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CEU Business School column: Hungary’s tax system misses the mark

When it comes to encouraging growth and improving income distribution, the country’s tax regime seems inadequate. 

Written by Mária Findrik, professor, Central European University Business School. 

Taxation is a common criterion, and also a determinate regulatory tool, for multi-faceted economies. There are countries and cultures where the necessity of paying taxes is not questioned, as it is considered the natural accompaniment of social existence, while in other places taxes are looked on as a tribute and an annoyance – one that never seems to benefit the taxpayer.

Regardless of how we feel, paying taxes is necessary, as: a) the government uses this tool to redistribute incomes and encourage cohesion among members of society; and, b) the amount of taxes taken away have a serious motivating (or demotivating) factor on performance. A good tax system takes revenue in a fashion that does not harm the motivating factor of wages. (The challenges of a good tax system, which seeks to redistribute wealth with the lowest social costs possible, should not be confused with the challenge of efficiency facing Hungary’s current tax system.)

So how does Hungary’s system fare?

At first blush, it is music to our ears that the rate of personal income tax, and also the tax on interest, is dropping from 16% to 15%, while tax allowances for families expand. The government has also decided to decrease extraordinary banking taxes as well: In the highest bracket, taxes on the rateable tax base of more than HUF 50 billion drop from 0.53% to 0.31% in 2016, and to 0.21% in 2017-2018. For those banks that increase their lending activities as compared to 2009, the amount of extraordinary taxes can be decreased further. The above-mentioned factors encourage decision makers to expect wages per individual to grow, along with the growth of consumption and GDP. This growth is expected to boost business activities and credit discipline – and increase demand, thereby increasing tax revenue. The declared purpose of changes, in both personal tax and banking tax, is to boost employment, and secure the dynamics of economic growth, the two weak points of the Hungarian economy.

Decrease merely symbolic

Unfortunately, the symbolic decrease in personal income taxes will not solve the structural problems of the Hungarian tax system. One of the big issues is the high amount of overall taxes that must be paid, as compared to the typical European practices: There is a big difference between net wages, as compared to gross wages, and the huge tax bite is definitely demotivating. While in most developed countries taxpayers generally receive 75% of their wages, Hungarians receive less than 65% of their wages. That means that the Hungarian government is taking away more from salaries that are already below the international average.

The high levels of taxes on employment – especially the social security contribution, which is well above the international average – has a double negative effect: It not only obstructs the growth of employment, it also pushes a part of employment into the gray or black economy. Unlike most European countries, there is no maximum social security contribution that a Hungarian worker must make – the payment increases with the size of a worker’s salary, to potentially infinite levels.

Another structural problem with the Hungarian tax system is that the types of indirect taxes are high in number, ratio and amount. Hungary levies more than 60 different types of taxes, while in the majority of developed Western countries the number is less than 30-40 on average. The typical citizen is unaware of the impact of indirect taxes, due to their large number and confusing nature. In many cases, indirect taxes are created by the state to fill in unforeseen gaps in the budget. The transparency of the tax system is further eroded by the possibility of applying for individual exceptions in the case of indirect taxes. Professionals say that the Dutch and British tax systems are the most effective in Europe, because of their high transparency and accountability.

The Hungarian tax system also compares poorly with others because taxes on consumption are relatively high. In Hungary, the rate of taxes on capital is below the European average, but the taxes on consumption are higher than average. When choosing this structure, decision makers act as if Hungary had a stable, strong and high-capital-income entrepreneurial sector.

Last but not least, a few thoughts about whether the tax system successfully strengthens social cohesion through the redistribution of wages – assuming this is an aim. Given the wage structure, many people have said that a flat tax for the personal income tax system is only beneficial for those who earn more. In fact, charging the same percentage of personal income tax regardless of wages contributes to expanding the wage gap. That is why, in socially sensitive countries, personal income taxes are bracketed. Hungary’s family tax allowances are dependent on the level of earnings, and therefore they end up being more beneficial for those who earn more. Support offered per child has not been increased significantly since 2008. The government’s new home-purchase subsidy scheme for families (CSOK) directly excludes those who are not married or have had no employment for a certain amount of time. Fostered workers –those who are given employment by the government because they could not find jobs in the private sector – are not included in this scheme.

All in all, we do not see a determined willingness to solve the structural problems of the Hungarian tax system, so it is more than likely that their undesirable effects on employment and social cohesion will continue. It is cold comfort that the majority of Eastern European countries are trapped in the same cycle.

This column is part of a continuing series of opinion columns from experts at the Central European University Business School in Budapest. The opinions stated here do not necessarily reflect those of the Budapest Business Journal.