does Non-Taxable
Severance       Pay    Encourage      Early     Retirement?),    Banka,     2011     (available  at:
www.banka.hr/UserDocsImages/.../AMS_Kristof_2011-03_17.ppt).
Minimum wage for the period 1 June 2012 to 31 May 2013 in the Republic of Croatia according to
the publication of the Central Bureau of Statistics (Official Gazette 60/12).
Opinion of the Ministry of Labor and Social Welfare, Class: 110-01/97-01/61, Filing nr.: 524-02-97-
2 of 14 March 1997
Decision of the Supreme Court of the Republic of Croatia no. Rev-1368/01 of 23 October 2001
Organisation for Economic Co-operation and Development. Employment Outlook. Paris:
Organisation for Economic Co-operation and Development, 2004
Ploug, Niels; Kvist, Jon. Social Security in Europe: Development or Dismantlement? The Hague;
London; Boston: Kluwer Law International, 1996
Income Tax Ordinance (Official Gazette 95/05, 96/06, 68/07, 146/08, 2/09, 9/09 – correction,
146/09, 123/10, 137/11, 61/12 i 79/13).
Ordinance on the Content of Calculation of Salaries, Remuneration or Severance Pay (Official
Gazette 81/10).
Pravni leksikon (Legal Lexicon). Zagreb: Leksikografski zavod Miroslav Krleža, 2007
Puljiz, Vlado et al. Socijalna politika (Social Policy) Zagreb: Pravni fakultet, 2005
Radni odnosi u Republici Hrvatskoj (Employment in the Republic of Croatia) (ed. Potočnjak,
Željko). Zagreb: Faculty of Law Zagreb; Organizer, 2007
Ravnić, Anton. Osnove radnog prava – domaćeg, usporednog i međunarodnog (Labor Law
Fundamentals – Domestic, Comparative and International Law) - Zagreb: Pravni fakultet, 2004
Ravnić, Anton. Socijalna država i država blagostanja (Social State and Welfare State), in: Hrvatska
kao socijalna država: Zadanosti i usmjerenja (Croatia as a Social State: Actualities and Directions)
(ed. Bahtijari, Hašim). Zagreb: Centar za industrijsku demokraciju SSSH, 1997
Reforming Severance Pay (ed. Holzmann, Robert; Vodopivec, Milan). Washington: The
International Bank for Reconstruction and Development; The World Bank, 2012
Bankruptcy Law (Official Gazette 44/96, 29/99, 129/00, 123/03, 82/06, 116/10, 25/12 and 133/12).


                                                                                                 68
Basic Collective Agreement for Civil Servants and Employees in Public Service (Official Gazette
141/12).
Urban, Ivica. Što porez na dohodak u Hrvatskoj čini progresivnim? (Why Can Income Tax in
Croatia Be Considered Progressive?) Newsletter of the Institute of Public Finance, 2006, 23.
(available at: www.ijf.hr/newsletter/23.pdf).
Urban, Ivica. Raspodjela poreznog opterećenja u Hrvatskoj (Distribution of the Tax Burden in
Croatia). Newsletter of the Institute of Public Finance, 2011., 58. (available at:
www.ijf.hr/newsletter/58.pdf).
Act on the Criteria to Participate in Tripartite Bodies and Representation for Collective Bargaining
(Official Gazette 82/12 and 88/12 – correction).
Act on Insurance of Workers' Claims in the Case of the Bankruptcy of the Employer (Official
Gazette 86/08 and 80/13).
Income Tax Act (Official Gazette 177/04, 73/08, 80/10, 114/11, 22/12 and 144/12).
Labor Act (Official Gazette 149/09, 61/11, 82/12 - Act on the Criteria to Participate in Tripartite
Bodies and Representation for Collective Bargaining, 88/12 – Correction of the Act on the Criteria
to Participate in Tripartite Bodies and Representation for Collective Bargaining 73/13).
Labor Act (Official Gazette 38/95, 65/95 – correction, 17/01, 82/01, 114/03, 142/03 and 68/05).
Zuber, Marija. Otpremnine – pravo radnika i porezno određenje (Severance Pay – Workers’
Entitlement and Tax Treatment). Zagreb: Računovodstvo i financije, 2012
Zuber, Marija. Kakva je veza između uplaćenog doprinosa i mirovine? (What is the Relation
between Paid Contributions and Pension?) Banka, 2011 (available at: www.banka.hr).




                                                                                                 69