Peter Rona’s ideas on the Hungarian economy and society (II)

Peter Rona published a lengthy study in three parts (Népszava, September 2, 3, and 4, 2008), the first of which I summarized yesterday. The second part's title is "Competition, Capital, Subsidies." The article begins with the economic situation around 2000 when after ten years of rather spectacular economic growth things slowed down. The economic growth of the first ten years was due mostly to an unusual amount of foreign investment. In the region Hungary was the favorite among foreign companies. However, by 2000 or so foreign companies also turned their attention to other East European countries: Poland, Slovakia, the Czech Republic, and (more recently) Romania. Economic growth which at one point was close to 7% slowed considerably by 2000.

The Orbán government's answer to this problem (quite defensible economically) was to increase internal consumption. They doubled the miminum wage, began a program to assist home buyers, and handed out substantial grants to small entrepreneurs. The programs initiated by the Orbán government were followed by the socialist-liberal Medgyessy government's "horn of plenty."  They exempted workers earning the mininum wage from income tax, raised the salaries of civil servants and state employees by 50%, and underwrote all sorts of other subsidies. All went fairly well on the surface until the deficit reached almost 10% and the national debt became unbearably high.

Rona focuses on Hungarian tax policy and argues against those who think that simply by lowering corporate and payroll taxes the Hungarian economy will be competitive again. It is not nearly so simple. Competitiveness, Rona explains, depends on the difference between the market price of the product and the price of production. If the difference between these two is about the same as or greater than in other countries all is well. The business tax rate (i.e., income tax) doesn't influence competitiveness because taxes are paid on profit.  Payroll taxes, however, do have an effect because they add to the cost of production.

Since the change of regime a dominant theme of government economic policy (endorsed by Hungarian economists) was to attract working capital. To achieve this goal Hungary offered all sorts of incentives to foreign companies. As a result, a foreign company that opens a plant or office in Hungary doesn't feel the sting of Hungary's relatively high payroll tax burden; its competitiveness is not negatively affected.

The government, however, takes a revenue hit on its subsidies to foreign investment; to compensate, it has an outsized payroll tax rate. As a result large multinational companies have a huge advantage over middle-sized, mostly Hungarian-owned companies. According to Rona, the tax burden of large foreign companies is less than half that of small and middle-sized firms.

And here comes, according to Rona, an interesting statistic. The amount allegedly not paid to the state by Hungarian tax evaders is exactly the same as the top 200 companies receive in tax breaks. By giving very generous subsidies to foreign companies, he argues, the government essentially undermined Hungarian companies. Those who do not receive subsidies simply cannot compete against those who do. In order to remain competitive they cheat on taxes.

Hungarian governments in the last twenty years desperately tried to increase competitiveness and therefore gave generous subsidies, but to this day the policy makers do not want to recognize the negative consequences of these measures. It's no wonder, Rona adds, that the European Union is trying to curb incentive programs. And, he says, it is not at all surprising that 66% of Hungarian companies are in foreign hands, way above the European norm.

If subsidies attracting foreign investment have led to the loss of competitiveness of Hungarian businesses, then further efforts in this direction cannot be a remedy. Right now the Hungarian government is making very serious efforts to get more and more foreign investments. Every time a foreign company opens a factory in some other country, the Hungarians are very upset. Rona doesn't say that Hungary should stop trying to get foreign capital because that would be outright stupid. What he says is that only those investments should be supported that have a comparative advantage, defined in economic textbooks as "the ability of a country to produce a specific good at a lower opportunity cost than its trading partners." Rona gives an example: tire production. (And yes, several tire companies have opened plants in Hungary.) Rona says: if there are no tire factories in the region, let's support companies who make tires.

Rona notes that the prime minister rightly acknowledges several components of competitiveness: education, the judicial system, cooperation, the general level of society. But although Gyurcsány's essay makes a stab at leveling the playing field, the multinationals still have a major advantage. Rona suggests that the crusade against tax evasion will be marginally successful. However, he contends that one must anticipate a rise in unemployment as a result of these attempts to prosecute tax evaders. Last year there was progress against the offenders; one of the results: 60,000 fewer jobs.

I don't know whether Rona is right or not, but at least we can have a discussion about his ideas.

