State fine tunes tax reform

TRUE to its promise, the Finance Ministry is refining the radical tax laws it pushed through in 2003. Finance Minister Ivan Mikloš recently proposed a draft revision to existing tax legislation that would create equal taxing conditions for a wide range of professions.

TRUE to its promise, the Finance Ministry is refining the radical tax laws it pushed through in 2003. Finance Minister Ivan Mikloš recently proposed a draft revision to existing tax legislation that would create equal taxing conditions for a wide range of professions.

Mikloš' proposal unifies the tax deductions allowed to self-employed individuals to 35 percent of their total income. The cabinet approved the measure on August 24.

(The proposal applies only to self-employed workers who do not keep itemized accounts. Self-employed workers who opt to itemize their deductions can continue to exceed the proposed 35 percent deduction rate.)

Current Slovak tax law governing the self-employed makes distinctions between professions. Those who earn their living exclusively from skilled labour (i.e. bricklaying, woodworking) can deduct as much as 60 percent of their income from their tax base. Other self-employed individuals can only take a 25 percent income deduction.

The Finance Ministry tried to pass a unified tax deduction for self-employed people in 2003 but had to sacrifice the proposal to get the entire tax reform package approved. While many self-employed individuals stand to benefit from a unified tax deduction rate, skilled craftspeople would lose out.

In addition to a flat tax deduction, self-employed people would still be able to deduct compulsory payments to social and healthcare funds.

Finance Ministry advisor Peter Papanek told the SITA news wire that if Mikloš' draft revision passes, self-employed people would be able to deduct 35 percent of their income on their tax return for the year 2006.

The ministry wants to unify tax deductions chiefly to deal with frequent amendments to the tradesmen law, which alters the list of craft activities that fall under the higher deduction levels.

For artists, journalists and accountants, for example, who are currently able to deduct up to only 25 percent of their income, the new law means a couple thousand crowns extra per month. Bricklayers, repairmen and construction workers, however, would see their taxes radically increase.

The ministry's message is clear: The tax deductions allowed to all small businesses must be equal. Those professions excluded from the tradesman law have been discriminated against for too long.

The executive director of the Business Alliance of Slovakia, Róbert Kičina, says that the more complicated the tax laws, the more people will find loopholes to avoid paying taxes.

"Unifying the level of flat expenditures [tax deduction rate] is a step in the right direction," Kičina told The Slovak Spectator.

Parliament must still approve the revision to make it effective.

Payroll taxes reduced

Mikloš's colleague, Labour Minister Ľudovít Kaník, also plans a small surprise for the self-employed: payroll tax reductions.

Kaník says that taxes paid by the average, self-employed Slovak to cover sickness insurance premiums could drop from 4.4 percent to 2.8 percent of their income.

Economists think Kaník's proposal is only a cosmetic fix to Slovakia's high payroll tax burden. The Labour Ministry says it has already reached a tentative agreement with the Finance Ministry over the payroll tax reduction proposal.

"The current proposal is a result of an agreement between the Finance and Labour Ministries and is built on reality. However, its final form will depend on the state budget," Labour Ministry spokesperson Anton Danko told The Slovak Spectator.

The Labour Ministry has high hopes for its proposal. "The goal of reducing the payroll tax burden is to help create new jobs, improve the business environment and through all this, raise the living standard of the common citizen," Danko said.

The Labour Ministry has already lowered payroll taxes by 3.25 percent and called for further cuts to payroll taxes. However, many economists still say Slovakia's payroll taxes are too high. Responding to criticism that the ministry's proposal is too little too late, Danko said that a steady, incremental reduction over time is a more responsible approach.

"Radical payroll tax reductions could endanger the liquidity of social insurer Sociálna poisťovňa and threaten pension payments," the spokesperson said.

The Business Alliance of Slovakia believes the ministry's move to reduce sick leave payments makes sense.

"In July, Sociálna poisťovňa released information indicating that sick leave in Slovakia is historically low, which means that sick leave insurance rates have dropped," Kičina told the Spectator.

While Kičina welcomes the minor reduction, he thinks it will do little to ease the overall payroll tax burden for businesses.

"We won't see radical changes to payroll taxes until after the [2006 parliamentary] elections. But the system of social insurance will have to be re-evaluated and reformed," Kičina said.

Liberal economist Martin Chren from the F A Hayek foundation says payroll tax reform will be successful when it reduces the burden by at least 50 percent.

Burden is too high

In late April, the World Bank recommended that Slovakia trim its compulsory payments to social insurance instead of playing with the idea of further reducing the 19-percent flat income tax rate.

The World Bank and other European institutions claim that a high tax wedge (the difference between a worker's take-home pay and what it costs to employ him) is partly responsible for long-term unemployment in Slovakia.

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. Based on an analysis by Ernst & Young, Slovakia has the second highest payroll taxes among countries belonging to the Organization for Economic Cooperation and Development (OECD).

Only France, which pours 70 percent of its citizens' gross income into social programmes, is ahead of Slovakia on the payroll tax ranking.

"Payroll taxes represent almost 50 percent of a person's gross income. In practice, it indirectly leads to supporting illegal employment," said Peter Chrenko, head of Ernst & Young's Slovak office and the company's tax consulting division.

Earlier this year, Richard Sulík, the co-author of Slovakia's 19-percent flat tax, said he could feasibly cut the country's high payroll taxes in half.

Sulík is proposing that a single 20 percent payroll tax rate replace the 13 different payments that exist today. These revenues would be directed into a so-called redistribution fund.

Presently, citizens receive 57 different types of social assistance benefits. Sulík proposes that the state unify these into one basic social assistance benefit, a sliding-scale payment guaranteeing income at a subsistence level and providing elementary healthcare. All other social benefits would be cancelled. This would allow the state to reduce compulsory payroll taxes from the current 48.7 percent maximum to 20 percent across the board.

Under Sulík's plan, the amount of the social assistance benefit would change according to the recipient's income, but it would ensure a subsistence living and access to healthcare. The maximum calculation basis for the tax would equal 10 times the subsistence level. Those who wanted to save more than the subsistence minimum could invest in commercial healthcare or pension insurance.

There is no concrete political support behind Sulík's idea at this point.

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