Identifier
Created
Classification
Origin
08BUDAPEST874
2008-09-04 13:15:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Budapest
Cable title:  

THE GOVERNMENT'S NEW TAX PLAN - TAX CUTS WITHOUT

Tags:  ECON PGOV HU EFIN 
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VZCZCXRO5188
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHUP #0874/01 2481315
ZNR UUUUU ZZH
R 041315Z SEP 08
FM AMEMBASSY BUDAPEST
TO RUEHC/SECSTATE WASHDC 3351
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE
UNCLAS SECTION 01 OF 03 BUDAPEST 000874 

SENSITIVE
SIPDIS

DEPARTMENT FOR EUR/CE LAMORE AND EB/OMA, AND INR/EC
TREASURY FOR JEFF BAKER AND LARRY NORTON

E.O. 12958: N/A
TAGS: ECON PGOV HU EFIN
SUBJECT: THE GOVERNMENT'S NEW TAX PLAN - TAX CUTS WITHOUT
SPENDING CUTS

REF: BUDAPEST 809

UNCLAS SECTION 01 OF 03 BUDAPEST 000874

SENSITIVE
SIPDIS

DEPARTMENT FOR EUR/CE LAMORE AND EB/OMA, AND INR/EC
TREASURY FOR JEFF BAKER AND LARRY NORTON

E.O. 12958: N/A
TAGS: ECON PGOV HU EFIN
SUBJECT: THE GOVERNMENT'S NEW TAX PLAN - TAX CUTS WITHOUT
SPENDING CUTS

REF: BUDAPEST 809


1. (U) Summary. The GOH unveiled its multi-year USD 7 billion
tax cut plan last week. Under the plan the government
proposes to remove the unpopular 4 percent "solidarity tax"
on businesses and to reduce employer social security
contributions for lower wage employees, but it also intends
to increase the corporate tax rate from 16 to 18 percent. The
plan would also reduce the tax burden for low wage earners by
raising the 18 percent personal income tax bracket. The
government intends to finance the cuts through "tight budget
planning" and by reducing the high level of tax avoidance in
Hungary. While economic analysts have expressed general
support for tax cuts to help stimulate growth, they believe
the government plan does not go far enough, maintaining that
it should include expenditure cuts and meaningful reform of
the pension and public assistance systems in order to promote
employment and growth in Hungary. They are also skeptical of
the government's ability to finance the tax cuts through a
reduction in tax avoidance levels. The minority Socialist
government currently lacks room to maneuver on pension and
social welfare reform - as well as the support of its
erstwhile coalition partner Free Democrats - as its tax cut
plan and its 2009 budget move toward debate on the floor of
Parliament. End summary.

THE PRIME MINISTER'S TAX CUT PLAN


2. (U) On August 26, Prime Minister Gyurcsany announced a
three to four-year plan to cut taxes by USD 6.2 to 7.4
billion (HUF 1,000 - 1,200 billion). The plan initially aims
to reduce tax revenue by HUF 300 billion (1 percent of GDP)
in 2009, and to increase the level of tax cuts thereafter.


3. (U) In the first year, the plan would eliminate the 4
percent so-called "solidarity tax" on businesses, but would
raise the corporate tax rate from 16 to 18 percent. Other key
cuts would include raising the income level of individuals
who fall into the 18 percent personal income tax bracket, and
reducing employer social security contributions by 5 percent
for low wage employees.


4. (U) Contrary to speculation prior to the announcement, no
change in the VAT level is being proposed. In addition, few

expenditure cuts are proposed as offsetting measures, and the
government estimates that 60 percent of the 2009 tax cut will
be financed through "extremely tight budget planning" where
expenditures would not increase in real terms.


5. (U) The Prime Minister hopes to finance the rest of the
tax cut through a further "whitening" of the economy -
reducing the number of people who either do not report
income, or who report only a portion of their actual income.
(Note: This continues to be a major problem in Hungary.
Recent estimates suggest that unreported employment in
Hungary amounts to as much as 20 percent of GDP, and informal
estimates often range much higher. End note.) To achieve this
goal, Gyurcsany's plan includes a one-time "amnesty" for
individuals who previously under-reported their income, and a
"no tolerance" policy for tax avoiders thereafter.


6. (U) Other sources of increased government revenue would
include a 10 percent increase in the excise taxes on
alcoholic beverages and tobacco products, an additional
healthcare contribution for benefits in kind, and a change to
the taxation scheme relating to company vehicles.


