VZCZCXRO1714
RR RUEHAG RUEHDF RUEHIK RUEHLZ
DE RUEHSL #0490/01 1671517
ZNR UUUUU ZZH
R 161517Z JUN 06
FM AMEMBASSY BRATISLAVA
TO RUEHC/SECSTATE WASHDC 9965
INFO RUCNMEM/EU MEMBER COLLECTIVE
RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 03 BRATISLAVA 000490 
 
SIPDIS 
 
DEPT FOR EUR/NCE 
TREASURY FOR AALIKONIS 
USDOC for MROGERS 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV LO
SUBJECT: Tax Reform and the Election 
 
REFTELS: (A) BRATISLAVA 457; (B) BRATISLAVA 461; (C) BRATISLAVA 
 
438 
 
This cable is sensitive but unclassified (SBU).  Please treat 
accordingly. 
 
¶1.  Summary.  The flat tax is the flagship of the reform agenda 
that helped the government of Prime Minister Mikulas Dzurinda 
quickly turn Slovakia into one of Europe's most attractive 
destinations for global investment.  While admired by investors, 
Slovakia's flat rates for income, corporate, and value-added 
taxes are a primary target for the front-running Smer opposition 
party, which would like to re-introduce graduated tax rates and 
the dividend tax.  Smer's tax proposals may attract voters but 
worry the business community, and it is hard to see how it can 
assemble a post-election coalition to implement its tax reform 
ideas.  Slovakia's high payroll taxes, a more likely target for 
post-election reform, have not become a major issue during the 
campaign.  End summary. 
 
Last Four Years Defined by Tax Reform 
------------------------------------- 
 
¶2.  The 2004 tax reform was designed to simplify the tax system 
by eliminating more than 200 exemptions and special regimes and 
setting the rates for the personal income tax, the corporate 
income tax and the value-added tax (VAT) at a flat 19 percent. 
This amounted to a net decrease in income and corporate taxes, 
but a net increase in value-added taxes.  The withholding tax on 
dividends, the succession tax, the gift tax and the real estate 
transfer tax were abolished to pursue the principle of no double 
taxation of saving and investment.  In addition, excise duties on 
mineral oils, tobacco and tobacco products, wine and beer were 
raised in order to be fully harmonized with EU regulations as 
required by Slovakia's accession treaty with the EU. 
 
¶3.  The tax reform package has not significantly altered the 
national budget, since increased revenue from value-added and 
excise taxes have largely balanced decreases from other taxes. 
After Slovakia introduced tax reform, tax revenues fell by only 
0.1 percent of GDP, from 18.1 in 2003 to 18.0 in 2004 and 
revenues increased in cash terms.  The simple regime also 
improved compliance and has reduced the need for individuals and 
businesses to seek creative ways to avoid paying taxes.  To 
address the potential problem of regressive taxation associated 
with higher value-added taxes and higher income tax levels in 
lower income brackets, the GOS significantly increased personal 
deductions so that those with incomes below SKK 9,000 per month 
(USD 300) do not pay income tax at all.  As a result, even 
citizens who were previously paying the lowest income tax rate of 
10 percent benefit from the new system. 
 
Wide support for further income tax cuts... 
------------------------------------------- 
 
¶4.  Most political parties are courting voters by calling for 
further income tax cuts; in fact there in something of a 
competition to come up with lowest number.  Within the ruling 
coalition, Dzurinda's SDKU calls for cutting personal income and 
corporate tax by one percentage point each year of the new 
electoral term, to 15 percent in 2010.  The drop in revenues 
would be compensated for by an "energy tax" and increased EU 
funds.  SMK is more restrained, proposing to cut income taxes to 
17 percent.  Former coalition members are calling for deeper and 
faster tax cuts: KDH calls for reducing income taxes to 14 
percent over the term, while ANO wants 15 percent tax rates by 
¶2008.  KDH also proposed doubling the non-taxable threshold and 
allowing families to deduct an additional SKK 100,000 during the 
first year of marriage. (NOTE: KDH's campaign was focused on 
"family values").  Vladimir Meciar's HZDS has been surprisingly 
friendly to the tax reform package, saying that he "does not 
disagree with the flat tax concept."  Free Forum would "preserve 
the system with further reduction of income tax rates."  Despite 
all these proposals, there is little evidence that income tax 
cuts are a voter priority this year. 
 
