Let me introduce our honourable guests who are here to discuss the topic of ideal tax system. We have Mr. Lajos Bokros here today, General Director of Central European University in Budapest, economist, former Minister of Finance of Hungary who is known for his "bloody tax reforms" in the midnineties, which were surprising considering his socialist background. Another distinguished guest today is Mr. Ivan Mikloš, former Minister of Finance of the Slovak Republic and current member of the Slovak Parliament. Furthermore, we have Pavel Mertlík, former Minister of Finance of the Czech Republic and current chief economist of Raiffeisen Bank. Last but not least we have Jaroslaw Neneman, economist and researcher with the Department of Economy at Łódź University, former State Secretary of the Polish Ministry of Finance.
I would like to ask our guests to describe what they think about an ideal tax system and then we will provide space for discussion and questions.
I am grateful to the organisers for giving me the opportunity to address this prestigious audience. Since there is quite a few of us here, I think we have to limit our introductory remarks to only a few words, because then the interesting thing will be to have a discussion including questions and comments coming from the audience. So, very briefly I would like to mention five important things. First, for me as an economist and also as a public policy expert,
there is no such a thing as an ideal tax system. We may talk about an optimal tax system, but never an ideal one. The question is what is the difference between an ideal and optimal. Is it not only playing with words? An ideal tax system would be something which is a kind of best practise, once for all, without any change over time and in space. When I say a tax system could be optimal, I mean two things by that. One is that an optimal tax system is different from one country to the next and even within the same country from one year to the next. It very much depends on the values of the society, and whether the tax system meets the expectations of the society. We used to say in university lectures that the best tax system is the one which shows the highest level of compliance on the part of society. If the people are happy with that, or at least comply with the rules and pay their dues, pay the taxes, it is probably acceptable, if not an optimal system. The second point I want to make is that a tax system should be obviously quite simple for the whole society to understand. It should not incorporate too many public policy objectives. We will probably hear it from Mr. Neneman that there are so many requirements one can expect from a tax system like equity, efficiency, competitiveness and so on. The most important objective is of course to generate sufficient amount of public revenue in order to pay for public goods and services. In order to be effective, a tax system should be predictable, understandable, calculable, stabile, and as a consequence, easy to comply with.
In that respect the 3rd point I want to make is equally important. We have learned an important lesson during transition in all the countries represented here. It is probably very important for a tax system not only to be easily understood, but also quite clean and simple, so that it is not mixed with other social objectives like social policy. A tax system should generate enough revenue for the public purse. When we want to employ tools for social policy it is better kept separate from the tax system rather than offering tax holidays and exceptions to many groups in society. Once we start doing that, it is a very slippery road. We go down the drain, and end up with a tax system which does not have any general rule, because everybody falls under some kind of exception. And than the tax system would be similar to a Swiss cheese, full of holes. By economic policy balance we can easily characterise this type of tax system with a huge discrepancy between nominal tax rates and effective tax rates. Let me give you an example. Unfortunately Hungary at this point in time cannot offer much food for thought in terms of what an optimal tax system should look like.
We have for example a very progressive personal income tax system, where you have four different rates: zero, 18, 36 and 40 percent. The last rate set at 40 percent was introduced last September when the government was obliged to implement another "bloody" authority package, so fortunately my package is now on the rubbish heap of history.
But this very progressive scale of taxation, which by the way works with very low thresholds of getting into higher rate of personal taxation, does not generate a huge amount of overall tax revenue. Nominal rates are seemingly, and in fact also in reality, very high. But what we would call effective tax rate is not high at all. Effective tax rate by definition could be calculated if you take the total amount of tax revenue out of personal income tax, divided by the tax base. Personal income is considered as part of the tax reliability for a personal income tax. If we make this calculation, we would end up having a 19 percent flat tax rate. So if we applied the Slovak taxation, the total amount of tax revenue, which is generated by the very progressive tax system, is not bigger than what would be generated by a relatively simple tax rate system. Why is it so? Because there are zillions of exceptions. Everybody can deduct almost everything. And the more taxable income you have, the more you can deduct. So it is even socially inefficient, and not very equitable. In many cases when social policy is mixed up with the tax system, the reason for this happening is that we want to support the poor. But if we put social policy into the tax system, rather than keep it separate, the end result is exactly the opposite. A socially absolutely inefficient result. The last point I would like to make is that the tax system can not be separated from the structure of public administration. There is no such a thing as an optimal tax system without taking into consideration which level of government gets the revenue, and how that revenue can be spent on the other side of profit and loss account of the level of government we are talking about. I am talking about the local government and the regional government, everything what we call "sub-sovereign level of government". There is a huge amount of literature and endless discussion about what role local taxation should play in generating income for spending on public goods and services. Here we have to acknowledge that the situation is very complex, so it is even more difficult to say what an optimal tax system would be. It is very closely linked to tradition, and also to political and administrative values.
