STRATEGY AND IMPLEMENTATION OF THE
FUNDAMENTAL TAX REFORM
IN THE SLOVAK REPUBLIC
Marek Jakoby
Advisor to the State Secretary
Ministry of Finance of the Slovak Republic
Prague
May 30, 2005
FISCAL REFORM: GENERAL CONTEXT
MAIN GOVERNMENT’S OBJECTIVE:
• reduce the general government deficit under 3.0% of GDP by
2006…
• … while simultaneously decreasing public expenditures as a share
of GDP
Fiscal Position of General Government (% of GDP)
2002
2003
2004
2005
2006
2007
Revenues
38.3
36.0
37.3
37.0
36.6
36.5
Expenditures
44.0
39.6
40.6
40.4
39.5
38.4
Net borrowing*
-5.7
-3.6
-3.3
-3.4
-2.9
-1.9
* excl. costs of second pillar of the reformed pension system
TAX REFORM IS A PART OF A COMPLEX REFORM
PACKAGE WHICH INCLUDES:
– 3-year general government budget
– program budgeting
• Health care reform:
– introducing co-payments and specification of basic package of services
covered by obligatory health insurance
• Pension reform:
– reformed PAYG
– introduction of second, pre-funded pillar
• Social assistance reform:
– tightening provision of social benefits
• Public administration reform
– fiscal decentralization
THE SLOVAK TAX REFORM: GOALS
BASIC PHILOSOPHY:
LIGHT, NONDISTORTIVE, SIMPLE AND TRANSPARENT
TAX SYSTEM
• create business and investment friendly environment for both
individuals and companies
• eliminate existing weaknesses and inefficiencies in the tax law
• eliminate distortive roles of tax policy as instruments for achieving
non-fiscal goals
• improve tax fairness by taxing all types and all amounts of income
equally
FISCAL IMPACT OF THE TAX REFORM
• reform designed to be revenue neutral in 2004
• serious attention paid to fiscal impact quantifications
• 5 independent estimations made by following institutions:
–
–
–
–
–
International Monetary Fund
Slovak Ministry of Finance - Institute of Financial Policy
special high-level working committee
Infostat (Slovakia)
Slovak Academy of Sciences
• conservative estimates adopted for fiscal purposes
TAX REFORM – main objectives and principles
• FLAT INCOME TAX - simplicity, fairness, proportionality
– cutting number of tax rates (18 → 1)
– broadening tax base (eliminating special treatments and
exceptions)
• allows low standard tax rate
• minimizes distortions in the economy
– eliminating double taxation
– progressivity of personal income taxation reduced but not
eliminated (tax free threshold bound to the living minimum)
Tax-free items
– Only one but much higher tax-free treshold
• Basic tax allowance for tax payer annually automaticaly
indexed to minimum subsistance level (as 19,2 x ) (SKK 38,760 →
SKK 80,832 →SKK 87 936 (2,800 USD) in 2005)
• Spousal allowance (SKK 12,000 → SKK 80,832 →87 936 in
2005
– Introducing annual child tax credit
• SKK 4,800 (USD 155) per child (part of new child support and
working incentives policy)
– Since 2005 introducing purpose-oriented allowance
• SKK 12,000 (tax-free long-term savings, ageing issue)
FLAT TAX STILL ENSURES PROGRESSIVE
TAXATION OF INCOMES
Effective Tax Rate
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
0.0
0.5
Poverty Line
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Personal Income
(as a percentage of the average salary in the economy)
4.5
5.0
TAX REFORM – main objectives and principles
• Efficiency – growth-oriented
– Incentives to work - lowering effective taxation of low- and
high-income groups
– Support of business environment
• Broad revenue neutrality
– Primary government objective: fiscal consolidation allowing for euro
adoption in 2009
=> shifting tax burden from direct toward indirect taxes
Direct taxes: Flat personal and corporate tax, abolishment of inheritance, gift