... but not a consensus 
----------------------- 
 
¶5.  Taxes are a centerpiece of Smer's criticism of the Dzurinda 
government, and is also the business community's main concern 
about a Smer-led government.  Smer has promised to enact a system 
similar to what existed before the Dzurinda reforms.  Above all, 
progressive income taxes would be re-introduced.  The Smer tax 
regime would be based upon three tax brackets: 15 percent tax for 
annual incomes of up to SKK 240,000 (USD 8,000); 19 percent for 
 
BRATISLAVA 00000490  002 OF 003 
 
 
incomes above SKK 240,000 and up to SKK 600,000 (USD 20,000) and 
25 percent for the richest.  The communist party (KSS) and the 
nationalist party (SNS) have also called for a graduated tax 
system, but have been less specific on details. 
 
¶6.  Smer is the only party that proposes specific tax increases 
for business.  While leaving the corporate rate at 19 percent for 
"regular companies", it wants to impose a special, 25 percent tax 
"for all natural monopolies, strategic enterprises, banking and 
financial institutions."  Without explaining which companies 
would be subject to the new "monopoly tax," Smer calculates that 
it would generate revenues of approximately SKK 4 billion (USD 
133 million).  Independent analysts estimate that such change 
would increase revenues by no more than SKK 3.1 billion, due to 
lower income of the state as a shareholder from dividends as the 
overall profit will be squeezed by the higher tax bite. 
 
¶7.  Smer and SNS both plan to bring back the withholding tax on 
dividends, which was abolished in 2004, and increase it from its 
former level of 15 percent to 19 percent.  SMER estimates 
revenues from this measure at SKK 9.8 billion for 2006.  This 
number differs significantly from independent assessments, which 
estimate additional revenue of only SKK 0.8 billion since non- 
residents would be inclined to pay taxes elsewhere if taxed on 
dividends in addition to the corporate income tax.  In 2003, the 
last year before the dividend tax was abolished, it brought into 
the state budget less than SKK 500 million.  Smer's revenue 
projections leave open to question whether it understands the 
degree of impact its tax policies will have on investors.  Also, 
considering that Smer has a sizeable number of domestic 
corporations supporting its campaign, it is unclear how it would 
be able to actually move forward on such a proposal. 
 
¶8.  Smer would also lower taxes in other areas, especially value- 
added taxes, as part of its effort to build the "social state." 
Specifically, it would re-introduce a two-tier VAT system, with 
lower rates applied for foodstuffs, medicals, books, utilities, 
and eventually other goods and/or services.  The lower rate would 
be reduced to 14 percent in the first phase, and later to 10 
percent.  The party expects that the measure would reduce state 
budget revenues by SKK 7.5 billion (250 million USD) in 2006, 
which independent analysts agree is a realistic projection.  Smer 
would also decrease excise taxes on gasoline and diesel.  KSS has 
also called for a two-tier system, lowering VAT on basic goods to 
10 percent, while SNS has called for lowering VAT but has not 
offered a specific plan.  Among the parties that pioneered tax 
reform, only KDH has seriously mentioned the possibility of 
reducing value-added taxes on some goods, but has not offered a 
firm proposal. 
 