In many countries, especially in former communist countries we have a tendency of centralising all tax revenue at the national level. And it is not only a simple negative legacy of communism, but also a consequence of need for redistribution. You simply cannot allow most of the revenues to be generated and spent locally, because as a consequence, there would be very huge discrepancy among regions, among cities, among villages. In Hungary for example there is a 1-25 gap between the income-generating capacities of regions. In the rich districts of Budapest the "fat cats" who live there could generate a much bigger amount of local tax revenue, as compared to some poor villages in the North-Eastern part of the country. And then the question comes: can we afford such a system to flourish in a situation when there are certain public goods and services which should be made equally available and affordable to all people? So the need for redistribution is there, and it is not only a consequence of the communist legacy, but also a very important primary public policy objective.
The last question, which makes life even more complex in this regard, is whether we allow local governments to spend these transfers from central government freely on whatever they want. There are several schools which would define autonomy of local government in many different ways. Autonomy can be defined as taxing autonomy, but also as spending autonomy.
In Hungary for example many local governments--and we have too many of them--are free to tax their own constituents. So they can implement many different types of taxes. They do not necessarily live with this, because they want to get re-elected, so they do not want to become unpopular by imposing too many local taxes. But at the same time when you have very little role for local taxes and you expect most of your revenue coming from the central government, it is not necessarily free spending. Government subsidies come "with strings" attached to them. You have a subsidy to be spent only on housing. You have another subsidy what can be only spent on public healthcare. There is a third one which can be only spent on primary schooling. So there is very little spending autonomy as a result of central redistribution of tax revenue.
We live in a world where people are all experts at least at three things. One is soccer, the second one is privatization, and the third is taxation. So as a consequence I leave the word to my distinguished colleagues.
I shall start with a theme that Lajos Bokros has already mentioned. There is no such thing as an ideal tax system in the world, like there is no ideal wife or husband. Still, it does make sense to seek an optimal wife or husband. The same applies to seeking an optimal tax system. As for theory, I believe we could agree upon the principles what an optimal or well-designed tax system should contain. A good theory is one of the most practical things. Theoreticians reached a consensus as a result of which one would surely find the following in every book of economics: tax system should be efficient, neutral; it should be simple, stable and just. The problem however is that there is virtually no tax system in the world which would satisfy these principles. There are several justifications of this situation. The most important one is that the establishment of a tax system is a product of a political process. In the 20th century with the expansion of large states and the existence of communist regimes, which were attractive for some part of the population, and hence even attracted voters in Western European countries, significant deformations occurred in textbook principles of tax systems. Lajos Bokros said that the neutrality of the tax system, its simplicity and stability should be based on the tax system accomplishing exclusively fiscal goals. It should assist in selecting means that the state needs, it should be as simple as possible, it should contain as few exceptions and various rates and deductible items as possible, etc. Only then, the system becomes simple, neutral and stable and no government should try to enforce other policies via their tax system--be it industrial, social or housing policy. Otherwise, the system is deformed, which means not only a bad tax system, but also an expensive and consequently also unjust social, industrial, housing or other policy which is supposed to be implemented via tax policy. So, my intention is to speak first not so much about technical issues, but more about political aspects, because it turns out that political aspects are key and substantial even in terms of reform and the establishment of a tax system.
Let's take a look at the political aspect of the issue. We can declare that tax systems in almost all Western-European countries and larger countries of the world fail to meet these criteria. Should they aspire to comply with them, they would have to introduce changes and reforms. However, their implementation is difficult for various reasons. It is not only a technical problem. A flat tax concept is, in my opinion, not only a theoretical invention, it is a practically proven
system shifting tax systems towards the fulfilment of these abovementioned principles. This concept has been introduced a long time ago and works in many countries. It is therefore a political issue because there is a huge number of lobby groups that refuse change and also because a significant part of voters basically objects to change. When it comes to the political economy of reforms, we can state that each reform means change and every change is hard to enforce, basically because people fear change. It is a natural phenomenon; no one can reproach them or be surprised. Even ordinary people who do not profit from a deformed system are afraid of changes and so are various influential groups who do make profit out this system. Even though, from a long-term perspective, it would be more beneficial for them to have the system reformed. From the viewpoint of neutrality, simplicity, stability and transparency, everything is quite clear and undisputable.
Passionate debates are going on and will be going on about fairness of tax systems. Whether progressive taxation or flat tax is a more just system. This is a dispute which cannot be easily settled because advocates of these concepts base their theories on different principles, different values. Advocates of progressive taxation usually start with the notion of social justice. They want justice in the tax system based on the principle of equality or balancing of living conditions. They claim that it is much more appropriate to take away from those who have higher incomes and distribute it in order to balance living conditions. In extreme terms it means a principle of equality of stomachs. Everybody should have the same size of stomach, and thus everybody should also have same kind of income.
Those who take equal tax as fair and socially just dwell on the understanding of social justice as a system based on equality of opportunities. However, equality of opportunities does not necessarily mean equality of living conditions, since people are diverse, with various qualifications, gifts, they are not equally industrious, lucky, etc.
To me, flat tax quite clearly satisfies a condition of horizontal and vertical justice. Horizontal justice means that every income, regardless of its type, should be taxed equally and vertical justice means that those with higher income pay higher taxes, even if the tax rate is equal simply because their tax base is higher. Moreover, in all flat tax systems--even in the Slovak system--there is a relatively strong deductible item present. It means that people with low income pay no tax at all.
