Fiscal reform is central to the process of transforming a centrally planned economy into a market economy. With the emergence of a significant private sector, the boundaries between the public and private sectors need to be more sharply drawn. The system in which the bulk of taxes came directly or indirectly from state-owned enterprises must be replaced by a legally-based, incentive-oriented and stable system of raising the revenue required for continuing public activities. A new CEPR study takes stock of the first five years of fiscal reform in the Visegrád nations: Hungary, Poland and the Czech and Slovak Republics. It focuses on three issues: the taxation of enterprises, in many ways the pivot of tax reform; the critical area of labour market policy, where institutions have had to be created quickly from virtually nothing; and the impact of tax and benefit reforms on households.
Tax and Benefit Reform in Central and Eastern Europe is edited by David Newbery. The volume reports studies commissioned by the PHARE programme of the European Commission. Contributors were selected for their knowledge of East European tax and benefit reform and their expertise in analysing survey data and/or building tax and benefit simulation models. Newbery is Professor and Director of the Department of Applied Economics at the University of Cambridge, and a Research Fellow in CEPR's Industrial Organization and International Trade programmes.
The taxation of enterprises is central to fiscal reforms. Maciej Grabowski (Gdansk Institute for Market Economics) and Stephen Smith (University College, London, and Institute for Fiscal Studies) argue that the tax system should be designed to minimize scarce administrative resources, in turn minimizing ambiguity and administrative discretion. Focusing on Poland, their emphasis is on the smaller, newly-emerging private companies, whose rapid rise at the expense of large, simple-to-tax state enterprises lies at the heart of the fiscal problem of replacing lost tax bases. Getting the right structure for these taxes is vital: changes in the tax regime for entrepreneurial income had an important effect on the pace and pattern of early growth of small businesses. The most severe transition difficulties arise from the lack of good valuation evidence from market transitions and the shortage of administrative resources. In this respect, the &nbspintroduction of a `revenue lump-sum tax' appears to have been sensible. The authors suggest that the most useful contribution to long-term tax efficiency is to avoid excessive discrimination between sectors or classes of activity. Tax privileges like those in Western Europe could prove costly to reform later.
Mark Schaffer (Heriot-Watt University and CEPR) discusses subsidies to enterprises, either as explicit budgetary transfers or as tax arrears that may eventually be forgiven and written off. He argues that analysis of state aids to industry should include tax arrears as a potential form of aid: there is evidence that the flow of arrears to the manufacturing sector is much larger than the flow of budgetary subsidies. Schaffer discusses the virtues of delaying bankruptcy proceedings against these firms by extending the period they are allowed to withhold paying their arrears, recommending that governments should use formal tax forgiveness programmes with caution to avoid the risk of subsequent tax indiscipline. But as long as the integrity of the overall tax system is not in danger, a continuation of the status quo is tolerable: nearly all accrued taxes are being collected and tax discipline is fairly high. The main culprits running arrears are severely financially distressed firms that generally do not have the money to pay. Forcing these firms into bankruptcy would not yield much revenue, and redeployment of their assets and labour forces would be difficult. In the meantime, since they appear to be covering costs to their suppliers, these firms are, with the aid of the tax arrears subsidy, generating positive value-added.
The introduction of an unemployment benefit system is an important step in the transition. But the fear is often voiced that the system introduced in Central and Eastern Europe is too generous, discouraging the unemployed from leaving the unemployment register. John Micklewright (European University Institute, Firenze) and Gyula Nagy (Budapest University of Economics) examine unemployment insurance in Hungary and the incentive it creates for re-employment. Their evidence suggests that reducing the generosity of unemployment insurance has a small impact in encouraging the unemployed to leave the register more rapidly; and the effect is even smaller for women. Given that the major cause of transitional unemployment is on the demand side, this may not be surprising. It does suggest, however, that the disincentive effects of taxes and benefits should not be exaggerated in the turbulence of transition, and that fiscal rectitude and the provision of social safety nets should be more important considerations in setting transitional policy. Nevertheless, given the difficulty of making fiscal reforms in quieter times, it remains desirable to get the basic structure correct early on, and such a structure will have to take more account of incentives.
Did differences in active labour market policies in the Czech and Slovak Republics after the `velvet divorce' contribute to the different unemployment experiences of these two countries. Michael Burda (Humboldt Universität zu Berlin and CEPR) and Martina Lubyova (CERGE, Prague) conclude that industry structure and demographics can explain persistently higher rates of unemployment incidence in the Slovak Republic. The higher rate of outflows from unemployment in the Czech Republic is, in part, due to the underground economy, but also to well-implemented active labour market policies: following the split into two republics, spending on such policies was reduced by 71% in the Slovak Republic. But while this bears some of the blame for the further deterioration of Slovak labour market conditions, the estimated effects of active labour market policies are modest and should not be regarded as a general panacea for the woes of transitional labour markets. They can be, however, used as a catalyst to help ensure rapid exits from the unemployment pool.
Christopher Heady (University of Bath) and Stephen Smith find that making value-added tax uniform in Central and Eastern Europe would have adverse distributional effects which could be eliminated by adjusting other taxes and benefits, but only at the cost of increasing the overall marginal tax rate. Similarly, improved targeting of social benefits can reduce poverty and government expenditure, but again at the cost of increasing marginal tax rates. Their simulations not only identify the trade-off between equity and efficiency, but also allow the quantification of the cost of greater equity in terms of increased marginal tax rates.
Sarah Jarvis (University of Essex) and Stephen Pudney (University of Leicester) look at the scope for redistributional policies in Hungary, the impact of recent changes in the tax-benefit system, and the potential for improving income distribution by different targeting techniques. They find that the personal income tax payments by the lower quintiles of the population increased faster than those of the upper quintiles. As a result, the progressivity of the direct tax system was reduced in a period in which incomes were falling and becoming more dispersed. They note that the succession of fiscal reforms `has been undertaken without a clear strategy, and particularly without a foundation of research to establish that the areas chosen for policy reform are indeed the areas that really matter in terms of the ultimate objective'. Based on the 1991 system of benefits, poverty would be reduced by making transfers from employed families with children to pensioners and the unemployed.
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