IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
Looking at the main tax types, there was no change in the corporate profit tax in 2012, the rate of the personal income tax remained 16% but the tax temporarily became progressive due to changes in the calculation of the tax base while the standard VAT rate increased from 25% to 27%. Furthermore, the sectorial taxes previously claimed to be temporary were definitively incorporated in the tax system, and a number of small-volume consumption taxes were introduced under the pressure for continuous budget adjustments due to the deteriorating economic figures.
In 2012 the Government went ahead with the overhaul of the personal income tax regime started in the previous year. In 2011 the progressive tax regime, with tax rates of 17% and 32% (in theory – in practice, the rates were 21.6 and 40.6% due to the so-called ’half-supergrossing’ arrangement) was replaced by a linear tax rate of 16% (in theory; 20.6% in practice). (The details of ’half-supergrossing’ are discussed in Box 1). In 2012, half-supergrossing was abolished up to an annual income level of HUF 2,424 thousand (€8,376), that is, the effective tax rate dropped to 16%. However, the system of employee tax credit that existed up to 2011 was abolished at the same time (for the discussion of tax credit see Box 1). The abolishment of tax credit would have resulted in a decrease in after tax income for low income earners; therefore, the Government increased the minimum wage by 19 % to HUF 1,116 thousand (€3,856) a year and announced, in a decree, the rates of wage increase they expected employers to implement in each income bracket. Failure to comply incurred no sanctions for undertakings; however, if the company did comply, they could make use of another tax benefit in the social contribution tax regime (new name of the social security contribution).
The new law that came into effect in 2013 eliminates ’half-supergrossing’ in its entirety and creates the personal income tax regime with a flat 16% tax rate envisaged by the Government.
No substantive change occurred in the corporate profit tax in 2012 or 2013. The standard rate continues to be 19% but a rate of 10% is applicable to the tax base up to HUF 500 mil (€1.73 mil).
As of 1 January 2012 the standard VAT rate was raised to 27%, the highest among EU Member States. The two reduced rates and the scope of products subject to these rates did not change: the tax rate for milk, bread and accommodation services remained 18% while the rate for therapeutic equipment, books, newspapers and district heating stayed at 5%.
Taxes on consumption other than the VAT also increased: the Government hiked the excise tax on alcohol, tobacco products and automotive fuels twice in 2012, followed by yet another rise at the beginning of 2013. However, the tax hike did not extend to alcohol produced for own use (mostly home-distilled brandy), which continues to be exempt up to 1,000 liters (a legal procedure is to be expected on the EU level as the Commission considers the Hungarian legislation giving preferential treatment to home distilling to be incompatible with EU rules).
Other special consumption-type taxes have been added to the two large taxes of this kind. Producers and providers of pornographic content has been liable to a cultural tax since the beginning of 2012 while mandatory motor liability insurance has been subject to a so-called accident tax since September 2011. The telecom tax entered into force in the middle of 2012: HUF 2 (€0.007) tax is payable on each minute of phone call and each text message sent. For private individuals, the first 10 minutes are free each month and there is a cap of HUF 700 (€2.4) a month for private individuals and HUF 2500 (€8.6) a month for corporate subscribers.
The public heath product tax entered into force already in September 2011. It is payable on foodstuffs that the Government considers unhealthy (soft drinks, energy drinks, sweetened products, salted snacks). The scope of products covered was expanded early in 2012 (flavoured beers, fruit jam) and the legal definition of certain terms was amended in response to producers circumventing previous definitions by altering their recipes.
The so-called crisis taxes, introduced in 2010, were abolished on paper in 2013; in practice, however, this mostly means a simple change of name. The bank levy remained in place in unchanged form, that is, it is calculated from the balance sheet total of 2009 (!) at a rate of 0.1% on the first HUF 50 bin (€172.76 mil) and at 0.53% above that threshold. The Government raises HUF 190 bn (€0.65 bn) of revenues from this levy, which is close to the total profits of credit institutions in the pre-crisis year of 2007.
The special tax on financial institutions does not apply to insurance companies; instead, the aforementioned accident tax has been introduced together with a new insurance tax payable on all insurance transactions except the MTPL.
The special sectoral tax on telecommunications companies has been replaced by the telecom tax mentioned above.
As a novel form of collecting the crisis tax on the retail sector, the rules applicable to the local business tax have changed: only a part of the cost of goods sold can be deducted from the tax base. Essentially, retail chains and energy suppliers are subject to a substantially higher local business tax.
Instead of the abolishment of the profit-based crisis tax on the energy sector at end-2012, it has been extended to other utility companies as of 2013 and its rate has increased from 8% to 31%. Thus the corporate profit tax of energy companies is 50% instead of the standard rate of 19%.