As far as justice is concerned, even taxation of natural persons in Slovakia applies a progressive system, since the major part--about 16% of the population--pay no tax at all. Only the marginal tax rate is the same--it is 19%--and there are no other rates. So, I am in no way trying to claim that the only correct understanding of tax systems is the one based on flat tax rate, however, it is very important that empirical analysis and comparisons point to the fact that countries with less progressive taxation or flat tax rate manage to attain much higher economic dynamics, and therefore much higher economic growth. A key factor, in terms of standard of living, is then the fact that even these processes have to be scrutinised in dynamics and tendencies. Although, it is true that income differentiation of economies based on flat rate principle or a principle of not very progressive taxation is higher than in countries with progressive and very high taxation, but at the same time, it is true that economic growth in these countries is much higher, and so in mid-term and long-term perspective even a low-income population reaches higher income level than they would be reaching in countries with lower economic dynamics. It especially applies to countries with lower economic level and need to catch up with the more developed ones.
The European Union is using very biased data to measure the so-called poverty. EU uses an indicator called poverty risk-what is the percentage of citizens in a particular country who dispose of income lower than 60% of the country's median. Median means a mean income, i.e. 50% receives lower and 50% receives higher income. According to this indicator, one of the highest poverty risks in EU--I repeat that it is non-sense--exists in Great Britain and Ireland, because the figure there oscillates around 19 to 21%. The EU average is around 15% and after the tax reform, Slovakia tends to reach around 13%. That would mean a higher poverty rate, which is non-sense. Bulgaria reports 14%, whereas Great Britain 20%. Claiming that Great Britain is a country posing greater risk of poverty than Bulgaria is surely non-sense. Let us take a more absurd example: according to this indicator, Northern Korea would mean a lower poverty risk than Southern Korea.
What is crucial from the tax system's point of view is that if any country wishes to improve the quality of life, living conditions and standard of living of their citizens, it has to adopt a policy which would lead it to high and sustainable economic growth. The countries reporting highest growth at the moment in Europe are Ireland, the Baltic countries-Estonia, Lithuania and Latvia-and Slovakia, since these are the countries which undertook similar reforms including tax reduction, tax system simplification and improvement of business environment. Taxes are not the only thing at stake; still they play an important role. So, if we are talking about the existence of an optimal or ideal tax system, my opinion is-and that is what I read in analysis and studies about this area--that Slovakia with its tax reform, was among the countries which are close to having an ideal system. Even though the number of exceptions in the law--as the results of the working group organised by the Ministry of Finance show--is still around twenty. Personally, I do not think that the system will be the best without any exceptions. Exceptions play a significant role only if they are true exceptions. There cannot be hundreds of them and their number and extent may not keep increasing. Discussion about the exceptions is very sensitive not only from a technical but also from a political point of view.
As the example of the Slovak tax reform shows if it is done well and if it is well-timed, then even in a case when a successive ruling party represents its fundamental opposition--and Fico is a fundamental opponent of the idea of flat tax, which he actually hates and would definitely change if he could--it brings about results. If, on top of it, the reform is conditioned by limitations like the Maastricht criteria, stability growth factor and others, the reform may be highly sustainable even if the government does not understand it, is not willing to understand it or if it endorses completely different principles and values. These people proposed in the pre-election programme of their party--which is the dominant party in the government--to rip the tax reform apart. Each and every tax of the past was proposed to be put in effect again. A result may be interesting. Here, I would like to declare one principal thesis which is neither well understood by the public, nor sufficiently reflected by the experts. The present government, especially its chairman keeps claiming that it is building a strong social state. It is one of their primary theses. One may choose various definitions of the social state, but its most complex indicator is distribution, i.e. a potion of the public expenditures of the gross domestic products. Sweden is a strong social state, Denmark, on the other hand has a 55-56% distribution rate and a high--about 50%--taxation rate. Slovakia has decreased its distribution rate in the past decade, namely in the past 5-8 years, to one of the lowest rate in EU. Today, it represents about 39%, ten years ago it was more than 50% of GDP. Taxation rate is 29%, the EU average is 38%.
Fico claims to be building a strong social state, but look what he has done with distribution rate in the past year? Has he increased it? Has he decreased it? What has he done about taxes? Two changes. The first one led to decreased VAT for pharmaceuticals and medical devices from 19 to 10%, and the second is related to gradually decreasing deductible and its cancellation for groups with higher income. Reduced VAT brought in minus three million crowns, decreased deductible plus one million. All in all, Fico's government managed to further alleviate one of the lowest tax burdens and distribution rates in Europe by another two billion crowns, while claiming to be building a social state. Absurd statement lacking any sense. Of course, we are happy to have the burden decreased, however, the problem is that this reduction is accompanied by wrongly set priorities in public budgets; that priority encompasses everything starting with thirteenth-month retirement pension, direct payments for agriculture, which then means lack of resources for things which should become a priority--mainly education, science, research and innovation, information society, etc.--to facilitate long-term sustainability of economic growth and competitiveness. That is a crucial problem.
