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TAX & AUDIT

Finance Minister addresses "knee-jerk" tax criticisms

THE FINANCE Ministry published its draft amendment to the Income Tax Act on September 12. The draft seeks to end certain irregular loopholes in the current system. It triggered a huge and knee-jerk howl of protest, one that did not wait for any discussion or analysis of what was actually being proposed. According to the first responses, we are about to destroy the third sector, self-employed people, and the insurance market.

THE FINANCE Ministry published its draft amendment to the Income Tax Act on September 12. The draft seeks to end certain irregular loopholes in the current system. It triggered a huge and knee-jerk howl of protest, one that did not wait for any discussion or analysis of what was actually being proposed. According to the first responses, we are about to destroy the third sector, self-employed people, and the insurance market.

The basic question, however, is whether anyone in this country will be paying higher than 19 percent in income tax once the draft becomes law. The answer: No, they will not.

I believe this is a pretty important fact. We are the only country far and wide whose citizens pay no more than 19 percent of their incomes in tax, and we are the only country in the world in which all economic players making whatever level of income from whatever source pay a single rate of tax. Slovakia's left-wing government has not only retained the flat-tax system, it has also not raised taxes, and it is even proposing to make the tax system more effective by eliminating certain loopholes.


Reduction in lump expense deduction


This change affects only self-employed trades people who are not payers of VAT, and who do not do their own accounting. In 2004, only 27,352 out of 342,452 self-employed people in Slovakia, or about eight percent, used the lump expense deduction. And only a fraction of those used the 60 percent lump expense provision [which the ministry proposed to reduce to 40 percent - ed. note].

These eight percent of self-employed people had a gross income of Sk5.076 billion, or only 1.25 percent of the Sk405.764 billion earned by self-employed people as a whole. Only part of the people who earned this 1.25 percent used the 60 percent lump expense provision, which means that the change we are proposing affects less than one percent of the income of self-employed people.

This does not mean, however, that they will henceforth be paying more than 19 percent in income tax; they will still be paying tax only on their gross incomes minus expenditures. So no one can claim that we are out to get self-employed people, and even in the past, the ministry planned to merge the two 25 and 60 percent lump sum expense rates that self-employed people can deduct from their taxable incomes at 35 percent. Today we are proceeding from the same reasoning as before, that there is no reason that some self-employed people should be allowed to deduct 60 percent as a lump-sum expense from their incomes, and others only 40 percent. That's just not fair.


Elimination of tax-deductible contributions to pension savings


Here again we are being accused by life insurance companies of trying to destroy the third pillar of the pension reform [private insurance accounts that individuals can save in while deducting up to Sk12,000 annually in savings deposits from their taxable incomes - ed. note]. We are also allegedly endangering voluntary pension savings schemes. What are the facts here?

As of December 31, 2005, there were 3.69 million life insurance policies in Slovakia, of which 93,700 were signed in 2004, and 94,600 in 2005, the year people could first deduct the savings from their tax base. In other words, the deductibility provision corresponded with an increase of 900 policies over the year before; on the other hand, it cost the state budget Sk2.3 billion, or Sk2.5 million for every one of those 900 extra policies. The question is: What do people who earn very little, and thus cannot afford life insurance policies, get out of this? Why should they contribute to an exception enjoyed by rich people? The rule allowing Sk12,000 in policy contributions to be deducted annually is unjust, irregular, and absolutely not needed by Slovakia's well-developed insurance market.


Elimination of the 2% tax assignment rule


Non-government organiza-tions have objected to this proposal [that corporate taxpayers no longer be allowed to assign two percent of their taxes payable to the NGO of their choice - ed. note] because they stand to lose an easy source of income. I understand. They will have to try harder to offer the public useful projects that can stand on their own without support.

In 2003, this tax assignation rule allowed only individuals to participate, and limited them to one percent of their taxes. The outcome was Sk97 million raised, and no outcry from NGOs. Then, when the flat tax was introduced in 2004, the assignation was raised to two percent, and companies were also allowed to participate. Nor did the former government follow through on plans to eliminate an absolutely paradoxical loophole: Non-profit organizations did not have to pay income taxes on their first Sk300,000 in profits.

Over the past four years, the tax assignation has risen by a factor of more than 10 to Sk1.056 billion in 2006. A rise this steep is a strong invitation to corruption and the ineffective use of resources. We are not out to destroy the third sector - after all, individuals will continue to be able to assign their taxes, and we have left the rate at two percent, meaning that NGOs stand to gain a maximum of Sk800 million from this channel. But we are convinced, however, that it is not necessary to pump so much money into the third sector.


Why we are doing it


First, we are continuing to eliminate the irregular, or "non-system" exceptions to tax rules, and to thereby improve the tax system. We are just doing it more thoroughly and more fairly than the previous government.

Second, the state budget needs revenues, because we want to fulfill the Maastricht criteria [for adoption of the euro] for the first time, without exceptions. The deficit for 2006 was planned at 2.9 percent, that's true, but this was not including the deficit in the second pillar of the pension system (1.3 percent), which in the past was given an exception.

For 2007 we plan a deficit of three percent, including the second pillar, which clearly calls for a major reduction in the shortfall. To achieve this, apart from other measures we need to increase state budget revenues. Not by raising tax rates, but by plugging loopholes.


Ján Počiatek is the minister of finance. This statement was first published in Slovak in the Hospodárske Noviny daily on September 19, 2006.


By Ján Počiatek

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