US embassy cable - 05BRATISLAVA428

UNCLAS  BRATISLAVA 000428 
 
SIPDIS 
 
 
TREASURY FOR CHRISTOPHER GREWE 
 
USDOC FOR MROGERS AND STIMMINS 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, ETRD, LO 
SUBJECT: KEY TO SUCCESS FOR SLOVAKIA'S FLAT RATE TAX SYSTEM 
 
1.  Summary.  Slovakia's adoption of a 19-percent flat rate 
tax for corporations and individuals has generated much 
attention internationally, but the Slovak general public has 
been quite mute.  Contending international policy camps have 
cited statistics to support their claims that the system is 
either a success or a failure.  In fact, the success of the 
system rests in complimentary legislation that promotes a 
policy of consumption taxes to offset the lowering of tax 
rates for businesses and most individuals.  After the first 
year, most Slovaks have been left better off or neutral by 
the flat tax rate, the country's fiscal condition has 
improved, foreign direct investment (FDI) is soaring -- that 
should qualify it as a success.  End summary. 
 
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RESULTS 
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2.  The preliminary statistical results of Slovakia's 
initial year under a 19-percent flat tax regime show that 
GOS tax revenues increased 4.2 percent from 2003, which is 
4.5 percent higher than budget estimates.  Clearly this 
shows that, so far, the new system is a success.  However, 
the results are easy to manipulate to bolster either side of 
the taxation debate.  The reason is that not only did 
Slovakia adopt a (generally lower) flat tax rate for 
corporate and individual taxes, but it simultaneously, and 
largely unrecognized, also moved towards a policy of 
consumption taxes by unifying and raising its value added 
tax (VAT) to 19 percent and raising excise taxes on mineral 
fuels, tobacco and beer. 
 
3.  The GOS budgeted that the flat tax rate would reduce tax 
revenue from individuals and corporations by about 40 and 20 
percent respectively during the first year, and that the 
difference would be made up by increases in VAT and excise 
taxes.  This is essentially what happened, but the results 
were better than forecasted.  Revenue from individual taxes 
only dropped by about 20 percent and that from corporate 
taxes actually increased by 2 percent.  In addition, VAT and 
excise taxes showed even stronger gains than forecasted by 
rising 19 and 14 percent respectively, or about 35 percent 
higher than targeted. 
 
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BACKGROUND 
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4.  Prior to 2004, Slovakia had a 25 percent corporate tax 
rate and five different individual income tax rates ranging 
from 10 to 38 percent with a large majority paying more than 
19 percent.  In addition, VAT was set at 20 percent for most 
items and 14 percent for food and other staple products that 
account for a large portion of expenditures.  Unifying the 
VAT was not necessary for Slovakia to qualify as a flat tax 
country, but increasing VAT receipts was definitely an 
important part of the plan.  Slovakia is the seventh 
central/eastern European country to adopt a flat tax rate 
and it has one of the highest VAT rates of the group.  In 
the end, flat tax regimes are usually more complicated than 
just leveling the tax burden for each unit of income earned, 
and they often depend on raising other taxes. 
 
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REACTION 
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5.  OPPONENTS OF FLAT TAX REGIMES TEND TO OVERLOOK THESE 
CONSUMPTION TAXES AND INSTEAD CONCENTRATE ON THE FACT THAT 
SLOVAKIA'S COMBINED CORPORATE AND INDIVIDUAL INCOME TAX 
REVENUES DROPPED OVER 10 PERCENT IN 2004.  THEY ALSO POINT 
OUT THAT LOWER-INCOME-EARNERS WHO ONCE PAID A TAX RATE OF 10 
PERCENT NOW FACED A TAX BURDEN ALMOST TWICE AS HIGH.  IN 
ADDITION, THESE SAME PEOPLE NOW HAD TO PAY SUBSTANTIALLY 
HIGHER TAXES FOR FOOD AND OTHER BASIC NECESSITIES. 
 
6.  THE GOS COUNTERS THESE ARGUMENTS BY EXPLAINING THAT AS 
PART OF THE NEW SYSTEM, STANDARD DEDUCTIONS FOR LOWER INCOME 
LEVELS WERE INCREASED SIGNIFICANTLY IN ORDER TO LEAVE 
VIRTUALLY ALL LEVELS OF INCOME EARNERS NO WORSE OFF THAN 
BEFORE THE INTRODUCTION OF THE FLAT TAX RATE.  ALTHOUGH 
CERTAIN CATEGORIES OF TAX RECEIPTS HAVE DROPPED, THE MORE 
IMPORTANT MEASURE OF OVERALL GOS TAX REVENUES (INCLUDING VAT 
AND EXCISE TAXES) ROSE BY 4.2 PERCENT.  IN CUTTING THE TAX 
RATE IN HALF FOR THE HIGHEST INCOME EARNERS, THE GOS HOPED 
TO SIGNIFICANTLY REDUCE THEIR LEVEL OF TAX EVASION.  WHILE 
THIS HAS NOT BEEN AS EFFECTIVE AS ORIGINALLY HOPED FOR, 
THERE HAS BEEN IMPROVEMENT AND THIS TREND SHOULD CONTINUE 
 
INTO THE FUTURE TO MORE CLOSELY MATCH THE RESULTS ACHIEVED 
BY OTHER FLAT TAX COUNTRIES. 
 
