| Country Study, Hungary
Country Study, Hungary
Country Study, Hungary
Introduction to Hungary’s political history
Hungary has had a long and volatile
history of political and economic change. Hungary as a organized society dates
back before 1000 AD and has been ruled by different monarchies and foreign
regimes every since. This brief introduction will outline Hungary’s political
and economic history starting with Hungary’s “Post-1945 World War II era”.
During WWII Hungary fell under German
control until the end of the war. After Germany’s defeat in WWII, a
commission was established among allied forces (American, Soviet, and British)
in which had ultimate sovereignty over the country. However, since the leader
of the commission was a member of Stalin’s inner circle, the Soviets exercised
absolute control.(Wash. Post., 1) The Government that was
provisionally instituted in Hungary after WWII was shortly dissolved and the
Hungarian Communist Party replaced them in the 1945 elections.
The (HCP)Socialist government had
instituted radical land ownership reforms and had made many utilities, banks
and heavy industries state ran. Then in 1949 at the beginning of the Post-Cold
war era the Soviet’s gained control of Hungary and in 1949 Hungary adopted a
Soviet-style constitution and formed the Hungarian People’s Republic.
Hungary’s economic state up until the mid 1950’s was a economy similar to that
of a Soviet modeled Centrally Planned Economy. However, the economy in the mid
1950’s had begun a rapid deterioration which led to more political reforms for
Hungary.(Wash. Post, 2)
In the mid 1950’s Hungary attempted
to withdraw from the Soviet sponsored Warsaw Pact and announced their
neutrality and sought backing from the UN. However, the United Nations failed
to respond, as they were preoccupied in other areas of the world. As a result
of lack of UN support, Soviet troops invaded Hungary and regained control,
during the invasion many Hungarians fled to other countries. This new Soviet
culture in Hungary had a more liberal culture and economic path as did the
Soviet regimes of the past. This Soviet government had become relatively
complacent for the next two decades until about the early 1980’s.
Start of Transition
By the 1980’s Hungary’s government
had some lasting economic reforms and was responding to political pressure to
encourage more trade with the west. This new plan to trade more with the west
for economic stimuli led to huge foreign debt as a result of unprofitable
industries. These new economic troubles as well as Hungary’s strong
nationalism to control their own destiny were Hungary’s first steps to a
Western style democracy. By the late 1980’s radicals with the party as well as
intellectuals were calling for change. In 1988 civic activism had accelerated
to an all time high and a Reform Socialist leader, Imre Pozsgay was elected.
Along with a new leader, Hungary also adopted a, “democracy package”, which
included: trade union pluralism, freedom of association, freedom of press,
freedom of assembly, a new electoral law, and radical revisions to their
Hungary’s steps to a market economy
In the following year the Hungarian
parliament adopted legislation providing for multiparty elections and direct
presidential elections. Hungary now had a new vision of government, the
government now was to focus on human and civil rights, and to ensure the
separation of powers among the executive, legislative and judicial branches.
One major step for Hungary in
asserting its move to a market economy was to restructure its national
security. In doing this Hungary reduced it’s defense expenditure by 17% and
reduced its armed forces by 30% between 1989 and 1992, thus dissolving their
membership in the Warsaw Pact . Currently Hungary is trying to develop
Western-style defense force to join NATO.(Wash. Post, 5)
Current Political Structure
The current political conditions in
Hungary are a system of many checks and balances. The Prime Minister whom is
elected selects the ministers in the cabinet. Each of the cabinet members
presides before four parliamentary committees in open hearings. The
legislative body in Hungary is a unicameral house and is the highest authority
in the state.
