Identifier
Created
Classification
Origin
05BRATISLAVA428
2005-06-06 05:38:00
UNCLASSIFIED
Embassy Bratislava
Cable title:  

KEY TO SUCCESS FOR SLOVAKIA'S FLAT RATE TAX SYSTEM

Tags:  ECON EFIN ETRD LO 
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UNCLAS BRATISLAVA 000428 

SIPDIS


TREASURY FOR CHRISTOPHER GREWE

USDOC FOR MROGERS AND STIMMINS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD LO
SUBJECT: KEY TO SUCCESS FOR SLOVAKIA'S FLAT RATE TAX SYSTEM

UNCLAS BRATISLAVA 000428

SIPDIS


TREASURY FOR CHRISTOPHER GREWE

USDOC FOR MROGERS AND STIMMINS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD LO
SUBJECT: KEY TO SUCCESS FOR SLOVAKIA'S FLAT RATE TAX SYSTEM


1. Summary. Slovakia's adoption of a 19-percent flat rate
tax for corporations and individuals has generated much
attention internationally, but the Slovak general public has
been quite mute. Contending international policy camps have
cited statistics to support their claims that the system is
either a success or a failure. In fact, the success of the
system rests in complimentary legislation that promotes a
policy of consumption taxes to offset the lowering of tax
rates for businesses and most individuals. After the first
year, most Slovaks have been left better off or neutral by
the flat tax rate, the country's fiscal condition has
improved, foreign direct investment (FDI) is soaring -- that
should qualify it as a success. End summary.

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RESULTS
--------------


2. The preliminary statistical results of Slovakia's
initial year under a 19-percent flat tax regime show that
GOS tax revenues increased 4.2 percent from 2003, which is
4.5 percent higher than budget estimates. Clearly this
shows that, so far, the new system is a success. However,
the results are easy to manipulate to bolster either side of
the taxation debate. The reason is that not only did
Slovakia adopt a (generally lower) flat tax rate for
corporate and individual taxes, but it simultaneously, and
largely unrecognized, also moved towards a policy of
consumption taxes by unifying and raising its value added
tax (VAT) to 19 percent and raising excise taxes on mineral
fuels, tobacco and beer.


3. The GOS budgeted that the flat tax rate would reduce tax
revenue from individuals and corporations by about 40 and 20
percent respectively during the first year, and that the
difference would be made up by increases in VAT and excise
taxes. This is essentially what happened, but the results
were better than forecasted. Revenue from individual taxes
only dropped by about 20 percent and that from corporate
taxes actually increased by 2 percent. In addition, VAT and
excise taxes showed even stronger gains than forecasted by
rising 19 and 14 percent respectively, or about 35 percent
higher than targeted.

--------------
BACKGROUND
--------------


4. Prior to 2004, Slovakia had a 25 percent corporate tax

rate and five different individual income tax rates ranging
from 10 to 38 percent with a large majority paying more than
19 percent. In addition, VAT was set at 20 percent for most
items and 14 percent for food and other staple products that
account for a large portion of expenditures. Unifying the
VAT was not necessary for Slovakia to qualify as a flat tax
country, but increasing VAT receipts was definitely an
important part of the plan. Slovakia is the seventh
central/eastern European country to adopt a flat tax rate
and it has one of the highest VAT rates of the group. In
the end, flat tax regimes are usually more complicated than
just leveling the tax burden for each unit of income earned,
and they often depend on raising other taxes.

--------------
REACTION
--------------


5. OPPONENTS OF FLAT TAX REGIMES TEND TO OVERLOOK THESE
CONSUMPTION TAXES AND INSTEAD CONCENTRATE ON THE FACT THAT
SLOVAKIA'S COMBINED CORPORATE AND INDIVIDUAL INCOME TAX
REVENUES DROPPED OVER 10 PERCENT IN 2004. THEY ALSO POINT
OUT THAT LOWER-INCOME-EARNERS WHO ONCE PAID A TAX RATE OF 10
PERCENT NOW FACED A TAX BURDEN ALMOST TWICE AS HIGH. IN
ADDITION, THESE SAME PEOPLE NOW HAD TO PAY SUBSTANTIALLY
HIGHER TAXES FOR FOOD AND OTHER BASIC NECESSITIES.


6. THE GOS COUNTERS THESE ARGUMENTS BY EXPLAINING THAT AS
PART OF THE NEW SYSTEM, STANDARD DEDUCTIONS FOR LOWER INCOME
LEVELS WERE INCREASED SIGNIFICANTLY IN ORDER TO LEAVE
VIRTUALLY ALL LEVELS OF INCOME EARNERS NO WORSE OFF THAN
BEFORE THE INTRODUCTION OF THE FLAT TAX RATE. ALTHOUGH
CERTAIN CATEGORIES OF TAX RECEIPTS HAVE DROPPED, THE MORE
IMPORTANT MEASURE OF OVERALL GOS TAX REVENUES (INCLUDING VAT
AND EXCISE TAXES) ROSE BY 4.2 PERCENT. IN CUTTING THE TAX
RATE IN HALF FOR THE HIGHEST INCOME EARNERS, THE GOS HOPED
TO SIGNIFICANTLY REDUCE THEIR LEVEL OF TAX EVASION. WHILE
THIS HAS NOT BEEN AS EFFECTIVE AS ORIGINALLY HOPED FOR,
THERE HAS BEEN IMPROVEMENT AND THIS TREND SHOULD CONTINUE

INTO THE FUTURE TO MORE CLOSELY MATCH THE RESULTS ACHIEVED
BY OTHER FLAT TAX COUNTRIES.

