According to the Hungary’s government, in the forthcoming two years minimum wage hike and lowering the direct tax burden of companies can give a new impetus to the slowing economic growth.
Recent statistical data shows a considerable slowdown in economic development of Hungary. For the period of January-September 2016, modest real GDP growth of 2 per cent can be noticed mainly as a result of the volatile performance of the industry and construction sector. Economic outlook is not splendid at all: market analysts expect only 2.0-2.3 per cent economic expansion for 2016 and forecasts mostly vary in the range of 2.5-2.9 per cent regarding next year. Nevertheless, the National Bank of Hungary and the Ministry for National Economy targeted 3-4 per cent annual economic expansion for medium-term to ensure the convergence to the level of EU average.
Therefore, a ‘6-year contribution halving scheme’ was initially communicated as a long-term vision of the government. The Ministry for National Economy originally proposed 4 percentage point (ppt) social contribution reduction in 2017 to be followed up by a 2 ppt cut in 2018. If the dynamic, annual real wage rise of some 6 per cent could be maintained, it would create room for a 2 ppt reduction in each of the following four years, i.e. the whole program could last until 2022. So, as if all the governmental expectations are met, the social contribution tax rate can be lowered gradually from 27 per cent to 13 per cent between 2017 and 2022.
After difficult negotiations, the government offered an additional 1 ppt cut in social contribution for 2017, thus the deal between the Hungarian government and the representatives of employers has been finally reached. Minister for National Economy, Mr. Mihály Varga announced the following pillars of the agreement at the press conference on Tuesday:
- The minimum wage will increase by 15 per cent and 8 per cent in 2017 and 2018, respectively.
- The minimum wage in jobs requiring skilled workers (so-called ‘guaranteed wage minimum’) will rise by 25 per cent and 12 per cent in 2017 and 2018, respectively.
- As the social contribution rate is the main labor tax burden of employers, it will be lowered by 5 and then additionally 2 percentage points in 2017 and 2018, respectively.
- If the average gross wage rise exceed 11 per cent in the first nine months of 2017, the government will additionally reduce the rate of social contribution tax by 0.5 percentage point in 2018.
If all the other factors remain unchanged, till 2018 these measures will result an increase of the lowest wages altogether by 24.2 and 40 per cent for unskilled and skilled workers, respectively. Concerning the pressure of wage hikes, short-term spillover effect is likely to be experienced in higher salary categories as well. One can notice that the reduction of the social contribution will significantly lower the relatively high level of Hungarian tax wedge. Currently, the total unit cost for employer, when providing HUF1 net wage for its employee, amounts to HUF1.93 in 2016 (ignoring the various forms of tax allowances). However, that will only partially offset the increasing labor cost the companies should face with. It could be a great challenge, especially, for either small- and medium sized enterprises (SMEs) or private entrepreneurs, since it is more difficult for them to increase their revenues in order to offset rising labor costs.
Prime Minister Mr. Viktor Orbán unexpectedly declared that the government will reduce the corporate income tax (CIT) burden of the companies by some HUF145bn (about EUR469.3m) in the next year. According to the announcement, unified CIT rate of 9 per cent will be applied from 2017 onwards, instead of the current system where 10 per cent CIT rate is applicable up to a tax base of HUF500m (EUR1.6m) and 19 per cent rate on the excess. It should be noticed that the level of 9 per cent will be one of the lowest CIT rate applicable in Europe. Based on the calculation of the Ministry for National Economy, SMEs can also gain about HUF20-25bn (EUR64.7-80.9m), nonetheless, the greatest winners would probably be the circle of 1,100-1,500 large companies operating in Hungary.
Nevertheless, it should be noted that in the first nine month of the current year real wages rose by 7.6 per cent in Hungary. Thus one can already experience a considerable pressure of wage increase on the labor market and both employees and employers should adopt themselves to the changing conditions.
High tax wedge and lack of labor force in certain sectors
Economic policy makers should tackle with acute labor shortage which is a growing problem almost in the whole Central Europe. Few companies in Hungary, mainly operating in automotive industry, IT, engineering and FMCG retail sector, have recently started to compete in wage increase or lure workers from each other by offering bonuses and other type of additional income. It also happened that a foreign company decided not to invest in Hungary due to the lack of skilled workforce in the targeted region. Besides manufacturing workers, IT specialists and engineers there are other typical positions struggling with ongoing labor shortages, inter alia, nurses, doctors, cooks, waiters, plumbers, carpenters, bakers, electricians, drivers and shop assistants.
