The following OECD assessment and recommendations summarise Chapter 4 of the Economic Survey of Hungary 2005 published on 19 July 2005.
Fiscal pressures inevitably make it difficult for the authorities to achieve substantial across-the-board cuts in the tax wedge on labour, and this will continue to be the case without significant further economies in public spending, though effective tax-base broadening measures could also finance tax rate cuts to some extent. In fact, the government has been finding some room for cutbacks on both the employers’ and employees’ components of the wedge. More are planned for the future. Though these are welcome, there is room for improvement in the envisaged policy measures.
The employment rate is far below benchmarks based on countries
with high labour utilisation
1. Persons aged 20-64 years.
2. Mobilisable labour resources are shown as the vertical sum of excess unemployment and excess inactivity. Excess unemployment is defined as unemployment above 5% of the labour force (if any). Excess inactivity is based on comparisons between actual participation rates for cells defined by age and gender, and international benchmark rates (calculated as the third highest value observed in the OECD).
Source: OECD, Employment database; OECD Employment Outlook (2003).
In particular the strategy on personal income tax reductions should be rethought. Reductions in tax bills for low-income earners are generated through tax allowances that imply zero tax at the minimum wage and reduced taxation for a large share of taxpayers earning above the minimum. This approach has the drawback of raising effective marginal tax rates sharply over a range above the minimum wage. In addition, the timing of the large recent tax cut to middle and upper income recipients arising from a shift from three to two tax brackets is questionable. A more appropriate approach to cutting taxes for both low and high earners would be to scrap the special zero-tax and allowance, replace them with a universal tax allowance and go for smaller tax reductions through bracket increases. The whole package should be phased in according to the budgetary room made available by savings on the expenditure side.
The size of the bias towards families with children should be reconsidered. Some improvement in the way child financial support is delivered is scheduled as part of the Hundred Steps programme. However, while there are understandable motivations (such as the low birth rate), the gap in post-tax incomes between households with and without children is exceptionally high in international comparison and there may be more efficient ways to reach family policy objectives.
Reforms to disability benefit are underway but progress in bringing recipient numbers down is likely to be slow
The number of disability benefit recipients grew massively over the 1990s, and the system has clearly ended up providing welfare to a much wider group than intended. In recent years policies have focused on containing the inflow by tightening up assessment, and there have been welcome falls in inflow in the past couple of years. Medical guidelines have recently been streamlined as a first step towards a system that takes more account of remaining work abilities and which encourages rehabilitation. However, given the often weak outcomes internationally from rehabilitation, the authorities need to be cautious in introducing new measures that require significant additional resources. Further tightening of the screening procedures for entering disability might be a more effective instrument.
Though there has been welcome adjustment of sick-pay rules for those facing unemployment, the system remains open to abuse and further reform is needed. The benefits for those facing unemployment while being sick should be brought in line with the unemployment benefit. In addition, granting of the discretionary 3 month prolongation of sick pay for those facing unemployment should be limited and further cuts to the standard period allowed for the unemployed to get sick pay extension should be considered.
Judicious increase in unemployment benefit could help widen labour-force attachment among the non-employed
Many people effectively exit from the labour force and go on disability benefit, or to a lessening extent sickness pay, because these schemes offer more money than the unemployment benefit (which is capped at a fairly low level). One way to retain some of the advantage of the current benefit amount, while dissuading application to other benefit schemes, would be for the unemployment benefit to start relatively generously but be reduced over time. Contact with the labour market offices also needs to be strengthened. Recent measures as part of the Hundred Steps programme have been undertaken. Requirements for job-search activity could also be boosted. While an activation scheme introduced in 2003, which requires especially intensive job-search, has thus far yielded disappointing results, the international evidence is that a strong “mutual obligations” approach including active job search requirements and efficient placement services, is an effective framework, and efforts should continue to improve its implementation in Hungary.
Reforms to early retirement could go further
Early retirement options mean that most people become pensioners at least two-years earlier than the standard age of retirement, i.e. somewhere below 60 for men and (currently) below 57 for women. These relatively low retirement ages are, in part, justifiable because of shorter life expectancy but nevertheless there will be a need for increases as life expectancies rise. There are some welcome changes already underway or in the pipeline (including further increase in the standard retirement age for women to 62 years) but additional reforms could be considered. In particular, the system would be improved if the Advanced Retirement Pension were phased out and if the pension adjustments in the Reduced Advanced Retirement Pension were reformulated.
Local labour mobility is hampered by weak progress in urban-transport reform and policy options to increase regional mobility seem limited
In transport infrastructure there is strong and appropriate policy attention to motorway construction. There has, however, been rather weak progress in urban transport systems, and this is restricting commuting distances. Indeed it is questionable whether sufficient progress on urban transport can be made within the current structure of transport policy. The authorities should consider alternative structures that improve the cohesion between responsibility, administration and financing. Movement between regions is affected by high levels of home ownership and is also discouraged by regional differences in the purchasing power of the minimum wage and welfare payouts. However, the room for positive policy moves on these fronts seem limited: active policies to reduce home ownership would in themselves be distorting and the Hungarian authorities argue that making minimum wages and welfare payouts vary across regions to reflect local price differences would be too difficult to administer. Nevertheless, the authorities should explore whether there are impediments to the development of rental low-cost housing markets in high growth regions.
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For further information please contact the Hungary Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by Philip Hemmings and Alessandro Goglio under the supervision of Andreas Wörgötter.