Current Political State
The Hungarian Socialist Party was
re-elected in1994 in a multiparty election after receiving 54% of the popular
votes. Although the (HSP) had taken back control of the government in the 1994
elections, the party has announced its intentions to: “continue economic
reform, privatization and to preserve political rights.”(Wash. Post, 6)
Economic Structure in Hungary
Hungary’s history of economic
vitality has predominately been agriculture. In 1950 , over 50% of Hungary’s
work force worked on the land. Hungary’s percentage of workforce working on
the land in 1993 was 7%. Hungary’s agricultural decline is directly tied to
lack of investment in the 1970’s and the 1980’s. Hungary’s decline is also a
product of large amounts of foreign debt that were accumulated in the 1970’s
and 1980’s.(6) The net foreign debt in 1972 was about 1 billion(U.S. dollars)
and in 1993 Hungary’s net foreign debt was 15 billion(U.S. dollars). Although
Hungary has the highest per-capita debt in central Europe their repayment
record is stellar.(Wash. Post,7) One of the major functions to Hungary’s
success to transition is their role in revenue policy.
Hungarian Tax Reform
Hungary's movement from a centrally planed economy to a
market economy has lead to massive tax reforms in the former soviet satellite country.
These taxes basically fall into three major categories: Value Added Tax,
Personal Income Tax, and Corporate Income Tax. In this section of the paper I
will first examine the attributes and disadvantages of the separate categories
of the taxes and compare them to the former means of revenue collection. Next,
I will demonstrate the success (or as the case may be, failure) of such taxes.
Finally, I will write about what effects Hungary has experienced due to the
tremendous changes in the tax system.
Value Added Tax
On January 1, 1988 Hungary introduced a Value Added Tax (VAT)
as part of a ovement from a socialist centralized country to on with a market
economy (Newbery 1). This tax is similar to the tax currently operating in the
European Union member states. This tax is interesting because it is an
inclusive tax. That is a tax in which the base is included in the invoiced
amount of the good or service. In other words the tax is passed down to the
end customer and in turn the seller is reimbursed the amount of taxes paid on
that particular good or service.
The concept of a Value Added Tax (VAT) was something that was
entirely different to managers that were used to output based goals (in the old
system) as opposed to budgets and cost minimization as practiced by their
western counterparts. The Value Added Tax (VAT) has become a vehicle to flush
out businesses that are experiencing market failure that demonstrate no
reasonable need to continue to operate (there are obvious exceptions to this such
as utilities, etc....). It also cut down on over production of certain goods.
The Value Added Tax (VAT) is also a way that a country such
as Hungary can use to encourage (or as the case may be discourage) certain
types of businesses in their country. According to Deloitte & Touche the
standard rate for the Value Added Tax (VAT) is currently 25%. However, many
products and services such as basic food products, medical instruments, and
utilities are charged 12% . In addition, various supplies qualify for
complete exemption such as education, cultural services, sport events, health
services, and services contributing to scientific research and development
Personal Income Tax
Along with the Value Added Tax (VAT) the Personal Income Tax
(PIT) was also introduced to Hungary in 1988. The Hungarian Personal Income
Tax (PIT) is a progressive tax with a universal additional tax for investment.
The tax is based on individual earnings from all forms of work, though interest
income is not taxed if certain conditions are meet (D&TII, 1). As shown
in figure 1.1 the progressive tax rates on income earned at work range from
Personal Income Tax Rates
Level of Taxable Income HUF
Rate Applicable to Level
Up to 110,000
100,001 - 150,000
150,001 - 220,000
220,001 - 380,000
380,001 - 550,000
Source 1996 Deloitte & Touche LLP
The Hungarian Personal Income Tax (PIT) has several
interesting features. The first feature that is unique is that all Hungarians
are taxed separately. In other words, unlike the American Tax system where a
family can jointly file the Hungarians prefer (for ideological reasons) to file
individually. However, this system is not with out it's flaws. The problem
that tax administers run into is when one spouse stays at home to look after
the children. The reason for this difficulty is the one wage earner is subject
to heavier taxation than two wage earners making the same total. Tax
administrators however are reluctant to change the current system because of
the administrative simplicity.
A second feature of the Hungarian Personal Income Tax (PIT)
that draws attention to itself is the fact that any income earned through
deposits and securities are tax free if the interest rates are lower than that
of the National Bank of Hungary. According to D&T the National Bank of
Hungary's interest rate in January was 25%. This means that all bank deposits
that pay lower than 25% are tax free. However, If an individual were to make
28% on investment he/she would be subject to a 20% tax on the additional 3% (as
shown in figure 1.2).
