19% in operation – the first year of the tax reform

18. 01. 2006

If we were to compare the Slovak reforms to a fleet, we could certainly identify the tax reform, popularly known and also called in its abbreviated form as “the flat tax”, as the flagship of this fleet.  It is necessary to view this reform in context with the other changes and reforms which have taken place in the economic policy of Slovakia during recent years and thanks to which Slovakia has gained international recognition in the field of economics.

The exceptionality of the tax reform lies in particular in the intensity of international (mainly positive) response, but also in the relatively rapidly apparent (again mainly positive) results. The important and specific position of the tax reform can perhaps be most accurately characterised by the fact that the so-called “Slovak model” has become an important part of the pre-election agendas of the parties of the centre-right in Germany, Poland and the Czech Republic respectively.

Of course, this fact also results in various, often narrowly self-serving or even misleading interpretations of the principles and rules, but especially of the results and impacts of this reform. Therefore I consider an objective analysis of the operation of the “Slovak model” tax reform, based on the facts and arguments, to be most important not only in the Slovak context but also in the wider international context.

An objective, academically critical account, an accurate and strict formulation of the presuppositions underlying the analyses and their conclusions, as well as very openly and accurately formulated limits from the perspective of a more complex and principal judgement of the results of the whole project, would, in my opinion, be the significant benefits of the proposed analysis.A single year’s operation of a new system, as is also clearly stated in the study, is not sufficient for principal and definite conclusions but, despite this, the results of analyses show that the project has been successful and it brings about positive results that may become more significant and apparent in the medium- and long-term horizon. Of course, this is based on the assumption that the reform will not be rescinded or will not be subject to a gradual erosion.

The Slovak tax reform has not brought about anything radically new as far as the principles on which it is based are concerned. In fact, quite the opposite could be stated in the sense that it is only the fulfilment of the basic tax principles, as adumbrated on the first pages of every textbook on tax theory.  These are: simplicity, neutrality, efficiency and equity. A further principle is the transfer of emphasis from the taxation of goods and creation of services (revenues) to the taxation of consumption. But the reality is that practice in this area is dramatically different in most of the world’s countries. The causes lie in particular in the gradual but successful penetration of statism, interventionism, subjectivism, populism, group interests and similar effects into economic policy and in the subsequent, politically very difficult, process of the removal of the distortions they cause in the tax system.

Our tax reform endorses the thesis that nothing is more practicable than a good theory. The authors emphasise in their analysis, very correctly in my opinion, that the simplification of the tax system, which is the result of the cancellation of almost all special rates, exceptions, special regimes, deductible items etc., is far more important than the rate changes.  And this is the principal difference between the tax reform in Slovakia and in those other countries (e. g. Russia, Ukraine or Romania) where tax reform, in principle, only meant a change of rates.

The results of the analysis disprove the statements of the tax reform opponents claiming that the tax reform was only advantageous for the rich and disadvantaged the poor. This is not true nor, during the first year of the tax reform operation, was there was any reduction in the net real income of individual groups of workers. Of course, this does not mean that it could not occur in particular individual  cases, but the reality is that most families (especially those with children) with at least one member in work have benefited from the tax reform. An individual on the minimum wage increased his/her real income by 3.1%; a couple on the minimum wage with two children increased their income by almost 9% in 2004. Nor did the real income of pensioners decrease (+0.4%). These positive results should become even more significant in the coming years, especially thanks to the dynamic growth in the economy and employment. Reforms are not carried out for the sake of reform, they are an essential precondition for high and sustainable economic growth without which growth in employment and living standards cannot be attained.  Any annulment of the reforms or their major revision would ultimately mean simply endangering the growth in employment and living standards. It remains valid that for each reform its approval is solely the first step, its proper implementation and the maintenance of the basic philosophy on which the successful reform is built are the important minimal requirements at the same level.  Although there is a risk of the total annulment of the tax reform, the threat of its gradual erosion through the approval of various exemptions, special rates and special regimes is far more real. Efforts towards a re-introduction of the lower VAT rate, or pressure towards a reduction of some consumption taxes (especially in the case of fuels) are examples of possible decisions that could initiate a gradual erosion of the tax system. And this would be a serious mistake and a big loss because the analysis that you have got in your hands also serves to prove that it is a successful project with positive results that could not yet be displayed.

I would like to say thank you to the authors of the publication for their work and at the same time I say thank you to all the people participating in the preparation and implementation of the tax reform in Slovakia.

Ivan Mikloš
Deputy Prime Minister and Minister of Finance

Economic Analysis of Financial Policy Institute