High payroll taxes must go

THE WORLD Bank says a high tax wedge is partly responsible for long-term unemployment in new European Union member countries. In other words, the difference between a worker's take-home pay and what it costs to employ him is too great. The bank repeated its request that Slovakia lower its payroll taxes.

THE WORLD Bank says a high tax wedge is partly responsible for long-term unemployment in new European Union member countries. In other words, the difference between a worker's take-home pay and what it costs to employ him is too great. The bank repeated its request that Slovakia lower its payroll taxes.

Slovakia has one of the lowest income tax rates in the EU. However, income taxes make up just a small sliver of the overall tax wedge, while payroll taxes make up the greatest portion. In Slovakia, payroll taxes are among the highest in the union.

The World Bank says high payroll taxes make the overall price of labour higher. Thus, there is no incentive among employers to offer jobs, particularly to low-income workers. According to the authors of the World Bank report, a strong and significantly negative relationship exists between a tax wedge and employment in new EU member countries, except Malta and Cyprus (EU8).

"The effective tax wedge is comparable across the EU8 countries, typically in the range of 35 to 40 percent for low-wage income earners and 40 to 45 percent for average-wage income earners. Social security contributions account for the largest portion of the tax wedge in all countries, and within these the employers' contributions dominate. The relatively large share of payroll taxes in the total tax wedge in EU8 countries is one of the key concerns in view of their likely more detrimental impact on employment (compared to income taxes)," reads the latest quarterly World Bank report.

The World Bank's analysis suggests that lowering labour taxation, particularly for low-income earners, would help boost employment and output growth.

"Each percentage point of the tax wedge increase is found to be associated with a decline in employment growth of 0.5 to 0.7 percentage points," reads the report.

Thomas Laursen, the World Bank's lead economist for Central Europe and the Baltic countries, stated: "There is an urgent need for labour market reform in the EU8 countries, where a decrease in the tax wedge - in a budget neutral way - particularly for low skilled workers should be contemplated as a policy option in order to boost employment and reduce high unemployment in some countries."

Anton Marcinčin, a World Bank economist for Slovakia, told the daily Pravda:

"Taxation of personal incomes [in Slovakia] are lower than in other countries in the region. Currently, further discussion on income tax rate cuts makes no sense."

The Slovak Labour Ministry agrees that cutting payroll taxes could help solve the problem of long-term unemployment for low-wage earners. Ministry spokesman Martin Danko said the ministry is discussing the issue. However, he stressed that it is a sensitive economic and political topic.

"There is an on-going discussion on this issue with the Finance Ministry. Payroll tax cuts by January 1, 2006 are still our serious goal. Fulfilling this is conditioned by favourable economic performance by social insurer Sociálna poisťovňa and political will," Danko told The Slovak Spectator.

The Slovak Finance Ministry has already indicated that the economic performance of Sociálna poisťovňa is not as good as expected. Consequently, Finance Minister Ivan Mikloš told the press that cuts in payroll taxes would not be easy.

The World Bank stresses that lowering the tax wedge would need to be done in a budget neutral manner: "While lowering the tax wedge might partly finance itself through higher employment and output, additional revenue measures or preferably expenditure cuts would likely be required, not least in view of emerging demographic pressures on social spending. In most countries, there is considerable room to streamline subsidies and rationalize social transfers, including through better targeting of these."

Slovak business agrees that high payroll taxes are one of the reasons for unemployment among low-income labour.

Tibor Gregor, the executive director of Klub 500, an association of companies with greater than 500 people, said: "Cheap labour is actually too expensive for an employer and thus it does not pay for him to create this type of job."

He added that the minimal difference between a low-wage worker's net salary and state social support payments is so small that it is not worth it for the employee to work.

Although Klub 500 is supportive of the Slovak cabinet's income tax cuts, Gregor added: "However, high payroll taxes make the overall price for labour too expensive, and this is still an obstacle for those seeking to invest in production expansion."

