It is too early to talk about taxing the rich in Hungary

This is how it began

The idea of launching a temporary solidarity tax on the wealthy has arisen in discussions among Fidesz and Christian Democrat (KDNP) MPs, said István Pálffy, member of the small ally of the governing Fidesz party, in an interview with Klubradio.

He said the tax could be levied on individuals with a certain annual income, but he did not specify a figure. He explained the revenues lost because of the implementation of a flat-tax regime need to be offset somehow.

Opposition in offensive mode

Green party LMP suggests starting discussions between parliamentary parties about the implementation of a just and sustainable tax regime. The party said Pálffy’s Wednesday comment about imposing a solidarity tax on the wealthy indicates that finally the governing parties are starting to realise that the flat tax has caused the country massive damages.

By implementing a single-rate personal income tax “Fidesz has hit a gaping hole on the budget, sparked overwhelming social tensions, made the livelihood of millions harder and reduced the number of jobs," LMP said.

Pálffy backtracks

After LMP issued its statement, local newswire MTI contacted Pálffy on Thursday evening only to hear him saying the flat tax system was a success. He said no discussion whatsoever is needed on this subject. He stressed that the idea of the solidarity tax has taken no political form and it is not even a proposal.

The single-rate personal income tax system is not causing serious damages. Quite the contrary, it has saved the people some HUF 800 billion since 1 January in the form of cash or bank deposits, Pálffy said. This money is right where it belongs, the families. No consultation is needed about this, it’s for the best. The people would object if the parties started to discuss how this money could be taken back, he told MTI.

The Christian Democrat MP, the spokesman for the party’s parliamentary caucus, said that in the discussions he had referred to earlier this week they addressed in a general fashion that there are situations - the crisis in Europe may be one like it - when certain groups may be asked to pay a solidarity tax, as a one-off measures for a brief period, temporarily.

The fact that thinking about social justice and solidarity brings to the surface different ideas that do come up in a general economic crisis situation in Europe does not mean this goes beyond thinking. It is not an official policy, not a proposal, an idea that can be linked to any of the governing parties. Therefore, from this point of view this matter does not need to be addressed, Pálffy added.

Not a unique idea

We do no have to go far - either in time or place - to find actions similar to the above idea that - as we learned from Pálffy - is not even an idea in fact. Two weeks ago the Italian government announced the implementation of a solidarity tax. The special levy on income above EUR 90,000 per year would be 5% and on income in excess of EUR 150,000 10%. The tax rate on financial income would also be hiked to 20% from the current level of 12.5% and the government also pledged to crack down on tax evasion.

The French government acknowledged on Wednesday the country's economy is slowing and announced USD 16 billion in new taxes to ensure it reaches its deficit-reduction targets. The measures, including higher income taxes on high-wage earners and stiffer levies on alcohol, tobacco and soda.

The government has announced that anybody earning more than EUR 500,000 a year will have to pay an additional 3% on their income tax bill. The measure would be lifted once the deficit target has been reached.

After a similar call in the United States by billionaire Warren Buffett, 16 of France's wealthiest people signed a petition urging the government to tax them more in a period of austerity. The group called for a "special contribution" in these difficult times but not a tax rate so high as to encourage the rich to quit France for overseas tax havens.

What is this all about?

If the idea became an actual proposal and it was approved and then put into practice, the government would (temporarily) give up one of its emblematic economic policy measures, the 16% flat personal income tax for the stake of fiscal stability.

Besides implementing a solidarity tax on the wealthy there could be another means to improve the budget balance, namely if the government put off the halving the tax base for supergrossing.

Origo.hu reported already in May that the government was considering dropping the plan to end supergrossing - operating the tax base at 127% of gross salaries instead of 100% - by 2013. Under Hungary's supergrossing system, a 16% flat income tax is being levied on social taxes in addition to gross income. Under the current phase-out plan, budget revenues would decline by hundreds of billions of forints next year (when supergrossing is supposed to be halved) and even more so in 2013, when it should fully disappear.

While halving supergrossing would have a negative impact on budget revenues, the tightening of tax credit would offset it, according to the Convergence Programme. The two measures together translate: 'tax hike’.

Gov’t may need tax hike

As the slower-than-expected economic growth requires additional fiscal measures to meet the budget deficit goal, an increasing number of analysts believe the cabinet might be forced to hike taxes.

Economist László Csaba, professor at the Central European University (CEU), has warned earlier this week that a rate hike appears to be inevitable in an environment where revenues in nearly every tax type come in behind the target, adding that the government may need to announce unpopular measures in the next few months.

“You need to watch financial stability very closely when there is a global crisis. The situation is extremely fragile right now; you cannot say the numbers do not matter and that we’ll grow out of these problems," he said.

“In the next months and next year (the government) will need to pursue an extremely disciplined policy and this will probably include a series of unpopular measures, such as spending cuts and tax hike," Csaba added.

Plans need to be reconsidered

In an interview with local daily Magyar Hírlap, Csaba said on Thursday the government will need to revise both the Széll Kálmán Plan, the package of structural reform measures, and the Convergence Programme so that their professional content will be in harmony with the new macro path.

The cabinet will need to decide what it wants to spend on what it has no funds for. Among others he said it should not invest in energy now, forget about building a new block at the Paks Nuclear Power Plant, increase spending in basic education and legal certainty and put off prestige investments.

In a report earlier this week Reuters also warned that the government is facing difficult times.

“Hungary's unconventional fiscal policies have failed to kickstart its domestic economy, and with the recovery elsewhere also ebbing, Budapest faces a hard choice between trimming spending or scaling back tax cuts to plug holes in its budget," it said.

"The personal income tax cut has not worked out as they (Fidesz) had hoped, neither economically nor politically," Reuters cited Péter Krekó, political analyst at think tank Political Capital.

"Fidesz will now have to prepare for ... the most difficult period of their term in government. Their entire four-year term will be about crisis management," he added.

Meanwhile, Zsolt Kondrát, economist at MKB Bank in Budapest, told the news agency that at this stage he does not think the government will “backtrack on such political sacred cows as the flat tax."

It looks like, however, that we’ll need to wait for more information until at least the end of September. Prime Minister Viktor Orbán said last week the government will work out until then what revenue- and spending-side measures will be needed to plug the estimated HUF 90-100 billion hole the feeble growth will hit this year on the budget. Some are already talking about this as the cabinet’s third economic action plan. According to press reports it may be the debt consolidation of state-owned railway company MÁV (HUF 300 bn) that could be postponed.

What makes the situation even more complicated is that based on a European Court of Justice (ECJ) ruling the state will need to fulfil the VAT refunds of certain companies. The ECJ decided in late July that Hungary's rules on value-added-tax refunds, which allow refunds for unpaid procurements, were incompatible with EU laws. The Economy Ministry stressed, however, that the refunds would have no impact on the budget goals in 2011 and 2012. This year the refunds would strip the budget of HUF 100-200 bn this year, but it may tap the de facto nationalised assets of private pension funds to conjure up this sum.

Solidarity tax would not be new in Hungary

Slapping a special levy on the wealthy is not unprecedented in Hungary. Such a surcharge, the so-called solidarity tax on private individuals (4% on top of the 36% PIT) entered into effect on 1 January and was abolished only on 1 January 2010. The levy added HUF 20-25 bn to state coffers annually.

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