As Hungary shows, West doesn’t always know best, by Stephen O’Connor

In all that time, I can say that I found a favorable business environment that rewarded success. So if the question is “Does the West know best?” – then, in my experience, the answer of Hungary and its neighbors is a firm “No.”

When the BBJ began in 1992, the recent history of Eastern Europe meant it was impossible to employ the older generation of journalists as they had been institutionalized by the communication style of the communist-era regimes. We thus had to take on young and inexperienced writers, and train them to deliver impartial, carefully researched information.

In 1992, some 70% of the Hungarian economy was in the hands of the state. That figure is now around 14%. By contrast, Austria had the same percentage of state-controlled economy in 1992, and yet the figure has remained constant to this day. I leave it up to you to decide which country has had a more productive and successful decade.

The pace and scope of East European reform has been breathtaking over the last ten years. More bills have gone through the Hungarian Parliament in the last 12 years than in the last 60 years in the U.K. True, quantity is certainly not the sole barometer of success, and Britain has not had to deal with 50 years of communism. Nevertheless, Hungary has taken steps to deal with issues that remain ignored by British politicians.

Among these, there is now hope that Hungary may follow the example of its neighbors Ukraine, Slovakia and Romania in implementing a flat tax. Although yet to be voted on in Budapest, the groundwork is being laid for such a move.

West European nations, by contrast, are completely closed to the type of blue-sky thinking needed to countenance a flat tax.

Hungary attracted the most foreign investment of all the countries in Central and Eastern Europe (including Russia!) in the first seven or eight years of its political and economic transition. The lion’s share of foreign investment thus went to a country with a population of 10 million and a graduated taxation system.

Despite its reticence in moving toward a flat tax, Hungary has got it right in other areas of tax law. The corporate tax rate is 16%, among the lowest in Europe. And real action was taken with the Bokros austerity measures of 1995, policies similar to the Balcerowicz Plan in Poland. The architects of both plans realized early on what they had to do and did it, even if they have been painted as the devil ever since.

And yet while Hungary can be proud of its early success, there is lately a danger that it is resting on its laurels.

Though its corporate tax rate is low, VAT is high, while the costs of employing people with all the various taxes and social security costs are preposterous.

For example, to employ somebody in Hungary on a basic €700 monthly salary costs around €2,000. This is because there are five different business taxes. There is a curious 2% local business tax on total revenue, not profit; an 18% tax on employees; a healthcare contribution; an 11% pension contribution; and a 3% employer tax. In addition, there is a further 1.5% fee that goes into a state training fund.

All this, unsurprisingly, has led to a burgeoning shadow economy for labor. Which, in my view, makes it high time for Hungary to accept the basic truth that lower taxes make people more honest.

Other areas of the social economy provide many different challenges.

There is a telling game on the Hungarian Finance Ministry website that allows players to manipulate the country’s spending priorities in order to demonstrate the difficulty of cutting expenditure. The game demonstrates the deeply ingrained attitudes about the role of the state in Hungary, and does not even entertain the notion that people would enjoy better lives if the state stopped taxing them into the ground, and allowed private service providers to develop.

The healthcare system, for example, is the stuff of local legend. Though private investors now operate within Hungary, they mostly choose to set up private hospitals, rather than take the risk of engaging within the public sector under the current regulatory burdens.

But hope does exist. In 2003, the Hungarian government implemented the simplified entrepreneurial tax (EVA), a 15% flat tax on the profits of entrepreneurs and small businesses, allowing them to escape the existing web of employment taxes.

At present, this remains a voluntary option for this one sector of the economy. However, its implementation reveals that the government has at last realized that small businesses are essential to the future vitality of the economy, and its popularity augurs well for the future.

In conclusion, though Hungary has been a regional leader in terms of economic growth and scope of reform, I believe a danger now exists that it may be left behind by its neighbors. Romania was the latest state to implement a flat tax, and I believe it is vital that the powers-that-be in Budapest do likewise.

Western Europe, meanwhile, offers a timely example to Hungarians of the dangers of failing to reform aging and inefficient tax and social systems.


Stephen O’Connor was the founder of New World Publishing Inc., which owned the Budapest, Warsaw and Prague Business Journals from 1993 until 2004. He was publisher and CEO of the BBJ from 1993 to 1995, and again from 1999 to 2005. He left Hungary this May to return to his native U.S., where he takes up a new job as group publisher of Eagle Publishing in Washington, DC. He can be contacted at soconnor@eaglepub.com.

Source BBJ.hu