You have heard Ivan Mikloš, a former Minister of Finance SR and present Member of the Parliament. Each of our guests today is unique in some way. Mr. Lajos Bokros is well-known mainly for his very tough package of measures applied in the mid-nineties in Hungary as well as for his courage to enforce something so unusual. Mr. Mikloš is known for his implementation of the tax reform in Slovakia, which is admired all around the globe. Mr. Neneman is famous for being an academic economist and a member of several governments at the same time, which implies a top position. It is very unusual for an academic. Mr. Mertlík is an interesting persona, because he found himself surrounded by people from a relatively old-type socialist government while being a respected economist himself. It is interesting that three of these men served in socialist governments, nonetheless their opinions are quite close to the viewpoints of Ivan Mikloš who not only did not serve for the socialist government, but opposed it strongly. Mr. Mertlík, floor is yours now.
The two distinguished speakers preceding me stated in the beginning that there is no ideal taxation system. I have to say that there is no optimal taxation system either, and the proof is very simple. In economics we have a theory of so-called effective markets, which means if there is a solution which is better than the others, then the markets sooner or later reach for this solution. If something like an optimal taxation structure or system exists probably the taxation system of most countries would not differ importantly. But this is not the case. I would like to summarise the things mentioned so far in three points. One of them is the level of taxation. The countries differ importantly by different levels of taxation, the total tax bargain in some countries are higher, there are countries which are taxing much more, and with such big discrepancies they certainly need different taxation systems. The second point is the structure of taxation from various aspects. First there is the structure of the distribution of tax bargain. It is definitely also a political issue, but anyway, we can tax different groups, different classes of tax payers in different ways. Societies, countries and nations differ very much in this respect. The last point is merely technical. There are certainly some theories which state that a certain arrangement is better than the other, in regards to some political issues. For example it is usually argued that one tax rate is better than two or more rates. If you have more than one rate, it means that the allocative function of taxation is not neutral. So the simple system is better, because it does not force the economic agent to make decisions according to the size of the level. On the other hand if you look at the European Union and the United States, the EU is applying the value added tax concept, in the United States they have traditional turnover tax. I think it is hardly possible to tell which one is better.
If you look at the Visegrad countries, it is interesting that not only our four Central European countries have different total tax bargain, but it has also developed differently over the time. In the Czech Republic we have 35% of total bargain or the GDP, and it is on a more or less constant level since 1995. There are some technical variations from year to year, one percentage point up or down. Quite a similar situation is in Hungary, where perhaps there is some small decrease from around 40 towards 38-39 %, but basically there is stability as well. Slovakia is a unique case, by starting from about 38% in the end of Mečiar's era to 29-30. The strangest case is Poland, where you can hardly find any regularity. Big jumps up and down over the period without any visible trend. This is not necessarily caused by the changes in government and political priorities alone, it is very often done by the business cycle as well. Basically we have many different countries in spite of similarities across the Visegrad taxation area.
Let me continue with the characteristics of the Czech tax system, and as I do not want to be an advocate of some changes in these trends, I would rather talk about what I think could be done with the definitely sub-optimal Czech system, where I can see some places for improvement.
The most important specification of the Czech system is an extremely high level of social contribution, which means social insurance and health insurance. It is something like 40% of the total taxation, which is one of the highest in Europe, and--what is important--it is slowly growing. By the way, for the Euro zone as an average during the same period of ten years, when the Czech Republic was moving from some 39 to 41%, it was siding down a bit from 40 to some 36-37% in the European Union. Another point is the negligible role of property taxes. The Czech Republic taxes were little with regards to property, and the total taxation of property is decreasing over time. It is something like 2 or 3%, rather going down from 3 to 2 in recent years. In the Euro zone the level is more or less constant, over 6%, so twice or three times more than in the Czech Republic. The other points are more or less in line, I mean the share or the ratio of direct income taxes and indirect taxes, but with regards to income taxes another important feature of the Czech taxation system is the very high taxation of corporate profits compared to personal income tax. The Czech Republic has something like 13% out of total taxation coming from profit taxation, while from personal income it is about 12%. In the European Union the figures are as follows: the personal income makes 21% out of total taxation, the corporate profit tax is something around 6%. As you can see the difference is huge, and the level of corporate profit taxation is getting even higher in the Czech Republic. It is influenced by the business cycle, and it is also the product of the big growth of corporate profits. Basically, we are talking about a long time development which was visible in times of recession as well. Now, what to do with that and what are the trends for the future? I think that the key point, which should be mentioned in relation to the level of taxation, is coming from the expenditure side. What do we really want to finance? What are the financing needs of the respective country, government and society? From this prospective I must say that I see lots of public goods and services in the Czech Republic underfinanced. On the first place it is education and research development, then it is public infrastructure, and last but not least it is defence and security. We are not investing into these, because up to few years ago we believed that we live in a safe world. The world is changing and it is not so safe any more, and I do not believe that it will be possible to spend so little on defence and security on the long run. I am definitely not a fan of military expenditures, but that is not important. Maybe a surprising issue is welfare. I definitely agree that a part of welfare expenditures are mismanaged and misused by some groups of the population. We live in an age of population aging. And because of that the financing and redistribution of needs, which are related to social and welfare issues, is getting more and more pressing over the years. It can certainly be done from the traditional financing schemes inside the budget, it can be partly withdrawn from the outside, and we can arrange private function schemes or mandatory ones. It is part of public finance in
general. So probably these needs of an aging society will be growing, if we like it or not, and it means a forever growing taxation bargain for the population. From this perspective it seems to me that the current 35% total tax bargain in the Czech Republic is about the right one. From a longer time perspective, like 10 or 15 years, I would be surprised if it was possible to keep it on such a low level. I do not really like big taxation or big government, but I am afraid this is what we have to expect.
