Country Study, Hungary

Country Study, Hungary

Country Study, Hungary

Dmitri Maslitchenko dmitri@mailroom.com

Introduction to Hungarys 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 Hungarys political and economic history

starting with Hungarys Post-1945 World War II era.

During WWII Hungary fell under German control until the end of the

war. After Germanys 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 Stalins 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 Soviets gained

control of Hungary and in 1949 Hungary adopted a Soviet-style constitution

and formed the Hungarian Peoples Republic. Hungarys economic state up

until the mid 1950s was a economy similar to that of a Soviet modeled

Centrally Planned Economy. However, the economy in the mid 1950s had

begun a rapid deterioration which led to more political reforms for

Hungary.(Wash. Post, 2)

In the mid 1950s 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 1980s.

Start of Transition

By the 1980s Hungarys 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 Hungarys strong nationalism to control their

own destiny were Hungarys first steps to a Western style democracy. By

the late 1980s 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)

Hungarys 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

its 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

Hungarys history of economic vitality has predominately been

agriculture. In 1950 , over 50% of Hungarys work force worked on the

land. Hungarys percentage of workforce working on the land in 1993 was

7%. Hungarys agricultural decline is directly tied to lack of

investment in the 1970s and the 1980s. Hungarys decline is also a

product of large amounts of foreign debt that were accumulated in the

1970s and 1980s.(6) The net foreign debt in 1972 was about 1

billion(U.S. dollars) and in 1993 Hungarys 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 Hungarys 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

|Personal Income Tax Rates | |

| | |

|Level of Taxable Income HUF |Rate Applicable to Level (%) |

|Up to 110,000 |--- |

|100,001 - 150,000 |20 |

|150,001 - 220,000 |25 |

|220,001 - 380,000 |35 |

|380,001 - 550,000 |40 |

|Over 550,000 |44 |

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 Taxes (VAT) the 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

| |HUF |

|Income before tax |100.00 |

|Calculated at 18% |(18.00) |

|Income after tax to be |82.00 |

|distributed | |

|Amount available for distribution|66.67 |

|after payment of additional tax | |

|(82/1.23) | |

|Total Tax Paid |33.33 |

|Effective Rate of the additional |15.33% |

|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

| |18% subject to |23% subject to |

| |Corporations |Shareholders |

|100% Exemption |100% reduction |No Reduction |

|60% Exemption |20% reduction |No Reduction |

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 Hungarys 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

Hungarys 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. Hungarys 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. Hungarys 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 Hungarys decrease in defense

spending over the last ten years.

Fig. 1.5

[pic]Source: SIPRI Military Expenditure Database

Social Welfare Reform

Reforms to Hungarys 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 Hungarys 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

Hungarys 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.

2. Washington Post. Hungary: State Department Notes

Washington Post.Com. http://www.washingtonpost.com/wp-

sterm/worldref/statedep/hungary.htm

3. Deioitte and Touche LLp, Taxation in Eastern Europe.

Webmaster@dtomlinr.com.1996.

4. Galai, Andras. Sale of Eight Electric Co.s Jolts

Privitization Back to Life.

Http://www.iqsoft.hu/economy/page95_4/privat.html. 10/17/96.

5. Galai, Andras. Gathering momentum.

Http://www.iqsoft.hu/economy/page95_4/csaba.html. 10/17/96

6. Langyel, Laszlo. Towards a new model.

Http://www.iqsoft.hu/economy/page95_4/langyel.html. 10/17/96.

7. Newbery, David. An Analysis of the Hungarian tax Reform.

Center for Economic policy Research. #558 May,1991.




2009 .