Initial Investment 100,000 HUF
Interest Paid on Investment
in Bank X (28%) 128,000 HUF
Interest Paid on Investment
National Bank (25%) 125,000 HUF
Taxable Interest Income 3,000 HUF
Taxes Due 600 HUF
This aspect of this tax allows for fair treatment to those
who would otherwise lose their money putting it in accounts that could not stay
up with the tremendous inflation that several countries in eastern Europe face
due to their recent transition to a market economy (Newbery, 6).
As was true with the Value Added Taxes (VAT) the Personal
Income Tax (PIT) also has exemptions. The following is a list of examples of
items exempt from tax (Okno 2).
Social Security allowances
Gains of up to HUF 100,000 from
the non commercial sale of moveable
Retirement gifts of up to HUF
Compensation of defined working
In addition as of January 1995 tax credits against taxes owed
were offered in several areas such as social security contributions by the
employee, for individuals making under 500,000 HUF, for installments on loans
for dwellings, charitable contributions, and for special savings accounts.
Corporate Income Tax
The corporate tax is levied on all businesses, no matter how
large or small, the same way. As of January of 1995 the corporate income tax
has been reduced from 36% to 18% on undistributed profits before tax. this is
called either the additional tax or the calculated tax. After this tax has
been levied the profits are then distributed among the shareholders and an
additional 23% is taxed to the shareholders. To illustrate this tax figure 1.3
demonstrates how the tax is calculated.
Calculation of Additional Tax
Income before tax
Calculated at 18%
Income after tax to be
Amount available for
distribution after payment of additional tax (82/1.23)
Total Tax Paid
Effective Rate of the
additional tax (% of income before tax
Source Deloitte & Touche LLP
In addition to the corporate tax employers must also make
Social Security contributions. Typically, employers must make a contribution
at a rate of 44% of their gross salary. Employees are required to make a 10%
contribution, however, it not unlikely to see individuals putting more than 10%
away of retirement.
Another tax that employers are subject to is the Unemployment
Fund Contribution. This is to continue to support the unemployed between
work. Employers must pay 4.2% of their employees gross salary and wages to the
Unemployment Fund. Employees are required to pay 1.5% of their salary.
However, employees' contribution is tax deductible.
Training Fund Contributions is yet another tax that
corporations are subject to. This tax is to provide for the cost of training
employees. This contribution is currently paid by the employer at 1.5% of the
total payroll. This tax is for corporate income tax purposes.
As with other Hungarian taxes exemptions are offered to
certain kinds of business. Hungary grants exemptions on a case by case basis
and either dose not grant an exemption or grants a 100%, or 60% exemption. The
figure below shows how companies are allowed to use their exemptions.
Percentage of Taxes due under specific exemption
18% subject to Corporations
23% subject to Shareholders
Businesses view this set of taxes as equitable and do not
squabble over the fairness of the taxes. They seem to be more interested in
how to receive tax exemptions and want reform in the exemption granting side of
the tax system (Newbery, 8). This is good because of the infectious shadow
economy in other former soviet countries. This means that businesses will be
more willing to pay taxes that are due to the government.
So What Does this mean for Hungary?
Newbery argues that the Hungarian tax system is at least as
egalitarian as any where else in the world as far as an equal distribution of
taxes. Especially since the method of redistribution is so good at keeping
poverty remarkably low. While the transition still will put a gap between the
“haves and the have nots”, the government needs to keep its eye out for the
most vulnerable such as the old and unskilled. Many argue that because of the
rough transition people may become disillusioned with a market economy and
never realize the gains that the countries leaders have fought so hard for.
However with vigilance and a little bit of patience Hungary will reach its
In addition to using tax collection as a source of raising
revenue, Hungary has turned to privatization to offset Hungary’s 31 billion USD
national debt (Galai, 1). The sale of government controlled industries such as
natural gas, oil, and electric powered utilities has earned the government over
1.4 billion USD in the past year.
Recently the Hungarian Government decided to sale shares in
eight of the fourteen nationally owned electrical power and distribution
companies. A German consortium agreed to pay 180 billion HUF for the shares
and controlling interest in the former government controlled utilities.
