Tax Systems and Tax Reforms in New EU Member States

Luigi Bernardi, Mark Chandler, Luca Gandullia, Luigi Bernardi, Mark Chandler, Luca Gandullia

• Publisher: Routledge
• Year: 2005
• ISBN:
  9781134270729
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Foreword is written by Vito Tanzi - a world renowned expert Tax is a surprisingly under-explored topic in the world of economics monographs - despite being of crucial importance Editor's previous book has almost sold out in 3 months

Part I

A general picture of tax systems and tax reforms in New EU Members

1
An overview of taxation

Luca Gandullia¹

1.1
Introduction and main conclusions

It is commonly recognized that the last decade of tax reforms in countries that are in transition from the previous centrally planned economies has provided a remarkable laboratory in tax policy design and practice. This is particularly true for those countries (such as Hungary, Czech Republic, Poland, Slovenia and the Baltic states) that moved rapidly and early into transition to introduce comprehensive tax reforms, a common objective being their accession to the EU. At the beginning of transition these countries had to create new fiscal institutions and new market-oriented tax systems, simultaneously preserving their revenue-raising capacity under the pressure of the existing levels of social security and welfare expenditures.

Compared with the other transition countries, the EU’s New Members can be considered as successful examples of tax reform implementation. Through early transition they have been able to avoid the fiscal crisis encountered by other transition economies. In New Members, the increase in income inequality has been generally lower than in the other transition countries. Moreover, they have shown a capacity in collecting tax revenues that is higher than in the slow transition reformer countries and close to the EU levels.

In all the ex-transition, now EU member, countries, the process of tax reform has been significantly influenced by their histories. Instead of making copies of Western-type tax systems, they followed a more evolutionary process that has led to the design of tax systems reflecting the structural characteristics of their economies.

At present, the New Members show models of taxation that are reasonably close to those in the EU, but in some key aspects there are wide differences. The following seem the most relevant. First of all, the tax mix is different and the distance from the EU benchmark has increased during the last decade; while the incidence of total taxes and social contributions is close to the European average, the tax mix between direct and indirect taxes is considerably different, with the New Members relying much more on indirect taxes and less on direct taxes.

Second, the degree of progressivity of personal income tax is lower than in most EU countries. The group of Baltic states applies a flat rate taxation; a linear system of personal income taxation has recently been introduced (2004) in the Slovak Republic. In Poland, the effective structure of the personal income tax (PIT) is almost linear. It should also be noted that the real progressivity of the PIT is even lower as the tax bases are narrow due to the exclusion of most capital income.

In the field of corporate taxation, New Members apply very low (compared with international standards) statutory tax rates with narrow tax bases. The most emblematic case is given by Estonia where the corporation tax on retained earnings has been completely abolished. In recent years, the tax bases have been partially broadened, but the reduction in tax rates has been considerable. On average, these countries show levels of effective taxation on investment much lower than the European benchmarks. The gap increases considerably if the effects of tax incentives are considered. More generally, in the presence of low statutory tax rates, the distortions on investment decisions induced by the corporation tax appear lower than in the EU. Many countries give strong tax preference to retained earnings over distributed profits. This result, together with the low taxation of capital income, shows the efforts to promote savings and investment.

In the field of indirect taxation, as noted above, New Member countries rely heavily (and more than the EU countries) on consumption-based taxes, but at the same time they show levels of implicit tax rates on consumption much lower than the European average, meaning that the tax bases are far from being comprehensive.

Finally, the tax burden on labor continues to be as high as it was in the early stages of transition. The tax wedges are close to the European average for many New Members. However, in some countries the tax wedge appears to be much higher than the European average for lowerpaid labor.

This chapter is organized as follows. Section 1.2 illustrates the starting point of tax systems and reforms at the beginning of the transition process. Section 1.3 presents some indicators of the macro structure and evolution of the tax systems over the last decade, focusing on tax ratios by legal categories and on the allocation of revenues across sectors of government. Section 1.4 gives a comparative analysis of direct and indirect taxation in the selected countries, while section 1.5 presents some indicators to measure and compare their main equity and efficiency profiles.

