US embassy cable - 04BRATISLAVA192

UNCLAS BRATISLAVA 000192 
 
SIPDIS 
 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, PGOV, ELAB, SOCI, LO 
SUBJECT: ECONOMIC REFORM: THE VIEW ON THE GROUND 
 
1.  Summary.  A radical tax overhaul, price liberalization 
and tightening of social benefits in recent months have 
combined to drastically alter the way most Slovaks view 
their incomes.  Approximately 90 new laws came into effect 
on January 1, 2004 along with a host of other changes in 
recent months.  While the GOS budget and the economy as a 
whole are on better off, nearly everyone has a new equation 
to use to calculate his income and many pensioners and 
unemployed people will be the most affected.  Reductions in 
social benefits have led to social unrest by Slovakia's Roma 
minority, the vast majority of which are long-term 
unemployed (septel).  Opposition parties and some 
presidential candidates hope to capitalize on public 
unhappiness in upcoming elections.  End summary. 
 
CUT IN SOCIAL BENEFITS 
---------------------- 
 
2.  Slovakia's generous program of social and unemployment 
benefits are often blamed as being disincentives for people 
to find work.  The country's unemployment rate is 16 
percent, half of which have been out of work for more than 
two years.  Historically, many recipients of unemployment 
benefits defrauded the system by having jobs on the black 
market.  This allowed them to earn far more than they 
otherwise could have, and had the double burden of cheating 
the GOS of income tax revenue and costing it unnecessary 
benefits payments.  On March 1 these benefits will be 
reduced by approximately 15 percent (short-term unemployment 
benefits by more than 50 percent) as the GOS introduces a 
new workfare program.  By performing community service or 
taking jobs at minimum wage, recipients will be able to 
regain or exceed their previous level of income that was 
formerly completely dependent on social benefits 
(unfortunately, it appears that a sufficient number of 
community service jobs will not be ready in time).  Social 
unrest has broken out within Roma communities, which often 
have unemployment rates above 90 percent, to protest the 
cuts in benefits (septel). 
 
19 PERCENT FLAT TAX RATE 
------------------------ 
 
3.  The most drastic change for the general public is a new 
19 percent flat tax rate for individuals and corporations. 
Previously, individuals paid taxes of between 10 to 38 
percent divided between five different tax rates, and the 
corporate rate was 25 percent. While the flat tax is 
expected to be revenue neutral overall, it represents a 
large tax cut to higher income earners.  The GOS hopes this 
will encourage them to actually pay their taxes and reduce 
the rate of tax evasion.  (Note: The Slovak National Tax 
Office estimates that overall 20 to 30 percent of taxes go 
unpaid in Slovakia.)  To help offset the effect of raising 
lower income earners' taxes from 10 percent to 19 percent, 
the GOS greatly increased the amount of tax deductions for 
the working poor.  Middle-income earners who are single are 
likely to pay higher taxes while a family of four would get 
a nearly 10 percent benefit.  However, the National Tax 
Office told econoff that the new program could hurt 
pensioners and the unemployed. 
 
19 PERCENT UNIFIED VAT 
---------------------- 
 
4.  Slovakia's previous two-tier value added tax regime was 
set at 20 percent for most items, but 14 percent for 
necessities such as food, electricity and natural gas.  The 
rise from 14 percent to 19 percent falls disproportionately 
hard on people in lower income brackets.  In simple terms it 
equals a five percent increase in inflation for basic 
necessities.  Critics of the new plan note that EU laws do 
not require a unified VAT.  Instead, they specifically allow 
for reduced VAT on necessities, medicines and other 
sensitive products. 
 
PRICE INCREASES 
--------------- 
 
5.  For several years, the GOS has been liberalizing utility 
prices from their previously highly subsidized rates, and 
2004 is the last year of liberalization before prices are 
considered to be at market rates.  Natural gas prices are 
expected to rise more than 30 percent (including the new VAT 
rate) for households in 2004 although they will drop by 
about two percent for industrial and public sector clients. 
Electricity prices will increase an average of 6.7 percent 
(including the new VAT) this year.  A local research group 
predicts a 14 to 20 percent jump in food prices due to the 
new VAT, increased farm costs and entry into the EU.  In 
August last year, the GOS raised excise taxes on petroleum 
products, beer and cigarettes that raised the overall price 
of gasoline and diesel by more than 10 percent, beer by 
approximately 10 percent and cigarettes by 20 percent 
 
(including a second tax increase in January 2004).  These 
tax increases were initiated to make up for a short fall in 
tax revenues.   To add to consumers' problems, inflation hit 
its highest rate in four years in 2003 at 9.3 percent and is 
estimated at 5.5 - 7.3 percent this year. 
 
HEALTHCARE AND COLLEGE NO LONGER FREE 
------------------------------------- 
 
6.  In June 2003, the GOS initiated a new fee-for-service 
program in the healthcare sector.  Although the fees seem 
nominal by western standards, they represent a high cost for 
many Slovaks who consider free healthcare a right of 
citizenship.  Slovakia's healthcare sector is deeply in 
arrears and its debts are rising due to a public accustomed 
to frequent doctor visits and doctors that over prescribed 
drugs (many of which are discarded).  The new charges 
include USD 0.63 for visiting a doctor's office, having a 
prescription filled, or spending the night in a hospital, 
although many exemptions were created to minimize the 
negative effects of this policy.  In addition, an increase 
in the cost of numerous drugs has helped make the Ministry 
of Health one of the least popular departments of the GOS. 
However, through the first six months of the plan medical 
costs are down and the sector's debts are rising at a slower 
pace.  This September, the GOS also plans to introduce the 
concept of college tuition.  Previously free undergraduate 
and graduate programs will cost approximately USD 125 to 650 
per year excluding books, housing and meals. 
 
7.  Comment.  The GOS has made many correct moves in recent 
years to prepare the country for NATO and EU membership, 
attract foreign investment, and generally catch up with the 
development of its neighbors.  Furthermore, the USG, the 
IMF, and other international organizations agree with the 
recent changes listed above, and have even promoted the idea 
of reducing social benefits for years.  However, the rapid 
pace at which some of these changes are being implemented -- 
before adequate numbers of community service jobs could be 
created and before the jobs created by new foreign 
investment flooding the country (septel) can take hold -- 
shows a lack of preparedness on the part of the GOS. 
Changing a decades-old- culture of living off the dole would 
prove difficult under the best of circumstances.  This view 
of economic hard times is the backdrop for the upcoming 
presidential election and referendum on early elections 
called for by labor unions and opposition parties. 
Coalition politicians seem determined to stay the course on 
reforms, but they may pay high political costs by not taking 
into account how the reforms are viewed by Slovakia's most 
vulnerable.  Opposition parties like SMER and KSS are trying 
to use this issue to force a government change, and 
President Schuster is campaigning for reelection on a 
platform which heavily criticizes the government's actions. 
 
THAYER 
 
 
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