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Preliminary conclusions and tentative policy options
Hidden Economy WorkshopBudapest December 5-6, 2007
Preliminary and for discussion only
Notes (1)
Informality only part of fiscal problem Hungary already collects high % of GDP in
taxes. Expenditures very high. Fiscal only part of informality problem
Concerns should also include competitiveness, social welfare
Tradeoffs in combatting informality Slow down economic growth? Price people
out of economy?
Preliminary and for discussion only
Notes (2)
Terms of reference for study emphasize concrete recommendations …
But need for underlying analysis Scale and composition of informal sector Understanding incentives, motivations Attitudes
As well as analysis of specific areas for potential interventions
Weak evidence base internationally on what works in terms of specific interventions
Preliminary and for discussion only
Simple model of informality and needed responses Informal economy due to
Requires
Exclusion because of regulatory and other barriersExit when entrepreneurs and workers choose to operate informally
Removal of barriers to operate formallyReducing the costs and increasing the benefits of operating formally (Carrots)andIncreasing the costs and reducing the benefits of operating informally (Sticks)
Preliminary and for discussion only
Potential areas for reforms
Tax and benefit systems Business and labor market regulations Enforcement and sanctions Public information and education
Note that following policy ideas are preliminary and incomplete
Preliminary and for discussion only
Tax and benefit systems (1) Most important area for addressing
undeclared economic activity/employment
Taxes create disincentives for formalization But they are also not competitive with tax
regimes in neighboring countries So tax reform needs to be based on
overall efficiency and competitiveness (within framework of fiscal consolidation) and not just “whitening” the economy
Preliminary and for discussion only
Tax and benefit systems (2) Labor taxes (PIT, social contributions) are
high and discourage formal employment, especially low-wage labor
Favorable tax treatment of non-labor income encourages underreporting of employment earnings
Further disincentives created by serious spikes (e.g., employment income tax credit)
Design of social benefits and programs likely encourages undeclared work
Preliminary and for discussion only
Tax and benefit systems (3) To extent feasible, employer social
insurance contributions should be reduced Targeted reductions for workers
overrepresented in low-wage employment have biggest impact on formalization
Compensate for reductions in revenues with other taxes (e.g., dividend, VAT, real estate) Set revenue target and allocate any added
revenues due to better compliance to tax rate cuts in next year
More comprehensive reform -- Flat tax with high personal exemption and comparable rates for earnings and profits?
Preliminary and for discussion only
Tax and benefit systems (4) Employment tax credit – encourages
formalization but more gradual phasing out Assess minimum contribution base as
double minimum wage – do added receipts justify decreases in formal employment?
Consider other options to tie social contribution/tax bases to assumed productivity E.g., Bulgarian example of differentiated
minimum thresholds determined by social partners
E.g., Presumptive taxation of self-employed and small companiesPreliminary and for discussion only
Tax and benefit systems (5) Evidence suggest prevalence of combining
undeclared work with receiving public beenfits For unemployment benefit (and some social
assistance) recipients Implement “activation” policies – closer monitoring
and stricter job search requirements, combined with subsidies for hiring employers; and/or
Allow some earned income while collecting benefits High proportion of older workers are
undeclared Are reforms in pension/disability provisions
needed?
Preliminary and for discussion only
Business and labor market regulation (1)
Assessment that regulation is not a major factor
Business regulation reforms in recent years have reduced costs of compliance
Further steps Complete planned reforms for business
start-ups Simplify licensing procedures
Preliminary and for discussion only
Business and labor market regulation (2) Although some employers cite labor
market regulation as a problem, review suggests that it is not a serious barrier to formal employment
Minimum wages should be kept relatively low
Involve social partners in fight against undeclared work E.g., commitment to fight undeclared work
in collective agreementsPreliminary and for discussion only
Enforcement and sanctions
Tax collection efficiency lower than in other EU countries
Consider further consolidation of various institutions
Should APEH be restructured (by taxpayer, not function)?
Labor inspectorate – investment in training and exposure to latest international practices
Preliminary and for discussion only
Public information and education Segmented communication plan Position tax evaders as minorities and
underline criminal nature of evasion Address fairness issue by highlighting
sanctions on rich and powerful Link tax paying with publicly provided
services and benefits
Preliminary and for discussion only