Hungary and the Euro-Plus Pact

This is not the first time that one hears from "reliable sources" that János Martonyi is leaving his post sometime after the end of Hungary's rotating presidency of the Europen Union. I personally heard from a private source that Martonyi was furious about the handling of the media law, that it was the straw that broke the camel's back. At the same time in good diplomatic fashion he defended the law in public.

In the last couple of weeks it has become evident that Viktor Orbán and his foreign minister don't see eye to eye on many issues. One of the most obvious contradictions between the statements of the two men occurred on March 12 when Martonyi announced that a "military option" against Libya is practically unavoidable while the prime minister on the very same day said the opposite. Or when Martonyi announced after agreement was reached on the European Stability Mechanism, otherwise known as the Euro-Plus Pact, that it was a decision of historic importance while at the same time, most likely because of Viktor Orbán's insistence, Hungary refused to join.

Hungary is not alone in its refusal to join the pact, but it is in the minority among the non-eurozone countries. Bulgaria, Romania, Poland, Latvia, Lithuania, and Denmark have decided to join the Berlin-inspired project. The four that have opted not to join: the United Kingdom, Sweden, the Czech Republic, and Hungary. Orbán said in Budapest that Hungary will not join the euro pact because it wants to retain its "tax independence" and build the "the most competitive tax system" in Europe. He also claimed that he had consulted with the opposition and found national unity on the issue.

I was most surprised to hear about this alleged consultation with the opposition. Viktor Orbán doesn't consult with anyone, especially not with the opposition. A day later we heard from members of the opposition that the so-called consultation consisted of an announcement of the decision. As far as "national unity on the issue" is concerned, that is also a fabrication. Mihály Varga, former finance minister in the first Orbán government, who has been shoved into the background of late, said at a meeting with factory owners that 85% of Hungarians agree with the provisions of the pact, but "we are not willing to give up our only competitive edge, our newly introduced tax system."

For some time now members of the opposition, economists, and tax experts have been saying that Viktor Orbán simply doesn't know what he is talking about. The harmonization is not about tax rates but about introducing common rules and regulations concerning the corporate tax base. As it now stands, what is being taxed and what kind of exemptions can be taken advantage of vary from country to country. Harmonization of the corporate tax base would make companies' lives a great deal easier. It would apply to foreign companies in Hungary as well as Hungarian companies within the European Union. The Czech opposition is not at all thrilled with the Euro-skeptic Czech government's decision. They claim that by staying out of the pact "the government is harming the interests of our country." They believe that such a move would shift the Czech Republic to the EU's periphery.

This is pretty much the opinion of eight Hungarian economists who made a statement in which they criticized the government for its decision not to join the pact. The eight economists are: Tamás Bauer, László Békesi, István Csillag, Péter Mihályfi, Balázs Muraközy, Mária Zita Petschnig, Károly Attila Soós, and Éva Várhegyi. The signatories called attention to the developments of the last two or three years that point to a division within the European Union. The countries in the first group show a willingness to follow a prudent economic course. Countries in the second group followed "an adventurist economic policy" and now have to face the consequences. These countries proved to be unreliable partners within the Union. Since they refuse to obey the rules of responsible fiscal policy, investors will avoid the countries in the second category. The economists called on the Hungarian government to change its mind and vote to join the pact this weekend.

I very much doubt that Orbán will change his mind. I'm not even sure whether his critics are correct in assuming that Orbán doesn't know the difference between the tax rate and the tax base. I think he purposely mixes up the two because in this way he can better justify his staying away from the pact. The reason that Orbán doesn't want to join is simple: if Hungary joins the pact it will not be able to levy extra taxes on unsuspecting firms. And although he keeps saying that these extra taxes will come to an end in a year or two, I suspect that in the back in his mind he knows that he will have to continue the bad practice in order to remain afloat.

Where will all this lead? Nowhere good.

 

 

Comments

[David]

Regarding the tax rate/tax base issue. It seems pretty likely that the Euro Pact will start dictating corporation tax rates at some stage, as Germany and France both seem to want harmoization of corporate tax rates throughout the EU; the Eurozone (current + aspirant) would be a good first step. Remember the EU always takes countries for lots more than they actually sign up for.