7. (SBU) Researchers and analysts are generally supportive of
the tax reductions, in particular the elimination of the
solidarity tax, which "serves the competitiveness of
businesses," but as KOPINT-TARKI director Eva Palocz puts it,
"the stimulating effect (of the government plan) is minor."
Istvan Hamecz, CEO of OTP Fund Management agrees, noting that
neither the extent of the tax cut nor the direction of other
measures will attract additional workers to enter the labor
market. Most analysts agree that the plan does not go far
enough to significantly increase growth or increase Hungary's
low labor participation rate, and question how the government
can pay for it without major cuts in expenditures.

WHAT'S NOT IN THE PLAN


8. (SBU) In addition to its lack of spending cuts, the plan
also does not seek to reform the pension or social welfare
benefit systems. According to Prime Minister Gyurcsany - who
we understand wrote the public roll-out of the plan himself,
the "social implications" of doing so "would be much graver

BUDAPEST 00000874 002 OF 003


than the country could tolerate or support." Economic
analysts criticize the plan's failure to address underlying
issues they see as impeding economic growth in Hungary.
Citibank analyst Eszter Gargyan notes that, "without a major
tightening of social benefits" the plan fails to "resolve the
underlying weaknesses in the economy that are related to low
labor participation, high public expenditure, and high tax
avoidance." As former Central Bank Governor Gyorgy Suranyi
told the Ambassador, the government's plan "to reduce taxes
without hurting anyone" is unrealistic, and Suranyi believes
it would "almost be preferable to focus exclusively on
deficit reduction" rather than undertake a plan that is "not
ambitious."

WHITHER THE CONVERGENCE PROGRAM?


9. (U) International analysts including Standard and Poor,s
have questioned the plan's impact on Hungary's "Convergence
Program." Although the Prime Minister has pledged to continue
the budget path toward budget deficits of no more than 3.2
percent in 2009, and 2.7 percent in 2010, some analysts
believe that the lack of clear expenditure cuts in the tax
plan (and the over-reliance on the projected economic
"whitening" effect by reducing the number of tax avoiders)
increases the risk that the deficit will overshoot the
Convergence Program goals, particularly in the 2010 election
year. Others are more circumspect, however, and believe that
the government is unlikely to undermine its efforts over the
last two years to bring the deficit under control. In
addition, under the government's plan, later year tax cuts
will only take place if the government is successful in
deriving additional income from its economic whitening
efforts.

FEWER TAX EVADERS?


10. (SBU) While the government has enjoyed some success
toward this goal through more aggressive tax law enforcement
(reftel),there is a debate over whether the tax changes in
the current proposal will promote less tax avoidance. The
plan envisions a one-time tax amnesty for tax avoiders,
followed by a "zero-tolerance" policy thereafter. The current
tax system tends to incentivize the underreporting of wages
by offering employers of minimum wage workers
disproportionately low tax and social security contribution
rates. This will continue under the government's plan.
Indeed, Gyula Toth of UniCredit argues that, "the new
threshold in the social security contribution may provide
even more incentives for tax avoidance." Gyorgy Suranyi
agrees, noting that the proposal "does not improve the
situation at all", because the highest tax rate of 38 percent
still starts at a level below the average monthly wage.
Standard and Poor's, while noting that the proposed tax cuts
are "generally a move in the right direction," argues that
financing the tax cuts from revenue generated by reducing the
number of tax avoiders is ultimately "not credible."

COURTING THE SOCIAL DEMOCRATS


11. (SBU) Commentators speculate that the Prime Minister's
tax plan was designed in large part to win support of the
former coalition partner Free Democrat (SzDSz) party, which
it needs in order to garner a majority in Parliament to pass
both the tax law changes and the 2009 budget. As one analyst
commented, "SzDSz asked for a HUF 1,000 billion tax cut, and
the Prime Minister delivered." Others have called the tax
proposal "the Socialist Party's marriage proposal to SzDSz".
Based on the initial negative reaction from SzDSz to the tax
proposal, however, it appears that SzDSz is not ready to take
another trip to the altar. SzDSz President Gabor Fodor argues
that the country needs "structural changes," and not more of
the government's "stop-and-go policy." (Note: See septel for
a discussion of the current political context).

COMMENT


12. (SBU) Although the government would likely be willing to
modify its tax plan as it continues to court SzDSz, the Free
Democrats have not been clear on what it would take to win
their support - assuming they actually know. But there will
be clear limits to the MSzP's flexibility: the Socialists
will likely remain unwilling (or unable, according to
Gyurcsany) to propose major spending cuts or reform to the
pension or social benefit systems. This puts the government -
once again - in the position of overemphasizing a plan that
underdelivers. With submission of its tax proposal to
Parliament required by September 15, and its budget by

BUDAPEST 00000874 003 OF 003


September 30, the two issues are likely to dominate the
legislative agenda in the weeks ahead. End comment.
Foley