II. Grounds for the Proposals
Protection of National Economy
Human Resources Management
The Necessity of Environment-oriented State Budget and Tax Reform
Benefits
Optimal State Redistribution
Anti-inflationary Policy
We have based our proposals on realistic economic principles that may improve the performance of the Hungarian economy. Unlike short-term crisis management, our policies focus on measures urging long term, structural changes that meet the requirements of Hungary’s future membership in the EU.
Since Hungary is an open economy, the internal balance can only be improved on condition that the external balance is improved at the same time. Therefore, ongoing improvement of the external balance is the key element of the policy. The point of this statement is to draw attention to long-term (i.e. longer than one year) trends. The current practice and approach of elaborating the annual (short term) state budget is not capable of managing the long-lasting, primarily external, deficit. (Recent years have brought some changes to include projections for another three years in the annual budget proposals. However, economic policies fail to be consistent with the projections.) Unfortunately, banks also pursue the same practice.
Bearing in mind the necessity of a long-term approach, the basic criteria for the economic policy and state budget should be the following:
Costs of labour need to be reduced not by cutting wages in real terms, but by changing the cost structure and by improved efficiency. This way, the national economy could gain a better competitive position both in the short and the long run. The key element is to reduce the rate of social security taxes and the personal income tax. At the same time, wages should be increased in real terms through – among other measures – the proposals presented in this document.
Activities harmful to health and the environment hit the entire society and the next generations, although consumers and producers of those harmful activities should pay for these costs. The part of the costs not borne by the consumers or the producers is called external costs. It is vital to incorporate external costs into the prices, preferably where they occur. Once these costs are included in prices, economic performance and life conditions may be improved.
Subsidies are inevitable to keep a society functioning. However, all public subsidies should be abolished that finance activities damaging people’s health and the environment.
The black economy can only be controlled by specific measures that, on the one hand, take away black revenues, and on the other, prevent revenues from being generated there.
Protection needs to be achieved in compliance with WTO guidelines; and based on that, through an export-oriented economic policy.
The quality of service in education, culture, healthcare and scientific research should be improved and supported by relevant budget items.
To eliminate social tensions and invest in Hungary’s future development, social welfare services are essential. The state budget should give more support to social welfare.
Preparations for Hungary’s EU membership need to begin with activities where adaptation is time-consuming, such as education, culture, healthcare, scientific research, environment, etc. Negotiations with the EU must prioritise Hungary’s economic interests.
Environmental protection offers opportunities to be fully exploited:
Protection of National Economy
Hungary is an open economy: nearly 40% of its GDP comes from external trade. Creating good conditions to achieve a state of external balance has become more difficult since customs duties were reduced (additional duties were completely abolished) and the national currency has been devalued, and so it will be in the future. These measures work against the state of balance for they encourage imports. To offset at least a portion of the adverse impacts, protective measures are required to restrict imports and, consequently, benefit domestic producers via protecting the quality of life and the environment. The following chapters discuss the measures and actions to be taken to achieve this goal.
Hungary can only become and stay competitive if competitiveness is achieved through long-lasting measures instead of actions fulfilling immediate needs. Labour force in Hungary is in a competitive position over that in the EU: it is qualified, and its productivity meets the European standards at a cost that is only a fraction of those in the EU. Hungary cannot afford further losses of jobs, what is more, competitive labour opportunities need to be opened up to produce goods that find their markets abroad and shrink the share of imports in Hungary. Such an economic policy may generate high returns in foreign exchange, improve the balance and increase added value even at a slight growth rate of exports. Products of relatively high labour content (versus material and energy) require methods and means of production that are less harmful to the environment.
By reducing gross labour costs, the rate of employment could be improved and the rate of inflation slowed down. The current 33% rate of social security taxes on gross wages should be reduced to at least 23% to see the benefits at the macro level. However, according to the government’s plans the total tax on labour will not change essentially.
Employment is a key issue in the EU as well. The Amsterdam Treaty says: "The European Union is to achieve a higher rate of employment and better quality standards of social safety, ensure equal treatment of male and female employees, improve the standard and the quality of life, promote economic and social cohesion, and strengthen solidarity among the member countries." Akin measures are necessary in Hungary to avoid importing "foreign labour" intensive products. Hungary has to face the problems of underemployment, so the measures should be efficient enough to open up job opportunities in the required numbers.
