TAX NEWS - June 2010

Hungary Tax: Hungary Goes for Growth

Budapest's plan for tax cuts and simplifications could spur economic activity and increase tax revenues — if the EU and the IMF allow it.

When Hungarian Prime Minister Viktor Orbán returned to power in May, skeptics wondered if the center-right politician could resist the populist instincts to which he was prone, and which would be so toxic given the country's economic crisis. But if his government's recently unveiled plans to cut business taxes and create a new flat tax of 16% on all family personal income become law, Mr. Orban may redeem his economic reputation.

The flat income tax would begin in 2011, and Budapest also says it wants to cut the small business rate to 10% from 19%, do away with several other small-business taxes, freeze spending, cut public sector wages by 15%, and make charitable donations tax-free, to name a few.

The financial panic of 2008 hit the Hungarian economy hard and fast, with a 6.3% contraction in 2009 after foreign lending dried up. That crash triggered an EU-IMF joint-credit line of €20 billion. Hungary has since managed to keep spending down and has not exhausted its 2008 EU-IMF handout. Today, Hungary's Central Bank forecasts a budget deficit of 4.5% of GDP for 2010. Compare that to the U.K.'s deficit of roughly 12%, Spain's of about 11%, or even the U.S.'s estimated 10.6%.

The government is still rightly focused on reducing debt. But in targeting economic growth as forcefully as the deficit, Budapest is thinking outside the IMF box. The rewards could be significant. Hungary's income tax rates are currently among the highest in the OECD — the average single Hungarian taxpayer keeps less than 47% of what he costs his employer — which makes tax cheating ubiquitous. Its loophole and credit-riddled tax code doesn't help, either. Last week's proposed cuts and simplifications would spur more economic activity and probably increase tax revenues.

That's if the EU and the IMF allow it. We're told that the Continental tabulators who hold the strings on the credit line may only approve the plan if they see sufficient growth in the Hungarian economy. That demand for short-term government revenue likely inspired the 200 billion forint ($876 million) temporary tax that Budapest says it will raise from its financial industry. But a 1,400% tax increase won't help banks' willingness or ability to lend — especially when the banks only book annual profits of about 300 billion forints.

It's not surprising that Hungarians seem instinctively to understand the economic benefits of cutting taxes. Too bad their creditors don't.