Dmitri Maslitchenko
dmitri@mailroom.com
Introduction to Hungary’s political
history
Hungary has had a long and
volatile history of political and economic change. Hungary as a organized
society dates back before 1000 AD and has been ruled by different monarchies
and foreign regimes every since. This brief introduction will outline
Hungary’s political and economic history starting with Hungary’s “Post-1945
World War II era”.
During WWII Hungary fell
under German control until the end of the war. After Germany’s defeat in
WWII, a commission was established among allied forces (American, Soviet, and
British) in which had ultimate sovereignty over the country. However, since
the leader of the commission was a member of Stalin’s inner circle, the Soviets
exercised absolute control.(Wash. Post., 1) The Government that was
provisionally instituted in Hungary after WWII was shortly dissolved and the
Hungarian Communist Party replaced them in the 1945 elections.
The (HCP)Socialist government
had instituted radical land ownership reforms and had made many utilities,
banks and heavy industries state ran. Then in 1949 at the beginning of the
Post-Cold war era the Soviet’s gained control of Hungary and in 1949 Hungary
adopted a Soviet-style constitution and formed the Hungarian People’s
Republic. Hungary’s economic state up until the mid 1950’s was a economy
similar to that of a Soviet modeled Centrally Planned Economy. However, the
economy in the mid 1950’s had begun a rapid deterioration which led to more
political reforms for Hungary.(Wash. Post, 2)
In the mid 1950’s Hungary
attempted to withdraw from the Soviet sponsored Warsaw Pact and announced their
neutrality and sought backing from the UN. However, the United Nations failed
to respond, as they were preoccupied in other areas of the world. As a result
of lack of UN support, Soviet troops invaded Hungary and regained control,
during the invasion many Hungarians fled to other countries. This new Soviet
culture in Hungary had a more liberal culture and economic path as did the
Soviet regimes of the past. This Soviet government had become relatively
complacent for the next two decades until about the early 1980’s.
Start of Transition
By the 1980’s Hungary’s
government had some lasting economic reforms and was responding to political
pressure to encourage more trade with the west. This new plan to trade more
with the west for economic stimuli led to huge foreign debt as a result of
unprofitable industries. These new economic troubles as well as Hungary’s
strong nationalism to control their own destiny were Hungary’s first steps to a
Western style democracy. By the late 1980’s radicals with the party as well as
intellectuals were calling for change. In 1988 civic activism had accelerated
to an all time high and a Reform Socialist leader, Imre Pozsgay was elected.
Along with a new leader, Hungary also adopted a, “democracy package”, which
included: trade union pluralism, freedom of association, freedom of press,
freedom of assembly, a new electoral law, and radical revisions to their
constitution.(Wash. Post,4)
Hungary’s steps to a market economy
In the following year the
Hungarian parliament adopted legislation providing for multiparty elections and
direct presidential elections. Hungary now had a new vision of government, the
government now was to focus on human and civil rights, and to ensure the
separation of powers among the executive, legislative and judicial branches.
One major step for Hungary
in asserting its move to a market economy was to restructure its national
security. In doing this Hungary reduced it’s defense expenditure by 17% and
reduced its armed forces by 30% between 1989 and 1992, thus dissolving their
membership in the Warsaw Pact . Currently Hungary is trying to develop
Western-style defense force to join NATO.(Wash. Post, 5)
Current Political Structure
The current political
conditions in Hungary are a system of many checks and balances. The Prime
Minister whom is elected selects the ministers in the cabinet. Each of the
cabinet members presides before four parliamentary committees in open
hearings. The legislative body in Hungary is a unicameral house and is the
highest authority in the state.
