Who pays for low taxes?

SLOVAKIA has rejected allegations by leaders of some "old EU" countries that the Slovak tax system, with its gracious income tax rates, will put another burden on the EU's budget and structural funds.
Swedish Prime Minister Göran Persson and German Chancellor Gerhard Schröder have begun criticising the new EU members for low taxation. The growing critical voices described the tax systems of these new EU members as tax dumping and dishonest competition.

SLOVAKIA has rejected allegations by leaders of some "old EU" countries that the Slovak tax system, with its gracious income tax rates, will put another burden on the EU's budget and structural funds.

Swedish Prime Minister Göran Persson and German Chancellor Gerhard Schröder have begun criticising the new EU members for low taxation. The growing critical voices described the tax systems of these new EU members as tax dumping and dishonest competition.

"Our low direct tax rates have no impact on the needs of our country for finances from the EU budget," Ivan Mikloš, the Slovak finance minister, told The Slovak Spectator.

Many of the new EU members introduced lower taxes prior to their entry to the EU.

Slovakia adopted a flat income tax rate of 19 percent on January 1, 2004. Hungary enjoys a 16 percent rate and in Poland the rate is also at 19 percent. The average tax rate of new EU countries is under 20 percent, while among the EU15 members it exceeds 30 percent. In Germany, the rate is almost 40 percent and in Sweden it ranges between 30 percent and 60 percent. The Slovak flat tax is a result of a massive tax reform designed to simplify and stabilise the whole tax and business environment. One of the main intentions behind the change was to attract foreign investors and thus encourage economic growth in the country.

"I, and it is not just me, consider the tax reform an important part of the structural reforms that we are carrying out in Slovakia. It should mainly improve the business environment, support sustainable economic growth, create job opportunities, and motivate [people and businesses] to work and invest through the simplified tax system," said Mikloš in an earlier interview with The Slovak Spectator.

Opponents of low income taxes warn that the new countries are net beneficiaries of EU structural and regional help while strong countries of the EU15 like Germany and France contribute the most to the EU budget and get almost no finances in return. They are no longer willing to support low taxes with their money through the funds and budget of the EU.

"If they think that we in Sweden, Finland, and Denmark will be paying high taxes and then they [the taxes] will go to eastern Europe through financial help so that entities with high incomes and no taxes can exist there, [well,] that is not sustainable for a long time," Reuters cited Persson as saying.

Schröder even mentioned that new EU members could have problems in acquiring EU finances for regional help because of their tax policy. "It will be a trend that we will have to discuss with the new members critically in the future," he said.

Mikloš disagrees with such allegations. He stressed that the Slovak tax reform will not negatively affect the tax incomes of the Slovak state budget, as the tax reform switched the main tax burden from direct income taxes to excise taxes. He also added that there was no connection between tax incomes and EU assistance.

"The Slovak tax reform does not lead to lower tax incomes. The reform transfers the tax burden to consumption, not activities. At the same time, it introduces order and healthy economic logic into the tax system.

"The current system does not encumber production too much and thus it is an important stimuli for investment and the creation of new jobs. It is definitely the best way to catch up to the living standard of the most developed countries," said Mikloš.

The Finance Minister also emphasised that the level of national contributions and drawings to and from the EU budget was not determined by a country's tax burden but on its gross domestic product (GDP). The faster GDP grows, the bigger the country's contributions to the EU budget are.

"Our tax system today strongly supports economic growth in Slovakia and thus supports decreasing the budget burden of the most developed EU countries... According to EU rules, income from structural funds cannot be used as a replacement for domestic sources to finance development projects. Thus, it is not a replacement of Slovak money with German or Swedish money," Mikloš said.

Mikloš does not think that EU entry creates room for decreasing domestic incomes because the expenditures connected to EU entry are always paid from the Slovak state budget; not all income coming from the EU enters Slovak state coffers. According to the minister, "Those expenditures are related to the need to co-finance various common programmes, including those that are not effective, like the huge agricultural subsidies."

The Finance Ministry's expectations are partially proven by the state budget results for the first four months of this year. Tax incomes collected from January to April represent about 45 percent of the volume anticipated for the whole of 2004, though the ministry warns that this favourable development could change later on this year.

"However, it looks like the ministry will fulfil its aim to meet the anticipated level of tax income for this year despite very significant changes to the system," Marek Gábriš, analyst with ČSOB bank, told The Slovak Spectator.

"This is very positive. I am sure that the Finance Ministry calculated their revenues thoroughly but there was a risk of changed consumer habits among inhabitants due to the new system. [The current figures] even create room for the possible further decrease of tax rates," he added. Economic theory follows the Laffer Curve, which indicates that, if the tax burden exceeds a reasonable level, unwillingness to pay taxes grows among citizens and a grey economy develops. On the other hand, low and transparent tax regimes encourage people to pay taxes, as the risk of tax fraud does not pay off. The highest reasonable level is somewhere around 40 - 45 percent. So far, Russia is a good example, according to the Czech magazine Reflex. The first year after it introduced an income tax rate of 13 percent, the Russian state budget collected 38 percent more in tax incomes compared to previous years and 47 percent more two years later.

Insiders suggest that it is not exactly concern about the tax incomes of new EU countries that bothers the critics of low taxation. The fear that investors and big corporations will continue to move their plants and operations eastward is a more likely reason. Lower taxation and cheaper labour create favourable conditions for their business there.

"The fact is that many European states should make structural reforms like those that we are now carrying out in Slovakia if they want to prosper and if we all want to get closer to the goals of the Lisbon strategy [under which the EU plans to become the most competitive economy in the world by 2010]," said Mikloš.

Some countries of the EU lag behind the USA in their social system, unemployment rate, and free market conditions, said Gábriš: "They have even built new barriers against the free market and free movement of people, which is not the best decision. Also, history shows that the free market leads economies to prosperity. I think that the new countries have hit a sore spot in the old Europe."

As a reaction, the German chancellor has even called for the common EU policy to cover the field of direct income taxes:

"Value-added tax and excise taxes are already harmonised in the EU. We consider it reasonable to include the income taxes of individuals and corporations. If it fails at the veto of different countries, we will do it in countries that agree," said Schröder for German newspaper Handelsblatt.

So far, the voices for common income taxes are few. Even officials of European bodies have turned down such ideas.

"Neither I nor the European Commission are considering the harmonisation of tax rates for corporations. I am a supporter of a rational competition in fiscal policy. Taxes in Europe are too high and represent a threat to economic development," Frits Bolkesteien, European commissioner for the internal market, told the press.

"Those who want to criticise so-called tax dumping are missing the point. If a state wants to compensate its geographical location on the EU edge, it has the right to adopt taxes as it wants," said Jonathan Todd, the spokesman of the European Commission for Tax Issues.

Hypothetically, common income tax rates would be a disaster for new EU countries. Low taxes and cheap labour are, in most cases, the only advantages that those countries can offer. No investors would be interested in unsuccessful copies of Germany, wrote Reflex magazine.

According to analysts it is likely that a common policy on direct taxes would require opening the accession treaty, which has to be approved by all member countries. So far, almost all central European countries have refused such initiatives. The only exemption was the Czech Republic, which has a 28 percent income tax rate.

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