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POLL RESULTS 
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7.  SLOVAK OPPOSITION POLITICIANS HAVE LARGELY BACKED OFF 
THEIR EARLY CRITICISM OF THE FLAT TAX REGIME, BUT MAINTAIN 
THAT THEY WOULD REDUCE THE VAT ON FOOD AND OTHER STAPLES. 
POST HAS NOT HEARD MANY COMPLAINTS ABOUT THE FLAT TAX REGIME 
AND THE INTERNATIONAL PRESS HAS OFFERED CONSIDERABLE PRAISE 
FOR IT.  SURPRISINGLY, WE HAD NOT SEEN ANY SLOVAK OPINION 
POLLS ON THE NEW SYSTEM UNTIL LATE MAY.  IN A SURVEY BY SME 
NEWSPAPER, 7.3 PERCENT OF RESPONDENTS SAID THEY WERE BETTER 
OFF WITH THE FLAT TAX SYSTEM, 40.8 PERCENT SAID THEY SAW NO 
CHANGE, 21.7 PERCENT HAD NO OPINION, AND 30.2 PERCENT SAID 
THEY WERE WORSE OFF.  LIKE ALL POLLS, THIS ONE USED A SMALL 
SAMPLE OF THE GENERAL PUBLIC, BUT IT WAS STILL LARGE ENOUGH 
TO BE STATISTICALLY MEANINGFUL 
 
8.  WHILE THE RESULTS OF THIS POLL ARE NOT A STRONG 
ENDORSEMENT OF THE NEW SYSTEM, THEY SHOULD BE CONSIDERED 
WITH CULTURAL BIASES IN MIND.  SLOVAKS ARE WIDELY RECOGNIZED 
TO BE AMONG THE MOST PESSIMISTIC PEOPLE IN EUROPE.  PAST 
OPINION POLLS HAVE SHOWN THAT THEY PERCEIVED THE INFLATION 
RATE TO BE 300 PERCENT HIGHER THAN IT ACTUALLY WAS, THAT 
REAL WAGE RATES WERE DROPPING (WHEN IN FACT THEY WERE 
STRONGLY RISING), AND THAT PRICE LEVELS WERE CONSIDERABLY 
HIGHER THAN THEY ACTUALLY WERE.  THE FACT THAT 62.5 PERCENT 
OF THOSE SURVEYED SAW NO DIFFERENCE OR HAD NO OPINION CAN BE 
INTERPRETED THAT MOST RESPONDENTS FELT GENERALLY NEUTRAL 
ABOUT THE NEW SYSTEM.  FURTHER RESEARCH INTO THOSE WHO FELT 
WORSE OFF SHOWED THAT THE LARGE MAJORITY OF THEM IDENTIFIED 
THEMSELVES WITH THE SLOVAK COMMUNIST PARTY, WHICH IS IN 
OPPOSITION TO THE GOS. 
 
9.  Ministry of Finance (MOF) statistics also support its 
claim that for nearly all income levels, people paid less in 
taxes, and for most of those who paid more the increase was 
insignificant (USD 1-2 per month).  During 2004, Slovaks had 
to contend with rising costs of health care and cuts in 
social benefits.  It is likely that some of the pain of 
these changes was erroneously blamed on the flat tax regime. 
 
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COMMENT 
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10.  IN THE BROADEST SENSE, THE NUMBERS POINT TO SLOVAKIA'S 
FLAT TAX AND CONSUMPTION TAX REGIMES AS BEING SUCCESSFUL. 
BESIDES INCREASING TAX REVENUES, WHICH HELPED TRIM THE 
BUDGET DEFICIT AS SLOVAKIA PURSUES ADOPTING THE EURO, THEY 
ALSO HELPED ATTRACT LARGE AMOUNTS OF FDI THAT WILL IN TURN 
CREATE JOBS, BOOST EXPORTS, AND HELP DEVELOP THE ECONOMY. 
ALL OF THESE ATTRIBUTES WILL AID THE COUNTRY'S FISCAL 
CONDITION FOR YEARS TO COME.  AS THE MORE DEVELOPED WELFARE 
STATES OF THE EU-15, AND THE U.S. FOR THAT MATTER, WATCH AND 
CONSIDER TAX REFORMS OF THEIR OWN, SLOVAKIA AND OTHER 
INNOVATORS ARE SCORING POINTS IN THE EARLY ROUNDS OF THE TAX 
DEBATE. 
THAYER 
 
 
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