From 2013 on, utility companies operating line networks (including most energy suppliers) are also subject to a so-called public utility tax, at the rate of HUF 125 (€0.0043 ) per meter of utility line.
The tax on financial transactions entered into force in 2013, imposed on payment transactions of households and businesses alike. Previously some South American countries have implemented such a tax, which is almost the direct opposite of the Tobin tax imposed on securities and foreign exchange transactions to curb speculation. While the Tobin tax basically affects speculative and derivative transactions and does not apply to non-speculative transactions (wage, transfer, purchase of goods and services, etc.), the Hungarian (and previous South American) taxes hit especially these non speculative transactions, while the interbank and other "wholesale" transactions are exempt.
Moreover the tax is degressive with a single rate (currently 0.2% of the transaction value) with a cap at HUF 6 thousand (€20.7), except for cash transactions, where the rate is 0.3%. The Government proposes to raise HUF 283 bn (€1 bn or 1% of GDP) from the transaction tax in 2013. According to recent data this is a gross overestimate of the actual revenue to be expected.
(The Government appears to be well prepared on the Tobin tax for once, as the law also provides for the transaction tax on securities that is being discussed in the EU, but the entry into force of those sections is conditional on the adoption of the levy on the EU level). The Government intended to expand the transaction tax, originally proposed to have a rate of 1 thousandth, to the transactions of the National Bank of Hungary (central bank) but it gave up on that plan in response to the intense opposition of the EU and the ECB. The revenue foregone has been offset by doubling the tax rate.
As of 2012, the Government has combined the various contributions payable by employers (health insurance, unemployment insurance, pension) into a single tax, the social contribution tax. The rate of the new tax is 27%, the same as the aggregate rates of the contributions replaced. The sole purpose of the name change was to exploit a legal loophole. In 2011 the Government nationalised the overwhelming majority of pension funds relying on a threat. They stated that private pension fund members refusing to ’voluntarily’ return to the state pillar, i.e., to pay the 8.5 percent employee contribution previously paid into the private pension fund to the state and also to donate the accumulated savings, potentially amounting to millions of forints, to the state would not be eligible to any state pension in their old age. One of the many legal issues with this threat was the fact that pension entitlement is based on the employee as well as employer contributions. Employer contributions were, and still are, paid into the pay-as-you-go state pillar, therefore those who remained private pension fund members should have obtained pension entitlements by virtue of contribution paid by their employers. The Government took that entitlement away by renaming the employer contribution a ’tax’, which, in the interpretation of the Government, does not give rise to any pension entitlement. Before 2010 the relevant act could have been challenged in the Constitutional Court; at the end of 2010, however, the governing parties, with their two-thirds majority in parliament, changed the Act on the Constitutional court, declaring that the Constitutional Court has no remit in cases affecting the budget.
In 2012 labour income above HUF 7.94 mil (€27,400) was not subject to the 10% employee contribution payment. As of 2013, this cap, which had affected some 2-3 percent of persons submitting PIT returns, has been abolished.
Mention should be made of the pro-employment measures of the Government. In order to safeguard jobs and to improve the position of SMEs, the Government announced a so-called Job Protection Action Plan in the summer of 2012. Under this programme, from 2013 on reductions are available from the social contribution tax for certain labour groups while two new tax regimes have been added to those already available to SMEs.
The special labour groups include employees below 25 and above 55 years of age, persons employed in jobs not requiring vocational qualifications, long term unemployed persons and women returning to work after giving birth. Of these, the social contribution tax for the long-term unemployed and women returning to work after giving birth is forgiven in its entirety up to the wage of HUF 100,000 (€345), while the tax is halved for the other groups. Moreover, under other laws, reductions are available to persons employed by projects established in free enterprise zones and to researchers employed in R&D, in both cases the entire sum of the social contribution tax is forgiven up to wages of HUF 100,000 and HUF 500,000 (€1,727), respectively.
Under the itemized tax of small businesses, one of the tax regimes for the SME sector, upon the payment of HUF 50,000 (€173) per month, the enterprise is relieved from almost all tax and administration burdens. Under the small business tax, a 16% tax is payable on the basis of the annual wage bill and the changes in financial assets during the year. The latter is more favourable than the 27% social contribution tax but higher than the 10% corporate profit tax, therefore it depends on the ratio of the components of the tax base whether this is advantageous for a particular business.