and real estate transfer tax, tax on dividends
Indirect taxes: unification of VAT rates 14%, 20% → 19%, tobacco,
beer and mineral oil tax rates)
IMPLEMENTATION STRATEGY
Chronology of the changes in the tax laws
1. Changes in indirect taxes:
•
•
amendment of VAT Act – introduction of unified rate of 19% (January
2004; before: 20% and 14%)
amendment to the Acts on Excise Duties – increase of certain excise
tax rates: mineral oils, beer and tobacco products
2. Changes in direct taxes:
• new Income Tax Act – introduction of flat tax (January 2004)
• new Real Estate Transfer Tax Act – abolition of gift and
inheritance tax and introduction of 3% flat rate for real estate
transfer tax (completely abolished as by January 2005)
3. Changes in indirect taxes in compliance
with EU tax legislation
- new VAT Act and new Excise Duties Acts - as of
May 1, 2004
THE REFORM RADICALLY DECREASES ECONOMIC
DISTORTIONS CREATED BY THE TAX SYSTEM
2003
PERSONAL
INCOME TAX RATE
CORPORATE
INCOME TAX RATE
VALUE ADDED
TAXES
OLD SYSTEM
5 tax rate bands:
10%, 20%, 28%,
35% and 38%
25%
standard rate: 20%
lowered rate: 14%
2004
NEW SYSTEM
1 flat rate:
19%
19%
one unified rate:
19%
THE REFORM RADICALLY SIMPLIFIES THE TAX SYTEM
AND INCREASES ITS TRANSPARENCY
2003
2004
PERSONAL
INCOME TAX BASE
OLD SYSTEM
LOTS OF
exceptions, exemptions
and special regimes
NEW SYSTEM
NO
exceptions, exemptions
and special regimes
CORPORATE
INCOME TAX BASE
LOTS OF
exceptions, exemptions
and special regimes
NO
exceptions, exemptions
and special regimes
OTHER TAXES
LOTS OF
special taxes and rates
VIRTUALLY NO
special taxes and rates
THE REFORM ELIMINATES MOST FORMS OF DOUBLE
TAXATION OF INCOME
DIVIDEND
TAX
GIFT
TAX
INHERITANCE
TAX
REAL ESTATE
TRANSFER TAX
(as of 2005)
TAX RATES FACED BY INVESTORS IN DIFFERENT
COUNTRIES
Slovakia
Estonia
Finland
Hungary
Czech Republic
Poland
Germany
Japan
UK
France
Ireland
USA (New York)
0%
10%
20%
30%
40%
50%
Corporate tax rate
Effective tax rate on investment income faced by a private investor (combined corporate tax and dividend tax)
60%
PRELIMINARY RESULTS OF TAX REFORM
• Tax revenue development in 2004 showed that the estimates of the
Ministry of Finance have been correct and collected overall tax
revenues were in line with the estimates
• Simplified administration and lower total tax burden have lead to
improved incentives for entrepreneurship and investment
• Positive impact on employment is expected in medium term
• From macroeconomic and budgetary point of view it is too early to
evaluate the overall impact of the tax reform
• Reform contributed to higher rating of the Slovak Republic
AAA- (S& P); A2 (Moody´s)
TAX REVENUES
TAX REVENUES (% OF GDP)
2002
2003
19,0
18,2
2004
budget
17,6
-direct tax
-indirect tax
6,9
12,1
6,9
11,3
Social security contribution
Total Tax Revenues
14,4
33,5
13,9
32,1
Tax
* Forecast
2004
2005*
2006*
17,7
17,4
17,3
5,7
11,9
6,3
11,4
5,0
12,4
5,0
12,3
13,4
31,0
13,4
31,1
13,5
30,9
13,5
30,8
CONCLUSION: POLITICAL WILL AND MANAGEMENT ARE
KEY FOR SUCCESSFUL REFORMS
• must have a clear vision where you want to go
• timing is key in the implementation
– implement less popular steps first
• resist lobbies and entrenched interests
– if you give in to one demand, you will be less able to say no
to others
• compensate the most vulnerable part of the population
THANK YOU FOR YOUR ATTENTION
Marek Jakoby
Advisor to the State Secretary
Ministry of Finance of the Slovak Republic
Štefanovičova 5
817 82 Bratislava
Slovak Republic
tel.: +421 2 5958 2305
fax: +421 2 5958 2354
e-mail: mjakoby@mfsr.sk
Internet: www.finance.gov.sk