Martin Bruncko

1
MAKING ROOM FORA RADICAL TAX REFORMThe case of
Slovakia

• Martin Bruncko
• Ministry of Finance of the Slovak Republic
• Paris
• January 11, 2006

2
SLOVAK ECONOMY KEY CHARACTERISTICS

• Lower middle income country
• 2004 GDP/head in PPP 54 EU25, 50 EU15, 52
  OECD
• Room for real convergence and catching-up
• Small and open economy
• 2004 - Export 77 GDP, Import 80 GDP
• Economic policy agenda structural reforms
• 2003-2004 pensions, labour market, welfare,
  education, tax reform
• since 2005 focus on knowledge-based economy

3
FISCAL REFORM GENERAL CONTEXT

• Medium term Fiscal Consolidation
• Reduction of the deficit to 3 of GDP in 2007
• ? meet Maastricht criterion
• ? adopt euro in 2009
• Meet the ultimate SGP goal in 2010 (close to
  balance or in surpluse position)
• Long term Ensure Fiscal Sustainability
• Inter-temporal constrain of public debt under 60
  of GDP
• Ageing issue
• Contingent liabilities

4
THE SLOVAK TAX REFORM GOALS

• BASIC PHILOSOPHY
• LIGHT, NONDISTORTIVE, SIMPLE AND TRANSPARENT
• TAX SYSTEM
• create business and investment friendly
  environment for both individuals and companies
• eliminate existing weaknesses and inefficiencies
  in the tax law
• eliminate distortive roles of tax policy as
  instruments for achieving non-fiscal goals
• improve tax fairness by taxing all types and all
  amounts of income equally

5
THE SLOVAK TAX REFORM GOALS

• Flat income tax - simplicity, fairness,
  proporcionality
• Cutting number of tax rates 18 ? 1
• Broadening tax base (eliminating special
  treatments and exemptions)
• ? Allows low standard tax rates
• ? Minimizes distortions in the economy
• Eliminating double taxation (e.g. dividends)
• Progressivity of taxation reduced but not
  eliminated (high tax free treshold, tax credit on
  children)

6
PERSONAL INCOME TAX CHANGES

• Abolishment of multiple tax rates including
  five-band rate structure on labour income
• Only one but much higher tax-free treshold
• Basic tax allowance for tax payer (SKK 38,760 ?
  SKK 80,832)
• Spousal allowance (SKK 12,000 ? SKK 80,832)
• tax free treshold automaticly indexed to minimum
  substince (poverty-line income treshold)
• Introducing annual tax credit of SKK 4,800 per
  child (part of new child support and working
  incentives policy)
• Since 2005 introducing purpose-oriented allowance
  of SKK 12,000 (tax-free savings, ageing issue)
• Tax exemption on income from the sale of
  securities held for 3 years or more
  cancelled

7
CORPORATE TAX CHANGES

• Most income tax exemptions cancelled (tax
  holidays for newly established firms, tax base
  reductions for certain sectors)
• Remaining investment incentives in compliance
  with the EU law on state aid
• Dividend tax abolished
• Reduction of effective tax burden on businesses
• Depreciation period on some groups of tangible
  assets shortened (property and buildings 30y ?
  20y)
• Loss carry-forward rules relaxed
• Limits on tax deductibility of advertising and of
  vehicle depreciation cancelled

8
THE REFORM RADICALLY DECREASES ECONOMIC
DISTORTIONS CREATED BY THE TAX SYSTEM

• 2003
• OLD SYSTEM

2004 NEW SYSTEM
1 flat rate 19
5 tax rates 10, 20, 28, 35
and 38
PERSONAL INCOME TAX RATE CORPORATE INCOME TAX
RATE VALUE ADDED TAXES
19
25
one unified rate 19
standard rate 20 lowered
rate 14
9
THE REFORM RADICALLY SIMPLIFIES THE TAX SYTEM AND
INCREASES ITS TRANSPARENCY