These taxation systems have one thing in common if we look at the distribution of tax bargain, namely that the biggest group of tax payers is the middle class. The no income people do not pay taxes, or they pay little, and the "big sharks" usually do not pay so much in terms of percentage because various schemes allow them to pay relatively low tax.
It is almost impossible to solve this problem, since the rich ones have tax heavens and various techniques how to avoid taxation. But it seems to me that in the Czech case most of the reforms of the past years are putting an even bigger tax bargain on people who are somewhere between average income and average income plus 40 %, so that means the traditional lower middle class. I think that at least some move towards the high end of the distribution of income would be reasonable for the society. This can be done in different ways, most of them are not very efficient. The one I want to mention is property taxes. As I said, we have low property taxes in the Czech Republic, unlike for example in the United Kingdom, a traditionally liberal country that has a very high taxation of property. So this example shows that it is not in contradiction with market principles. This is certainly a very efficient instrument in taxation, although, it is definitely unpopular.
Another thing I want to mention--and this has been the principle most radically applied in the last 10-15 years in Estonia--is the fact that the re-invested, or simply the invested profit is not taxed, with regards to corporations.
We can use the Estonian example to show how to improve the situation. The general principle is that if the corporate profit is used for consumption, it is taxed, and if it is used for investment, it is not taxed. This is a very rational economic principle.
The last point I have to make if I speak of Slovakia, the famous country of flat tax, is that there are some arguments in favour and against flat tax. I would disagree with some points Ivan Mikloš made here, and I would try to show you why. Progressive taxation system was introduced in 19th-century Europe based on the principle of what in economy is called diminishing utility. According to this microeconomic law if you have something and you get another piece of the same item, the second one is going to be less important for you than the first one. So if you drink a glass of water, you feel fine. Then you drink another one, you are still fine, but maybe if you have a third glass, you would not be perfectly all right. This is diminishing utility, which is relevant for income as well. So, simply said, if you earn 20,000 Slovak crowns per month, and someone adds you 200 crowns to that, you get something, but if you earn 200,000 Slovak crowns and someone adds 2,000 to that, which is the same percentage, you also get something, but your personal subjective utility is lower, because of the difference structure of consumption, of spending, saving and so forth. If you take the same rate in term of income, in fact, subjectively you withdraw from the loss. So the loss is a similarly positive utility developing the same way. This was the key argument when in the 19th century--preceding the development of the 20th-century welfare state--these progressive streams were introduced, first in England, and later in the Austro-Hungarian Monarchy. So it is coming from Austrian economics, and for me it is sometimes ridiculous when some of the new liberal advocates of flat tax oversee this Austrian economic heritage.
On the other hand, the existing taxation systems are progressive as well. Even if you have flat tax, you have to take into consideration the deductible items. Take the example of Slovakia, where it started from zero and moves up, and then gets to somewhere about the average income. So there is a more or less flat tax for the high end of income classes, and progressive tax for the lower ones. So this is an argument for why not to be always radical. Certainly, some arguments like simplicity and comprehensiveness speak for flat tax.
You have heard Mr. Mertlík, a chief economist of Raiffeisen Bank and former Minister of Finance of the Czech Republic. The last speaker will be Mr. Jaroslaw Neneman, an economist and researcher from the Department of Economy at the European University, and former state secretary of the Polish Ministry of Finance.
Some of my conclusions are similar to what we have already heard. It means that there are many principles economists can agree on. It is the politicians that create problems.
There is a long list of what we should expect from taxes. But for most economists it is certain that we cannot expect from taxes to assure competitiveness, justice and so on. Unfortunately for politicians the answer is yes. They believe that the tax system is good for everything. Unfortunately some examples show that you can win elections using taxes. But as you probably know, the only reason for taxation is getting money.
As you heard, the perfect tax system does not exist; it is similar to a perfect wife or a perfect husband. But it does not mean that there should not be any discussion about it. Taxation is taking money from the people, and people do not like that, and they do their best to save their money. Any tax creates distortion. There is no business friendly taxation. The politicians sometimes claim that they can introduce a tax system that is good for the people and good for the business. There is no such tax system. We can choose between very bad taxes and plainly bad taxes. But I think that the discussion is useful among
economists and not among politicians. Let me show you some ideas of the optimal tax system.