|Name of tax||Sector||Description of the tax|
|PIT||Households||Up to an annual income of HUF 2.4 million (EUR 8376) the elimination of ’half-supergrossing’ (See box 1), abolition of tax credit.|
|VAT||The standard rate increased from 25% to 27%.|
|Social contribution tax||Employers||The aggregate of the pension, health care and labour market contributions renamed a tax, at the rate of 27%.|
|Cultural tax||Producers and suppliers of pornographic content||25% of the net turnover from the activity concerned.|
|Accident tax||Insurance companies||Tax on mandatory third party liability insurance; 30% of the premium.|
|Telecommunications tax||Telecommunications||HUF 2 (0.7 euro cent) on each minute of call and each text message sent, but the first 10 minutes are free for private individuals and the monthly tax amount is capped (at HUF 700 for private persons and HUF 2500 in general).|
|Name of tax||Sector||Description of the tax|
|PIT||Households||The abolition of ’half-supergrossing’ in respect of all income (See Box 1).|
|Special tax on the energy sector||Energy sector||On top of the 10/19% corporate profit tax, a 31% profit tax, from which the value of investments can be deducted up to 50% of the tax.|
|Utility tax||Energy sector, telecommunication, public utility companies||A tax of HUF 125 (EUR 0.4) on each meter of utility line owned, progressive depending on the total length of lines: companies owning small networks need to pay only part of the tax.|
|Local business tax||Retail chains, energy sector||The items deductible from the base of the local business tax are reduced by brackets, that is, if higher turnover is generated, the tax based is reduced by a proportionately smaller amount.|
|Insurance tax||Insurance companies||Tax on insurance products other than the mandatory third party liability insurance; 10% of the premium (15% for Casco).|
|Financial transaction tax||Financial sector||0.2% of the value of bank transactions must be paid as transaction tax, with a cap of HUF 6000 (EUR 20.7). The tax rate on cash transactions is 0.3%. Securities-related and speculative transactions are not subject to the tax.|
|Itemized tax of small businesses (KATA)||SME sector||Upon the payment of HUF 50 thousand (EUR 173) the employer is exempted from other dues payable to the central budget.|
|Small business tax (KIVA)||SME sector||A flat tax of 16% is payable on the wagebill and cash-based profits, but it replaces the 27% social contribution tax and the 10/19% corporate profit tax.|
The Government expect substantial budgetary income from the measures aiming to curb the black economy. One of the most important elements of this is the on-line connection of cash registers to the National Tax and Customs Administration, through which the tax authority would be able to verify every retail invoice. The system was originally proposed to start up early in 2013 but now it is expected to be implemented only in the second half of the year, thus the additional income of HUF 95 bn (€328 mil) expected by the Government may turn out to be lower. The examples of other countries (Bulgaria, Sweden) indicate that this measure may indeed improve the efficiency of tax control. The limitation of cash payment serves the same purpose as cash payments between two businesses may not exceed HUF 1.5 mil (€5,183) a month, while in case of intercompany payments of at least HUF 2 mil (€6,910), the companies affected need to submit the related VAT returns itemised by invoice.
Half-supergrossing: In the Hungarian regime the so-called half-supergrossing simply meant that the PIT base was not simply the gross wage but the sum of the gross wage and the employer contribution (renamed social contribution tax from 2012 on), that is, 1.27 times the gross wage. As the employer contribution was 27% throughout the existence of the half-supergrossing regime, this substantively corresponds to a tax rate increase of 127%. This arrangement was introduced primarily for considerations of political marketing: ’at first glance’ this made the nominal rate lower, thus and a higher tax bracket ceiling could be included in the law. Originally, the proponents of ’supergrossing’ did not have this type of political marketing in mind when putting forth their ideas. Instead, they thought that if employees are confronted with the total levies on their labour, namely, the tax wedge between the total cost to the employer and the net wage of the employee, this may be conducive to greater social support for the reduction of labour taxes and the government policies aimed to improve the international competitiveness of the Hungarian economy.
Pension reform: In two steps in 2010 and 2011 the Hungarian Government forced 97% of private pension fund members to transfer to the state pillar, confiscating some HUF 3 thousand billion (corresponding to approximately 10% of the annual GDP.) At the same time, the 10% pension contribution payable by the employees was also diverted into the central budget, thus the members remaining in private pension funds can add to their accumulated savings only through voluntary payments. As a result of these measures, a number of pension funds have closed down or merged, and the second pillar of the pension system has disappeared. Simultaneously, the Government also revised the rules of retirement and the tightening trend started in 2008 was continued, primarily by limiting the possibility to go into early retirement. However, the sustainability of the pension system was worsened by the abolition of the ceiling on contributions in 2013, as the cap on pensions to be paid has also been removed.
Tax credit: A tax allowance employed in the Hungarian personal income tax regime between 1997 and 2012. Taxpayers could deduct a certain percentage of their income from employment from the amount of tax up to a specified ceiling. The employee tax credit has the advantage of alleviating the tax burdens of low-income persons without giving high income earners any part of the benefit. The challenge is to find a way to assure that the tax credit is not available above a certain income level. In the band where the tax credit drops from maximum to zero, the marginal tax rate is higher than the legal rate, which provides incentives to reduce the reported income (less work and/or concealment of income).