Perhaps the most interesting things about the Hungarian and Czech opt outs are that they would seem to be indicative of longer term policy decisions to stay out of the Euro. Remember that Britain and Sweden are not obliged to adopt the Euro, and have no plans to do so, in fact even proposing it in Britain would be electoral suicide. Hungary and Czech Republic are both obliged to adopt the Euro eventually under their accession agreements. Staying out of this pact basically means that they have no plans to do so in the forseeable future.

The down side of this will come when Hungary next needs an EU bailout. When Bajnai went to the IMF it was before the financial crisis had hit Europe with much force and the money was therefore there for him to borrow. Orban seems to think that if he reaches similar difficulties the EU will provide him with a bailout, unfortunately I suspect that this is unlikely without a lot of strings attached. Given the nature of the EU the strings will be the elimination of any tax advantages that Hungary may have over Germany and France.

[Ron]

David: Given the nature of the EU the strings will be the elimination of any tax advantages that Hungary may have over Germany and France.

Can you mention any advantages, because I cannot?

[Kirsten]

David: It is Britain and Denmark that have an opt-out clause, Sweden is deliberately violating one of the entrance criteria (exchange rate) but it does not have a formal opt-out clause.

I know that it always sounds as if it were the malicious Germans and French who want to crush the tax advantages of smaller countries, it may look as such, no doubt. But what I never understood is that the smaller countries are not opposed to getting money from the EU funds that are to some extent filled by countries that tax their own citizens and firms at higher rates. I was thinking whether it is "fair" that the recipients of EU development funds use their "tax advantages" while at the same time financing part of the public investments through money from those countries that tax more heavily. Ireland with its low corporate rate has been a recipient of EU funds for infrastructure even if it had an income per capita above the EU average.

But as regards the euro-sceptic Czech position, in some points it has similar reasons as the Hungarian argumentation. What if the EU through its rules made it difficult to use the budget and the tax system for the vital needs of the politicians, their parties and friends? Also, a small country has to make a real effort and show real dedication if it wants to seriously contribute in the EU discussions, certainly more than what the Czech R has been presenting. Then it is much easier to insist on "sovereignty" (even if most people somehow "feel" that this is not exactly applicable for a country that exports 1/3 of GDP to Germany alone). But in one thing the reasons differ from those of OV as the Czech government claims to undertake reforms in line with the budgetary discipline the EU pact foresees. It is reassuring that these prudent actions are not forced on us from Brussels, Berlin or Paris !

[Kirsten]

I forgot: the No.1 EU-sceptic residing on Prague Castle (the Czech president) recently said that if there was the possibility of a small currency union with Germany and the Netherlands and all the "strong currency states", he would certainly recommend the Czech Republic to join. Just to give you a flavour of the importance of "sovereignty".

[someone]

Kirsten, you seem to understand way more about the tax issues that I can, so can you explain how would the harmonization could "backfire" on smaller countries? I take Canada for example, where certain taxes are set in stone (corporate) from the Federal level, but tax incentives can arrive from the provincial level. General Sales Tax is federal, provincial sales tax are provincial. Some provinces opted for Harmonized Sales Tax that encompasses the two tax, but the PST (provincial) portion is not the same for all provinces, only the federal portion. Tax breaks and grants (refunds) can come form the provincial level. THe film industry is the greatest example. In order to attract US productions, Ontario provides a great tax break and some refunds. So, what I am asking here how would a harmonized procedure from the EU for member countries would differ from the harmonized procedures of Canada for its provinces? (Of course if someone else has the answer, that is also welcomed.)

[Ron]

Someone: Can you explain how would the harmonization could "backfire" on smaller countries?

I do not know smaller countries, and how it would backfire. I do know Hungary.

The Hungarian system is based upon changes every year. Not to improve it, but to meet the budget set for next year. As result, some weird solutions were implemented or were about to be implemented, before it was shot by the Constitutional Court. For example the Petty Cash tax.

The system excels in being non-transparent, as a result nobody knows how it is actually working when these law(s) are implemented, including the National Bank, APEH and the Ministry of Finance. It will take approximately 2-3 months before they solved it, and then a joined statement is made.

In the meantime the tax payers need to implement the rule, and they hope it is for the best. After a while a tax audit will take place and penalties will be levied (the question is not penalty yes or no, but how high), as it is another revenue income to the state, and the bonusses of the tax audit employees is depending upon this.