The tax should be as low as possible, and the imagined tax range should be close to the effective tax range. In Poland for instance the expenditure for internet can be deducted from the income, so in fact the effective rate is lower, but what can we achieve from this tax allowance? Nothing. It is a complicated system without anything positive. The tax base should be as broad as possible, because with the low rate and broad base there is plenty of money for the budget. Moreover, it is fair and the lobbying is limited. Taxes should be stabile. In my country in this century each year we have a new Finance Minister. In fact last year we had five ministers. And each minister had his own view of the tax system. I used to ask politicians and businesses people: let's not talk about the details, but let's discuss the tax system for the following twenty years. What will we have in twenty years? There is no vision of that.
Our four countries are below the average. They are definitely far below the Swedish or Danish example. Unfortunately we do not use property taxes. Ten or twelve years ago the Polish government introduced the cadastral tax. Last year it was stopped. Why? Because this tax was unpopular. In the global world where the capital is very mobile, there is a tendency towards taxing consumption rather than income. As you heard the Czech example is a bad example, while the Hungarian example with the high share of indirect taxation is a good example. The Czech example is also bad because of the social security contribution. For the general audience the most popular tax is personal income tax. If the people are talking about taxes, they usually care about the rates. But in my opinion rates are not important. More important is the tax wedge. In Poland nowadays it is very popular; there is a lot of discussion about that. Five years ago this subject was completely new. The tax wedge is the difference between the labour costs and the net pay of the worker. The higher the tax wedge is, the lower is the demand for labour, on the other hand the higher the tax wedge is, the lower is the supply of labour. For many years we had problems with the demand for labour. Nowadays the situation is changing and soon we will have problem with supply of labour.
In our four countries unfortunately the tax deducted from wages is increasing, with the exception of Slovakia. In Hungary it is very high and rising. Let me tell you about the Polish experience. In the first tax bracket for 95% of tax payers the system is progressive. They produce 55% of personal income tax revenue. For 4 % of tax payers the system is slightly progressive than regressive, because of the pension contribution. And for the richest 1% of tax payers the system is flat. In fact this is only a partly progressive system and only for the self-employed. Because of the social security contribution, and because of tax allowance, self-employed people pay a 19% flat tax, just like private individuals. The outcome is strange. Previously the system was progressive, then flat, and now it is highly regressive. A poor owner of a small shop pays as a percentage far more than a rich owner of a huge shop. This makes no sense at all. This happened because of the introduction of this kind of taxation for the people running business activities, as the first step to introduce flat tax. Bud it did not happen.
As for the VAT we are sure that one rate is the solution, and that almost all exceptions should be eliminated. Something has to be done also with tax evasions. The next tax is consumption tax, my favourite one. This tax definitely needs re-thinking. What the Commission is doing is not the way. For instance in the case of cigarette-taxation the rates are very high, in this part of Europe we are below the minimum rates, what means that in two years the price of cigarettes will almost double. You have probably heard about the reasons why cigarettes are so highly taxed in the European Union. Smoking is bad, smoke kills you, so the government should in a sense punish people by using the revenue to help the health care system. But according to some estimates this is not a good explanation for accessing duty on tobacco. Why? Because smokers die earlier, and it is good for the health care system. This does not mean I prefer smoking or that the tax system should prefer smoking. But the explanation is not true.
Another problem is criminal activity which takes place all over the European Union. I tried to discuss this issue in the Commission, but they claimed they do not see this. Nowadays in the Commission there is a discussion about increasing the consumption tax on diesel. I do not believe there is such a need, because the higher the duty on diesel is, the bigger is the gap between the duty on diesel and heating oil, which is almost the same, there is no difference between them. And if you have the same goods and the tax difference is huge, you obviously encourage criminal activity. In the Czech Republic they managed to stop it, but in other countries the problem continues. In Poland we are the biggest market for LPG for cars in Europe, and we are the second in the world as I remember. LPG for cars is taxed, whereas LPG for heating is not. They are exactly the same product. There is one problem of money, another problem of criminal activity, and the third problem is that it is dangerous, because people are doing different things to pump their cars with LPG supposed to be used for heating.
Thanks very much to Mr. Jaroslaw Meneman, former Deputy Minister with the Ministry of Finance, Polish Republic. Now, let me open the floor for discussion.
This is a question to the ex-minister Bokros: As far as I know, your fame started with a quite conservative bunch of economic concepts, which were actually implemented in your country. What is your opinion today? Was not this package too difficult to handle for the Hungarian society, so it might be the consequence of such a package, that today, a completely opposite doctrine is in practice which quite clearly hinders and limits Hungary's acceptance into the Eurozone?
I do not think that there is a direct link between the package introduced by my government twelve years ago and the inability of the present government in Hungary to meet the Maastricht criteria. That would be an overstretch to say that as a consequence of the negative popularity of measures twelve years back the present government is unable to do this. I fully acknowledge and understand that the measures in that time had a very negative impact on many people, especially the loss of real income for 90 % of the population, the double digit loss income especially for lower paid people. But as a consequence of that the country avoided fiscal collapse. In the next five to six years Hungary experienced a relatively high level and financially sustainable export led growth. It was after 2000 and 2001, when the government started irresponsible fiscal overspending and destroyed the fiscal balance once again. So in 2002 when there was an election, and once again in 2006 when there was another election we had almost the double digit fiscal deficit. In this Hungary is not only a European champion but almost a world champion. But it is very difficult to say that this is a consequence of something what happened twelve years ago.