Payroll taxes 
------------- 
¶9.  In contrast to previous elections, much of this year's 
campaign debate is focused on Slovakia's health, social security, 
and welfare insurance systems.  All of these sectors are financed 
by payroll taxes, which were marginally reduced but otherwise 
unaffected by the GOS reform package.  Overall payroll taxes in 
Slovakia remain the highest of the Visegrad countries, and high 
by EU standards.  In Slovakia, employees pay on average 13.4 
percent of their wages in payroll taxes.  In addition, employers 
are assessed payroll taxes of 35.2 percent on top of employee 
wages, which dramatically increases labor costs for business. 
Consequently, taxes on capital in Slovakia are much lower than 
taxes on labor, which encourages capital- instead of labor- 
intensive investment in a country that still has an unemployment 
rate of 11 percent.  The payroll tax system is particularly 
unfavorable to poorer and less-educated regions such as Eastern 
Slovakia, where labor productivity is lower. 
 
¶10.  Most of the front-running parties recognize this problem to 
some degree, and parties ranging from SDKU to Smer have suggested 
payroll tax reform.  Parties have not been very specific in their 
payroll tax reform platforms, however, even though the current 
system is highly unpopular and no party has a serious stake in 
preserving it, which suggests that reform is possible.  Former 
and current ruling coalition parties - SDKU, KDH, SMK, and ANO - 
have called for relaxing the payroll tax burden, and uniting the 
collection of diverse payroll taxes under one office to reduce 
administrative costs.  These parties also seem to agree on the 
need to unify payroll tax assessment bases by shifting the 
portion of payroll taxes paid by the employer to the employee and 
recalculating wage rates (upward) accordingly.  Under this 
system, gross wage rates would be equal to the cost of labor plus 
payroll tax-financed social benefits.  This change would solve 
past problems with companies that have failed to pay their 
payroll tax obligations.  Notably, SDKU and other parties have 
 
BRATISLAVA 00000490  003 OF 003 
 
 
not been specific about payroll tax rates.  Smer's position on 
payroll taxes is even less defined, a result of wanting to lower 
taxes while simultaneously increasing expenditures on health 
care, pensions, and other social insurance. 
 
(11.  While parties have been loathe to discuss significant 
payroll tax schemes, Richard Sulik, former advisor of Finance 
Minister Ivan Miklos and author of the flat tax reform, has put 
forward a specific proposal.  Sulik calls for a payroll tax 
schemes with a single "redistribution contribution" rate equal to 
18 percent of all labor income and a single "contribution bonus" 
equal to the minimum subsistence level.  In this scenario, the 
state would provide basic health care, and all other social 
insurance would become private, including pensions.  Higher 
employment and tax revenues would be expected to finance part of 
the transition cost and any special arrangements for particularly 
vulnerable groups like disabled and single mothers.  This model, 
which would radically reduce and restructure payroll taxes, has 
been endorsed by the influential Alliance of Entrepreneurs in 
Slovakia.  It has not gained the official support of any major 
party.) 
 
Coalitions and Tax Policy 
------------------------- 
 
¶12.  Slovakia's economy is growing at a rate of 6 percent per 
year, and unemployment has fallen from 20 to 11 percent since 
¶2002.  Most observers in Bratislava believe that Slovakia's tax 
reforms greatly facilitated this boom, but voters in other parts 
of Slovakia are less willing to give the government credit and 
are more willing to give Robert Fico and Smer a chance.  But Fico 
would find governing much more difficult than winning first place 
in the election.  To form a coalition, Smer will need to unite 
with partners like SMK, KDH, or perhaps HZDS, all of which 
disagree with most of Smer's tax policy proposals.  SNS and KSS, 
which agree more closely with Smer, are not viewed as viable 
partners, and the latter may not make it into parliament.  As a 
result, Smer will likely have to back out of the great majority 
of its proposed tax reforms, especially those on corporate and 
personal income taxes.  Changes to value-added taxes and payroll 
taxes are more plausible, but it is unclear what direction those 
reforms will take.  In any case, Smer will find it almost 
impossible to deliver on its key tax reform campaign promises. 
 
VALLEE