Current Political State
The Hungarian Socialist
Party was re-elected in1994 in a multiparty election after receiving 54% of the
popular votes. Although the (HSP) had taken back control of the government in
the 1994 elections, the party has announced its intentions to: “continue
economic reform, privatization and to preserve political rights.”(Wash. Post,
6)
Economic Structure in Hungary
Hungary’s history of
economic vitality has predominately been agriculture. In 1950 , over 50% of
Hungary’s work force worked on the land. Hungary’s percentage of workforce
working on the land in 1993 was 7%. Hungary’s agricultural decline is
directly tied to lack of investment in the 1970’s and the 1980’s. Hungary’s
decline is also a product of large amounts of foreign debt that were
accumulated in the 1970’s and 1980’s.(6) The net foreign debt in 1972 was
about 1 billion(U.S. dollars) and in 1993 Hungary’s net foreign debt was 15
billion(U.S. dollars). Although Hungary has the highest per-capita debt in
central Europe their repayment record is stellar.(Wash. Post,7) One of the
major functions to Hungary’s success to transition is their role in revenue
policy.
Hungarian Tax
Reform
Hungary's movement from a centrally planed economy to
a market economy has lead to massive tax reforms in the former soviet satellite
country. These taxes basically fall into three major categories: Value Added
Tax, Personal Income Tax, and Corporate Income Tax. In this section of the
paper I will first examine the attributes and disadvantages of the separate
categories of the taxes and compare them to the former means of revenue
collection. Next, I will demonstrate the success (or as the case may be,
failure) of such taxes. Finally, I will write about what effects Hungary has
experienced due to the tremendous changes in the tax system.
Value Added Tax
On January 1, 1988 Hungary introduced a Value Added
Tax (VAT) as part of a ovement from a socialist centralized country to on with
a market economy (Newbery 1). This tax is similar to the tax currently
operating in the European Union member states. This tax is interesting because
it is an inclusive tax. That is a tax in which the base is included in the
invoiced amount of the good or service. In other words the tax is passed down
to the end customer and in turn the seller is reimbursed the amount of taxes
paid on that particular good or service.
The concept of a Value Added Tax (VAT) was something
that was entirely different to managers that were used to output based goals
(in the old system) as opposed to budgets and cost minimization as practiced by
their western counterparts. The Value Added Tax (VAT) has become a vehicle to
flush out businesses that are experiencing market failure that demonstrate no
reasonable need to continue to operate (there are obvious exceptions to this such
as utilities, etc....). It also cut down on over production of certain goods.
The Value Added Tax (VAT) is also a way that a country
such as Hungary can use to encourage (or as the case may be discourage) certain
types of businesses in their country. According to Deloitte & Touche the
standard rate for the Value Added Tax (VAT) is currently 25%. However, many
products and services such as basic food products, medical instruments, and
utilities are charged 12% . In addition, various supplies qualify for
complete exemption such as education, cultural services, sport events, health
services, and services contributing to scientific research and development
(D&T 8).
Personal Income Tax
Along with the Value Added Tax (VAT) the Personal
Income Tax (PIT) was also introduced to Hungary in 1988. The Hungarian
Personal Income Tax (PIT) is a progressive tax with a universal additional tax
for investment. The tax is based on individual earnings from all forms of
work, though interest income is not taxed if certain conditions are meet
(D&TII, 1). As shown in figure 1.1 the progressive tax rates on income
earned at work range from 0-44%.
fig. 1.1
Tax Rates
Income HUF
to Level (%)
150,000
220,000
380,000
550,000
Source 1996 Deloitte & Touche LLP
The Hungarian Personal Income Tax (PIT) has several
interesting features. The first feature that is unique is that all Hungarians
are taxed separately. In other words, unlike the American Tax system where a
family can jointly file the Hungarians prefer (for ideological reasons) to file
individually. However, this system is not with out it's flaws. The problem
that tax administers run into is when one spouse stays at home to look after
the children. The reason for this difficulty is the one wage earner is subject
to heavier taxation than two wage earners making the same total. Tax
administrators however are reluctant to change the current system because of
the administrative simplicity.