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Adrian
Guest
“subsidies attracting foreign investment have led to the loss of competitiveness of Hungarian businesses” Only if the foreign businesses are operating in the same industries as the Hungarian businesses. I am not aware of any Hungarian business that is direct competition with a subsidized foreign business, does Rona offer any concrete examples? The example I am most familiar with is tobacco. When the tobacco industry was privatised in the early 90’s, each of Hungary’s four cigarette factories were sold to foreign investors – BAT, Philip Morris, Reetsma and RJReynolds – thus introducing competition between the multinationals within Hungary’s cigarette market. It was obvious to anyone familiar with the tobacco industry that the volume of the Hungarian cigarette market (40 billion) wasn’t sufficient to economically support one factory let alone 4 without proctection from imports; Philip Morris’s European production is focused on 2 mega factories in Bergen-op-zoom and Berlin, both of which produce over 70 Billion cigarettes a year. As soon as Hungary joined the EU the tobacco industry would come under enormous pressure. It was possible however that Hungary could become a European production centre either by volume or for niche products. Certainly during the nineties the local factory managers… Read more »
Eva S. Balogh
Guest

Adrian: “I am not aware of any Hungarian business that is direct competition with a subsidized foreign business, does Rona offer any concrete examples?”
No, he doesn’t.

Odin's lost eye
Guest
@Adrian In many ways I agree with you re cigarette manufacturing. I thought that the market in Hungary was about 4 billion sticks per year not the 40 billion. But I suppose it is how you define billion. Either way it is a mere drop in the EU production bucket. Cigarette and tobacco trade in Europe is NOT subsidised (except for the Greek tobacco growers). The only advantage it has over normal manufacturing processes is that it’s products are made, transported and stored in ‘Bond’. This means that tobacco products can be made in Germany and shipped ‘duty free’ to anywhere. It is only when they are shipped across the ‘Blue Line’ to the retail trade that duty is payable (at the local rates). Also there is cross production where one maker makes another’s brand for local use etc. There is always the hoary old subject of protectionism v.v. the open market. What are manufacturers looking for when they invest in a new factory? Basically it all boils down to the unit cost per item in the market place. If you can make say ‘wigets’ in say Poland, which have a lower unit cost when they arrive in your main… Read more »
GDF
Guest

Eva: “Rona suggests that the crusade against tax evasion will be marginally successful. However, he contends that one must anticipate a rise in unemployment as a result of these attempts to prosecute tax evaders. Last year there was progress against the offenders; one of the results: 60,000 fewer jobs.”
This, in a way, proves that those who advocate less taxation are right. After all, the supply of money is finite. Not that I am advocating the underground economy, but the fact is that when money is removed from one area (the underground economy that does provide some of the jobs in Hungary) and moved to another area (taxes, that are used to cover government deficits and provide few new jobs), the net effect is a decrease in the number of jobs.
I am not knowledgeable enough in economic theories to suggest a good solution to this dilemma.

Odin's lost eye
Guest

P.S.
Subsidisation of manufactured goods in any way shape or form is severely frowned on by the EU competition authorities. They have their beady eyes on several countries where the have found some very indirect form of subsidies. There used to be a ‘4 week work trial’ where an employer could employ a worker for (I think) on a 4 weeks trial basis, paying only the basic unemployment rate. The dept of Employment made up the rest of the pay. This was stopped as EU said that the employers were getting subsidised labour.

Odin's lost eye
Guest

@GDF
I am afraid Mr Rona’s ideas about the ‘black economy’ do not fly very well. Even when you shut down a ‘black’ business the ‘work’ it was doing is still there and needs to be done. People still need their shoes mended; they still need their bath tap fixed and help putting up a fence etc. The problem with the alleged 60,000 jobs lost is how many of them were in the ‘luxury trade’? The real problem is with ‘black business men’ they pay their workforce a pittance (to supplement their unemployment benefit) and charge their clients the going rate.
(Sorry Professor very off topic)
@GDF – I need a young engineer, I have a wonderful project for one who is on benefit, I wish we could correspond.

Adrian
Guest
GDF, “Last year there was progress against the offenders; one of the results: 60,000 fewer jobs.” I don’t thing this relationship is as straightforward as you suggest: Odin is right “the ‘work’ …. is still there and needs to be done”. One of more peculiar outcomes of last year’s crackdown of tax evasion was peculiarly high wage inflation in certain industries put down to the whitening of their operations: “In the financial sector, there was a major acceleration in wage payments … and there was also a jump in the real estate sector. Looking at ex-bonus figures, real estate sector wages jumped most sharply. This is in partly due to the whitening of the economy. Many white collar workers were brought properly onto the payroll.” http://hungaryeconomywatch.blogspot.com/search?q=Whitening I was very disappointed during the confusion that followed “A nice little essay” not to find any figures relating to how much APEH had already squeezed out of the black economy, and how much Gycursány felt could be squeezed out in future. Squeezing costs money, and the net returns have to diminish as the government catches all the big fish and has to concentrate on catching lots of little fish. Language teachers, for example… Read more »
GDF
Guest
Adrian: “I don’t thing this relationship is as straightforward as you suggest: Odin is right “the ‘work’ …. is still there and needs to be done”. One of more peculiar outcomes of last year’s crackdown of tax evasion was peculiarly high wage inflation in certain industries put down to the whitening of their operations: “In the financial sector, there was a major acceleration in wage payments … and there was also a jump in the real estate sector. Looking at ex-bonus figures, real estate sector wages jumped most sharply. This is in partly due to the whitening of the economy. Many white collar workers were brought properly onto the payroll.” http://hungaryeconomywatch.blogspot.com/search?q=Whitening I was very disappointed during the confusion that followed “A nice little essay” not to find any figures relating to how much APEH had already squeezed out of the black economy, and how much Gycursány felt could be squeezed out in future. Squeezing costs money, and the net returns have to diminish as the government catches all the big fish and has to concentrate on catching lots of little fish. Language teachers, for example are broadly in line with the nation and probably supplement their meagre salaries by 20%… Read more »
Eva S. Balogh
Guest

