Hungary: Raising Taxes to Save the Welfare State

Europe’s struggle with saving its welfare states has thus far claimed at least two victims: Greece and Spain. Other countries attempting to do the same are teetering on the edge of fiscal and social turmoil. The reason is their dogmatic commitment to austerity policies.

Some welfare state advocates criticize austerity as a failed policy and suggest that it is better to try and raise taxes. This argument is particularly popular with Europe’s radical left, and is being notoriously put to work in France. But there are others who have already embarked on a crusade to tax themselves out of a welfare-state caused deficit. As the Budapest Business Journal reports, Hungary is a good example – not only of higher taxes but of the consequences of those higher taxes:

Hungary’s government has raised its projection for consumer price inflation next year to 5.2% from 5.0% in light of a new round of fiscal measures, a supplement to the Excessive Deficit Procedure (EDF) report on the steps published on the government’s website on Thursday shows. … The government said the inflationary effects of higher corporate costs resulting from the new [fiscal policy] measures – such as the reversal of a reduction in the bank levy, a higher duty on financial transactions and the extension of a utilities tax to wires and pipelines – would outweigh the disinflationary effects of a prolonged output gap.

From a macroeconomic viewpoint the choice between this Hungarian approach and the Greek alternative is basically a toss-up. Both strategies are going to drive the economy into the ditch. As the Budapest Business Journal story continues, we learn that this is already happening in Hungary, in a way that is eerily reminiscent of where Greece was two years ago, and where Spain is today:

The projection for GDP growth in 2013 was lowered – as announced by Matolcsy on Wednesday – to 0.9% from 1.0%. The projection for growth in 2014 was knocked down to 2.0% from 2.5%. Investments are set to fall 1.0% in 2013, compared to the previous forecast for stagnation. They are seen edging up 0.3% in 2014, under the 1.2% rise forecast earlier. The projections for export growth were lowered to 6.2% from 6.6% for 2013, and to 6.4% from 6.8% for 2014. The forecasts for import growth were lowered to 4.5% from 5.1% for 2013, and to 5.3% from 5.4% for 2014. … The revisions in the projections could worsen the budget balance by the equivalent of about 0.1% of GDP, an amount that can be “safely covered” by the raised level of the Country Protection Fund, according to the report.

Unemployment remains in the 10.5-11 percent bracket, reinforcing the impression of an economy in trouble. High unemployment, sluggish growth and rising inflation is a really bad combination, and if nothing is done about it, it could expand into a very deep, lasting and socially destructive recession.

Part of the problem for Hungary is that it has had to adjust its economy to EU dictates, especially when it comes to taxes and the labor market. These adjustments have not been painless, and together with other dictates from Brussels they provoked a nationalist election victory in 2010. Their agenda included reinforcing the Hungarian welfare state, a strategy that has contributed to the national government’s budget trouble.

To deal with its problems, Hungary has for the  past year been talking to the IMF about a “relief” loan. As a result, the IMF has taken a keen interest in the Hungarian economy. Interestingly, their recommendations, which come with their loan offer, are quite different from the recommendations given to, e.g., Greece. On October 4 Bloomberg Businenss Week reported that the IMF is not recommending harsh austerity measures in Hungary, but instead wants to see…

…“more balanced” policies that improve the growth outlook and [the Fund] doesn’t recommend austerity measures on top of the government’s planned 2013 budget cuts. “We are not looking for more fiscal adjustment beyond what the government is already planning, there is no more austerity in our proposals,” Iryna Ivaschenko, the IMF’s representative in Budapest, said in an e-mailed response to questions. “But we think the adjustment can be achieved with more balanced measures, and more generally, we are looking for policies that can boost growth.”

Could it be that the IMF has burned its fingers in Greece? After sacrificing Greece and essentially throwing the country into a whirlpool of social unrest, economic instability and political extremism, the IMF appears ready to take a fresh look at its own policy recommendations.

The absence of tougher austerity measures is of course laudable, but the alternative proposed by the Hungarian government is not long-term sustainable. Their ambition is, plain and simple, to preserve their welfare state, which, as the Bloomberg report explains, they have communicated to the IMF:

Prime Minister Viktor Orban on Oct. 1 ruled out an IMF loan agreement that entails cuts in pensions, jobs or wages, conditions which last month he said were demands of international lenders. Hungary can finance itself through mid-2013 without bailout, or “with luck” even longer, Mihaly Varga, the government’s chief IMF negotiator, said in interview with the weekly Heti Valasz, published today. Hungary, the European Union’s most-indebted eastern member, which is suffering its second recession in four years, requested aid in November [of 2011] as its credit rating was cut to junk.

So to save its welfare state the Hungarian government is raising taxes:

The steps being considered by the government to prevent next year’s deficit from widening by 600 billion forint ($2.7 billion) include raising the value-added tax, imposing a transaction levy on central-bank deals, delaying the full introduction of the flat personal-income tax, and increasing the tax load of commercial banks … .

Which, as mentioned earlier, is driving up inflation. Which, again, leads to less growth, higher unemployment, eroded tax revenues – basically a downward spiral similar to that which follows austerity policies.

Until Europe gives up its welfare state, they are going to have to get used to these crises emerging in country after country.

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