Wednesday, September 20, 2006

Do Hungary's woes signal the end of New Europe's tax-cutting fad?

The IMF has forecast Hungary's 2006 budget deficit to be 10% of GDP, way above the Maastrict Treaty's recommended 3% and way above what any sensible economist thinks is sustainable.

Budget deficits arise when you don't raise enough tax to meet your spending. In recent years, Hungary has been cutting taxes, trying to keep up with the likes of Slovenia, while keeping spending the same. Corporation tax was slashed to 16%. Income tax on incomes up to 1,550,000 Forints was slashed to 18%, and 36% above that, the middle band having been abolished.

Ferenc Gyurcsany, the Prime minister since 2004, admitted to his party that this was unsustainable and that they'd been "lying in the morning, in the evening and also at night" when they implied to the public that they could have it all. He's introduced austerity measures, increasing utility prices, charging student tuition fees and patient's doctors fees, as well as cutting public sector jobs. The reaction of the public was confused, a demand that he resign, a demand that he reverse the austerity measures and in effect a demand that they have it all (low taxes but same spending) - possibly a sign of the immaturity of their voters.

For a number of years now, New Europe and their "exciting" low-tax models have been touted everywhere, and Old Europe (including Britain), which has insisted on raising sufficient tax to meet spending and has tried to stick to deficit rules and balance spending with tax, has been labelled fuddy-duddy. But what is the evidence that New Europe is performing better? 16% unemployment in Poland? 10% budget deficits in Hungary? Looks like the fuddy-duddies have it right. There is such a thing as cutting taxes too low, and there is such a thing as having to maintain a certain level of public spending to provide public goods that can't be got otherwise.

If anyone waves the New Europe tax-model at us, throw Hungary back in their faces.


Glass House said...

I'd like to see what happens in the flat tax economies over the next few years too

Unknown said...

Could a revenue-neutral flat tax be worse than the system we have now? There's no evidence here to support the status-quo.