Remedies that will not save the economy

Old Polish zloty mockup (photo KM/OF)

The announcement of Prime Minister Donald Tusk’s keynote address has spurred the Polish opposition into action. In early September, all opposition parties presented their ideas for the economy. They can hardly be called programmes, as they have the form of more or less haphazard proposals. Their common feature is a disregard for the economic situation in the region and for the declining power of the budget.

All the parties have focused on actions taken by the State rather than on private companies and the market. All of them promise that implementation of their programmes will stimulate economic growth, although they fail to explain how this could happen.

A social Right

The largest opposition party, Law and Justice [PiS], proposes a significant increase in social spending.

For retirees:

• repeal the law raising the retirement age to 67 and return to the age thresholds of 60 years for women and 65 years for men with the option of a voluntary extension of the employment period by eligible persons;

• introduce the option of choice in the pension system (Social Security Institution [ZUS]/Open-ended Pension Funds [OPF]);

•  refund tax for those retirees who draw retirement pension of PLN 1,000 and less.

For families:

• extend the scope of tax credits for children to those taxpayers who do not pay the income tax or pay such small amounts that they fail to qualify for the exemptions. Moreover, families are to be eligible for the extension right from the moment of conception of a child;

• introduce a family benefit for the purchase of textbooks for children;

• extend maternity leave;

• the State will fund social insurance contributions for parents on parental leave;

• credit the maternity leave of self-employed women to their contributory period;

• provide a voucher for families who send their children to nurseries and preschools – parents could redeem the voucher in the institution attended by their child, regardless of whether it is a public or a private establishment (the value of the voucher is PLN 300 per month per child);

• offer benefits for large families in the form of a family card that could be used to obtain discounted transportation fares and access to cultural and sporting institutions;

• extend financial aid for young families applying for housing;

• implement a National Housing Programme;

Healthcare:

• dissolve the National Health Fund and eliminate funding of healthcare directly from the budget via the Ministry of Health;

• establish a National Network of Hospitals;

• increase reimbursement of medicines;

• introduce school doctors.

The Law and Justice’s economic platform is far more modest. The largest opposition party has focused on taxes and the labour market.

Taxes

• adopt a new tax act which will set out the rules for PIT (personal income tax) and CIT (corporate tax) calculation and introduce a uniform tax base;

• introduce a single, universal VAT declaration;

• introduce a bank tax and a turnover tax for superstores;

• reduce the excise duty charged on fuel;

• introduce tax relief for enterprises and employers in return for investments and creation of jobs.

Solutions to unemployment

Law and Justice’s ideas to reduce unemployment include:

• reduce social security contributions for school graduates by 50% for  2 years, introduce educational scholarships during the period of study and job search;

• reduce pension contributions for employers by 2 percentage points;

• restrict flexible contracts between the employee and the employer;

• increase funding for the activation of the unemployed;

• assist communes with high unemployment levels.

A cursory review of the programme (some of the points are merely slogans, it is impossible to precisely calculate their impact on the budget) reveals a striking disproportion between budget expenditure (or loss of revenues) and the growth in revenues potentially generated by the introduction of the proposals of Law and Justice.

According to the party’s experts, public revenues will increase by more than PLN 11 billion, with PLN 5 billion generated by a reformed tax system and PLN 6 billion coming from a tax levied on banks and other financial institutions and superstores. Even though PiS claims that these are conservative estimates, such calculations rely on wishful thinking rather than on reliable simulations. Rewriting tax laws from scratch is no guarantee of an increase in budgetary revenues. On the contrary – it may result in a decline in revenues, especially since Law and Justice promises to extend the scope of tax credits  and a definition of tax-deductible costs that would be more favourable to businesses.

A reduction in excise duty on fuel alone may diminish the budget  by PLN 0.5 – PLN 1 billion (depending on the scale of the cut).

The platform put forward by Law and Justice, like many other agendas of Polish opposition parties, assumes that fiscal stimulation of the economy will bring about an additional GDP growth and the creation of new jobs, which will compensate for the loss of revenues.

This sort of assumption is very risky, especially in view of deteriorating conditions in the region of Central Europe . It also ignores a potential increase in debt servicing costs as a result of investors’ negative reactions to fiscal loosening.

