The conservatives are currently in the lead in Europe, at least as far as numbers of MEPs are concerned. We are colleagues in the same European party and yet we are from very different countries. Slovakia and the nine other accession states may have a thing or two to teach our longer-standing counterparts, and I will try to outline some of these today.
Slovakia is fortunate to be entering the second term of a centre-right coalition government, unlike the other members of the Visegrad Four country grouping. The Czech Republic, Poland and Hungary, by contrast, have all experienced a change at the top. Continuity has allowed Slovakia to implement a comprehensive system of reforms, the results of which are starting to become apparent. The World Bank recently declared Slovakia the number-one reformist country in the world.
The topic under discussion is labour market accessibility. The pre-accession EU fifteen had already taken some steps towards the deregulation of the European labour market. Despite this there have been calls from some quarters to impose a seven-year transitory period on accession states such as Slovakia to prevent the much-hyped flood of cheap labour moving from east to west. Yet this has failed to materialise. On the contrary, companies and specialists are moving to Slovakia to take advantage of the favourable business environment.
The chief contributor to this change in climate has been the steps taken towards reform of the tax system. I will attempt to outline briefly the most important of these.
But before I come to tax reform, I must first touch upon the changes to the state pension and health systems. One of the legacies of the communist regimes of Eastern Europe was that they created an unrealistic cultural attitude towards healthcare. People were led to believe that because it was free, it also cost nothing. This attitude has led to resistance, particularly among older elements of the population, towards reforms instituting charges for some pharmaceutical products or for contributions to general health expenditure. While unpopular, these reforms are vital, especially given the current birth rate of 1.3/1.4 children per couple, which is dramatically below the replacement rate for any society.
Having explained some of the problems Slovakia is facing, let me return to the issue of tax. I would argue that tax reform has been the most important action of the Slovak government in creating a highly competitive and non-distortive market environment.
In its manifesto, the government pledged to reduce income tax rates and consider the possibility of implementing a flat rate of tax. In reality, actual reform went beyond these original ambitions. The government’s ultimate goal was to transform the Slovak tax system into the most competitive in the entire EU, and maybe even in the OECD area. ‘Competitive’ does not merely translate into low rates of taxation. It also stands for efficiency, transparency and a non-distortive system.
Designed to be fiscally neutral, the reform is intended to achieve the following growth objectives:
. creation of a business and investment-friendly environment for both individuals and companies;
. elimination of existing weaknesses and distortionary effects of the tax law;
. achievement of a high degree of tax fairness by taxing all types and amounts of income equally. These goals should be achieved by careful implementation of several simple principles on which the tax reform is based:
. shifting the tax burden from direct to indirect taxes, from taxing production to taxing consumption;
. introducing low standard tax rates and eliminating all exemptions regimes;
. introducing flat tax rates in personal income tax, replacing the regime with different tax brackets;
. eliminating the distortive role of tax policy as an instrument for achieving non-fiscal goals;
. eliminating, as far as possible, double taxation of income.
A central plank of this reform has been the implementation of a flat rate of income tax on individuals and corporations of 19%. This came into law on 1 January 2004.
The new legislation eliminated 21 different types of taxation, including five different personal income tax rates of 10%, 20%, 28%, 35% and 38%. This radical change has several major advantages. First, the flat rate tax still maintains the progressive nature of effective tax rates, as all personal incomes of up to 1.6 times the poverty line are exempt from any form of income tax.
Also implemented on 1 January 2004 was a new rate of corporate tax, reduced from 25% to 19%. Value Added Tax has also been set at the magic figure of 19%. These reforms have attracted the interest of observers from all over the world, who are coming to learn from the Slovakian example. There were fears that the reduced rate of income tax would lead to dramatic falls in government revenue, but because the uniform rate of 19% has enhanced entrepreneurship and the prospects for small to medium-sized enterprises, people are happy to come to Slovakia to do business. The government eliminated some other forms of taxation as well, such as real estate transfer tax, donation tax and inheritance tax.
The future of Slovakia depends on the development of human resources. With a population of 5.6 million, Slovakia is roughly comparable to Denmark or Scotland. We have led Europe in terms of tax reform, and it is likely we will again set a trend by encouraging immigration to meet increasing demand for labour in the years ahead.
© Copyright; Foundation for Economic Growth and various authors. Individual authors retain their own copyright.
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