1.2
Tax systems and reforms during transition

The tax systems in force during the socialist command economy were not comparable to the Western-style ones, their role being deeply different and more limited (Tanzi 1992; Tanzi and Tsibouris 2000). Most tax revenue was obtained from three major sources (enterprise tax, turnover tax and payroll tax), while taxes on personal income accounted for a very small share of total revenue (Dabrowski and Tomczynska 2001; Martinez-Vazquez and McNab 1997). Tax rates were numerous and non-parametric, tax structures were complex and tax liabilities were discretionary and negotiable. The earnings of state-owned enterprises were the main source of financing government spending. Not-basic consumer goods were subject to highly differentiated turnover taxes. Payroll taxes were collected by enterprises on behalf of employees. The enterprise taxes, the most important source of revenue, were used to centralize and regulate enterprise incomes.

In centrally planned economies, taxes were not collected on the basis of codified tax laws and rules for the determination of taxable bases and applicable tax rates. They were collected mostly on the basis of negotiations between government and enterprises. Thus, there was little need for a tax administration because of the presence of few taxpayers (mainly large enterprises) and the role of a mono-bank in processing payments.

The impact of transition on the public finance system was radical. The process raised the fundamental need to create (together with economic reforms) necessary and well-working fiscal institutions (Tanzi and Tsibouris 2000). The old tax systems could not simply be reformed at the margin, but completely new tax systems were needed. The basic choice was between the adoption of a modern market-oriented tax system with a ‘shock therapy’ approach and the adoption of new tax systems following a more evolutionary approach (OECD 1991; Tanzi 1992).

At that time, important economic and institutional constraints were present. The path of tax reform during the transition period was largely determined by the legacy of the past systems (Martinez-Vazquez and McNab 1997; Stepanyan 2003): an interventionist tradition; taxes were frequently negotiated; the tax systems lacked transparency and there was no experience with voluntary compliance; the previous tax systems were not designed to pursue efficiency and equity objectives; finally, the tax administration was underdeveloped. Given these constraints, there was a general consensus between foreign experts on the desirability of a more evolutionary and country-specific approach to tax reforms. Emphasis was placed on the need to modernize tax administration and to adopt taxes that could be enforced, with a stable revenue raising capacity.

Progress in tax reform has varied across individual countries in transition. The main EU accession countries (Hungary, Czech Republic, Poland, Slovenia and the Baltic states) rapidly moved early into transition to introduce comprehensive tax reform, a common objective being their accession to the EU. This is the main reason why, in these countries, tax reforms generally moved faster than in other transition countries (Martinez-Vazquez and McNab 2000). Compared with the other countries of the former Soviet Union the specific group of Baltic states can be considered as successful examples of tax reform implementation (Stepanyan 2003; Dabrowski and Tomczynska 2001). These countries managed to adopt, in a relatively short period, new tax systems consistent with the best international standards and to recover the tax revenue levels prevailing before transition (see also Chapter 8).

For most transition countries, the early stages of this process led to a substantial decline in the traditional tax bases and to a consequent fall in tax revenues. However, between transition countries, those (such as the Czech and Slovak Republics, Poland, Hungary and Slovenia) that made the most progress in terms of market-based reforms have seen their revenue share in GDP maintained or sometimes increased (Tanzi and Tsibouris 2000; Dobrinsky 2002). For instance, in Poland, the tax system performed well during the 1990s, particularly in its revenue raising capacity on a continuous basis (Lenain and Bartoszuk 2000); as a consequence, Poland has been able to avoid the fiscal crisis encountered by other transition economies. The same countries were among the transition countries in which the increase in income inequality has been generally lower (according to the data reported by Tanzi and Tsibouris 2000).

In all the accession countries, the process of tax reform has been significantly influenced by their history and their state at the starting point of the process. In the design of the tax systems, countries continued to favor an interventionist stand providing special tax treatments and incentives, which in turn have led to tax erosion, economic distortions, compliance costs and equity problems. This heritage from past experience with central planning reflected, as noted by Tanzi in the foreword, a lack of trust in the ability of a market economy to make the right choices. Only in the second half of the 1990s has this trend been partially reversed.