GDF: “The main reason for this is that it is the hardest to catch (I give you my work, you give me cash).”
I read a short piece in today’s Népszabadság. The journalist tells about hiring someone to do some work in his garden. The owner of the small business arrives with two genuine Romanians who obviously are illegally working in the country. The owner tells horrible things about this government, the prime minister, the MSZP, the SZDSZ. Eventually the journalist becomes mad and decides that he will demand a receipt. Receipt? Oh, he doesn’t have the book that includes the receipt forms. OK, says our journalist, go home and get it. He arrives with it and says to the journalist: “Do you know how to fill this out because I have no idea. I haven’t done one before.” Rona cannot blame that on the foreign companies’ subsidies.

Adrian
Guest
GDF, “No effort to get taxes paid is “hardly cost effective”. The government has on its payroll prosecutors and jails, so the effort is practically free” OK, now I believe you when you write “I am not knowledgeable enough in economic theories” but this is more to do with common sense. Take a look at this article: http://www.realdeal.hu/20080130/search-for-tax-cheats-yields-apeh-bumper-crop-of-offenders-in-2007 So last year APEH ‘discovered’ an average of 5.7 Mft unpaid taxes per invesigation. 20% of a teachers’ salary (gross) is probably 400,000 Ft, so unpaid taxes on this are 200,000 Ft. So the potential yield is only 3.5% of an average investigation. Further, this money is paid in many small amounts: for example I have a colleague who is paid 5,000 Ft or so in cash every week or so for a private lesson, which he then spends on a meal in a restaurant – not a new car or a foreign holiday. To prove this undeclared income An APEH investigator is going to have to tail the teacher and observe the payment being made. Maybe tapping his phone to find out where and when the lesson is going to be held. All to establish unpaid taxes of 2,500Ft. There were… Read more »
Odin's lost eye
Guest

One of the problems is the large amount of cash money swilling about in the economy. If this can be reduced and got it into the banking system then part of the black economy will vanish. It is this cash which allows the black economy to operate. The UK has a problem at the moment with the European Central Bankers over the large denomination Euro Notes, which are being used in the criminal world to pay debts etc. The Largest UK bank note is £50 (about 70 Euros) but I think the largest Euro Note is the 500 Euro.
There are European Directives concerning ‘Money Laundering’ which I hope APEH have read and will use. These are particularly concerned with the exportation of money to evade paying taxes. Both the Swiss and the Lichenstiners agreed to give limited information about individual bank accounts if asked by the tax authorities.

GDF
Guest

Adrian is disputing the usefulness of investigating unpaid taxes because the untaxed incomes are relatively small.
I disagree. The IRS is relatively successful because it scares everyone into paying their taxes. Occasionally it locks people up for some years (some of them being high visibility people) and that is enough to make the rest of us think twice before we avoid declaring any of our income. And it also audits people’s tax returns, based on some random formula, just ask around how most people dread such an audit.
The fact that one gets a relatively small amount weekly is not an excuse. Tax returns are for the yearly income, and all the small amounts received should be part of it. What would these same teachers say if they were asked to pay for 20% of their medical care costs and other government covered expenses (such as roads, schools etc), based on the same logic?
Based on the referendum I think they wouldn’t like it.

Adrian
Guest

GDF,
“Adrian is disputing the usefulness of investigating unpaid taxes because the untaxed incomes are relatively small.”
No, he is not: I am dispting the COST EFFECTIVENESS of tax investigation WHERE untaxed incomes are small and made up of lots of small payments.
“The IRS is relatively successful”
Comparision with other tax collection agencies is always useful. But it should be remembered:
1) the IRS doesn’t use blanket investigations, it randomly selects individuals for investigation which I think would be cost effective.
2) Even so, it is estimated that $345 billion dollars of taxes were not collected in 2007, or 14% of US federal taxes.
http://www.npr.org/templates/story/story.php?storyId=15111003
There are limits to what even the more efficient tax agencies can collect. I wanted to know how much Gyurcsány thought he could collect in Hungary.

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