“An optimal tax structure should be defensible, effective and simple — both to implement and to maintain” .
( József Sivák )

On 1 May 2004, 10 new countries (so-called Accession Countries) joined the European Union, experiencing crucial changes that can be considered as a turning point in their history and development. Hungary was among those countries and there’s no doubt that E.U. enlargement definitely resulted its economic growth and positively influenced the flow of investments.
But E.U. membership also brought drastic alteration to Hungary in the sphere of taxation and thus the environment and conditions for the trade businesses changed considerably.


For a long period of time, Hungary has had one of the most effective and strong economies in the region of Accession Countries. Many experts considered Hungary to be a perfect place for foreign direct investment, partially because of the tax system incentives. But as the process of accession continued and this remarkable tax system had to comply with the requirements of the European Union legislature. The ordinary taxpayers and the tax Authorities faced challenges in the mazes of the changing tax system and tried to find solutions, as the immense opportunities of possible gains lured them. Thus Hungarian tax structure was altered to incorporate the EU Laws. As part of the modernization process the Hungarian Authorities carried out reforms in the old system of tax incentives and the elements, non-compliant with the European requirements, were eliminated (e.g. the offshore regime and the investment tax allowances) and brand new elements appeared as well (the development reserve and the development tax allowance). To crown it all the directives of the European Union, concerning the direct taxation have been insensibly included in the Hungarian tax regulations. To a great extent, these directives have been integrated carelessly, leaving behind lot of challenges or the so-called barriers concerning their interpretation or their practical usage. The regulations’ conciseness even now causes mistakes and misinterpretations influencing the companies and the individuals. And neither Hungarian Courts nor the Hungarian tax authorities made any significant steps to find an appropriate solution. The tax legislature barriers emerged right after accession of Hungary to the European Union when the E.U. directives and ECJ (the European Court of Justice) decisions automatically applied to Hungarian taxpayers notwithstanding the readiness of the tax authorities or the current status of Hungarian laws. Accession to the EU created administrative challenges (i.e. requirements for new documentation and administrative procedures) in tax collection, and tax rate increases generated temporary inflationary pressures. One of the important issues is VAT (Value Added Tax). VAT applies to almost every aspect of a business, from research and development, manufacturing, marketing, distribution, and after-sales service. Thus one of the reasons for Hungary’s 2004 inflation rate at nearly 7 per cent was the results of one-off effect of the increased rates of VAT (Value Added Tax) and the excise tax. According to the statistics, even before joining the E.U., Hungary had one of the highest standard VAT rates of 25% and the reduced VAT rate of 12% among Accession Countries. Recent differences in accrual and cash deficits not only reflect one – off VAT effects resulted from EU accession but also alternation of accounting practices, which have increased the difficulty of interpreting budgetary trends.
Hungary’s heavy tax burden is one of main tax barriers which simply creates obstacles for employment and investment and the overall development of the Hungarian economy. The actual state of affairs presented in the chart below.

Tax burdens have significant impacts on the economic growth, the competitiveness in global markets and on the ability to attract foreign investment. “I think the tax burden is much too high and this is very worrying. In fact, the reason for this is the enormous number of civil servants,” says Pieter de Haes, chairman of the Netherlands/Hungarian Chamber of Commerce. “You see a tendency that the government wants to reduce its corporate tax, but the increase in the VAT affects the tax burden overall. If you do the calculation, there is a much higher tax burden in Hungary than in other countries. The government is just window dressing.” Hungary’s 2004 budget planned to increase and decrease taxes at the same time, shifting tax burdens from one source to another. Corporate and personal income taxes were lowered, but sales taxes increased. Thus there’s a rising criticism regarding the Hungary’s tax levels, taking into consideration that Hungary is still a developing country. Another tax barrier is the Hungarian tax wedge on labor which is extremely high.

The comparative analysis in the text table below clearly shows a considerable difference in tax wedge of some other countries.