During the 1990s, in most transition countries tax policy reforms were generally more advanced than reforms in tax administration (Martinez-Vazquez and McNab 2000; see also Chapter 5). The experience of transition economies has shown the interrelation between tax policies and tax administration (Stepanyan 2003), with the reform of tax administration playing a crucial role in successful tax policy implementation. Even in this field the leading transition countries (like most New Members) have shown a capacity far collecting revenue from the main taxes (corporate tax, VAT and social contributions) that is higher than that of the slow transition reformer countries and close to the EU benchmarks (Schaffer and Turley 2001).

1.3
Tax systems: structure and developments

The data made available by the EU Commission (2000) for the period 1992–98 allow for comparisons over time and cross-sectionally to be made between New EU Members and existing EU members countries. Looking at the ratio of taxes to GDP as a signal of the country’s preference for the size of the public sector, in the period 1992–98 (see Table 1.1) tax ratios increased on average within the EU (going from 41.4 to 42.6 percent), while the same figures for the New Members show an opposite trend, with the average ratios decreasing from 41.0 to 38.6 percent.

Table 1.1 Structure and development of fiscal revenue in New Members and EU 15 as a percentage of GDP, 1992–98

This results from the different pattern of two groups of countries: in some of the New Members (Estonia, Poland and Slovenia) the ratio has remained stable, while for those countries (Czech Republic and Hungary) where at the beginning the ratios where higher than the average (and higher than the EU average) the reduction has been significant (from 42.8 to 38.3 percent in the Czech Republic and from 46.0 to 38.9 percent in Hungary).

At the end of the period (1998) the difference between the highest ratio (40.5 percent in Slovenia) and the lowest (37.5 percent in Estonia) is less than at the beginning of the 1990s, indicating a process of convergence among the New Members, while the distance from the EU countries has increased by about 3.6 percentage points. On average, the tax pressure in the New Members (0.4 points lower than the European average in 1992) becomes 4.0 percentage points lower than in the EU at the end of the period (1998).

The lower tax burden is due to the lower incidence of both tax revenues (2.8 percentage points) and social security contributions (1.2 percentage points). Within tax revenues, the incidence of direct taxes is much lower than in the EU (4.1 percentage points), while the share of indirect taxes is higher (1.4 percentage points).

Among the accession countries the share of individual taxes in GDP shows large differences. The difference between the highest and the lowest figure is about 2.2 percentage points for direct taxes, 6.5 points for indirect taxes and 4.8 points for social security contributions. Similar differences are not found in EU member countries (Gandullia 2004).

More updated comparable figures are available but only for the OECD member countries (Czech Republic, Hungary, Poland and Slovak Republic; OECD 2003a). In the years after 1998 (1999–2002, provisional data) the tax-to-GDP ratio has decreased for all these countries, excluding the Czech Republic, where the ratio increased from 38.9 to 39.2 percent. The ratio decreased from 39.1 to 37.7 percent in Hungary, from 35.0 to 34.3 percent in Poland and from 34.4 to 33.8 percent in the Slovak Republic. Even if the data from the EU Commission and those from the OECD are not directly comparable (in addition the coverage of countries is different), it can be argued that during the decade 1992–2002 a general process of reduction in tax pressure has taken place in most of the accession countries.

The tax structure by legal categories, measured as the distribution of tax revenue among major taxes (direct taxes, indirect taxes and social security contributions) has changed over time (see Table 1.2), while in the same period the tax mix has remained quite stable within the EU members.

Table 1.2 Tax mix in New Members and EU 15 as a percentage of total taxation, 1992–98

At the beginning of the 1990s, the broad fiscal structure of New Members comprised social sec...

Table of contents

• Cover Page
• Half Title page
• Title Page
• Copyright Page
• Contents
• Figures
• Tables
• List of Contributors
• Foreword
• Preface
• Acknowledgements
• Part I A general picture of tax systems and tax reforms in New EU Members
• Part II Country studies of tax systems and tax reforms in New EU Members
• Index