By introducing the tax harmonization, in other words the calculation of the tax base will be the same, there is no opportunity to make some extra money.

[Johnny Boy]

1. 'Orbán said in Budapest that Hungary will not join the euro pact because it wants to retain its "tax independence"'

2. 'The reason that Orbán doesn't want to join is simple: if Hungary joins the pact it will not be able to levy extra taxes on unsuspecting firms.'

How are these not coherent and logical?
What he said was simply the truth but you still struggle to present this issue as some kind of crookedness. The whole thing is an open book.

[vermogensbeheer]

The chaos in Libya have affected nations surrounding it. But the case of Hungary have brought raging conflicting theories and ideologies. There are times that we have to fight for the belief that we have and the things that we desire. No one has the right to force others to follow what he believes in. It is a matter of choice.

[John G]

Off topic: Am I the only one who is wondering who is writing Torok Gabor's blog these days? Once a must read, since the beginning of this year, i.e the implementation of the new media law, the blog seems to have been taken over by some babbling bore, who is incapable of making an assertive statement. The major part of each entry now is taken up by justification, modification and softening of each and every statement. The blog has taken on the feel of the communist era Nepszava, where one had to learn to read between the lines to even guess at the true meaning of any comment.

[Sackhoes Contributor]

Johhny Boy: since you are a strong supporter of Orban and his government, I am intereted in your opinion. Was it a mistake for Hungary to join the European Union and should it leave it now?

Since Orban's government assumed leadership and especcially since Hungary tk ver as rotating President, it seems to be consistently at odds with EU leadership and policies. Recently Orban publicly compared the EU's capital, Bruxelles, to Vienna of 1848 and Moscow during the Cold War. Pretty strong words, practically a declaration of war. So why stay, then?

[Johnny Boy]

John G: I too recognized that Török is saying practically big nothings in his recent blog entries. Your comparison to the communist era style writing is of course totally off the mark, but Török's writings may have changed because he too became a deputy in his local government and he has no time to write analyses. He also writes a lot more rarely than before.

Sackhoes Contributor: I think it was overall a good decision to join the EU (although I voted NO so that the YES doesn't win that huge), but one cannot disregard its drawbacks.
Orbán's words were indeed harsh considering they came from the rotating president of the EU, but they were for "domestic consumption". Sure you can exaggerate such actions as if they were a declaration of war but actually it takes a looot more than a few words to get on bad terms with the EU. And many forget that Orbán is a vice president of the EPP and has very good connections in Europe. (This is why I always have a good laugh at wishful left-lib thinkings about how bad Orbán's reputation in the EU is. It is not. Come to accept it.) It took years' hard work even for Gyurcsány to forfeit his inherent credibility in the eyes of the EU, he had to falsify numbers and lie consistently right after every meeting with anyone of high office, and so on.

There is a huge common misbelief among left-libs (also on this blog) that anyone with influence in the EU would be outraged at Orbán's actions. All such visions are unfounded, and also are all implications stemming from it. The roaring sound of the antagonistic 'liberal' press, and a few imponderable lefty EU MPs may appear as if Orbán were in trouble in the EU, but it is far from the truth. The European Parliament serves as an exhibition window while the real decisions take place in the European Commission where everything is going right.

Orbán's only "enemies" are the corporations that have been hit 'hard' by the extra levies. (Mind you, they still gain a larger margin of profit from Hungary than from other countries, even with the levies!)

Many articles in the Western press are reporting that the Hungarian presidency is performing above many expectations, but of course no such articles get mentioned on this blog. But notice how the condemning articles have ceased to pour in as the ballooned scandal of the media law has lulled.

[Kirsten]

@someone: I do not know much about the tax harmonisation topic. What I found out is that tax harmonisation or at least harmonisation of the tax base has been an issue at the European Commission for some years now, so it seems that it has been put on the agenda now because one should not "waste a window of opportunity". The corporate tax is a relatively small item in the budgets of countries such as France or Germany, and it is relatively more important for a country such as Ireland (with the "aggressive" 12 % rate). The problem is that some multinationals are engaging in tax arbitrage so they are declaring the business (and making the profits) in a country with lower tax rates. I think it was considered appropriate for an economic union such as the EU not to distort the playing field of firms through this tax competition and a harmonisation of the tax base should be the first step (there is otherwise only some harmonisation in VAT rates, nothing else). But for countries such as Ireland that depend on this income from the corporate income tax, the loss of their tax advantage would mean a loss of substantial tax income, which they cannot replace quickly from other sources. This is in very general terms what I think means that some countries would be hurt by this tax (or tax base) harmonisation.