Slovak analysts believe that payroll tax cuts would help the Slovak economy. However, they do not expect the cabinet will do anything in 2005.

In a previous interview, Ľudová banka's Mário Blaščák told The Slovak Spectator: "The biggest challenge facing Slovakia in 2005 is payroll tax cuts. Despite the Finance Ministry saying Slovakia has one of the lowest tax burdens, payroll taxes make labour costs high. I doubt the ministry will lower payroll taxes in 2005, but perhaps it could become a pre-election agenda for certain political parties."

The Labour Ministry is trying to cut unemployment rates by rewarding organizations that create jobs for the long-term unemployed or provide re-training. Additionally, Slovakia adopted several reforms designed to bolster the labour market and reach a dynamic economic growth. However, the unemployment rate in Slovakia is still among the highest in the region. According to the World Bank report: "Unemployment rates eased somewhat in most EU8 countries, notably in Lithuania, although they rose further in Slovakia, the Czech Republic and Hungary. Unemployment rates in Slovakia and Poland are more than twice the EU15 average, and the Baltic countries also continue to experience relatively high unemployment.

"Much of the unemployment is structural, with more than 50 percent unemployed for more than one year in all countries except in Latvia and Hungary ... Slovakia has taken a number of steps in 2003-2004 to boost employment (including adoption of a new, more flexible Labour code, and an overhaul of the social benefit systems) but the results remain to be seen."

Tax wedge in new EU8 member countries in 2004
Country Personal income Social security contributions (in %)
Employer Employee Total
The Czech Republic 15-3 35 13 48
Estonia 26 34 1 35
Hungary 18-38 32 14 46
Lithuania 33 31 3 34
Latvia 25 24 9 33
Poland 19-40 21 25 46
Slovakia 19 35.5 13.4 49
Slovenia 17-50 16 22 38
Source: World Bank


Structural policy priorities in EU8 OECD countries

The Organisation for Economic Cooperation and Development (OECD) published a report, "Going for Growth", on structural policy priorities in its member countries including the Czech Republic, Hungary, Poland and Slovakia. Measures focussed on using labour more effectively and increasing labour productivity, which generally meant lowering the tax wedges on low-income workers, enhancing labour market mobility, revisiting disability pensions and enhancing competition, particularly in network industries.

The Czech Republic
Labour utilization Labour productivity
Stimulate employment by cutting the costs of employment protection legislation for regular workers. Strengthen work incentives of low-income workers by reducing the tax wedge imposed on them. Increase labour mobility by further liberalizing the rental housing market. Implement intended reform of bankruptcy laws and simplify business registration. Reform system of taxes and benefits to reduce poverty traps for non-employed households.

Labour utilization Labour productivity
Strengthen incentives for low-income workers to work in formal economy by reducing the tax wedge imposed on them.

Encourage those with substantial work capacity to enter the labour market by refocusing disability benefit schemes.

Facilitate labour mobility by downsizing the housing loan subsidy programme and thus reducing housing market distortions.

Reduce state control on the operations of network industries to allow prices to better reflect market signals and to facilitate entry.

Promote greater domestic competition by reducing administrative costs for start-ups.

Labour utilization Labour productivity
Stimulate hiring for youth and low-skilled workers by allowing for a relative decline in the minimum cost of labour.

Encourage those with substantial work capacity to enter the labour market by refocusing disability benefit schemes.

Increase labour mobility by improving transport and housing infrastructure.

Intensify competitive pressures in a number of sectors by strengthening the privatization programme.

Reduce barriers to foreign ownership to enhance technological transfers from abroad.

Labour utilization Labour productivity
Strengthen incentives of low-income workers to work in the formal economy by reducing the tax wedge imposed on them.

Promote a rules-based business environment by strengthening the governance of the judicial and enforcement systems.

Reduce future pension contributions by raising the standard retirement age.

Reduce state control in certain network industries to promote effective competition.

Raise the overall level of human capital by improving secondary education and access to tertiary education.


Source: World Bank

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