The government tries to facilitate the mobility from Eastern Hungary to the most developed western and central regions of the country, where the unemployment rate is often lower than 3 per cent. Economic policy also provide with financial incentives for companies to take part in vocational education and organize in-house trainings for the workforce available. However, it is certainly hard to compete with much higher wages in the Western Europe which attracts well-skilled, young people from CEE and Baltics. They go mainly to Austria, Germany, Sweden and the United Kingdom. In several Central European countries, which became a manufacturing production center in the recent years, policy makers already consider attracting thousands of cheap foreign workers (mainly from Ukraine) to fill the vacancies.
To ensure the long-term convergence to Western Europe, reaching and sustaining dynamic, 3 5 per cent economic growth rate is one of the top priorities of the Hungarian government. However, external (e.g. Brexit) and internal shocks (e.g. labor shortage) can jeopardize this strategic goal, thus the Ministry for National Economy were requested to work on an economic stimulus package. Chambers, business associations, several tax advisors and economic policy analysts urged cutting social contribution long time ago. Significant labor cost reduction may provide a solution for easing labor shortages in certain industries and facilitate job creation in private sector.
In Hungary, every euro paid out for an employee (net wage) costs the employer some EUR1.93. Belgium, France and Austria have higher, while Germany and Greece have similar ratio. Nevertheless, in comparison with other CEE countries, Hungary has definitely disadvantage in this respect. The above-mentioned ratio (so-called the ‘tax wedge’) amounts to 1.73-1.76 in Romania, Latvia, Slovakia and the Czech Republic, while it is about 1.64-1.70 in Croatia, Poland, Lithuania and Estonia. It is obvious that as far as Hungary is concerned, competitiveness needs to be improved by significant cut in social contribution tax to achieve the average of the regional peers.
Macroeconomic and budgetary consequences
Certainly, the government has to take into consideration other aspects of such a measure. Social contribution revenues should cover the health and pension expenditures. In Hungary, these funds have become balanced in the recent years as a result of reducing shadow economy and increasing employment, inter alia. Nevertheless, the government has promised to preserve the purchasing power of pensions, thus if inflation increases close to 2 per cent next year, as a result of wage hikes, the originally planned 0.9 per cent pension increase will not be enough to preserve the real value of pensions. In case of the Hungarian ‘pay as you go’ pension system, pensions’ increase can either be financed by additional (tax) revenues or it can raise the budget deficit. The Hungarian government aims to facilitate economic growth and job creation with preserving fiscal balance, therefore public budget deficit should be kept under 3 per cent of the GDP.
With the aim not to not lose all the room for budget maneuvering, the government combined the multi-year program for gradual reduction of social contribution with significant rise in minimum wages. Nonetheless, analysts said that lowering the social contribution by every percentage point can cause some HUF90bn (EUR291m) net loss of income in the state budget (in case of public sector, social contribution reduction means lowering spending of the general government). However, as a result of the dynamic growth of households’ income generated by the wage hikes, income and consumptions tax revenues can (partially) offset the loss of revenue caused by the cut of social contribution itself. According to the newspaper Magyar Idők, based on the original proposal of 4 ppt social contribution cut combined with the boost in minimum wages, the government estimated some HUF15bn (EUR48.5m) loss of state revenue for 2017.
The bill including the future changes regarding social contribution, CIT and minimum wages will be submitted to Hungarian Parliament soon, as these measures are expected to enter into force from 2017. Answering the questions of Portfolio.hu, Hungarian economic news portal, Mr. Varga said that although these measures were not incorporated in the budget plan for 2017 and 2018, no prompt modification would be required. He pointed out that as the budget reserves for the next fiscal year amount to some HUF200bn (EUR647.2m), it could be sufficient to cover the net losses of tax reductions. The government intends to review the macroeconomic and budgetary trends in the first quarter of 2017 and take the necessary amendments. As the economic policy makers themselves expect that wage increase will result higher growth rates of consumption, retail sales and inflation which can boost economic growth considerably, changes in the macroeconomic projection seems to be inevitable.
Finally, one can notice that the measure of considerable hike in wages is undoubtedly very popular political decision and it should be borne in mind that the Hungarian parliamentary elections are expected to be in 2018.
Gábor Braun is a senior economist at the Hungarian Institute for Foreign Affairs and Trade.