Ivan Mikloš

Minister of Finance of the Slovak Republic

KyjevMay 16, 2005

THE TAX REFORM IN SLOVAKIA

2

INVESTORS THINK THAT SLOVAKIA HAS THE BEST INVESTMENT CLIMATE

Source: Czech-German Chamber of Commerce and Industry, 2004

91% of current foreign investors in Slovakia intend to expand their local investment!

Source: US Chamber of Commerce in Slovakia, 2003

Which country has the best business environment?

0% 10% 20% 30% 40% 50% 60%

Germany

Hungary

Poland

Czech Republic

Slovakia

3

BUSINESS ENVIRONMENT IS RAPIDLY IMPROVING

• World’s best reformer according to the World Bank– #1 in Doing Business 2005– currently among top 20 countries

in the world regarding the quality of business environment

Source: Heritage Foundation and Wall Street Journal

Index of economic freedom

36

59

74

6066

35

0

10

20

30

40

50

60

70

80

2000 2001 2002 2003 2004 2005

SK CZ HU PL

4

FISCAL REFORM: GENERAL CONTEXT

MAIN GOVERNMENT’S OBJECTIVE:

• reduce the general government deficit under 3.0% of GDP by 2006…

• … while simultaneously decreasing public expenditures as a share of GDP

Fiscal Position of General Government (% of GDP)

  2002 2003 2004 2005 2006

Revenues 38.3 36.0 36.2 37.0 36.6

Expenditures 44.0 39.6 40.0 40.4 39.5

Net borrowing -5.7 -3.6 -3.8 -3.4 -2.9

5

THE SLOVAK TAX REFORM: GOALS

BASIC PHILOSOPHY:LIGHT, NONDISTORTIVE, SIMPLE AND TRANSPARENT

TAX SYSTEM

• create business and investment friendly environment for both individuals and companies

• eliminate existing weaknesses and inefficiencies in the tax law

• eliminate distortive roles of tax policy as instruments for achieving non-fiscal goals

• improve tax fairness by taxing all types and all amounts of income equally

6

FISCAL IMPACT OF THE TAX REFORM

• reform designed to be revenue neutral in 2004• serious attention paid to fiscal impact quantifications• 5 independent estimations made by following institutions:

– International Monetary Fund– Slovak Ministry of Finance - Institute of Financial Policy– special high-level working committee– Infostat (Slovakia)– Slovak Academy of Sciences

• conservative estimates adopted for fiscal purposes

7

IMPLEMENTATION STRATEGY Chronology of the changes in the tax laws

1. Changes in indirect taxes: • amendment of VAT Act – introduction of one single rate of 19%

(before: 20% and 14%)• amendment of Acts on Excise Duties – increase of certain excise duty

rates: mineral oils, beer and tobacco products

2. Changes in direct taxes: • new Income Tax Act – introduction of flat tax • abolishment real estate transfer tax and gift and inheritance

tax

3. Changes in indirect taxes in compliance with EU tax legislation

- new VAT Act and new Excise Duties Acts - as of May 1, 2004

8

THE SLOVAK TAX REFORM: SPECIFIC CHANGES

• radical simplification of the tax system– elimination of virtually all exceptions, exemptions, deductions, special rates,

and special regimes– elimination of dividend, inheritance, gift taxes, and real estate transfer tax

• introduction of low nominal rates– 19% flat individual income tax– 19% corporate tax– 19% unified VAT on all goods and services - without any exceptions

• shift from direct to indirect taxes

9

1 flat rate: 19%

1 flat rate: 19%

THE REFORM RADICALLY DECREASES ECONOMIC DISTORTIONS CREATED BY THE TAX SYSTEM

2003OLD SYSTEM

2004NEW SYSTEM

PERSONAL INCOME TAX RATE

CORPORATE INCOME TAX RATE

VALUE ADDED TAXES

5 tax rates: 10%, 20%, 28%,

35% and 38%

5 tax rates: 10%, 20%, 28%,

35% and 38%

19% 19% 25% 25%

one unified rate: 19%

one unified rate: 19%

standard rate: 20% lowered rate: 14%

standard rate: 20% lowered rate: 14%

10

THE REFORM RADICALLY SIMPLIFIES THE TAX SYTEM AND INCREASES ITS TRANSPARENCY

2003OLD SYSTEM

2004NEW SYSTEM

PERSONAL INCOME TAX BASE

CORPORATE INCOME TAX BASE

OTHER TAXES

LOTS OF exceptions, exemptions

and special regimes

LOTS OF exceptions, exemptions

and special regimes

NO exceptions, exemptions

and special regimes

NO exceptions, exemptions

and special regimes

LOTS OF exceptions, exemptions

and special regimes

LOTS OF exceptions, exemptions

and special regimes

VIRTUALLY NO special taxes and rates

VIRTUALLY NO special taxes and rates

LOTS OF special taxes and rates

LOTS OF special taxes and rates

NO exceptions, exemptions

and special regimes

NO exceptions, exemptions

and special regimes

11

THE REFORM ELIMINATES MOST FORMS OF DOUBLE TAXATION OF INCOME

DIVIDENDTAX

DIVIDENDTAX

REAL ESTATETRANSFER TAX

REAL ESTATETRANSFER TAX

GIFTTAX

GIFTTAX

INHERITANCETAX

INHERITANCETAX

12

Effective Tax Rate

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0

Personal Income(as a percentage of the average salary in the economy)