Nevertheless, the Law and Justice experts argue that “we will pay less for servicing the debt which has been increased so much by Donald Tusk’s administration.” They also declare: “We want to get closer to the credit ratings of the Czech Republic, where the government bond yields are two times lower than the yield on Polish bonds”, even though this statement is just a pie in the sky. One can rather expect an increase in yields on Polish debt securities, especially if the next administration actually repealed the act which has raised the retirement age. This act is the most important vehicle for reducing public spending, especially after 2020. If it were to be overturned, it would become necessary to introduce other cuts on social spending — something that PiS has not proposed.

The party’s platform is a short-term one. The biggest “savings” that it suggests may be achieved by a further reduction in contributions to the OPF [Open-ended Pension Funds]. According to PiS experts, given a choice between the OPF system and the Social Security Institution, 80% of Poles will opt for the latter solution. The transfer of savings from the OPF to the Social Security Institution will yield a substantial, one-off revenue for public finances. A similar solution applied in Hungary in 2011 generated a budget surplus amounting to 3.6%of the GDP. However, the structural deficit reached – 5% of the GDP, while the yield on 10-year bonds, as at the end of 2011, was close to 10%, which goes to show that financial markets react negatively to “unconventional” methods of solving fiscal problems.

A statist Left

The economic programme of SLD [Democratic Left Alliance] is as left-wing as that of PiS, although the “Left” lays greater emphasis on state intervention in the economy rather that on social spending. Public investments are to be the main driver of growth. The left wing proposes to establish three new industrial regions:

1. Central region – near Łódź and the junction of two European motorways: the A1 and the A2;

2. Northern region – in the Tricity area (Gdańsk, Sopot, Gdynia), with access to the ports of Gdańsk and Gdynia;

3. Southern region – near Cracow.

In the industrial regions, “planned and carefully selected industries: machinery and electrical machinery, precision engineering, the automotive industry, electronics, biotechnology, the pharmaceutical industry, renewable energy and IT” are to be developed. Companies located there will receive state aid and a variety of concessions and privileges. The State will make direct investments in those areas and will subsidise private investments – up to 25% of their value. It will also develop the sites and provide the necessary infrastructure. The companies will receive preferential loans and guarantees, with micro-enterprises from the IT sector enjoying special privileges. SLD argues that the programme will help create over 500 thousand new jobs within 5 years.

It is impossible to escape the impression that the programme is a copy of plans from the interwar period to create a Central Industrial Region (CIR), which (as few people remember today) ended in disaster. The state-owned plants constructed within the CIR were inefficient and generated losses. While ensuring employment and output, they also drained the scarce capital resources of pre-war Poland. To rehash that programme 80 years later is a complete anachronism.

Why should the exact geographical locations of industrial regions be indicated by SLD? And why should these specific industries be developed there? The plants located there would compete with private companies scattered across Poland, driving many of them into bankruptcy, as such plants would enjoy privileges that enterprises located outside the “industrial regions” would not have. The net result – expressed in the number of jobs or a growth in the added value – is likely to be negative, as the companies protected by the State would be less effective than those which would lack such an umbrella, since the former would not have to face tough competition which forces enterprises to become more productive and more efficient.

In addition to establishing the “regions”, SLD is proposing to increase public investments, including construction of local infrastructure – for at least PLN 8 billion a year. Local governments are building local infrastructure even without political agendas, provided they get the necessary funds. The problem is that in the coming years there will be less money in the budget – both in terms of the State’s own revenues and the EU funds. Reallocation of State funds from fixed expenditure (mainly of a social nature) to investments would require reforms in the social sphere – this, however, is something that SLD is not proposing.

SLD wants to use statist methods to boost export. Loans granted to exporters “in respect of selected, priority export destinations” are to bear an  interest rate of 1%. Priority is to be given to Eastern markets – Russia and China. The SLD set of targets includes, i.a., to establish economic diplomacy agencies in 5 largest cities of Russia and China.

Beyond the question of international regulations (preferential export loans can be challenged both by the European Commission and the WTO), the aims of such support are not clear. Poland’s export is growing rapidly without such assistance and without specifying the “priority destinations”. Political interference in this area can only bring harm.

The proposal to create “consistent and uniform rules for key investments in the country” is certainly notable, as is the idea of amending the Public Procurement Law. However, experience shows that amendment of law can do little to change the situation in the public sector, which is developed by officials, lobby groups and politicians. The poor quality of investment processes results from the poor quality of state institutions and not from the absence of adequate laws.