In 2012 numerous tax measures were implemented in Hungary. These were driven by two main motives: the Government that obtained qualified majority at the election of 2010, in order to offset the effects of the significant PIT rate cut implemented in 2010, continued last year to raise consumption taxes and special sectoral taxes so that it can permanently reduce the fiscal deficit below 3 percent of GDP. In 2011, due to one-off measures (such as the nationalization of the assets of private pension funds) the Government was able to produce a substantial fiscal surplus corresponding to 4.3% of GDP. However, the position of the budget was less favourable because without the one-offs the deficit amounted to 5.5% of GDP, which in effect represented a 2 percentage point relaxation as compared to 2010.
Consequently, in 2012 the Government had to adopt a number of decisions to improve the fiscal balance. Due to the structure of the measures adopted, growth prospects continued to worsened, therefore the macroeconomic path moved even further from the unrealistically optimistic scenario originally envisaged by the Government. Even though the Government managed to achieve its goal through a series of adjustments (a total of 9 packages in the course of 2012), and the deficit calculated with the EU methodology was around 2.7% of GDP (according to preliminary data) in line with the undertakings of the Convergence Programme, the potential growth rate was reduced to near-zero. The public debt to GDP ratio fell from 81.4% at end-2011 to 79.1% at end-2012. However, some 40% of the debt is denominated in foreign currencies, and thus by February 2013 the ratio rose to above 80% again due to the weakening of the EUR/HUF exchange rate.
In possession of its qualified majority, the Government would be able to implement structural reforms, but most of these are still waiting to happen. Even though the spring Convergence Programmes of 2011 and 2012 both included ambitious expenditure cuts, a substantial part of these were never realised (e.g., the reform of public transportation as recommended by international organisations failed to happen, and health care and education also saw only centralisation while efficiency increases are still to be seen). In addition to the absent reforms, the overly optimistic growth expectations led to constant adjustment needs in the budget. The tax revenue increasing proposals thought up in the last minute were prepared in a frenzy and legislation already adopted often had to be amended due to difficulties encountered in their implementation. Frequent amendments in turn led to increased uncertainty, which is shown by the fact that SMEs are very reluctant to switch to tax regimes entailing smaller tax burdens for them - approximately one third of the potential targets made use of the opportunity offered. Effectively, the Government has manoeuvred itself into a vicious circle: it wants to address fiscal problems with haphazard decisions, but the price of short term benefits (in a few months horizon) tends to be the inception of longer term problems (with growth, regulation and credibility). In this respect, the tendency to be expected in 2013 is not substantially different from the trends seen in the previous year.
The tax changes of the 2010-2013 period can already be evaluated from three aspects:
> 1. The cut in income tax rates in 2010, the linear PIT system and the increase of the ceiling of the corporate profit tax bracket from the former HUF 50 million to HUF 500 million did not trigger the explosive growth envisaged by the Government; indeed, the ad hoc, unpredictable measures to stop the gap thus generated in the budget definitely and significantly reduced the growth rate. In 2012 household consumption declined by 1.2%. Based on model estimates, the flat-rate PIT system increases employment, a priority among the Government’s goals, by a mere 0.4% in the long term, thus no exceptional consumption growth is to be expected from this effect either (Benczúr et al: Assessing changes of the Hungarian tax and transfer system: A general equilibrium microsimulation approach, 2011, p.10, URL: http://goo.gl/FQZsv ...). The adoption of a linear tax regime may also appear rather peculiar in a regional context as other countries in the region have admitted difficulties in maintaining the flat-rate system, and some countries have already re-introduced the progressive tax regime.
> 2. The constant hikes in consumption tax rates have increased inflation and kept inflation expectations high. Even though in 2013, as the effects of previous consumption tax increases fade, inflation will fall below 3 percent, the expected treatment of the persistent fiscal problems (more consumption tax hikes) is more conducive to higher inflation. (This may temporarily be dampened by the new method of the Government whereby, irrespective of profits, purchase prices and any other taxes, it compels utility companies to reduce their rates by 10 percent but this obviously cannot be maintained even in the medium term, and it is already under legal scrutiny by the EU.)
> 3. Through taxing businesses (primarily multinationals) the Government saves households from the burdens of taxation only on the level of communication, as consumers will eventually have to pay for those taxes as the costs are passed through to them. If the companies are unable to pass through the new or increased taxes to consumers or their own employees, then in order to restore their profit rates, they will move towards constraining their activity, investments and exposure to Hungary, which will definitively undermine long term growth prospects.
Romhányi Balázs ,
Fiscal Responsibility Institute Budapest (KFIB)
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