Effective Tax Rate

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0

Personal Income(as a percentage of the average salary in the economy)

FLAT TAX STILL ENSURES PROGRESSIVE TAXATION OF INCOMES

Poverty Line

13

INFLUENCE OF FLAT TAX ON INCOME(person with unworking wife and 2 children)

-15

-10

-5

0

5

10

15

20

25

30

35

6 00

0

16 0

00

26 0

00

36 0

00

46 0

00

56 0

00

66 0

00

76 0

00

86 0

00

96 0

00

[%]

20032004

Negative tax (tax bonus)

14

TAX RATES FACED BY INVESTORS IN SLOVAKIA

0% 10% 20% 30% 40% 50% 60%

USA (New York)

Ireland

France

UK

Japan

Germany

Poland

Czech Republic

Hungary

Finland

Estonia

Slovakia

Corporate tax rateEffective tax rate on investment income faced by a private investor (combined corporate tax and dividend tax)

15

TAXATION II IN EU 25, (year 2003)

2005

2004

2003

28,929,3

30,7

0,0

10,0

20,0

30,0

40,0

50,0

60,0

SE

DK BE

FR FI AT IT LU

Euro

zone

EU

15 DE

EU

25 SI

NL

HU EL

PT

UK ES

CZ PL

CY

MT EE IE

Slo

vakia

Slo

vakia

Slo

vakia LV LT

[% HDP]

Poznámka: Eurostat uvádza pre SR 30,9% z HDP, avšak medzitým sa revidovali údaje HDP v SR za rok 2003 smerom nahor.

16

TAXATION II IN EU 25, change 1995 - 2003

-9,9-12,0

-10,0

-8,0

-6,0

-4,0

-2,0

0,0

2,0

4,0

6,0

CY EL PT MT ES AT SE BE

UK FR IT LT CZ

EU15

Euro

zone D

KD

E SIEU

25 NL

LU FI PL IEH

U EE LVSl

ovak

ia

[% HDP]

Poznámka: Eurostat uvádza pre SR pokles o 9,7% z HDP, avšak medzitým sa revidovali údaje HDP v SR za rok 2003 smerom nahor; pokles medzi rokmi 1995 až 2005 sa odhaduje až na 11,7% z HDP

17

PRELIMINARY RESULTS OF TAX REFORM

• Tax revenue development in 2004 shows that the estimates of the Ministry of Finance have been correct and collected tax revenues should be in line with the estimates

• Simplified administration and lower total tax burden have lead to improved incentives for entrepreneurship and investment

• Positive impact on employment is expected in a medium term

• From a macroeconomic and budgetary point of view it is too early to evaluate the overall impact of the tax reform

• Reform contributed to better rating of the Slovak Republic (A-)

18

THE SLOVAK TAX REFORM: RESULTS

• no decrease in tax revenues– increased revenues from indirect taxes– less scope for tax evasion and tax avoidance– more motivation to pay taxes

• better incentives for investment and work– thanks to lower marginal rates– thanks to more transparent and equitable taxation

FASTER CATCH-UP = LESS REVENUES FROM EU FUNDS!

19

FDI IS GROWING STEADILY

* ForecastsSource: National Bank of Slovakia

Foreign Direct Investment Stocks (US$ )

$0

$2 000

$4 000

$6 000

$8 000

$10 000

$12 000

$14 000

1997 1998 1999 2000 2001 2002 2003 2004*

FDI Stock by Country of Origin, 2003

France; 7.1%

Italy; 8.4%

UK; 7.1%

Czech Republic;

4.7%

USA; 3.9%

Hungary; 5.3%

Austria; 13.6%

Netherlands16.6%

Germany; 24.7%

Other; 8.3%

20

POLITICAL WILL AND MANAGEMENT ARE KEY FOR SUCCESSFUL REFORMS

• must have a clear vision where you want to go• timing is key in the implementation

– implement less popular steps first• resist lobbies and entrenched interests

– if you give in to one demand, you will be less able to say no to others

• compensate the most vulnerable part of the population

21

OTHER STRUCTURAL REFORMS

• pension reform– radical reform of the pay-as-you-go pillar– introduction of a fully-funded pillar (private pension accounts invested in

capital markets)• health-care

– make the system financially self-sustainable– improve the quality of services provided

• education– improve efficiency and quality of secondary education system– increase capacity and quality of tertiary education

• public administration– improve the quality of the public service– continue the de-centralization of public administration

22

CONCLUSION: ENLARGEMENT CAN GIVE A NEW PRO-REFORM STIMULUS TO THE EU

• competitive pressures coming from the new members– current EU members will have to reform as well if they will

want to stay competitive in medium and long term

• “change of mood” within the EU– at least 10 out of 25 people around the table will be from

dynamic countries with significant reform experience

23

Ivan Mikloš

Minister of Finance of the Slovak Republic

KyjevMay 16, 2005

THE TAX POLICY IN SLOVAKIA