In addition to the sale of the utilities Hungary has had
discussions about selling the National Bank of Budapest to investors. However
analyst point out the bank will have to spend the next year fixing up the bank
before they can think about selling it. Government officials would expect a
heavy return if the bank were to be sold.
While some analyst applaud the actions the government has
taken others wonder who is really in control in Hungary. Is the government
still calling the shots or is it the foreign investor with the most money
invested in a majority of Hungary's' industry. Another key step to Hungary’s
transition to a market style economy is expenditure policy.
Along with changing revenue policy expenditure policy is a
crucial role of any government and especially important policy questions for
governments in transition. Hungary’s main policy stance on expenditures is to
try to match in-kind efforts and expenditure policy to specifically earmarked
As mentioned in the introduction when Hungary decided to
withdraw their membership with the Warsaw Pact they decided to drastically
reduce their military expenditure. Hungary’s reduction in defense spending was
a key decrease in fiscal consolidation to help decrease their ever rising budget
defict. The graph in Fig. 1.5 represents Hungary’s decrease in defense
spending over the last ten years.
Source: SIPRI Military Expenditure Database
Social Welfare Reform
Reforms to Hungary’s Social Welfare systems have been
plentiful. Decreases in Welfare systems have mainly been reallocation of
subsides on a stricter criteria basis. Hungary has made constant efforts to
restructure social programs in which have proven to be ineffective. One
example is the reform of the “Family Allowance System.” After a evaluation of
the old program it was proven to be cost ineffective and replaced by a new
“Family Support System”. This new “Family Support System” target families in
need based more on income criteria and targeted people in the greatest need.
Another key social expenditure reform was that of pension and health
Pension and Health Programs
Hungary experience great abuse in the areas of health and
pension programs, but have taken steps in the right direction to help correct
the situation. One such of these decisions was that of increasing the number
of days employers are liable for sick pay. This reform travels in the right
direction because the policy had reduced the Social Insurance Fund and also
created minimum incentives for abuse of the system. Much more needs to be
done in the way of pension and health reform however this policy shows a step
in the right direction..(CCET,2)
The underlying tone of Hungary’s expenditure policy is that
of reducing the budget deficit without creating economic turbulence. Hungary
faces many obstacles in trying to reduce their budget deficit. Such obstacles
are rising inflation and high rates of unemployment these problems lead to substantial
social problems. Regardless, Hungary is still looking the right “social safety
net” but not at the expense of its economic viability and without effecting
production and output ion a negative way.
Hungary has come a long way since the initial transition from
a centrally planed economy to a market economy in 1988. However, Hungary
continues to strive to overcome the obstacles described in this paper. The
transition has been difficult for the people of Hungary. People accustom to a
centrally planned economy are not typically faced with subjects such as
unemployment or cost budgeting. Therefore, many Hungarians have become
disillusioned with the new market economy. However, most (including socialist)
have insisted that economic progress continue. In order for Hungary’s economy
to continue its success it must remain to be egalitarian in both the way it
collects cash through taxes and the way it redistributes resources to the
people of Hungary. Hungary must be sensitive to the vulnerable such as the
unemployed and the unskilled, during the sometimes unforgiving transition to a
CCET. “The Center For Co-Operation With The Economies in
Transition.” OECD-OCDE. Http://www.oecd.org/sge/ccet/hun_fisc.htm.
2. Sipri. “Military Expenditure Database”.
3. Washington Post. “ Hungary: State Department Notes” Washington
4. Deioitte and Touche LLp, “Taxation in Eastern Europe”. Webmaster@dtomlinr.com.1996.
5. Galai, Andra’s. “Sale of Eight
Electric Co.’s Jolts Privitization Back to Life.”
6. Galai, Andra’s. “Gathering
momentum.” Http://www.iqsoft.hu/economy/page95_4/csaba.html. 10/17/96
7. Langyel, Laszlo. “Towards a new
model.” Http://www.iqsoft.hu/economy/page95_4/langyel.html. 10/17/96.
8. Newbery, David. “An Analysis of the
Hungarian tax Reform.” Center for Economic policy Research. #558