City welcomes tax cut plans, doubts financing

Dresdner Kleinwort said on Wednesday that, overall, it views the decision to support the competitiveness of the economy by significantly reducing the tax burden on companies as positive. “We also welcome the decision to avoid new changes in VAT, which in our view would create new distortions and undermine again the MNB’s task to bring inflation back to target within a reasonable horizon”. At the same time, however, concerns on the fiscal performance will remain, “if not modestly intensify”, particularly from 2010 onwards.

The decision to avoid a VAT change is fundamentally positive, but puts significantly more pressure on the government’s commitment and ability to reduce spending and quickly tackle the black economy. According to the government, the black economy is estimated to value as much as 20% of GDP. Although that gives scope for large potential revenue collection, it is usually challenging to achieve meaningful results quickly, Dresdner said.

On a similar note, Christian Keller at Emerging Markets Strategy of Barclays Capital told Econews that “history tells us that governments that have built on this (extra tax revenues from the withening of the economy) too much (found that) these effects take some time ... they exist in theory but in practice it is usually quite difficult”. Tax reductions “are fine ... unfortunately, however, they have to reduce the deficit further, and without having an offsetting measure, i.e. a VAT increase, and hoping to finance it only from higher tax revenues - that seems to be a little bit of a risk”, Keller added.

4cast, a London-based financial research group, said that “one has to give credit” to the plan for the fact that “it strikes a healthy balance” of how the cuts are distributed across the sectors. This redistribution serves to boost competitiveness, hence medium term growth. The conditional nature of the implementation of the package is also an idea reflecting caution.

At the same time, however, “we have to express our deep skepticism” about the plan as “the Gyurcsány-2 package” is “largely based on wishful thinking.” Forint 1,200 billion is simply a far too big figure to be recovered purely from whitening the economy, 4cast said. “We do not expect incomes from whitening coming in (anywhere) near the targets ... in an optimistic case this will suffocate the Gyurcsány-2 package before its complete implementation, while in a pessimistic scenario it will derail the convergence program”, it added.

The fact that there is no VAT hike is clearly positive for monetary policy but the increased likelihood of softening budgetary discipline “that comes through the plan” leaves a strong negative impression that should only increase the apparent cautiousness of the Monetary Council, 4cast said. (MTI-Econews)