Some household movers are self-employed. (source: SME)
THE CABINET of Iveta Radičová has approved the broad outlines of an overhaul of what it calls deformations in the country’s income tax and payroll levy legislation. Observers are saying that pushing the concept through the cabinet was the easy part as the initiative has been accompanied by fiery discussion since its very inception and will likely face a rather rocky ride in parliament, as certain aspects of the plan face opposition even among MPs from the ruling coalition.
While the philosophy of bringing more transparency to the income tax and payroll levy systems appeals to all parties of the coalition, MPs from the Civic Conservative Party (OKS), who sit within the Most-Híd parliamentary caucus, say that true reform should be accomplished in a way that it does not have a negative impact on certain groups in society.
At the same time, Slovakia’s trade unions have prepared an alternative proposal to overhaul the tax systems and strongly reject some of the key elements of the reform advocated by Finance Minister Ivan Mikloš.
Some observers believe that the government’s proposed changes may discourage those with higher incomes from switching from standard employment to self-employment and observers also noted that the changes might encourage self-employed persons to engage in various forms of creative accounting, including declaring fictitious business expenses to lower their taxable income.
Mikloš, a nominee of the Slovak Democratic and Christian Union (SDKÚ) has said that it is impossible to remove what he calls multiple deformations in Slovakia’s revenue system without harming some groups of people.
Based on calculations made by the Ministry of Finance, the proposed changes will mean that many self-employed individuals and people working on so-called limited work agreements (“na dohodu” in Slovak) will pay more in payroll levies and income taxes.
But the ministry also said that 99.5 percent of persons with standard employment contracts will be better off after the reforms are adopted, adding that the same is true for persons who are self-employed if they have annual incomes of less than €4,823, before income tax and payroll levies. Mikloš said 116,600 self-employed individuals have business income less than that amount, the TASR newswire wrote.
But Mikloš said the self-employed with “high earnings and negligible expenses” will see their net income drop due to the proposed changes in the lump-sum allowance that currently is deducted from a person’s gross self-employed income before income taxes are calculated. The minister has argued that these high-earning, self-employed individuals include large numbers of those who only have pro-forma self-employed status and without what he calls this “deformation” they would be included in the payroll levy system as standard employees.
Some specific changes
The government’s proposal will introduce a so-called super-gross wage and the rates of the payroll levies for social insurance and health insurance will be reduced for some persons. The mandatory health insurance levy was approved by the cabinet at a rate of 9 percent, except for disabled persons who will pay half that rate. The proposed levy for the various components of Slovakia’s social insurance programme (old-age and disability pensions as well as sickness, accident and unemployment insurance) is 19 percent for employees, 13 percent for self-employed people and 10 percent for those working via “na dohodu” agreements, TASR wrote.
The tax-exempt base, the amount on which no taxes are paid, will be decreased from its current level of 19.2 times the country’s minimum subsistence level to 18 times. Projected into annual income, the amount of tax-free income will drop by €200 in 2012. However, TASR wrote that this tax-exempt base will not be reduced as incomes rise and this will effectively scrap what is now called Slovakia’s ‘millionaire’s tax’.
The Finance Ministry also said that its package of measures will have an unfavourable impact on the state budget, with a loss in revenue of €59.9 million projected in 2012.
The proposal will also establish an overall maximum insurance levy, which in 2012 will be set at €8,965 for social insurance contributions and €4,246 for health insurance contributions. The Finance Ministry said this will replace the maximum income base currently used when calculating these levies.
The 40 percent allowance that self-employed persons can currently deduct from their annual income to represent their self-employment expenses will have a monthly cap of about €200 per month in the future, as it will be pegged to Slovakia’s monthly subsistence level under the cabinet proposal. Also, payroll levies going to social insurance and health insurance will no longer be deductible from a taxpayer’s income before calculation of personal income tax liability.
Some of the objections
MPs from the OKS and some MPs from the Christian Democratic Movement (KDH) have made critical comments about the proposal. OKS MP Ondrej Dostál organised a Facebook press conference and stated that he would stop shaving his face until his concerns about the treatment of self-employed persons and those working via “na dohodu” work agreements are dealt with.
“OKS has long been saying that it would not support increasing the [income] tax-payroll tax burden for the self-employed or those with ‘na dohodu’ work agreements,” Dostál said, calling on citizens who disagree with the cabinet’s tax proposals to join in his symbolic protest, with men no longer shaving and women painting their nails black.
Ján Figeľ, the chairman of KDH who also serves as the minister of transport, construction and regional development, said that the cabinet proposal could be modified in parliament.
“Simplification, unification and bringing more transparency to the system certainly has wider support than some of the partial solutions,” Figeľ said, as quoted by the SITA newswire.
One economist’s reaction
Radovan Ďurana of the Institute for Economic and Social Studies (INESS) views the idea of a super-gross wage as the most appealing part of the reform proposals.
“The current state of informing employees about their payroll taxes is non-transparent and hard to understand,” Ďurana told The Slovak Spectator. “Greater transparency is welcomed and necessary.”
Ďurana added that the moderate overall decrease in the payroll levies for employees is also a positive step. He noted that if the changes also accomplish the goal of simplifying regularly submitted payroll levy reports it will save time and costs for all contributors to the social insurance system.
“The reform also means shifting the burden from [payroll] contributions to income taxes,” Ďurana said. “This shift should be reflected as well on the expenditure side of the social system, since the [payroll] levies aren’t of a reward character.”
Regarding risks that he sees in the reforms approved by the cabinet, Ďurana said that the changes will impact some groups of self-employed persons as well as persons working on “na dohodu” work agreements who are using these work agreements alongside their standard employment.
