Hungary's 'wonder weapon' brings budget billions of forints

The online invoicing system has been live and operating without any negative comment for six months. This is the cabinet’s newest ‘weapon’ against the black economy. Although we have not heard much about the new system since its inception, it is apparently doing what it was created, and it is doing it extremely well.

VAT revenues boom

Firstly, let’s see a few charts on how VAT revenues have been changing.

• Calculating an annual average of the monthly (cash flow-based) VAT revenue figures, we see that VAT revenues have been growing at an accelerating rate this year.

• If we take the Central Statistical Office’s (KSH) quarterly data on the general government sector as the basis, it is also clear that VAT revenues have been growing at a higher rate in 2018 than in the last few years.

(We need to highlight that VAT revenues are affected by the fact that reliable taxpayers get their refund sooner than the average, and that the refund period was cut to 45 days from 75 days previously as of January 2017, and further to 30 days as of last year. This change reduces the state’s VAT revenues on a cash flow basis.)

We should also underline that according to general government sector data, VAT revenues grew by 16.3% yr/yr in the third quarter (i.e. in the three months after implementing the real-time online invoicing system), which was the highest growth rate (on a yr/yr basis) since 2014 (16.9%). Before that, an even higher rate was recorded only in 2005, in the July-September period. It also matters a lot that the growth of VAT revenues showed a level change already in Q2 when yr/yr growth reached 15.9%. An even higher growth rate in the second quarter was last seen in 2000. Consequently, there must have been something in the background already. Such a major growth could not have possibly occured by chance. And we’re going to show you below that it did not.

What does the Finance Ministry see?

Portfolio has contacted Norber Izert, state secretary in charge of tax issues at the Finance Ministry to inquire about the robust VAT revenue increase. He said rapid economic growth also contributed greatly to the dynamic increase in VAT revenues in 2018. He also noted that while the cash flow revenues could be distorted by numerous factors, the accrual-based numbers in Q2 and Q3, which are influenced less by distorting elements, also show a 16% and a 16.6% growth over 2017, respectively.

This growth is considerably - by about 4% according to the ministry’s present knowledge - higher than what would be justifiable purely by the increase of macroeconomic indicators (retail consumption, private investment, revenues related to state assets). This suggests, in fact, that the whitening of the economy that started a few years ago continued and that online invoicing made a contribution to that, said Izert.

He also said that the VAT gap, which is the difference between expected VAT revenues and VAT actually collected, dropped considerably to 13% by 2016 from 22% in 2012. The above figures strongly suggest that the index fell substantially further in 2018, but the related estimate will be published by the European Commission only in 2020.

Central bank (MNB) staff also pointed to the growth of VAT revenues in the latest Report on Inflation, saying these were perhaps also boosted by the launch of the online invoicing system in early July.

Analysts at OTP Research also noted in a recent research note about the Q4 budget balance that the pick-up in revenue growth compared to the previous quarter is primarily explained by higher other (mostly EU transfers) and VAT revenues.

“In addition to buoyant consumption growth, higher VAT revenues could also be related to the introduction of the real-time VAT reporting," they said.

How much is it then?

We had two estimates (based on Q3 2018 data) on how strongly the whitening of the economy contributed to the jump in VAT revenues, i.e. how directly it was linked to the introduction of the real-time online invoicing system.

One of the obvious solutions was to estimate the amount of VAT that may be collected and compare it to the actually collected amount. For this calculation we have the VAT revenue data for Q1-Q3 2017 and the rate of inflation, and consumption growth data for the first nine months of 2018. We also take into consideration the impact of the targeted VAT cuts (Internet, catering, fish, pork offal) as of 2018. We estimate that actually collected VAT revenues exceeded the theoretically collectible level by HUF 180 bn in January-September. Our detailed estimates also show that there was a spectacular (HUF 100 bn) overshoot in VAT revenues already in Q2, i.e. the introduction of the real-time VAT reporting system had had a whitening impact already before the measure was put into place. In consideration of the potential implications (penalties), some businesses “cleaned up their act" before the deadline.

The other way to go if we want to estimate the whitening impact is to compare the actually collected VAT revenue to the tax base (to household spending, according to our extremely simplified approach). This gives us an effective VAT rate that may be compared to the effective VAT rate in Q1-Q3 2017. Based on our calculation (the result of which is a ballpark figure we must stress), this ratio came to 20.6% by the end of September 2018, down from 19.4% a year earlier. This 1.2ppt improvement has to do with the whitening of the economy. When we apply the same calculation for cumulated H1 data, we find that a spectacular improvement (as concluded above) started already in the second quarter. It seems that the pending launch of the online VAT reporting regime made a lot of businesses think twice about the potential implications of shady deals.

In view of the above, it is possible that the annual whitening impact of the new online VAT reporting system could reach HUF 300 billion in the form of VAT revenue. This gives the cabinet additional manoeuvring room. The question is what it will be used for: tax reduction, increased spending, sharper deficit or public debt reduction?

What is this online system?

• As of 1 July 2018, all VAT-registered businesses must submit domestic business-to business (B2B) sales invoices with a VAT amount equal to or more than HUF 100,000 to the NAV, Hungary’s Tax and Customs Administration, within 24 hours of issuing the invoice. The data should be submitted in XML format through the government web portal, referred to as KOBAK. Failure to report invoices in real-time could result in penalties of up to HUF 500,000 per invoice. Data provision is mandatory also for those that use paper invoices. The tax authority practically gained insight into every deal subject to VAT, i.e. it sees invoice traffic worth HUF 50 trillion a year.

• Tags:
• economy,
• tax,
• value-added tax,
• vat