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How Low can it Go?

Employer social security contributions have been cut to a new low, though some are demanding even more to boost competitiveness. Economic reality might stand in the way of such wishful thinking.

Employers in Hungary have historically been exposed to a heavy tax burden. In 1996, they had to pay social security contributions of not less than 46.7%, which had gradually dropped to 22% by 2017. Thanks to the dynamic macroeconomic performance of the country, another cut of 2.5% to 19.5% was introduced as of January 1, 2018, which is half a percentage point more than had been initially envisaged.
According to the Hungarian Chamber of Commerce and Industry (MKIK), the picture is not all that rosy, though. As highlighted by its statement to the Budapest Business Journal, the reduction doesn’t fully offset the effects of heavy wage increases at micro enterprises and SMEs, with a large proportion of workers earning the minimum wage or the guaranteed wage minimum (the lowest salary to be paid to a person with secondary education).
“We believe improving the situation of the private sector would justify - and budgetary conditions would allow - a total decrease of 5% for 2018 instead of the currently effective 2.5%,” the MKIK statement reads.
Other economists have gone further still and demand a 50% cut of the current total. This scenario presumes that employers’ profitability would soar, the extra funds could be used to raise wages, those growing incomes would fuel consumption, and ultimately less Hungarians would consider leaving the country. Some might even consider returning.
However, Péter Honyek, senior manager at PwC’s tax and international mobility unit stresses that all those hypothetical effects won’t necessarily translate into reality. Profits would not land with staff exclusively, not the whole portion of wage increases would be spent on products and services, and it is wishful thinking to expect Hungarian immigrants to turn up in droves just because of such a measure.

Economic Reality

“Pushing down the social security contribution rate by a single percentage point causes HUF 100 billion in less taxes,” says Honyek. “Therefore, a 10% decrease would add up to HUF 1 billion, which equals the budget tax revenues of one whole month. There is no way the state budget could handle such a large deficit, which would need to be compensated by new taxes. And that would question the sense of the entire measure.”
Honyek recalls that the government has been going down the path of cutting labor costs with a view to economic reality. The fact that gross wages went up by 12.8% between October 2016 and 2017 can be mainly attributed to employers’ enlarged room for financial maneuver, which, in turn, is partly due to the reduced social security contributions payable by them.
Hungary’s scores are average by CEE comparison in terms of employer burden: social security contributions were well over the 30% mark in Slovakia, Czech Republic, Estonia and Lithuania according to the Central Eastern European Tax Brochure 2017 by Mazars Group.
MKIK argues that, in terms of competitiveness, what has been truly decisive is the total cost of employment and the challenge to retain the right number of qualified staff. Reducing social security contributions would also greatly boost development and operational efficiency of enterprises, especially those that are capable of development. In the long run, pressure on wages should have a positive effect, since salary increases could be offset by improving efficiency and productivity. MKIK argues that the so-called tax wedge (the total amount of income tax plus employer and employee social security contributions as a percentage of labor costs) is still very high in Hungary.
Honyek holds that the 45% tax wedge for those with low or average incomes is large, indeed. On the basis of OECD statistics for 2016, Hungary was ranked among the countries with a high tax wedge. (Belgium leads the pack with 54%, whereas the average OECD figure is 36%.) The V4 average of 35-43% is still below Hungary’s. All that means that workers in lower income brackets carry a bigger burden than it is typical in other parts of CEE.
On the other hand, workers earning higher than average wages enjoy a competitive tax wedge in the EU. “In most foreign countries, the tax wedge keeps going up substantially because of progressive tax rates, whereas in Hungary it remains stable,” notes Honyek. “The fact that highly skilled people could make handsome money here under the current conditions also explains that Hungarians do not go abroad to work because of the local tax regime.” By implication, changing it won’t bring them back.

Benefit SMEs or Draw in FDI?

The government has also come in for criticism from some quarters that, instead of reducing the corporate income tax to 9%, labor costs should have been cut even more significantly. However, Honyek argues that the primary aim of the government was to secure a better position in the international tax rivalry. Foreign investors decide about a location foremost based on the level of corporate income tax, and not the tax burden on employers, which they rather regard as part of future wage costs.
“Our 9% corporate income tax rate, which is a record-low in the EU, has attracted a number of high-profile investments that work as key engines of the Hungarian economy in many areas,” Honyek says. “We agree that most Hungarian SMEs − which typically turn out modest profits, and thus hardly pay any corporate income tax − would have benefited a lot more from reducing employer costs further. But the current major objective, that is to get more foreign investors into the country, is better served by the 9% corporate income tax.”