SLD also presents some ideas which are supposed to improve the environment of private companies. The party proposes, i.a.,  to introduce a cash-based VAT collection system for companies with a turnover below PLN 800 thousand, extend the catalogue of companies entitled to lump-sum settlement of taxes and a fixed amount tax system, exemption from social insurance contributions for 18 months for all those who have hired their first or second employee. SLD opts for creating a mechanism of fiscal incentives (deductions) for businesses investing in education, introducing micro-loans for start-ups and tax reliefs for the construction of housing for rental and for reducing the current lump-sum tax on rental of apartments.

However, the proposals also include ideas that will harm small and medium-sized enterprises. SLD proposes to raise the minimum wage to 50% of the average wage (and to index it), to deduce social insurance contributions from most contracts concluded with employees other than contracts of employment and to increase the upper personal income tax rate to 40%. It is difficult to assess the credibility of claims that public offices which assist businesses will operate more efficiently.

SLD, quite like PiS (and the incumbent administration) views the reserves of the open-ended pension funds as potential sources of financing public expenditure. The left wing proposes to create a state-controlled OPF to make “reasonable and profitable investments” from the savings of prospective retirees. No doubt, such investment will be selected and managed by government officials and politicians.

The myth of the bank tax

SLD has outbid PiS when it comes to the amount of revenue which the State is supposed to generate by taxing the financial sector. While PiS estimates that revenues from the bank tax would amount to PLN 6 billion, SLD believes that levying the so-called Tobin tax on financial transactions will yield PLN 34 billion. The latter estimate seems to be unfounded.

In January 1984, Sweden introduced the Tobin tax at the rate currently proposed by SLD
(0.5 % on the value of a sale and purchase transaction) The results were disappointing. For example, the trading of bonds was expected to generate a revenue of SEK 1.5 billion a year, but the actual proceeds amounted to SEK 50–80 million. Taxation of stock-market transactions led to a sharp decline in trading and a capital flight. Sweden eventually abolished the tax in 1990.

In September 2011, the European Commission made a proposal to introduce a European financial transaction tax (EU FTT), which should come into force in 27 EU countries in 2014. The tax rate is to be 0.1% on transactions involving shares and bonds and 0.01% on transactions involving derivative instruments. The Commission expects tax revenues from the entire EU to amount to EUR 57 billion per year, with EUR 10 billion to be gained by the UK, as London is the largest financial centre in Europe. According to SLD’s estimates, similar revenues are to be obtained from the small Polish market.

Since the UK opposes the idea, the tax is likely to be introduced only in the euro area.

On 1 August 2012, the tax on financial transactions entered into force in France. The act under which it was introduced was adopted in March, under Nicolas Sarkozy’s presidency. The tax is levied on transactions involving shares and certain bonds of companies with a value exceeding EUR 1 billion. The rate is 0.2% on the transaction value. According to the incumbent president François Hollande, the tax will contribute EUR 170 million to the budget this year and EUR 500 million next year, i.e. 0.05% of the public sector’s revenues.

In 2010, the Hungarian parliament passed a tax on banks’ assets with a rate ranging between 0.15 and 0.5%. The government hoped to raise EUR 690 million, but the plan has not been accomplished. The tax is expected to generate a revenue of HUF 187 billion (approx. EUR 660 million) this year, but according to recent forecast it will only yield HUF 76 billion (approx. EUR 270 million). Such a dramatic decline in revenues has been brought about by the deteriorating situation of banks which deduct their losses from the tax.

In early September, the Hungarian government made a proposal to change the formula of the tax and to levy 0.1% on financial transactions. According to some sources, deposits in the National Bank of Hungary are also to be taxed at the rate 0.01%. The idea sparked negative reactions from the European Commission and the European Central Bank, as well as from the investors who lend money to the Hungarian government. Prime Minister Viktor Orbán’s Cabinet hopes that the new tax will yield EUR 500–600 million.

In Poland, the revenues could amount to over EUR 1 billion (PLN 3–4 billion), with a downward trend. Investors who have to pay the transaction tax quickly learn how to circumvent it, while losses for the financial stability and the economy outweigh the potential benefits.

OF

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