The statistics shows the necessity for the tax reforms based on lower tax rates and the authorities has already offered some basic amendments for the tax legislature. They consider the reforms to be vital and the new tax legislation of 2006 is expected to broaden the base and help considerably in the issues of administration. The amendments will improve such tax issues as corporate tax, value added tax, personal income tax (the rate is 38 %), extremely high social security taxes, excise duty, registration tax. The necessity for the reforms in the sphere of taxation will also bring amendments to the Accounting Act and the Act on the Rules of Taxation. The authorities came to the conclusion that ongoing reforms and a slight tax reduction could be a real incentive for individuals and companies because Tax burden, pressing the individuals, influences mainly their business activities and thus may well influence the country’s economy. Among other tax barriers it’s necessary to mention that the increased Excise taxes for gasoline, alcohol and tobacco are harmful and the actual state of things can cause more inflationary pressures. Among the other issues, showing Hungarian tax barriers are taxes for the social benefits. The 63 per cent total payroll taxes for social benefits, split 51 and 12 between employer and employee, are among the world’s highest. Now the entrepreneurs must provide the sick pay for the first ten days of an employee’s illness. This influences the social security costs and the entrepreneurs do employ fewer workers than they actually need. The drawbacks of Hungarian tax legislation have also brought administrative dereliction even concerning untimely refund of customs duties and fees paid on “imports for reexport”. International companies producing in Hungary, especially auto parts manufacturers, complain that Hungarian tax authorities refund the duties and the fees at an extremely slow pace, having the sufficient amounts of money at their disposal. This causes the environment for informal market when some entrepreneurs sell the goods without receipts and actually delay the growth of free and legal entrepreneurship.
Taking into consideration dividends it’s important to underline that the economic double taxation of dividends received by individuals is not limited in Hungary as well as in some other countries as Ireland, Poland, Switzerland and Sweden. The Hungarian government reducing one tax has also created another barrier called minimum tax. All the enterprises pay this tax irrespective of their earnings. The enterprise startup allowance was also abolished. As it was already mentioned, the high level of taxes influence not only enterprises but individuals as well. During the period of reforms the personal income taxes almost trebled and though the process of the privatization of economy goes on in Hungary, the economic growth is delayed, thanks to the weak incentives of both investors and consumers. Their indecisiveness is solely a result of high tax rates in the country. And one more tax barrier is the level of registration taxes.
“Member States are free to introduce and also to increase the level of registration taxes on motor vehicles” said EU Taxation and Customs Commissioner László Kovács. “But they must respect the Treaty principle of non-discrimination between domestic and EU products as well as secondary community law”. This question remains open and the prompt actions should follow.
Notwithstanding the fact that Hungarian Tax Barriers exist the accession to the European Union brought many opportunities to the country. Hungary is an active member of the OSCE and the Council of Europe. It plays a role in regional groupings such as the Visegrád Group (Hungary, Poland, and the Czech and Slovak Republics) and the Central European Initiative. It is also a founding member of the World Trade Organization (WTO). The location of Hungary makes it open for the transit trade between East and West. The dynamic growth of exports in the past decade was mainly due to the settlement of multinational companies in Hungary. Over 70 percent of the country’s exports are produced by partly or fully foreign-owned companies. Substantial foreign investment had flown into Hungary, and the accession times witnessed massive export output. The geographical structure of Hungarian foreign trade has completely changed in the past 15 years: in 2004 over 75% of foreign trade was carried out with European Union countries, while previously a similar percentage went to the former socialist countries. In 2004, the top customers of Hungary were Germany (31,4%), Austria (6,8%), France (5,7%), Italy(5,6 %), the United Kingdom (5,1%) followed by Sweden and the Netherlands, each with 3-4 %. The top suppliers included Germany (29,1 %), Austria (8,3%), the Russian Federation (5,7%), the Netherlands (4,9%), China (4,9%), France (4,7%) and Japan with 3,1%.
The value of Hungarian exports grew by more than 10% (y-on-y) in the first half of 2005. Due to the slower dynamics of imports (4,3% y-on-y growth in the same period), the trade balance of Hungary continued to improve, in fact the deficit has not been this low in the past years.
As a result of consistent economic strategies followed in recent years, the Hungarian economy has been stabilized and conditions for a sustainable economic development have been created.

Sources:
1. (Hungary, prepared by the Staff Representatives of International Monetary Fund for the 2005 Consultation with Hungary. Approved by Susan Schadler and Liam P. Ebrill, p. 20)

2. (László Szakál, Róbert Heinczinger, European Union + 10 -Tax Accession, Ernst &Young, issue # 7,p. 1-28 )

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