Lower social security taxes must be compensated by other sources of income for the state. Taxes on material and energy-intensive products that pose serious threats to the health and the environment should be increased and directly transferred to the social security funds. This is also required by the "polluter pays" principle. Another favourable impact is that the rate of inflation would go down because wages costs would be lower and the taxes would be imposed on end-users.
Due to the government’s obligations to foreign investors in the energy sector, energy prices will increase even when prices of electricity and natural gas are moving down in the international market. At the same time, the government will not impose higher taxes on energy, and this way, fails to meet EU standards and the requirements of protecting the environment and restructuring the economy. We propose that higher energy taxes be introduced.
Surplus revenues from increased energy taxes should be used for compensating households and public institutions in need and providing funds for better energy efficiency. Energy efficiency is a useful tool of promoting economic development in Hungary through lower energy consumption. (Besides, the lower is the demand for energy, the less profits can be repatriated by foreign investors in the sector.)
Our proposals are meant to promote employment and help the entire economy, which would reduce per capita social costs.
Human resources are key factors in a country’s economic development – and they should be treated accordingly. Government expenditure on human values seems to ignore the indirect (long term) but even the direct (short-term) impacts of human resources development.
Hungary requires qualified, well-trained and healthy human resources. Only such a labour force can survive in a developed economy approaching the EU. This is true for today’s Hungary too: the majority of unemployed people hardly meet this requirement; they have poor qualifications, if any. Unemployment of highly qualified people in Hungary or in developed countries is only structural, i.e. those people are jobless only for a short period, since they can be easily re-trained and find another job soon. Finding a job for poorly trained and unhealthy people is almost hopeless, even in the long run. Therefore, the less we spend on education, culture, social welfare healthcare and environment protection, the more we suffer from a shortage of human resources that are capable of boosting the economy, and the more people find themselves without jobs, which poses further difficulties for the state budget and the society. (Official statistics fail to reflect the reality for they only discuss data on registered unemployment, and omit the number of jobless people unregistered. For example nearly 300,000 disabled people are not registered although they could do without their pensions and find jobs for themselves after rehabilitation.)
It is only highly qualified, well-trained people who are capable of producing high quality goods; and only those products sell well in international markets. The EU is about to open up 12 million new job opportunities over the next five years, and diminish the average rate of unemployment. The number of jobless young people is expected to fall by 50%.
The returns of the money assigned to education, culture, scientific research, social welfare, healthcare and environmental protection can be expected not only in the long run but also sooner, shortly after its provision. First, a large part of it is pumped back into the state’s pocket within a short period of time through taxes. Second, it generates demand both directly (e.g.: more orders for industrial goods, construction industry or services), and indirectly through wages. Therefore, the government’s efforts "to save money" on those areas may lead to a decline in production as a consequence of slumped demand, and in this way, less revenues are collected from taxes. Ultimately, budget revenues may drop to an extent that exceeds the projected savings.
We feel it is important to note that the majority of people dismissed from public institutions are not likely to find new jobs in the market sector, so they will add to the number of the unemployed. Again, budget expenses will not go down, however, further invaluable resources are wasted and social tensions are caused.
Although a slight economic growth started in 1998, the Hungarian economy had shrunk to an extent where any further drop in performance (due to the diminishing number of working people who should finance a growing number of dependants) may paralyse the financing of normal reproduction process. And more importantly, society may lose its ability to function in an acceptable way.
The solution is not to manage the country as a company, to shrink its activities and initiate bankruptcy or liquidation, which would all be normal with businesses. A country, however, cannot be "liquidated"; banking methods are of no use. The way a country is properly managed is by encouraging activities that are efficient and eliminating activities that generate losses. This way the national economy may operate effectively.
The Necessity of Environment-oriented State Budget and Tax Reform
An increasing number of events posing threat to human health and the environment have proved world-wide that economic policies of today will not lead to further development. The UN Intergovernmental Panel on Climate Change warns that to avoid world-wide ecological disaster the emission of carbon dioxide should be reduced by 60% all over the world. Hungary’s emission is double of the international average so the rate of reduction required is 80%. And the emission of a series of other pollutants is also urgent.
P. and A. Erlich have developed a formula describing the relationships between the world’s population, their consumption and their environmental impact. (The formula and its explanation are also found in a publication by Károly Kiss – Ezredvégi Kertmagyarország.)
I = PCT, where:
I:the environmental impact of an economic activity,
P:the world’s population,
C:per capita consumption,
T:the environmental impact of consumption and its intensity (comprising all the changes of technology, and that of the structure of economic growth factors and the national product.)