• 2003
• OLD SYSTEM

2004 NEW SYSTEM
LOTS OF exceptions,
exemptions and special regimes
NO exceptions,
exemptions and special regimes
PERSONAL INCOME TAX BASE CORPORATE INCOME TAX
BASE OTHER TAXES
NO exceptions,
exemptions and special regimes
LOTS OF exceptions,
exemptions and special regimes
VIRTUALLY NO special taxes
and rates
LOTS OF special taxes and
rates
10
THE REFORM ELIMINATES MOST FORMS OF DOUBLE
TAXATION OF INCOME
DIVIDEND TAX
GIFT TAX
INHERITANCE TAX
REAL ESTATE TRANSFER TAX (as of 2005)
11
IMPLEMENTATION STRATEGY Chronology of the
changes in the tax laws

• 1. Changes in indirect taxes
• amendment of VAT Act introduction of one single
  rate of 19 (before 20 and 14)
• amendment of Acts on Excise Duties increase of
  certain excise duty rates mineral oils, beer and
  tobacco products
• 2. Changes in direct taxes
• new Income Tax Act introduction of flat tax
• new Real Estate Transfer Tax Act abolishment of
  gift and inheritance tax and introduction of 3
  flat rate for real estate transfer tax
  
• 3. Changes in indirect taxes in compliance
  with EU tax legislation
• - new VAT Act and new Excise Duties Acts - as of
  May 1, 2004

12
FLAT TAX STILL ENSURES PROGRESSIVE TAXATION OF
INCOMES
Poverty Line
13
IMPACT ON TAX PAYERSAVERAGE EFFECTIVE TAX OF
INDIVIDUAL IN
Average wage in 2004 SKK 15, 825
Marginal rate 19
Minimum wage since January 2004 SKK 6,080
14
IMPACT ON TAX PAYERS (2) AVERAGE EFFECTIVE TAX
OF INDIVIDUAL WITH NON-WORKING SPOUSE AND 2
CHILDREN IN
Average wage in 2004 SKK 15,825
Negative tax (tax credit on children)
15
REFORM IMPACT ON SELECTED TAX PAYERS
16
TAXING LABOUR INCOME IN SLOVAKIA 2003 VS. 2004
Source OECD, I individual C couple number
of children in average wage in industry
17
TAXING LABOUR INCOMESLOVAKIA VIS-A-VIS OECD IN
2004
Source OECD, I individual C couple number
of children in average wage in industry
18
EFFECTIVE CORPORATE TAX RATE IN SLOVAKIA
Effective corporate tax rate statutory
corporate tax rate x dividend tax rate
19
COMPANY EFFECTIVE TAX BURDEN IN 2004
Source ZEW Economic Studies Vol.28, OECD Tax
Database
20
OVERALL TAX BURDEN IN EU25 ( OF GDP, ESA 95),
2003
Note Eurostat published 30,9 of GDP for
Slovakia in 2003 but GDP was revised upward
since then.
21
CHANGE IN OVERALL TAX BURDEN IN EU25 IN THE
PERIOD 1995-2003 ( OF GDP, ESA 95)
22
REFORM IMPACT ON GOVERNMENT REVENUES (1)
23
REFORM IMPACT ON GOVERNMENT REVENUES (2)
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POSITIVE BUDGETARY IMPACT IN 2004

• Sources
• Macroeconomic development ()
• Conservative approach to budgeting revenues ()
• Assessment limitations
• Corporate tax cyclical upturn or tax planning by
  coprorations
• Reliability of wage distribution data

25
REFORM IMPACT ON MACROECONOMIC ENVIRONMENT

• Short-term period minimum effect (broadly
  budgetary neutral)
• Medium-term period expected scenario

26
CONCLUSION POLITICAL WILL AND MANAGEMENT ARE
KEY FOR SUCCESSFUL REFORMS

• must have a clear vision where you want to go
• timing is key in the implementation
• implement less popular steps first
• resist lobbies and entrenched interests
• if you give in to one demand, you will be less
  able to say no to others
• compensate the most vulnerable part of the
  population

27
BACK-UP SLIDES
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KEY MACROECONOMIC INDICATORS
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KEY MACROECONOMIC INDICATORS