Fiscal reform is central to the process of transforming a Soviet-type economy to a market economy, for with the emergence of a significant private sector, the boundaries between the public and private sectors need to be more sharply drawn. In Discussion Paper No. 1167, Research Fellow David Newbery draws lessons from the experience of the Visegrád countries: Hungary, Poland, the Czech and Slovak Republics. The broad outline of the new tax systems were constrained to be compatible with the EU, but governments still needed to make difficult decisions about the balance between taxes, the tax rates, the level of revenue as a share of GDP with implications for the amount of redistribution to be achieved through the tax and benefit system, and the mechanisms to be employed.

The first lesson is that profits tax revenue is almost bound to fall, both in absolute terms and as a share of GDP, but this does not necessarily mean that the share of total tax revenue in GDP will fall, though whether maintaining the original high tax share is desirable must be doubtful. The second observation is that cutting subsidies to the traded, manufactured sector appears reasonably simple, though consumer subsidies may be more difficult to cut. Falling tax revenues combined with falling output do not necessarily imply increased public deficit, just as an apparently successful rebound does not guarantee that deficits will disappear. Raising direct and indirect taxes on individuals is clearly possible, and the adverse distributional impact of moving to uniform indirect taxes may be offset by adjustments in the tax system, possibly at some cost of increased marginal tax rates. In addition, too little strategic thinking is being directed at the expenditure side of the budget, and specifically at improving the targeting of transfers to achieve the desired redistribution at minimum total cost.

Tax and Benefit Reform in Central and Eastern Europe
David M Newbery

Discussion Paper No. 1167, April 1995 (IM)