“The increased payroll tax burden might lead to changes in people’s form of employment or efforts to circumvent this burden,” Ďurana said.
Ďurana said the proposed change in the 40-percent lump-sum allowance that self-employed persons can currently use is a problematic point.
“It is unclear what the current role [of the 40-percent allowance] is, while the duty to report actual expenses could hardly be understood as an improper requirement for the self-employed,” Ďurana said. “But the cancellation of this item will impact self-employed who have an extensive range of expenses and who will thus see their administrative burden significantly increased.”
Ďurana added that this group of self-employed persons, however, will not have a higher income tax calculation base as a consequence of the reform, except for the payroll levies for social insurance and health insurance, which will no longer be deductible items from income for income tax purposes.
“Financially, this step will affect those self-employed persons who do not have actual expenses at 40 percent [of income],” Ďurana told The Slovak Spectator. “It is unclear, however, what the real effect of this approach will be and whether the self-employed will report a higher tax base or they will devote their energy toward securing high enough [actual] expenses.”
Ďurana suggested that the Slovak government could take some inspiration from other countries where he said the lump sum allowance ranges from 40 to 80 percent.
Ďurana also noted that the government’s reform is not directly aimed at reducing the burden of payroll levies but is instead intended to simplify the payroll levy collection system and that reduction of the payroll levies should come in the upcoming period.
“I think, however, that the government could have reached for a reduction of payroll taxes already this year,” Ďurana said.
Impacts on the self-employed
In response to the most debated part of the reform, the INEKO (Institute for Economic and Social Reforms) think tank in cooperation with the Business Alliance of Slovakia (PAS) calculated some of the expected impacts of the proposed changes on self-employed persons.
According to the figures published on the INEKO blog at Etrend.sk, self-employed persons with monthly incomes less than €329, with no expenses, who will no longer be required to make social insurance contributions, will still see their income reduced by €9 per month due to increases in their contribution for health insurance.
Self-employed persons with a gross monthly income over €605 with actual expenses from zero to 20 percent, those earning €675 with actual employment expenses of 40 percent of their income, and those with gross monthly incomes over €1,010 with actual expenses of 60 percent of their income will all see their monthly take-home pay fall, according to INEKO, which added that the higher the income, the larger the loss in spendable earnings will be.
Self-employed people with higher incomes and low employment expenses will lose the most from the proposed changes, INEKO said, explaining that these include self-employed persons who perform demanding intellectual work as well as the so-called pro-forma self-employed, a category of people who transferred from standard employment to self-employment in order to reduce their income taxes and payroll levies.
INEKO offered the example of self-employed persons with gross monthly incomes of €3,000 with actual employment expenses at 20 percent of their income, who it calculates will see their after-tax income drop by €367 per month, equivalent to a loss of 20 percent.
INEKO expects that the impact of the changes will be somewhat softer on self-employed persons with higher levels of actual employment expenses, for example a self-employed person with a €3,000 gross monthly income with actual expenses of 40 percent of income will lose €121 per month, equivalent to about 10 percent of income.
“As a consequence of the reduction of the lump sum for expenses and cancellation of the deduction of payroll levies from the [income] tax base, the number of self-employed who will be paying their payroll levies from the minimum calculation base will most probably drop,” Peter Goliaš of INEKO wrote in a blog entry.
INEKO also noted that it expects the changes will reduce the incentive for people with higher incomes to switch from standard employment to self-employment.
“This fact, along with the factors that the proposal simplifies the payroll tax system and offers a [future] reduction of payroll levy rates for employees are the main reasons that INEKO, in principle, supports the reform,” Goliaš wrote.
However, Goliaš wrote that an impact could also be that self-employed persons with higher incomes who currently use the lump sum deduction for their expenses will have stronger motivation to switch to actual accounting of their expenses and could potentially seek to reduce their tax base by recording fictitious expenses, as well as bearing a greater administrative burden.
The unions’ alternative proposal
Slovakia’s Confederation of Trade Unions (KOZ) said the government completely ignored the trade unions when preparing the proposed changes to the income tax and payroll levy systems.
“We had reservations about the proposal but we couldn't discuss them because no interest at all was shown in having such a discussion," said Vladimír Mojš of KOZ, as quoted by TASR, who also said that the government’s proposals will negatively impact 81 percent of the people in Slovakia.
The union confederation has prepared its own alternative plan to reform the system, the confederation’s spokesman, Otto Ewiak, told The Slovak Spectator. Among others proposals, the KOZ plans calls for the installation of a unified tax and payroll levy report to be transmitted to the tax offices to ease the administrative burden of collection of both kinds of mandatory payments.
KOZ also proposes to use the concept of ‘cost of labour’ as the shared basis for calculating income tax and payroll levies. This change, according to KOZ, does not require the establishment of a super-gross wage since the total cost of labour is already expressed as the payroll cost in the current system. On the basis of this simplification of the system, KOZ proposes the social insurance levy to be set at 25 percent and the levy for health insurance at 11 percent.
Ďurana of INESS, however, interprets the response by KOZ to the government’s proposal as rejecting the new name [super-gross wage] for what is essentially the same financial value. He suggests, de facto, that this is an ideological conflict, saying the unions refuse to call the reward for work a wage and insist on calling it labour cost which Ďurana believes makes the essence of this employer-employee financial relation to a certain degree murky.
“The expenses of an employer which stem from rewarding work, in our opinion, should be called a super-gross wage so that an employee unambiguously knows that it is the [financial] reward for their work, which the state – by mandatory transfers – reduces by an average of 40 percent,” Ďurana stated.