A question to Mr. ex-minister Mikloš: Where can you see the prospect of sustainability of the much praised flat tax in Slovakia? Is the KDH's requirement of tax sovereignty a suitable defence of your beloved child against potential changes taking place in other EU countries or USA, where several tax system changes have taken place? This were either related to changes in the government or-more understandably-with state budget.
I have always claimed that to develop a relatively sound tax system or tax reform is not as difficult as to sustain it. It might have been presumed that politicians as well as lobbyists would try to deform the system in order to make political or economic profit or to realise their visions. So far the intervention has been minimal. To me, decreased VAT for medications was a negative step, because it means fall-out, but also, it sets a bad precedence. It opens a Pandora's Box of further proposals and the Prime Minister has already announced similar proposals concerning study tools and the internet. The problem, however, is that consumption tax decrease does not necessarily have to lead to dropped prices. By the way, after the VAT decline, the prices for medications did not go down, as expected. Instead, they went up. There are various reasons for that. Subsidies based on exceptions or decreased rate is the worst, least just and most expensive way of subsidising. Even if the price went down--and I repeat, it did not--it would drop for everybody. Those with higher income spend more, not in relative, but in absolute figures, on children for instance, medical aids or the internet. That describes sustainability as a problem regardless of the type of government. Nonetheless, the risk grows higher with a government that does not regard it as a problem.
A declaration on tax sovereignty could have had a positive impact and that is why we supported it, especially in relation to the harmonising efforts of Commissioner László Kovács and the European Commission regarding the income tax of legal entities. If you are interested, I can also explain why we are fundamentally against it. Not only against harmonisation of rates, but also against tax base harmonisation.
Ex-minister Mertlík, I will be more concise. Do you not think that the Czech society is still marked with the message of that banner hanging on the façade of the National Museum in Prague 1918 citing: "socialist nation"? That connotation is still present to some extent and each Czech government including the present one reckons with this fact to some extent, which causes headache to economic analysts.
As for the "socialist nation" slogan, it was one of the key slogans of the 1918 anti-Austrian revolution in Prague. I think this question should be posed to a social scientist and not to me, an economist. But anyway, just two small comments. The diversity of income and the gap between high and low income groups in the society is quite small internationally, and the process of bigger income differentiation is going on rather slowly. You can see this fact both in the private sector and on the corporate level, but certainly also in the actions of the government. The Czech redistribution system is trying to erase social differences, particularly in those groups which are much dependent on welfare schemes, i.e., pensioners or generally the older people
I would like to know how do you perceive the harmonisation of taxes on the European level and chiefly, where are we going to be in terms of harmonisation of direct taxes in 15-20 years? What do you think about the trends, are they positive or negative? Is harmonisation sensible? Where does it end, in your opinion, in terms of amount of taxes and tax bases if you consider economic and political aspects?
I think that the idea of tax harmonisation is a very old one within the European Union, but with a very little progress. The harmonisation of VAT has been going on for decades without any visible outcome. And as for the income taxes, I can imagine that within 15 years or sooner we shall have some harmonisation of the tax base for a better comparability, but also particularly in favour of corporations operating cross-border. Sometimes they have to do a lot of work with calculating different tax bases according to different principles in different countries. I do not think that anything like harmonisation of tax rates is realistic.
We need to differentiate between indirect and direct taxes. When trying to define whether to harmonise taxes and which ones, we should start by identifying what may help the competitiveness of Europe and European economies. Single market, which we still lack, will surely help. We have not managed to establish a single market even after fifty years of signing the Roma treaties aimed at its establishment. In terms of indirect taxes, single market requires harmonisation in order for it to function well. When it comes to indirect taxes, we can hardly talk about any progress; instead we have recorded regress by approving a trial for labour-intensive professions and services. Some countries have extended their items. It should have served as temporary experiment, although it was assessed as completely unsuccessful.. Nonetheless, no country agreed to cancel their temporarily decreased rates.
In case of direct taxes, I am convinced that Europe needs no harmonisation, definitely not a harmonisation of rates, especially corporate ones. When harmonising tax bases, one faces a little more difficult situation. The fact is that there are reasons for it and Pavel mentioned them, such as decreased transaction costs for companies operating in several countries, decline in the number of law court trials, etc. The major problem, however, is that some politicians vote and will vote not only for harmonisation of tax bases, but also for rate harmonisation. That is harmful and it would not even help the countries with problems. They do it under the pressure of political delocalisation. It would decrease competitiveness of new member countries with more competitive tax systems. There will be a demand for rate harmonisation, but without the harmonisation of tax bases one may not harmonise rates. Should we strive to harmonise tax bases, we would only increase the risk of actual rate harmonisation, which would harm everybody.
