ECONOMIC REFORM: THE VIEW ON THE GROUND

UNCLAS BRATISLAVA 000192

SIPDIS


E.O. 12958: N/A
TAGS: ECON EFIN PGOV ELAB SOCI LO
SUBJECT: ECONOMIC REFORM: THE VIEW ON THE GROUND


1. Summary. A radical tax overhaul, price liberalization
and tightening of social benefits in recent months have
combined to drastically alter the way most Slovaks view
their incomes. Approximately 90 new laws came into effect
on January 1, 2004 along with a host of other changes in
recent months. While the GOS budget and the economy as a
whole are on better off, nearly everyone has a new equation
to use to calculate his income and many pensioners and
unemployed people will be the most affected. Reductions in
social benefits have led to social unrest by Slovakia's Roma
minority, the vast majority of which are long-term
unemployed (septel). Opposition parties and some
presidential candidates hope to capitalize on public
unhappiness in upcoming elections. End summary.

CUT IN SOCIAL BENEFITS
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2. Slovakia's generous program of social and unemployment
benefits are often blamed as being disincentives for people
to find work. The country's unemployment rate is 16
percent, half of which have been out of work for more than
two years. Historically, many recipients of unemployment
benefits defrauded the system by having jobs on the black
market. This allowed them to earn far more than they
otherwise could have, and had the double burden of cheating
the GOS of income tax revenue and costing it unnecessary
benefits payments. On March 1 these benefits will be
reduced by approximately 15 percent (short-term unemployment
benefits by more than 50 percent) as the GOS introduces a
new workfare program. By performing community service or
taking jobs at minimum wage, recipients will be able to
regain or exceed their previous level of income that was
formerly completely dependent on social benefits
(unfortunately, it appears that a sufficient number of
community service jobs will not be ready in time). Social
unrest has broken out within Roma communities, which often
have unemployment rates above 90 percent, to protest the
cuts in benefits (septel).

19 PERCENT FLAT TAX RATE
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3. The most drastic change for the general public is a new
19 percent flat tax rate for individuals and corporations.
Previously, individuals paid taxes of between 10 to 38
percent divided between five different tax rates, and the
corporate rate was 25 percent. While the flat tax is
expected to be revenue neutral overall, it represents a
large tax cut to higher income earners. The GOS hopes this
will encourage them to actually pay their taxes and reduce
the rate of tax evasion. (Note: The Slovak National Tax
Office estimates that overall 20 to 30 percent of taxes go
unpaid in Slovakia.) To help offset the effect of raising
lower income earners' taxes from 10 percent to 19 percent,
the GOS greatly increased the amount of tax deductions for
the working poor. Middle-income earners who are single are
likely to pay higher taxes while a family of four would get
a nearly 10 percent benefit. However, the National Tax
Office told econoff that the new program could hurt
pensioners and the unemployed.

19 PERCENT UNIFIED VAT
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4. Slovakia's previous two-tier value added tax regime was
set at 20 percent for most items, but 14 percent for
necessities such as food, electricity and natural gas. The
rise from 14 percent to 19 percent falls disproportionately
hard on people in lower income brackets. In simple terms it
equals a five percent increase in inflation for basic
necessities. Critics of the new plan note that EU laws do
not require a unified VAT. Instead, they specifically allow
for reduced VAT on necessities, medicines and other
sensitive products.

PRICE INCREASES
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5. For several years, the GOS has been liberalizing utility
prices from their previously highly subsidized rates, and
2004 is the last year of liberalization before prices are
considered to be at market rates. Natural gas prices are
expected to rise more than 30 percent (including the new VAT
rate) for households in 2004 although they will drop by
about two percent for industrial and public sector clients.
Electricity prices will increase an average of 6.7 percent
(including the new VAT) this year. A local research group
predicts a 14 to 20 percent jump in food prices due to the
new VAT, increased farm costs and entry into the EU. In
August last year, the GOS raised excise taxes on petroleum
products, beer and cigarettes that raised the overall price
of gasoline and diesel by more than 10 percent, beer by
approximately 10 percent and cigarettes by 20 percent

(including a second tax increase in January 2004). These
tax increases were initiated to make up for a short fall in
tax revenues. To add to consumers' problems, inflation hit
its highest rate in four years in 2003 at 9.3 percent and is
estimated at 5.5 - 7.3 percent this year.

HEALTHCARE AND COLLEGE NO LONGER FREE
--------------


6. In June 2003, the GOS initiated a new fee-for-service
program in the healthcare sector. Although the fees seem
nominal by western standards, they represent a high cost for
many Slovaks who consider free healthcare a right of
citizenship. Slovakia's healthcare sector is deeply in
arrears and its debts are rising due to a public accustomed
to frequent doctor visits and doctors that over prescribed
drugs (many of which are discarded). The new charges
include USD 0.63 for visiting a doctor's office, having a
prescription filled, or spending the night in a hospital,
although many exemptions were created to minimize the
negative effects of this policy. In addition, an increase
in the cost of numerous drugs has helped make the Ministry
of Health one of the least popular departments of the GOS.
However, through the first six months of the plan medical
costs are down and the sector's debts are rising at a slower
pace. This September, the GOS also plans to introduce the
concept of college tuition. Previously free undergraduate
and graduate programs will cost approximately USD 125 to 650
per year excluding books, housing and meals.


7. Comment. The GOS has made many correct moves in recent
years to prepare the country for NATO and EU membership,
attract foreign investment, and generally catch up with the
development of its neighbors. Furthermore, the USG, the
IMF, and other international organizations agree with the
recent changes listed above, and have even promoted the idea
of reducing social benefits for years. However, the rapid
pace at which some of these changes are being implemented --
before adequate numbers of community service jobs could be
created and before the jobs created by new foreign
investment flooding the country (septel) can take hold --
shows a lack of preparedness on the part of the GOS.
Changing a decades-old- culture of living off the dole would
prove difficult under the best of circumstances. This view
of economic hard times is the backdrop for the upcoming
presidential election and referendum on early elections
called for by labor unions and opposition parties.
Coalition politicians seem determined to stay the course on
reforms, but they may pay high political costs by not taking
into account how the reforms are viewed by Slovakia's most
vulnerable. Opposition parties like SMER and KSS are trying
to use this issue to force a government change, and
President Schuster is campaigning for reelection on a
platform which heavily criticizes the government's actions.

THAYER


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