Slovakia: tax reform


Slovakia’s 19% flat rate tax has not been greeted with universal enthusiasm but it has given a boost to foreign investment: flat tax revenue in 2005 is thought to have exceeded Ministry of Finance expectations by more than 8% (c. SKK 17 billion).

A recent survey suggested that most Slovaks do not feel the flat tax has helped their incomes. Around 30% said their income had fallen since it was introduced, 40% said there was no change and only 7% said it had increased. The most negative about the flat tax, according to the survey, were opposition party voters and people on incomes between SKK 12,000 and SKK 15,000 a month.

The main opposition party, SMER, was opposed to the flat tax from the outset and its leader, Robert Fico, said on more than one occasion that he would abolish it if he came to power. Now, he has come to power and the flat rate tax is under threat. Mr Fico would like to restore the old dual-rate VAT system and replace the current 19% flat rate income tax. These changes would cause a SKK 40 billion shortfall in the state budget.

The Slovak Foreign Policy Association claims that flat rate tax has made the rich richer and the poor poorer. The business association says the flat tax is fairer than the previous tax system and provides a significant incentive for people to work. Vladimir Meciar, the former Prime Minister, believes the flat tax has benefited low-income groups. He claims that the real earnings of workers on the minimum wage have increased by 3.1% a year, while couples on the minimum wage with 2 children have seen real earnings increase nearly by 9% a year. This is because the earnings threshold before tax becomes payable has risen from SKK 32,000 to about SKK 90,000.

The flat rate tax may give Slovakia the lowest average rate of income tax in the EU but, other taxes and compulsory contributions to social and health care system mean that the total tax burden in Slovakia is nowhere near the lowest, according to information released by the Eurostat agency.

The Slovak parliament has now approved legislative changes to allow self-employed workers to declare 40% of their total income as non-taxable, as well as being able to deduct compulsory payments to social and health care funds. Any claim to deduct more than 40% in allowable expenses must be supported by evidence, involving a greater administrative burden such as book keeping. Self-employed workers who earn their living exclusively through skilled labour will be able to declare as much as 60% of their earned income as non-taxable.

In its 2005 report on economic development in Visegrad Group countries, the World Bank suggested that lower payroll taxes for low-income professions would increase employment and could help to ensure sustainability and efficiency in the pension system. Slovak business people agree that payroll tax remain the greatest problem for business.