A second feature of the Hungarian Personal Income Tax
(PIT) that draws attention to itself is the fact that any income earned through
deposits and securities are tax free if the interest rates are lower than that
of the National Bank of Hungary. According to D&T the National Bank of
Hungary's interest rate in January was 25%. This means that all bank deposits
that pay lower than 25% are tax free. However, If an individual were to make
28% on investment he/she would be subject to a 20% tax on the additional 3% (as
shown in figure 1.2).
fig. 1.2
Initial
Investment 100,000 HUF
Interest Paid on Investment
in Bank X
(28%) 128,000 HUF
Interest Paid on Investment
National Bank
(25%) 125,000 HUF
Taxable Interest
Income 3,000 HUF
Taxes
Due 600 HUF
This aspect of this tax allows for fair treatment to
those who would otherwise lose their money putting it in accounts that could
not stay up with the tremendous inflation that several countries in eastern
Europe face due to their recent transition to a market economy (Newbery, 6).
As was true with the Value Added
Personal Income Tax (PIT) also has exemptions. The following is a list of
examples of items exempt from tax (Okno 2).
·
Social Security
allowances
·
Gains of up to HUF
100,000 from the non commercial sale of moveable
property
·
Retirement gifts of up
to HUF 10,000
·
Compensation of defined
working clothes
In addition as of January 1995 tax credits against
taxes owed were offered in several areas such as social security contributions
by the employee, for individuals making under 500,000 HUF, for installments on
loans for dwellings, charitable contributions, and for special savings
accounts.
Corporate Income Tax
The corporate tax is levied on all businesses, no
matter how large or small, the same way. As of January of 1995 the corporate
income tax has been reduced from 36% to 18% on undistributed profits before
tax. this is called either the additional tax or the calculated tax. After
this tax has been levied the profits are then distributed among the
shareholders and an additional 23% is taxed to the shareholders. To illustrate
this tax figure 1.3 demonstrates how the tax is calculated.
fig 1.3
Calculation of Additional Tax
tax
18%
to be distributed
for distribution after payment of additional tax (82/1.23)
of the additional tax (% of income before tax
Source Deloitte & Touche LLP
In addition to the corporate tax employers must also
make Social Security contributions. Typically, employers must make a
contribution at a rate of 44% of their gross salary. Employees are required to
make a 10% contribution, however, it not unlikely to see individuals putting
more than 10% away of retirement.
Another tax that employers are subject to is the
Unemployment Fund Contribution. This is to continue to support the unemployed
between work. Employers must pay 4.2% of their employees gross salary and
wages to the Unemployment Fund. Employees are required to pay 1.5% of their
salary. However, employees' contribution is tax deductible.
Training Fund Contributions is yet another tax that
corporations are subject to. This tax is to provide for the cost of training
employees. This contribution is currently paid by the employer at 1.5% of the
total payroll. This tax is for corporate income tax purposes.
As with other Hungarian taxes exemptions are offered
to certain kinds of business. Hungary grants exemptions on a case by case
basis and either dose not grant an exemption or grants a 100%, or 60%
exemption. The figure below shows how companies are allowed to use their
exemptions.
fig. 1.4
Percentage of Taxes due under specific exemption
Corporations
Shareholders
Businesses view this set of taxes as equitable and do
not squabble over the fairness of the taxes. They seem to be more interested
in how to receive tax exemptions and want reform in the exemption granting side
of the tax system (Newbery, 8). This is good because of the infectious shadow
economy in other former soviet countries. This means that businesses will be
more willing to pay taxes that are due to the government.
So What Does this mean for Hungary?
Newbery argues that the Hungarian tax system is at
least as egalitarian as any where else in the world as far as an equal
distribution of taxes. Especially since the method of redistribution is so
good at keeping poverty remarkably low. While the transition still will put a
gap between the “haves and the have nots”, the government needs to keep its eye
out for the most vulnerable such as the old and unskilled. Many argue that
because of the rough transition people may become disillusioned with a market
economy and never realize the gains that the countries leaders have fought so
hard for. However with vigilance and a little bit of patience Hungary will
reach its goal.
Privatization
In addition to using tax collection as a source of
raising revenue, Hungary has turned to privatization to offset Hungary’s 31
billion USD national debt (Galai, 1). The sale of government controlled
industries such as natural gas, oil, and electric powered utilities has earned
the government over 1.4 billion USD in the past year.