We have got one more special evidence against income tax base harmonisation. What is that common base supposed to be? Slovakia has got one of the broadest tax bases, since we abolished almost all exceptions, deductible items and special rates and introduced a 19% tax with such a broad basis. Germany has established one of the narrowest tax bases, since it has many different deductible items, special rates, large companies entertain tax remits, etc. The rate there is 38.5%. What is that common basis supposed to be like? When repeatedly asking this question myself at ECOFINs, I said: We are very much against it, since there is not a slight or theoretical chance that the Slovak tax base could be established. Although some said, let us discuss the Slovak basis as a possible common start for the entire EU. Then I asked my 24 colleagues at the table whether they believe it could be realistic to abolish almost all exceptions, deductible items and special tax bases in all twenty-four countries. And they laughed and said absolutely not. So we would need a consensus to determine a number based on the mean value of tax bases, a neutral, stable and transparent system of exceptions, deductible items and special rates, a narrowed basis as well as a necessary rate increase in order to reach the same tax income that we manage to gain with broader basis and lower rate.
Now I would like to list some key figures that show the senselessness of a system with narrow basis and high rate, and the false character of the statement that such system necessarily means higher taxes. Slovakia is somewhere between Ireland and Germany. In Ireland, the rate of income tax is 12.5%, whilst in Germany it is 38.5%. In Ireland, they accumulated 3.6% of GDP in 2005, in Germany they generated 1.6% of GDP with their rate reaching 38.5%. Triple the amount of rate and the yield is almost three times lower. Slovakia generated 2.6% in 2004, but in 2005 it was already 2.8%. It is therefore clear why we have opted for this way. We are a bit concerned though, since nobody knows how the situation will evolve in the future. During the era of Fritz Bolkenstein, responsible for taxes, the EU Commission was against the harmonisation of tax bases. Now we have Commissioner Kovács who is a passionate advocate of tax base harmonisation and the Commission's position has changed, too. There were seven EU countries which were originally against it: Ireland, Great Britain, the three Baltic countries, Slovakia and Malta. Today the Prime Minister starts to melt down and claim that we cannot go head against the wall. What is even worse is that he accepted the rhetoric claiming that our tax system is not fair but based on dumping, which is clear non-sense. The figures clearly show the situation. The argument used by the former Chancellor Schröder as well as the Swedish Prime Minister Person and present President of France Sarkozy talked about tax dumping, about missing money, since we decreased taxes and we want to replace them with money from the EU. It is the other way round. Slovakia has undertaken the most radical reform, we lack no tax money, tax yields after the reform in 2004 increased only slightly comparing to the year 2003. Tax burden decreased whilst GDP recorded growth. Since the reforms move us forward a little faster, we shall receive less money from the EU due to decreased taxes. We shall be in the position of receiver up to a certain level. If we reach it sooner, we shall receive less money.
I can hardly predict what is going to happen in the next fifteen years, since the pressure increases. In the EU, even a small country may veto and prevent changes in the tax field. However, reality is much more complicated. It is very difficult for a small country to stand against something that everybody else has agreed on; especially, in the international political situation of today's Slovakia. I find it crucial to learn to what extent the above mentioned countries stick to their principles in other matters the way they did regarding tax base harmonisation.
Ivan mentioned the most important argument. I hope you have paid attention to that. The tax Commissioner of the European Union is Hungarian. So watch out! There will be a tax harmonisation at any rate. As for the future dynamic of this process, a big question is whether the European Union will ever have a meaningful fiscal sector at all. Today the European Union's common budget is extremely small. As a consequence it does not matter how you calculate the tax base and the tax rate. If the politicians will ever decide that the European Union is going to evolve into something like a federal state or more federal type of structure, and as a consequence they will feel that it is important to have a much bigger budget distributed according to EU priorities, then the issue of tax harmonisation will become much more relevant. Because then they will have to calculate with a much more precise manner how you take away a certain amount of income from whatever country.
In fact everything was said on the subject, but let me add something. In case of indirect taxation we have seen no results of harmonisation at all. And I am sure that it will continue this way, for example the United Kingdom will never agree on the abolition of zero rate for food. There was a discussion last year about increasing access duty on beer, just to adjust for inflation. It makes sense.
In case of direct taxation there are two elements. From the business point of view it makes a lot of sense to harmonise the tax base, which is not possible, and if the harmonisation of tax base is treated as the first step, then obviously some countries, like Poland are against it nowadays.
On behalf of the Cultural Institute of the Hungarian Republic, the Czech Centre and the Polish Institute I would like to thank Jaroslaw Neneman, Lajos Bokros, Ivan Mikloš and Pavel Mertlík for this pleasant meeting and their very interesting thoughts.
Lajos Bokros (economist, General Director of Central European University in Budapest, former Minister of Finance of Hungary), Ivan Mikloš (economist, former Minister of Finance of the Slovak Republic, member of the Slovak Parliament), Pavel Mertlík (chief economist of Raiffeisen Bank, former Minister of Finance of the Czech Republic), Jaroslaw Neneman (economist and researcher with the Department of Economy at Łódź University, former State Secretary of the Polish Ministry of Finance). Moderator: Robert Žitňanský (editor of TA3, deputy editor-in-chief of the Týždeň magazine)