Should we follow the ideology of Karl Marx or that of Hong Kong in regard to taxation? There are not only economical but also political-philosophical aspects to consider in whether the country opts for the progressive tax band model applied in Western European states or the single flat rate taxation used in the region.     

In the spirit of the principle of letting the rich foot the bill Marx recommended the introduction of the progressive system in his Communist Manifesto of 1848. This is the tax policy applied by developed countries today, which favours the poor and imposes a proportionately high burden on those who earn a lot.

Flat taxation - in which the incomes of rich and poor are taxed at the same percentage - disappeared for a while, then was reintroduced in booming Hong Kong in the forties and again from the nineties in the developing Eastern European countries.

No such thing as a cure all

The Orbán government undertook a considerable risk last week when it scrapped its much progressive taxation and chose to replace it with a linear personal income tax. The economic analyses did not make this decision any easier since no tax system is a cure all. Even the French model regarded as an etalon among family-centred systems did not fully satisfy expectations: experience has demonstrated that its redistribution of income in favour of people with children is minimal. Moreover, it is complicated and thus the tax declaration that Viktor Orbán still hopes would fit onto a beer coaster could not be based on this model.

This could only be realised with a pure flat taxation system, which in addition to its tempting simplicity gives far more to the rich: the 16 percent flat rate announced in the government's action plan means that billionaires would pay the same 16 percent in tax as a teacher or nurse; moreover, it is lacking social-political and other concessions. This could be deemed unfair and there has been disagreement about it within Fidesz too: According to Mihály Várga, the prime ministerial state secretary, an improvement in competitiveness has finally won the day.

The fact cannot be ignored that our competitors in the region converted to linear taxation years ago. Tax is paid according to this system in Slovakia, Romania, Ukraine and Serbia, and in general there is a favourable balance in regard to this system stimulating the economy and decreasing bureaucracy. It is only in the area of revenue for the treasury that the expected results have not been achieved: whatever the politicians say, switching over to taxation involving the reduction of taxes meant a decrease in personal income tax revenues in most countries.

The exception is Russia, where before the introduction of the 13-percent taxation system tax evasion was almost a national pastime, but after it the treasury's revenue increased by 26 percent. It is from this that the secret of the linear system's success derives: improvement came about where the black economy was flourishing and tax evasion was widespread, thus it would be difficult to introduce a Scandinavian type system interspersed with social concessions since a proportion of people would pay nothing or constantly be looking for loopholes.   

In the post-communist countries the model that proved to the most feasible was one in which taxes could be easily gathered and avoiding them was difficult or not even worth the trouble. One thing in favour of linear taxation is that it is now not such a step backwards in comparison to progressive taxation.  It is true that it is primarily used by less developed countries, and it is introduced on a temporary basis, but in half of Europe the tax bracket has decreased as well as the income bands and the number of concessions since the pressure created by competition cannot be ignored, even by the biggest states.  

Shifting incomes

In Hungary changing over to linear tax is made easier by the changes in taxation last year which placed 90 percent of workers into one tax bracket of 17 percent. This will be even more so next year, when the single tax bracket will be applied up to an annual income of 15 million forints. However, this idea can be disregarded along with the tax credits to ensure a tax free minimum wage: the government intends to withdraw the latter from the system within two years.

This taxation will push one million people on the minimum wage into the tax payers bracket and save the budget 300 billion forints, which would largely compensate for the income shortfall generated by the introduction of the single tax bracket," says Szabolcs Vámosi-Nagy, a tax expert for Ernst & Young.

If the government takes the single tax bracket seriously and eliminates every concession from it, those on low earnings will lose out, while those who earn way above the average will significantly benefit. According to Heti Válasz's calculations people on the minimum wage will have 15 thousand forints less in their pockets than they do at present. At the same time, the vast majority of people on the minimum wage are employees and the type of workers who receive most of their salaries unofficially. 

There are no reliable statistics but the real number of employees on the minimal wage is probably around 300 thousand, and they would probably be the hardest hit by the single bracket tax if they do not receive compensation. However, tax payers earning more than the minimum wage would not fair well either, right up to a salary of 290 thousand forints per month. Above that amount the tables turn and increasingly serious amounts are gained by high earners. The state company manager with a gross monthly salary capped to two million forints would gain 343 thousand per month.    

Death to the super gross?

The changeover to the 16-percent single tax bracket would be more favourable to Hungarians if in addition to scrapping tax credits the government also eliminated the so-called "super gross system", something much hated by tax experts. (According to this method of calculation the national insurance paid by the employer must be added to salaries,  thus the earlier 100 forint personal income tax basis became 127 forints from January).  

In this case tax payers earning in excess of 230 thousand forints per month would gain from the changes, and minimum wage earners would earn somewhat less, losing close to 11 thousand forints per month. However, the state would come out of this worse off: according to the calculations of Concorde's analyst, János Samu, this version would put a 320 billion forint hole in the budget in both 2011 and 2012. It is not surprising that a decision had not yet been made on the fate of the super gross system by the time our magazine went to press.   

Whatever change we look at if there is no compensation, only one quarter or one fifth of employees would benefit from the 16-percent flat tax. However, the government keeps promising that in two years at most everybody will be better off. This could be realised by a combination of the super gross system, tax credits, an annual rise in the minimum wage and the not yet decided family elements.

In connection with the latter, the most that Mihály Varga alluded to was that there would be no fixed amount of tax relief after children, but that a part of income would be tax free depending on the number of children. If ten units out of an income of one hundred units falls out of the tax system - as a recognition of the costs of raising children -, only the remaining 90 units would be taxed. This would serve as an encouragement to be productive, take on work and found a family in one. 

Source: HV calculations

"With the flat tax rate the simplified entrepreneur tax (eva) would no longer make sense, nor would the simplified system of contribution (ekho), and all the concessions for agricultural workers as well as vouchers for travel and food could disappear," warned Iván Vadász, the president of the Hungarian Association of Tax Consultants.

For example, the cessation of ekho would mean an extra burden of several thousand forints per month for those affected; thus, the government must move carefully: the advantages that can be achieved by flat taxation greatly depend upon the benefits to be added to or phased out of the system.  

Despite the many as yet undecided details, most of the changes aimed at strengthening middle- and upper income groups working and bringing up children are regarded as correct. Thus, the impossible situation would cease whereby the taxes paid by close to forty percent of the 3.6 million citizens who make personal income tax declarations do not even account for three percent of revenue from personal income tax.