Recently the Hungarian Government decided to sale
shares in eight of the fourteen nationally owned electrical power and
distribution companies. A German consortium agreed to pay 180 billion HUF for
the shares and controlling interest in the former government controlled
utilities.
In addition to the sale of the utilities Hungary has
had discussions about selling the National Bank of Budapest to investors.
However analyst point out the bank will have to spend the next year fixing up
the bank before they can think about selling it. Government officials would expect
a heavy return if the bank were to be sold.
While some analyst applaud the actions the government
has taken others wonder who is really in control in Hungary. Is the government
still calling the shots or is it the foreign investor with the most money
invested in a majority of Hungary's' industry. Another key step to Hungary’s
transition to a market style economy is expenditure policy.
Expenditure Policy
Along with changing revenue policy expenditure policy
is a crucial role of any government and especially important policy questions
for governments in transition. Hungary’s main policy stance on expenditures is
to try to match in-kind efforts and expenditure policy to specifically
earmarked funds.
Defense spending
As mentioned in the introduction when Hungary decided
to withdraw their membership with the Warsaw Pact they decided to drastically
reduce their military expenditure. Hungary’s reduction in defense spending was
a key decrease in fiscal consolidation to help decrease their ever rising budget
defict. The graph in Fig. 1.5 represents Hungary’s decrease in defense
spending over the last ten years.
Fig. 1.5
Source: SIPRI Military
Expenditure Database
Social Welfare Reform
Reforms to Hungary’s Social Welfare systems have been
plentiful. Decreases in Welfare systems have mainly been reallocation of
subsides on a stricter criteria basis. Hungary has made constant efforts to
restructure social programs in which have proven to be ineffective. One
example is the reform of the “Family Allowance System.” After a evaluation of
the old program it was proven to be cost ineffective and replaced by a new
“Family Support System”. This new “Family Support System” target families in
need based more on income criteria and targeted people in the greatest need.
Another key social expenditure reform was that of pension and health
programs.(CCET, 2)
Pension and Health Programs
Hungary experience great abuse in the areas of health
and pension programs, but have taken steps in the right direction to help
correct the situation. One such of these decisions was that of increasing the
number of days employers are liable for sick pay. This reform travels in the
right direction because the policy had reduced the Social Insurance Fund and
also created minimum incentives for abuse of the system. Much more needs to be
done in the way of pension and health reform however this policy shows a step
in the right direction..(CCET,2)
Expenditure Summary
The underlying tone of Hungary’s expenditure policy is
that of reducing the budget deficit without creating economic turbulence.
Hungary faces many obstacles in trying to reduce their budget deficit. Such
obstacles are rising inflation and high rates of unemployment these problems
lead to substantial social problems. Regardless, Hungary is still looking the
right “social safety net” but not at the expense of its economic viability and
without effecting production and output ion a negative way.
Conclusion
Hungary has come a long way since the initial
transition from a centrally planed economy to a market economy in 1988.
However, Hungary continues to strive to overcome the obstacles described in
this paper. The transition has been difficult for the people of Hungary.
People accustom to a centrally planned economy are not typically faced with
subjects such as unemployment or cost budgeting. Therefore, many Hungarians
have become disillusioned with the new market economy. However, most
(including socialist) have insisted that economic progress continue. In order
for Hungary’s economy to continue its success it must remain to be egalitarian
in both the way it collects cash through taxes and the way it redistributes
resources to the people of Hungary. Hungary must be sensitive to the vulnerable
such as the unemployed and the unskilled, during the sometimes unforgiving
transition to a market economy.
Bibliography
1.
CCET. “The Center For Co-Operation With The
Economies in Transition.” OECD-OCDE.
Http://www.oecd.org/sge/ccet/hun_fisc.htm.
2. Sipri. “Military Expenditure
Database”.
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Department Notes” Washington Post.Com.
http://www.washingtonpost.com/wp-s…term/worldref/statedep/hungary.htm
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Eight Electric Co.’s Jolts Privitization Back to Life.”
Http://www.iqsoft.hu/economy/page95_4/privat.html. 10/17/96.
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10/17/96
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#558 May,1991.