A model developed from the formula by P. Ekins assumes that the world’s population will double in fifty years from now, and meanwhile environmental impact of economic activities will have been reduced by 50%. (The model, therefore, is a disaster plan rather than a model of sustainability since emission of pollutants is already larger than the critical limit and it is required to reduce them by 60-90% immediately – as opposed to the 50% in the model – so that an environmental disaster could be prevented. Ekins is also aware of this fact; his approach and "generosity" just underline his point.)
If consumption and economic performance increase by a slight 2-3% a year, they will grow fourfold in fifty years. So the equation needs to be modified as follows:
I = 2P ´ 4C ´ (T/8)
This means that the environmental hazard (the impact and the intensity) of one unit of consumption should be reduced to the eighth, i.e. by around 90%, which is infeasible. Even if economic growth is assumed to be zero (which, of course, is a mere hypothesis), the environmental impact factor should be reduced by 50%.
The changes in the environment are accelerating radically. The sooner a country can adjust to the new conditions and circumstances by taking action to manage the changes, the more advantageous position it can acquire.
Thick volumes of literature are available about expected benefits of an environment-oriented tax reform (some of them are listed in Appendix 14). Here we cite from a book by German authors (The Pitfalls of Globalisation by Hans-Peter Martin and Harald Schumann) to illustrate the point of a tax reform.
"The environment-oriented tax reform could open up great opportunities; and even liberal-minded economists accept this. By making energy consumption more expensive through imposing higher taxes on it gradually and over the long run, environmental hazards could be controlled, and at the same time demand for labour force would increase. Transnational distribution of labour would also be restricted by the increasing freight costs. Moving warehouses of suppliers and never-ending convoys of heavy trucks would not pay off any more.
The German Economic Research Institute has developed a conservative model of the tax reform. The model has proved that in ten years after taxes are imposed and gradually increased on heating oil, gasoline, natural gas and electricity, over 600,000 job opportunities could open up in Germany. More efficient energy consumption would require buildings to be refurbished and energy production decentralised, involving a great deal of labour.
Walter Stahel has also found that even more people could find jobs if consumption and use of raw materials were taxed higher. His calculations have been published in his work titled ‘The Trap of Speed, or, The Triumph of a Turtle’. If prices of resources were higher, durable, reusable goods would have an advantage over disposable, "good-for-nothing" products and would also put a high value on labour. Stahel has shown the possibility to reverse the trend through an example of motorcar manufacturing. The body and the engine compartment of motorcars are designed to last for about ten years today although technically it could be feasible for them to last for even twenty years. The purchase price of a motorcar today (with a ten-year life expectancy) accounts for 57% of the costs of manufacturing while repair and maintenance is only 19% of the total costs. The ratios change drastically if calculated at a twenty-year life expectancy: the purchase price is 31%, and the costs of repair and maintenance are 36%. Assuming that buyers pay the same amounts for the cars with either a ten, or a twenty-year life expectancy, the value of manufacturing involving little labour would drop, and repair and maintenance with a much higher labour-content would be more appreciated.
Other aspects of life require human labour as well. More hands are needed in healthcare, in the overcrowded higher and lower education, in removing the damage caused to agricultural lands or in rehabilitating housing estates – just to mention a few. Private companies and the market sector are not capable of fulfilling those tasks alone. They need assistance from the central or the local governments to carry out those tasks and give jobs to a number of people."
Several surveys and estimations have been done recently in the EU to find out the impacts of an environmental tax reform on the employment. A study titled Climate Change and Employment in the European Union and financed by the European Commission’s Environmental Directorate (DG VII – Environment) in May 1998 summarised the findings and concluded that such a tax reform would provide much more job opportunities in environmentally sound activities than it would close in environmentally damaging industries.
Optimal State Redistribution
By implementing our proposals, the central budget would not be required to increase the share of state redistribution over that in 1998. However, the Hungarian Government’s intentions to shrink the share of state redistribution even further (published in the press and also as an explanation to the state budget proposals on page 268-269, Volume 1) give some reasons to worry.
