VZCZCXRO5188
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHUP #0874/01 2481315
ZNR UUUUU ZZH
R 041315Z SEP 08
FM AMEMBASSY BUDAPEST
TO RUEHC/SECSTATE WASHDC 3351
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE

UNCLAS SECTION 01 OF 03 BUDAPEST 000874 
 
SENSITIVE 
SIPDIS 
 
DEPARTMENT FOR EUR/CE LAMORE AND EB/OMA, AND INR/EC 
TREASURY FOR JEFF BAKER AND LARRY NORTON 
 
E.O. 12958: N/A 
TAGS: ECON PGOV HU EFIN
SUBJECT: THE GOVERNMENT'S NEW TAX PLAN - TAX CUTS WITHOUT 
SPENDING CUTS 
 
REF: BUDAPEST 809 
 
¶1. (U) Summary. The GOH unveiled its multi-year USD 7 billion 
tax cut plan last week. Under the plan the government 
proposes to remove the unpopular 4 percent "solidarity tax" 
on businesses and to reduce employer social security 
contributions for lower wage employees, but it also intends 
to increase the corporate tax rate from 16 to 18 percent. The 
plan would also reduce the tax burden for low wage earners by 
raising the 18 percent personal income tax bracket. The 
government intends to finance the cuts through "tight budget 
planning" and by reducing the high level of tax avoidance in 
Hungary. While economic analysts have expressed general 
support for tax cuts to help stimulate growth, they believe 
the government plan does not go far enough, maintaining that 
it should include expenditure cuts and meaningful reform of 
the pension and public assistance systems in order to promote 
employment and growth in Hungary. They are also skeptical of 
the government's ability to finance the tax cuts through a 
reduction in tax avoidance levels. The minority Socialist 
government currently lacks room to maneuver on pension and 
social welfare reform - as well as the support of its 
erstwhile coalition partner Free Democrats - as its tax cut 
plan and its 2009 budget move toward debate on the floor of 
Parliament. End summary. 
 
THE PRIME MINISTER'S TAX CUT PLAN 
 
¶2. (U) On August 26, Prime Minister Gyurcsany announced a 
three to four-year plan to cut taxes by USD 6.2 to 7.4 
billion (HUF 1,000 - 1,200 billion). The plan initially aims 
to reduce tax revenue by HUF 300 billion (1 percent of GDP) 
in 2009, and to increase the level of tax cuts thereafter. 
 
¶3. (U) In the first year, the plan would eliminate the 4 
percent so-called "solidarity tax" on businesses, but would 
raise the corporate tax rate from 16 to 18 percent. Other key 
cuts would include raising the income level of individuals 
who fall into the 18 percent personal income tax bracket, and 
reducing employer social security contributions by 5 percent 
for low wage employees. 
 
¶4. (U) Contrary to speculation prior to the announcement, no 
change in the VAT level is being proposed. In addition, few 
expenditure cuts are proposed as offsetting measures, and the 
government estimates that 60 percent of the 2009 tax cut will 
be financed through "extremely tight budget planning" where 
expenditures would not increase in real terms. 
 
¶5. (U) The Prime Minister hopes to finance the rest of the 
tax cut through a further "whitening" of the economy - 
reducing the number of people who either do not report 
income, or who report only a portion of their actual income. 
(Note: This continues to be a major problem in Hungary. 
Recent estimates suggest that unreported employment in 
Hungary amounts to as much as 20 percent of GDP, and informal 
estimates often range much higher. End note.) To achieve this 
goal, Gyurcsany's plan includes a one-time "amnesty" for 
individuals who previously under-reported their income, and a 
"no tolerance" policy for tax avoiders thereafter. 
 
¶6. (U) Other sources of increased government revenue would 
include a 10 percent increase in the excise taxes on 
alcoholic beverages and tobacco products, an additional 
healthcare contribution for benefits in kind, and a change to 
the taxation scheme relating to company vehicles. 
 
¶7. (SBU) Researchers and analysts are generally supportive of 
the tax reductions, in particular the elimination of the 
solidarity tax, which "serves the competitiveness of 
businesses," but as KOPINT-TARKI director Eva Palocz puts it, 
"the stimulating effect (of the government plan) is minor." 
Istvan Hamecz, CEO of OTP Fund Management agrees, noting that 
neither the extent of the tax cut nor the direction of other 
measures will attract additional workers to enter the labor 
market. Most analysts agree that the plan does not go far 
enough to significantly increase growth or increase Hungary's 
low labor participation rate, and question how the government 
can pay for it without major cuts in expenditures. 
 
