Will Tax Brake Protect Citizens’ Wealth in Slovakia?

Pieter Brueghel the Younger "The Tax-Collector's Office" // Public domain

One of the basic economic lessons is that the first slice of bread will bring you the highest utility. Definitely, you will be better off than with the second slice, or the third which is rather more likely to bring costs. The law of diminishing marginal utility applies generally to all human action, including the public administration.

The first 10% of tax burden brings a significantly higher utility than the last 10%. The first 10% can cover the judiciary, police, army, primary and secondary education, environment protection, healthcare for people without income and there will still be ten times more left of what you give today for material need assistance.

What will bring the last 10% of the total 40% tax burden? Purchase of fighter jets, instead of their rental, a non-functional digitization of public services, paternity leave benefit, free trains for pensioners, free lunches for all children, even though 80% of those do not need them and a clerk, who will scrutinize if a hiking boot bears the label of a hiking boot.

We had the opportunity to see by ourselves how the rise of tax revenue diminishes the already poor quality of public expenditure, in the last electoral period. The thirteenth pension is a memento of the political “illness”, which can be recognized by the claim: we need to share (their) economic growth with citizens.

This ineffective distribution of tax revenue is even better observable from reports of the governmental Value for Money Committee. The Committee, which needs to cautiously criticize the expenditure of ministries, also sees official savings for hundreds of millions euro. They you would certainly identify them in billions, should they not face the risk of elimination for too strict reports.

This committee shall increase the efficiency of public spending, but not actual savings. The very existence of these reports is conditional on the promise that the achieved savings will be redistributed within the given department.

If we simplify the process with an example, then the Ministry of Labor is saving money on its operations so that the thirteenth pension can be paid. Thanks to the defunct governmental Implementation Unit, which was supposed to evaluate and stimulate the achievement of savings, we know that these savings in the ministries have not been achieved for a long time.

Politicians are unwilling to expose their resources. Although they will gladly talk about balanced budgets, they are well aware that their key power lies in generating new expenditure or raising it. This inventive process was supposed to be stopped by a pull of the debt brake.

By some miracle, the opposition and coalition in 2011 managed to reach an agreement on that Slovak debt should not exceed 40% of GDP. If the debt was close to 50%, the government would need to prepare a balanced budget. This law was given a nickname “Debt brake”, a new body supervising public finances called the Budget Council was created, and it also acquired the political weight of being set up by a constitutional law.

Until recently, it was relatively followed also by the former leftist government and due to economic growth, the share of the debt on GDP was in decline.

However, it turned out that the debt brake brakes well only in good times. The economic crisis came, significantly exacerbated by COVID-19, and no one in Slovakia asked about the debt we should come out of the crisis. The government drafted the deficit as needed and it appears that the estimate was too high.

Nevertheless, the year 2019 ended with a 48,5% debt and this year, Slovakia will exceed 60% GDP line for the first time.

The constitutional law was not built for such a jump in debt, figuratively speaking, it blew all its control lights off. Of course, there is already an amendment on the table, which not only pushes the upper debt limit 5% higher, but also defines the period for which Slovakia should get into a debt optimum of 15 (!) years.

Although the amendment contains a new element of expenditure control, the so-called “expenditure limits“ but these are also formulated in a manner that leaves politicians with a distinct degree of freedom.

Before we move to the debt brake, I need to explain the situation with the so-called Constitutional laws in Slovakia. They have gained immense popularity, indeed. A Constitutional Act prohibited the transport of water by pipeline abroad. Another Constitutional Act introduced a retirement ceiling. Fortunately, it has already been canceled.

A month before, a Constitutional Act introduced the right of retired parents to receive a pension bonus from their working children, the so-called parental bonus. Constitutional laws are quite successful in concreting the growth of public expenditure.

The former government turned a blind eye to citizens and came up with a budget deficit of 3,5% of GDP. The deficit would reach this level even without corona crisis. Neither the debt brake, nor the European rules of responsible fiscal policy have stopped this behavior.

Of course, the new government will suffer the consequences and they will also need to deal with a colossal deficit. They will search for a solution that will culminate somewhere around the interval from – cutting an adequate amount of expenditure, up to – financing the entire deficit by raising taxes.

Politicians don’t like to cut the expenses, as we have seen in 2012 and 2013, they rather prefer “temporary” increase in taxes, which then becomes the new “optimum”. Compared to 2007, the tax burden in Slovakia increased by a third (!).

The budget for 2022 and 2023 does not contain any restrictive measures. Yet we know that analysts of the Institute for Financial Policy at the Ministry of finance have been advocating for their proposal of an increase in property taxes, a carbon tax or introduction of a sugar tax.

The likelihood of an increase in these taxes is high, and only the greatest optimist believes that direct taxes and levies will fall to the same extent. The probability that the new government will cement the expenses of Fico, Danko “and co.” with new taxes is high.

Thus, it is unbelievable that there are politicians that are willing to “put one hand behind their back” and prohibit the possibility of raising taxes. The Freedom and Solidarity (SaS) party came up with a proposal of the so-called Tax brake. They want to add provisions on the maximum amount of tax revenue, corporate tax rate and workload to the same amendment of the debt brake law.

According to the publicized compromise proposal, this is not a radical intervention, but it still allows the public administration to control 40% of the value created (41.4% in 2019).

Looking superficially at public spending, it is clear that compliance with this limit would not cause any problems for the responsible government, it is enough to stop making reckless promises and cut out some of the distributions from previous years.

Some analysts object that Slovakia has low spending compared to the OECD average. First, it is not set in stone that social issues should be solved only by public spending. Switzerland taxes significantly less than Denmark. Second, GDP is not a good indicator for comparing countries, it does not reflect differences in the structure of economies.

However, the average taxpayer in Slovakia already pays almost 60% of income on income and consumption taxes, which is the standard of developed countries.

Tax brake in a form of a constitutional law is a non-standard means of responsible policy enforcement, just like it will be complicated to exact it.

Of course, the today’s leftist opposition will not agree with a constitutional form of this brake, but at the same time, they do not have to be necessarily afraid. After all, they had, or could have had, a constitutional majority for the past 8 years.

Therefore, the resistance from the rest of the current coalition is surprising in regard to this brake, which will create real pressure to prioritize spending.

The next five years will be crucial. Public finances should come out of huge deficits, and the lesson from the previous crisis is clear. Tax increases will never be temporary. Pulling the tax brake can serve as an additional “austerity” argument in the discussion on lowering the deficit.

Contrary to the intricate constructions of European fiscal rules or arguments about the definition of primary balance, a significant benefit of this brake is that the public will understand it. Including the politicians.

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