--------------
POLL RESULTS
--------------


7. SLOVAK OPPOSITION POLITICIANS HAVE LARGELY BACKED OFF
THEIR EARLY CRITICISM OF THE FLAT TAX REGIME, BUT MAINTAIN
THAT THEY WOULD REDUCE THE VAT ON FOOD AND OTHER STAPLES.
POST HAS NOT HEARD MANY COMPLAINTS ABOUT THE FLAT TAX REGIME
AND THE INTERNATIONAL PRESS HAS OFFERED CONSIDERABLE PRAISE
FOR IT. SURPRISINGLY, WE HAD NOT SEEN ANY SLOVAK OPINION
POLLS ON THE NEW SYSTEM UNTIL LATE MAY. IN A SURVEY BY SME
NEWSPAPER, 7.3 PERCENT OF RESPONDENTS SAID THEY WERE BETTER
OFF WITH THE FLAT TAX SYSTEM, 40.8 PERCENT SAID THEY SAW NO
CHANGE, 21.7 PERCENT HAD NO OPINION, AND 30.2 PERCENT SAID
THEY WERE WORSE OFF. LIKE ALL POLLS, THIS ONE USED A SMALL
SAMPLE OF THE GENERAL PUBLIC, BUT IT WAS STILL LARGE ENOUGH
TO BE STATISTICALLY MEANINGFUL


8. WHILE THE RESULTS OF THIS POLL ARE NOT A STRONG
ENDORSEMENT OF THE NEW SYSTEM, THEY SHOULD BE CONSIDERED
WITH CULTURAL BIASES IN MIND. SLOVAKS ARE WIDELY RECOGNIZED
TO BE AMONG THE MOST PESSIMISTIC PEOPLE IN EUROPE. PAST
OPINION POLLS HAVE SHOWN THAT THEY PERCEIVED THE INFLATION
RATE TO BE 300 PERCENT HIGHER THAN IT ACTUALLY WAS, THAT
REAL WAGE RATES WERE DROPPING (WHEN IN FACT THEY WERE
STRONGLY RISING),AND THAT PRICE LEVELS WERE CONSIDERABLY
HIGHER THAN THEY ACTUALLY WERE. THE FACT THAT 62.5 PERCENT
OF THOSE SURVEYED SAW NO DIFFERENCE OR HAD NO OPINION CAN BE
INTERPRETED THAT MOST RESPONDENTS FELT GENERALLY NEUTRAL
ABOUT THE NEW SYSTEM. FURTHER RESEARCH INTO THOSE WHO FELT
WORSE OFF SHOWED THAT THE LARGE MAJORITY OF THEM IDENTIFIED
THEMSELVES WITH THE SLOVAK COMMUNIST PARTY, WHICH IS IN
OPPOSITION TO THE GOS.


9. Ministry of Finance (MOF) statistics also support its
claim that for nearly all income levels, people paid less in
taxes, and for most of those who paid more the increase was
insignificant (USD 1-2 per month). During 2004, Slovaks had
to contend with rising costs of health care and cuts in
social benefits. It is likely that some of the pain of
these changes was erroneously blamed on the flat tax regime.

--------------
COMMENT
--------------


10. IN THE BROADEST SENSE, THE NUMBERS POINT TO SLOVAKIA'S
FLAT TAX AND CONSUMPTION TAX REGIMES AS BEING SUCCESSFUL.
BESIDES INCREASING TAX REVENUES, WHICH HELPED TRIM THE
BUDGET DEFICIT AS SLOVAKIA PURSUES ADOPTING THE EURO, THEY
ALSO HELPED ATTRACT LARGE AMOUNTS OF FDI THAT WILL IN TURN
CREATE JOBS, BOOST EXPORTS, AND HELP DEVELOP THE ECONOMY.
ALL OF THESE ATTRIBUTES WILL AID THE COUNTRY'S FISCAL
CONDITION FOR YEARS TO COME. AS THE MORE DEVELOPED WELFARE
STATES OF THE EU-15, AND THE U.S. FOR THAT MATTER, WATCH AND
CONSIDER TAX REFORMS OF THEIR OWN, SLOVAKIA AND OTHER
INNOVATORS ARE SCORING POINTS IN THE EARLY ROUNDS OF THE TAX
DEBATE.
THAYER


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