WHAT'S NOT IN THE PLAN 
 
¶8. (SBU) In addition to its lack of spending cuts, the plan 
also does not seek to reform the pension or social welfare 
benefit systems. According to Prime Minister Gyurcsany - who 
we understand wrote the public roll-out of the plan himself, 
the "social implications" of doing so "would be much graver 
 
BUDAPEST 00000874  002 OF 003 
 
 
than the country could tolerate or support." Economic 
analysts criticize the plan's failure to address underlying 
issues they see as impeding economic growth in Hungary. 
Citibank analyst Eszter Gargyan notes that, "without a major 
tightening of social benefits" the plan fails to "resolve the 
underlying weaknesses in the economy that are related to low 
labor participation, high public expenditure, and high tax 
avoidance." As former Central Bank Governor Gyorgy Suranyi 
told the Ambassador, the government's plan "to reduce taxes 
without hurting anyone" is unrealistic, and Suranyi believes 
it would "almost be preferable to focus exclusively on 
deficit reduction" rather than undertake a plan that is "not 
ambitious." 
 
WHITHER THE CONVERGENCE PROGRAM? 
 
¶9. (U) International analysts including Standard and Poor,s 
have questioned the plan's impact on Hungary's "Convergence 
Program." Although the Prime Minister has pledged to continue 
the budget path toward budget deficits of no more than 3.2 
percent in 2009, and 2.7 percent in 2010, some analysts 
believe that the lack of clear expenditure cuts in the tax 
plan (and the over-reliance on the projected economic 
"whitening" effect by reducing the number of tax avoiders) 
increases the risk that the deficit will overshoot the 
Convergence Program goals, particularly in the 2010 election 
year. Others are more circumspect, however, and believe that 
the government is unlikely to undermine its efforts over the 
last two years to bring the deficit under control. In 
addition, under the government's plan, later year tax cuts 
will only take place if the government is successful in 
deriving additional income from its economic whitening 
efforts. 
 
FEWER TAX EVADERS? 
 
¶10. (SBU) While the government has enjoyed some success 
toward this goal through more aggressive tax law enforcement 
(reftel), there is a debate over whether the tax changes in 
the current proposal will promote less tax avoidance. The 
plan envisions a one-time tax amnesty for tax avoiders, 
followed by a "zero-tolerance" policy thereafter. The current 
tax system tends to incentivize the underreporting of wages 
by offering employers of minimum wage workers 
disproportionately low tax and social security contribution 
rates. This will continue under the government's plan. 
Indeed, Gyula Toth of UniCredit argues that, "the new 
threshold in the social security contribution may provide 
even more incentives for tax avoidance." Gyorgy Suranyi 
agrees, noting that the proposal "does not improve the 
situation at all", because the highest tax rate of 38 percent 
still starts at a level below the average monthly wage. 
Standard and Poor's, while noting that the proposed tax cuts 
are "generally a move in the right direction," argues that 
financing the tax cuts from revenue generated by reducing the 
number of tax avoiders is ultimately "not credible." 
 
COURTING THE SOCIAL DEMOCRATS 
 
¶11. (SBU) Commentators speculate that the Prime Minister's 
tax plan was designed in large part to win support of the 
former coalition partner Free Democrat (SzDSz) party, which 
it needs in order to garner a majority in Parliament to pass 
both the tax law changes and the 2009 budget. As one analyst 
commented, "SzDSz asked for a HUF 1,000 billion tax cut, and 
the Prime Minister delivered." Others have called the tax 
proposal "the Socialist Party's marriage proposal to SzDSz". 
Based on the initial negative reaction from SzDSz to the tax 
proposal, however, it appears that SzDSz is not ready to take 
another trip to the altar. SzDSz President Gabor Fodor argues 
that the country needs "structural changes," and not more of 
the government's "stop-and-go policy." (Note: See septel for 
a discussion of the current political context). 
 
COMMENT 
 
¶12. (SBU) Although the government would likely be willing to 
modify its tax plan as it continues to court SzDSz, the Free 
Democrats have not been clear on what it would take to win 
their support - assuming they actually know. But there will 
be clear limits to the MSzP's flexibility: the Socialists 
will likely remain unwilling (or unable, according to 
Gyurcsany) to propose major spending cuts or reform to the 
pension or social benefit systems. This puts the government - 
once again - in the position of overemphasizing a plan that 
underdelivers.  With submission of its tax proposal to 
Parliament required by September 15, and its budget by 
 
BUDAPEST 00000874  003 OF 003 
 
 
September 30, the two issues are likely to dominate the 
legislative agenda in the weeks ahead.  End comment. 
Foley