[Ron]

Kirsten: For years Ireland had the Shannon Free Zone, the Dublin International Financial Services Centre, which they had to abolish, because they (together with Spain) forced Hungary to abolish its Hungarian Offshore structure, which was a major competitor for Ireland. After the abolishment Ireland introduced the general 12% rate.

This was logic as the income was mainly from payroll taxes (bookkeeping, audit, legal and consulting fees). The business came mainly from Canada and the US using the tax treaties, so it was income for doing nothing.

However, after the crises the multinationals reorganized and retreat from Ireland leaving a huge gap. Same was applicable for Luxembourg. But this has nothing to do with tax harmonisation.

Tax harmonisation has to do with the same tax base, but everybody can use different tax rates.

[Kirsten]

Ron, but then I do not understand why this has been so much opposed by Ireland or am I somehow mixing two topics...?

[Kirsten]

I read it in this (admittedly not the most recent) text
(www.ifo.de/DocCIDL/Forum102-focus5.pdf)
and this sounds as if tax base harmonisation and tax rate harmonisation are to some extent viewed as different routes in addressing the same problem (more transparent tax systems in the EU).

[Ron]

Kirsten: Ireland may oppose this (and this is only assumption from my side)due to the fact that some valuation parts can be abolished, such as tax free extraordinary depreciation of goodwill or licences or debtors. Furthermore, the abolishment of tax treaties. Ireland, after Holland has the most tax treaties and the one with USA and Canada are looked at favourable compared to other countries.

Another issue also mentioned in your pdf file is that fact that when tax harmonisation is implemented the multinationals may shop to the cheapest countries qua payroll (the social part issue)and not tax rates. This for example happened when the minimum salaries in Hungary went up significantly companies like Flextronics immidiately moved parts of their production to Thailand/Korea. This may also happen with regard to the Shared Services Centers in Hungary.

So tax harmonisation make things transparent, but this may hurt a country either via Corporate Tax income or payroll tax income.

[Kirsten]

Ron, thank you very much for these explanations and examples.

[Ron]

Kirsten: you may want to look at wikipedia:

http://en.wikipedia.org/wiki/Euro_Plus_Pact

Tax harmonisation is a small part of a bigger part. After reading this I can imaging that VO does not want to enter this. It is totally opposite of Fidesz election program.

[Kirsten]

One has to hope for OV (or not) that Hungary will really not to have to ask for fresh support from European institutions again, otherwise he will get this pact as a "bonus".

[Paul]

"Many articles in the Western press are reporting that the Hungarian presidency is performing above many expectations..."

I look forward to 'Kenny' providing us with the "many" links and sources he no doubt has to back up this statement.

[Sackhoes Contributor]

Johnny Boy: thank you for your insight, it was very interesting. I won't comment on your unusual logic to vote NO on accession, it's your personal business.

I agree his harsh attack on Bruxelles was "for domestic consumption" and many Hungarian politicians mistakenly believe that their unique language shields them from prying Western eyes (just look at the global financial panic Kosa Lajos caused speaking to a groupin Debrecen). Surely Orban's speech is also instantly translated to other European languages and that should not be a surprise.

I was more interested in your comment why Orban thought that a domestic audience would find it inspirational to hear him hashly attacking the European Union. By applauding Orban equating Bruxelles with Moscow are Fidesz voters wish to be free from the European Union in the same way they yearned to be free from the Soviet Union? Surely Orban, who is a very skilled politician, would not have risked such a statement unless he was sure it would draw applause on March 15. What does that say about the state of mind of his ardent supporters?

[someone]

Ron and Kirsten: Thank you for the info and for the links.