Figure 2
State Redistribution as a Percentage of GDP in Hungary
Table 18
Tax Components in OECD Countries, 1995
tax revenues as % of GDP
Country |
Personal and Corporate Income Tax |
Social Security Tax |
Wage Taxes |
Property Tax |
Taxes on Goods and Services |
Other |
Total |
Canada |
17.1 |
6.2 |
– |
3.9 |
9.5 |
0.5 |
37.2 |
Great Britain |
13.0 |
6.3 |
– |
3.7 |
12.3 |
0.1 |
35.4 |
USA |
12.8 |
7.0 |
– |
3.1 |
5.0 |
– |
27.9 |
Australia |
17.1 |
– |
2.1 |
2.7 |
9.0 |
– |
30.9 |
Switzerland |
12.6 |
12.7 |
– |
2.4 |
6.3 |
– |
34.0 |
France |
7.8 |
19.3 |
1.1 |
2.3 |
12.2 |
1.8 |
44.5 |
New-Zealand |
23.1 |
– |
0.4 |
2.0 |
12.7 |
– |
38.2 |
OECD Average |
13.3 |
9.8 |
0.3 |
1.9 |
11.9 |
0.3 |
37.5 |
Denmark |
31.0 |
1.6 |
0.2 |
1.8 |
16.6 |
0.1 |
51.3 |
Netherlands |
11.6 |
18.4 |
– |
1.8 |
12.0 |
0.2 |
44.0 |
OECD Average in Europe |
13.3 |
11.6 |
0.3 |
1.6 |
13.0 |
0.4 |
40.2 |
Ireland |
13.2 |
4.9 |
0.4 |
1.5 |
13.8 |
– |
33.8 |
Poland |
13.1 |
13.0 |
0.3 |
1.2 |
15.0 |
0.1 |
42.7 |
Germany |
11.8 |
15.4 |
– |
1.1 |
10.9 |
– |
39.2 |
Portugal |
8.9 |
9.1 |
– |
0.8 |
14.7 |
0.2 |
33.7 |
Austria |
11.3 |
15.4 |
2.8 |
0.6 |
11.7 |
0.5 |
42.3 |
HUNGARY |
8.8 |
12.0 |
0.1 |
0.5 |
17.6 |
0.2 |
39.2 |
Source: OECD Revenue Statistics, 1965–1996 and OECD, 1997
Figure 3
Total Tax Revenues in OECD Countries
as % of GDP
Source: OECD and the Central Statistical Office in Norway
Another technique worth considering is that taxes imposed on financing environmental projects and investments are not calculated as part of the state redistribution. The reason is obvious: expenses today will more than pay off through economising costs and improving the general state of the environment in the future.
The optimal extent of the state redistribution needs to be determined through a series of social and economic impact assessments and studies, as well as meaningful negotiations involving professionals and civil movements.
During its election campaign in 1998, Fidesz-MPP (the majority party in the government coalition today) stated in its program: "Fidesz-MPP considers that the extent of state redistribution is not too high. … Public services granted by the state will not need to be cut further. Or rather, the state should provide more assistance to certain activities to give them the chance to meet the European standards." Although current trends and the approved State Budget Act for 1999 do not reflect what is stated in its program, we hope that budgets for the following years will.
Inflation is generated by the underdeveloped structure of the Hungarian economy and downsizing that eliminates jobs, which decrease added value and therefore, contributes to higher costs borne by the society. (A diminishing number of working people keeps a growing number of dependants.) The most efficient and lasting tool against inflation is economic restructuring. Reducing labour costs, abandoning energy price subsidies, improving effectiveness of labour and competitiveness through better use of manpower are all means of rooting out inflation. As a result, the state debt can be controlled, and projected debt service can be significantly reduced.
Inflation and inflationary expectations have been boosted by the price rises of water and sewer services as well as public transportation at a higher rate than the actual rate of inflation.
International studies show that environment-conscious budget and tax policies might help curb inflation in the long run. INFRAS Research Institute in Switzerland had assessed over forty studies about the impacts of an environmental tax reform in Europe, and they publicized their findings during the conference "Environmental Tax Reform in Europe" held in October 1997 in Brussels. What they found was that an environmental tax reform would not have any significant impact on inflation. Publications by the European Commission (the Green Paper titled Towards Fair and Efficient Pricing in Transport; 1995 and the White Paper titled Fair Payment for Infrastructure Use; 1998) went further and found that a reasonable price increase in transportation could lead to lower costs in aggregate. On the one hand, higher prices would ease traffic congestion and reduce the losses due to damages to health and environment, which hit the EU very hard today. On the other hand, extra tax revenues can be channelled back into the economy (with reducing labour taxes, for instance). This way, the EU could gain a competitive advantage.
