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Country Study, Hungary

Dmitri Maslitchenko dmitri@mailroom.com

Introduction to Hungary’s political history

Hungary has had a long and volatile history of political and economic change. Hungary as a organized society dates back before 1000 AD and has been ruled by different monarchies and foreign regimes every since. This brief introduction will outline Hungary’s political and economic history starting with Hungary’s “Post-1945 World War II era”.

During WWII Hungary fell under German control until the end of the war. After Germany’s defeat in WWII, a commission was established among allied forces (American, Soviet, and British) in which had ultimate sovereignty over the country. However, since the leader of the commission was a member of Stalin’s inner circle, the Soviets exercised absolute control.(Wash. Post., 1) The Government that was provisionally instituted in Hungary after WWII was shortly dissolved and the Hungarian Communist Party replaced them in the 1945 elections.

The (HCP)Socialist government had instituted radical land ownership reforms and had made many utilities, banks and heavy industries state ran. Then in 1949 at the beginning of the Post-Cold war era the Soviet’s gained control of Hungary and in 1949 Hungary adopted a Soviet-style constitution and formed the Hungarian People’s Republic. Hungary’s economic state up until the mid 1950’s was a economy similar to that of a Soviet modeled Centrally Planned Economy. However, the economy in the mid 1950’s had begun a rapid deterioration which led to more political reforms for Hungary.(Wash. Post, 2)

In the mid 1950’s Hungary attempted to withdraw from the Soviet sponsored Warsaw Pact and announced their neutrality and sought backing from the UN. However, the United Nations failed to respond, as they were preoccupied in other areas of the world. As a result of lack of UN support, Soviet troops invaded Hungary and regained control, during the invasion many Hungarians fled to other countries. This new Soviet culture in Hungary had a more liberal culture and economic path as did the Soviet regimes of the past. This Soviet government had become relatively complacent for the next two decades until about the early 1980’s.

Start of Transition

By the 1980’s Hungary’s government had some lasting economic reforms and was responding to political pressure to encourage more trade with the west. This new plan to trade more with the west for economic stimuli led to huge foreign debt as a result of unprofitable industries. These new economic troubles as well as Hungary’s strong nationalism to control their own destiny were Hungary’s first steps to a Western style democracy. By the late 1980’s radicals with the party as well as intellectuals were calling for change. In 1988 civic activism had accelerated to an all time high and a Reform Socialist leader, Imre Pozsgay was elected. Along with a new leader, Hungary also adopted a, “democracy package”, which included: trade union pluralism, freedom of association, freedom of press, freedom of assembly, a new electoral law, and radical revisions to their constitution.(Wash. Post,4)

Hungary’s steps to a market economy

In the following year the Hungarian parliament adopted legislation providing for multiparty elections and direct presidential elections. Hungary now had a new vision of government, the government now was to focus on human and civil rights, and to ensure the separation of powers among the executive, legislative and judicial branches.

One major step for Hungary in asserting its move to a market economy was to restructure its national security. In doing this Hungary reduced it’s defense expenditure by 17% and reduced its armed forces by 30% between 1989 and 1992, thus dissolving their membership in the Warsaw Pact . Currently Hungary is trying to develop Western-style defense force to join NATO.(Wash. Post, 5)

Current Political Structure

The current political conditions in Hungary are a system of many checks and balances. The Prime Minister whom is elected selects the ministers in the cabinet. Each of the cabinet members presides before four parliamentary committees in open hearings. The legislative body in Hungary is a unicameral house and is the highest authority in the state.