[Local SEO]

For several instance now members of the antagonism, economists, and tax experts have been saying that Viktor Orbán only doesn't know what he is chatting about. The coordination is not about tax rates but about introducing ordinary rules and regulations relating to the business tax base. As it now stands, what is being taxed and what kind of exemptions can be taken improvement of vary from country to country.

[Minusio]

The "Euro-Plus Pact" addresses more than just tax issues. And what has been said above is all very true. Including that Orbán wants to be able to resort to fancy extra taxes any time he so chooses.

The general aim of the Euro-Plus Pact is to hinder member countries to get into a situation where they need a bailout.

As inflation is always a threat, it is important to ban wage indexation. Why? Because wage indexation, i.e. automatic wage increases, can very quickly lead to hyperinflation. But that doesn’t apply to Hungary at the moment.

Raising pension ages is also made mandatory. It makes sense because of demographic reasons, and the differences among EU countries are huge.

The fourth major point is to adopt debt brakes, something Fidesz wants to put into the new constitution – theoretically. If I read correctly, this will only become effective once sovereign debt drops below 50% of GDP. This seems to be off for a while.

The underlying ideas of the Euro-Plus Pact were expressed already in the Lisbon competitiveness targets adopted in the year 2000. The well intended introduction of the euro had uncovered what everybody should have known: Fiscal “mentality” is not the same everywhere. Some countries habitually spend more than their fiscal revenues would allow for, and wage increases outpace productivity increases by far. The traditional way was to devaluate the currency as soon as the country had lost too much of its competitiveness. For euro-zone members this is no longer possible, and drastic scenarious were painted for the “culprits”: exclusion, a two-tier eurozone, EU insolvency procedures, and what have you.

Only Ireland showed what has to be done to regain competitiveness (the Anglo-Saxon banking morality is another matter and remains unresolved) within the euro-zone: cut government spending, cut wages, fire people. This is very unpopular, as all PIIGS governments had to learn. However, Ireland is now one of the most competitive countries in the euro-zone, and its future would look rosy if it weren’t for the banking crisis (and the brain drain that occurred in the meantime).

As the "Euro-Plus Pact" also calls for sustainability and, moreover, transparency, we can easily see why Orbán is shy to join the Pact. Although his government entertains fantasies of huge growth rates, the truth is that in 2012 the sh** hits the fan. Huge amounts of debt will become due for repayment. Orbán will have to come up with all sorts of “unconventional” measures to stay afloat. And he will. As “austerity” is a no-no for him, he has to go more into debt than less and, of course, he will resort to inflation (as the earlier post-transition governments did). Why do you think he needs to gain control over the Hungarian Central Bank so urgently?

So, the real reason is not tax-base harmonisation, but the rejection of almost everything else most other European countries (including Switzerland, not an EU member) consider to be prudent fiscal governance. [Never mind Vaclav Klaus, my European pet peeve.]

[Johnny Boy]

It's nice to see some valuable comments here that add to the very biased and defective content of the original post. If only all comments were like these.

Sackhoes Contributor: "I was more interested in your comment why Orban thought that a domestic audience would find it inspirational to hear him hashly attacking the European Union"

This is pretty straightforward. More knowledgeable Hungarian voters are aware of the sad fact that Hungary has been made defenceless economically. Most of our national assets were simply sold by the Horn/Gyurcsány governments, foreign firms took off a lot more profit from Hungary than from other countries (even Lidl/Aldi whose prices are generally below average), and in the past decades of our history we've always been made dependent of other powers. No wonder that such statements resonate strongly with Fidesz's core voter base. And the more gets implemented of these harsh words, the better. The firms condemning OV's independence actions are the beneficiares of the previous schema, it doesn't take a rocket scientist to figure out why they've been so loud. But does this mean we should agree with them? In my opinion: no!

Just to give one but characteristic example: Hungary's electric network has been sold by the Horn government with the slogan "the state is a bad owner" (no wonder since it was they who were leading it). And the French bought it. And guess who? The French state! Now is the state inherently a bad owner or not? This slogan was nothing more than a cover for theft of national assets, and as a result we were put to the mercy of the French electricity-wise. Same for most infrastructure and energy sources, the water ways are mainly handled by Suez (French again), the operating the highway system was also sold by Horn to foreigners with a guaranteed (!!!) profit with state backing (!!!).
You wonder why they are often charged with treason? I don't.