A gradual increase of prices of transport as described in the Green Paper would ensure that prices reflect actual costs already existing but not paid by the users and/or the polluters. The White Paper quotes the findings of research programs such as TRENEN and EUNET that have examined the expected impacts of the introduction of road tolls and other charges in Amsterdam, Brussels, Dublin, Helsinki, London, and Naples. They have found that carefully scheduled introduction and increase of the tolls would result in the improvement of living conditions and economic performance, as well as a drop in the costs in each city. Benefits of less traffic congestion and fewer accidents, a lower degree of pollution, and channelling back revenues into the economy largely outweigh the disadvantages of increased prices of transportation.
The reason why a green state budget reform has an anti-inflationary impact is that prices of goods and services are getting closer to the "optimal" value from the point of view of society and economy.
When prices of energy, including fuels, are raised, demand for energy-intensive products and activities drops, which reduces the impact of the price rise on inflation on its own. Accumulated impacts of the rise are also less significant than generally assumed, because a large part of the energy is consumed by households and not at production. Furthermore, the rise could reduce the waste of energy, encourage innovation, which all have a cumulative cost-reducing effect on the entire economy.
It is also evident that when subsidies are cut somewhere, taxes (including the personal income tax and the social security tax, i.e. the price of human labour) can be reduced. As shown in the present document, the consumption of natural gas, oil, coal and nuclear energy as well as petrol-fuelled transportation is subsidised both directly and indirectly. Cutting subsidies will open up opportunities to lower social security tax and personal income tax rates, which, again, would reduce corporate expenses. Therefore, prices could go down, or at least, rise at lower rates.
Unless users of energy are forced to pay for the damage they cause, or cover the costs of prevention and/or remedies, others will pay the price at a multiplied rate. For example, maintenance and renewal costs of buildings and other facilities will surge as a result of corrosion, just as costs of making up the environmental damage caused in agriculture, or costs of medical care and reduced working capabilities as a result of deteriorating health. Thus, open or hidden governmental support of environmentally hazardous products and activities is not capable of preventing the national currency from losing its value, but the other way round, it speeds up inflation.
That idea can be easily adapted to scientific research, culture and education. Unless facts necessary for decision-making are identified (and now they are often left unknown in an attempt to save money), wrong decisions are likely to be made, which might result in actions that involve higher costs than the savings on proper preparation for decision-making. Much higher prices are also paid when a country entirely or partly lacks well-educated, qualified experts, officials and executives who manage to get on in a complex world like ours. In simple terms: besides pollution, ignorance and insufficient education are the other most influential factors that generate inflation.
Impacts of the consumer tax increase on inflation, however, are only temporary; and its impacts on production are not significant. Beverages or tobacco are obvious examples, but the impacts of the rise in fuel prices for motor vehicles are also expected to be temporary and moderate since cars, which account for nearly 70% of the total fuel consumption of transport, are primarily used for private and not production purposes. Furthermore, if untaxed use of cars by companies is restricted, inflation can be depressed further. On the other hand, wages are constant factors of production, therefore, by reducing the costs of wages, total production costs will be also reduced. The cumulative impact of all these measures detailed above is a lower rate of inflation by the end of the fiscal year. It is equally, or even more, important that by reducing the costs of wages, the international competitiveness of industries involving relatively high wages costs can be improved. Employers also benefit from lower taxes on wages: the more people they employ now, the more costs they save on social security expenses; and as a result they gain more than they spend on higher fuel taxes.
By reducing the crawling peg rate (hand in hand with non-tariff protection measures) would control the impacts of our proposals on inflation, and even cut back on the projected rate of inflation. Measures and proposals listed above restrict primarily imports into Hungary that have been granted preferences since 1998, the year of removing customs barriers and introducing liberalisation. A further advantage of the measures proposed over devaluation is that they are not entirely incorporated into the prices of exports, thus improve Hungary’s competitiveness. As a result, debt service (capital and interests) can be reduced from the projected HUF 768.7 billion to 650 billion or so after inflation, and especially interest rates, go down. The savings in the Debt Service line of the state budget may well amount to HUF 100 billion.
Inflation can only be curbed through a long-term approach. The current monetary approach pursued by the Ministry of Finance and the National Bank, however, are only capable of short-term reduction of the inflation rate. They are attempting to take the most possible advantage from the lower inflation rate to increase real interest rates (or, at least, reduce the pace of decrease), which attracts "hot money". The approach involves significant risks of an on-going financial crisis, and subsequently, drastic and destructive austerity measures. (Inflation rate today is low as a result of a drastic decline in energy prices in the world. However, it cannot be sustained in the long run because, for instance, prices of crude oil are currently lower than the prices of production in the North Sea, which reinforces dependence.)