Reducing Undeclared Work in Hungary- the role of Tax policy and administration by Willi Leibfritz

1. Reducing Undeclared Work in Hungary- the role of Tax policy and administrationbyWilli Leibfritz

2. Undeclared work in Hungary What is the problem and how big is it? What are the reasons? High taxes or ineffective enforcement or both? • Tax level and tax mix • Labour tax burden and labour market outcomes • Measuring cost-efficiency and effectiveness of tax administration Policies to reduce undeclared work: a „carrot and stick“ approach

3. EU survey on undeclared work (1) Questions relating to the size of undeclared work • Have you required services, stemming from undeclared work? Did you carry out undeclared work? Did your employer pay out part or total salary in cash? Is undeclared work acceptable or not? Answers in Hungary • Always above EU 27 average, but never in the top group (like Denmark, The Netherlands, Latvia, Estonia, Bulgaria and Sweden), with country ranking depending on the individual questions. Which sectors and groups are most affected? Ranking in Hungary • Construction, repair, retail, household services, industry, agriculture, transport, hotels and restaurants • Unemployed, illegal immigrants, self-employed, pensioners, fully-employed workers, part-time workers

4. EU survey on undeclared work (2) What are the main reasons for under-declared work? General anwers in Hungary • lower price of goods and services (59%) • helping someone in need of money (20%) Answers from suppliers of undeclared work in Hungary • Seasonal work not worth declaring (55%) • Both parties benefitted from it (51%) • High level of taxes and social security contributions (36%) (EU average 13%) • Person who acquired it insisted on non-declaration (28%) • Could not find a regular job (27%) • Undeclared work is common practice (21%) • Could get a higher fee for work (19%) • Unsatisfiesd with public services (15%)

5. Size of informal economy and fiscal costs • EUROSTAT (2000) 12% (Poland and Slovakia 15%, Czech Republic 7%) • Estimates by others (Lacko, Todt, Semjén): 17-18% in 2006, down from one third in 1993 • World Bank/EBRD survey: Hungarian firms did, on average, not declare 10-15% of their sales, 10-15% of firms bribed tax collectors (somewhat lower than in Poland and Slovakia but higher than in Czech Republic, Slovenia, Estonia, Latvia, Lithuania) • 30% revenue gap in social security contributions • Effective VAT rate is only 46% of standard rate

6. Assessing the tax system • The overall tax level, as measured by tax revenues as % of GDP, is relatively high, despite pervasive tax evasion • The tax mix is dominated by taxes on labour and consumption while capital taxation is relatively low • The implicit tax rates on labour and consumption are well above EU average (tax revenues as % of theoretical tax base from National Accounts)

7. Tax level in international comparisonTax revenues incl. social security contributions as % of GDP

8. Tax level excl. social security contributions

9. Taxes on labour as % of GDP

10. Taxes on consumption as % of GDP

11. Taxes on capital as % of GDP

12. Average implicit tax rates on consumption and labour in Hungary and the EU-27

13. Labour tax burden • Average and marginal labour tax wedges are high in international comparison and in absolute terms • The withdrawal of income dependent benefits increases the marginal effective tax rate (METR) further and increases incentives to under-declare wages and to work in the informal sector

14. Average labour tax wedge

15. Marginal effective tax rates incl. withdrawal of income dependent benefits

16. Marginal effective tax rate incl. all payroll taxes

17. Elements of the tax system which also create incentives for tax evasion • The large gap between tax rates on labour and profits contributes to under-declaring wages • Self-policing nature of VAT should, in principle, help to combat evasion. It is also a means of taxing (indirectly) those who escape direct taxation • Simplified tax treatment, such as EVA, has positive and negative effects on evasion, with the net effect being (probably) negative

18. Net income as % of total wage costs Annual income (HUF) 2 Mio 4 Mio 10 Mio EVA 64.5 76.7 83.9 EKHO 61.7 65.8 60.8 Dependent employment 46.9 40.8 38.9

19. Effects of taxes on the labour market and undeclared work • The effect of labour taxes on wage costs and employment depend on the flexibility of wages • Minimum wage sets a floor to the gross wage so that employer contributions have to be born by firms and raise wage costs • The combination of high labour taxes and high minimum wages reduces job opportunities for lower-skilled workers in the formal sector and creates incentives to under-declare earnings • The higher the minimum wage, the bigger the incentive to just declare the minimum wage

20. Aggregate tax wedge at the country level Annual hours worked per person in employment 2100 Grc Cze 2000 Pol Hun 1900 Aus Jpn Can Usa 1800 Isl Ita Svk 1700 Fin Prt Gbr Irl Aut Esp Swe 1600 Lux Fra Bel 1500 Dnk Deu 1400 Nld Nor 1300 1200 0 . 3 0.4 0 . 5 0 . 6 0 . 7 (Taxes and social contributions + indirect taxes) / GDP Source : Bassanini and Duval (2006); OECD Economic Outlook No 81, OECD Taxing Wages database. Labour tax wedge and employment in international comparison

21. Tax policies to reduce undeclared work (1)Designing a strategy How to overcome the dilemma of the need to reduce labour taxes without putting fiscal consolidation at risk? „Carrot and stick“ approach: Reduce labour taxes, increase some other taxes and strengthen enforcement Set a revenue target and promise that any additional revenue from improved enforcement will be used for tax cuts in the next year

22. Tax policies to reduce undeclared work (2)Changing the tax mix • reduce employer contributions to social security • increase dividend tax • raise VAT • introduce real estate tax

23. Tax policies to reduce undeclared work (3) • Simplifying the tax system (reduce loopholes and exemptions, eliminate minor taxes)

24. Tax policies to reduce undeclared work (4) • Targeting specific sectors (retail sector, construction etc.)

25. Social and labour market policies to reduce undeclared work • Strengthen the link between social security contributions and benefits • Reduce undeclared work of unemployment benefit recipients - by better monitoring - by allowing them to work officially within limits

26. Some (tentative) considerations about improving tax collection (1) Are tax authorities under-staffed?

27. Tax authority administration costs/net revenue (2004) %

28. Inhabitants/full-time tax authority employees (2004)

29. Some (tentative) considerations about improving tax collection • Should the various institutions (APEH, Customs and Finance Guard HCFG, local tax administrations) be merged into one agency? • Should tax authorities be more independent (e.g. from political influences, setting performance-based pay to boosting motivation of staff)? • Is the organisational structure of APEH by functions (registration, accounting, information processing, audit, collection) too rigid and should it be supplemented by a taxpayer- type organisation (large business, SMEs, self-employed, employees etc.)? • How could auditing be improved? (Joint auditing of all taxes, Risk analysis)

30. The End