Current Political State

The Hungarian Socialist Party was re-elected in1994 in a multiparty election after receiving 54% of the popular votes. Although the (HSP) had taken back control of the government in the 1994 elections, the party has announced its intentions to: “continue economic reform, privatization and to preserve political rights.”(Wash. Post, 6)

Economic Structure in Hungary

Hungary’s history of economic vitality has predominately been agriculture. In 1950 , over 50% of Hungary’s work force worked on the land. Hungary’s percentage of workforce working on the land in 1993 was 7%. Hungary’s agricultural decline is directly tied to lack of investment in the 1970’s and the 1980’s. Hungary’s decline is also a product of large amounts of foreign debt that were accumulated in the 1970’s and 1980’s.(6) The net foreign debt in 1972 was about 1 billion(U.S. dollars) and in 1993 Hungary’s net foreign debt was 15 billion(U.S. dollars). Although Hungary has the highest per-capita debt in central Europe their repayment record is stellar.(Wash. Post,7) One of the major functions to Hungary’s success to transition is their role in revenue policy.

Hungarian Tax Reform

Hungary's movement from a centrally planed economy to a market economy has lead to massive tax reforms in the former soviet satellite country. These taxes basically fall into three major categories: Value Added Tax, Personal Income Tax, and Corporate Income Tax. In this section of the paper I will first examine the attributes and disadvantages of the separate categories of the taxes and compare them to the former means of revenue collection. Next, I will demonstrate the success (or as the case may be, failure) of such taxes. Finally, I will write about what effects Hungary has experienced due to the tremendous changes in the tax system.

Value Added Tax

On January 1, 1988 Hungary introduced a Value Added Tax (VAT) as part of a ovement from a socialist centralized country to on with a market economy (Newbery 1). This tax is similar to the tax currently operating in the European Union member states. This tax is interesting because it is an inclusive tax. That is a tax in which the base is included in the invoiced amount of the good or service. In other words the tax is passed down to the end customer and in turn the seller is reimbursed the amount of taxes paid on that particular good or service.

The concept of a Value Added Tax (VAT) was something that was entirely different to managers that were used to output based goals (in the old system) as opposed to budgets and cost minimization as practiced by their western counterparts. The Value Added Tax (VAT) has become a vehicle to flush out businesses that are experiencing market failure that demonstrate no reasonable need to continue to operate (there are obvious exceptions to this such as utilities, etc....). It also cut down on over production of certain goods.

The Value Added Tax (VAT) is also a way that a country such as Hungary can use to encourage (or as the case may be discourage) certain types of businesses in their country. According to Deloitte & Touche the standard rate for the Value Added Tax (VAT) is currently 25%. However, many products and services such as basic food products, medical instruments, and utilities are charged 12% . In addition, various supplies qualify for complete exemption such as education, cultural services, sport events, health services, and services contributing to scientific research and development (D&T 8).

Personal Income Tax

Along with the Value Added Tax (VAT) the Personal Income Tax (PIT) was also introduced to Hungary in 1988. The Hungarian Personal Income Tax (PIT) is a progressive tax with a universal additional tax for investment. The tax is based on individual earnings from all forms of work, though interest income is not taxed if certain conditions are meet (D&TII, 1). As shown in figure 1.1 the progressive tax rates on income earned at work range from 0-44%.

fig. 1.1

Source 1996 Deloitte & Touche LLP

The Hungarian Personal Income Tax (PIT) has several interesting features. The first feature that is unique is that all Hungarians are taxed separately. In other words, unlike the American Tax system where a family can jointly file the Hungarians prefer (for ideological reasons) to file individually. However, this system is not with out it's flaws. The problem that tax administers run into is when one spouse stays at home to look after the children. The reason for this difficulty is the one wage earner is subject to heavier taxation than two wage earners making the same total. Tax administrators however are reluctant to change the current system because of the administrative simplicity.

A second feature of the Hungarian Personal Income Tax (PIT) that draws attention to itself is the fact that any income earned through deposits and securities are tax free if the interest rates are lower than that of the National Bank of Hungary. According to D&T the National Bank of Hungary's interest rate in January was 25%. This means that all bank deposits that pay lower than 25% are tax free. However, If an individual were to make 28% on investment he/she would be subject to a 20% tax on the additional 3% (as shown in figure 1.2).

fig. 1.2