Slovakia's Introduction of a Flat Tax as Part of Wider Economic Reforms

Slovakia’s fundamental tax reform of 2004 considerably improved the simplicity and efficiency of the tax system by eliminating exemptions and special regimes and setting the rates for the personal income tax (PIT), the corporate income tax (CIT) and the value added tax (VAT) all equal to 19%. This paper assesses the impact of this reform in the context of Slovakia's wider package of economic reforms. With respect to economic efficiency, the two key conclusions are as follows: First, the reforms are expected to improve both the level and efficiency of capital investment in Slovakia – although further improvements could be made by eliminating the double taxation on projects financed by retained profits. Second, the combination of the tax and social benefit reforms has enhanced the incentives for unemployed workers to seek work, which should result in higher labour supply. Labour demand should also have increased, thanks to the more flexible labour market. However, as overall taxes on labour remain high, labour demand for very low skilled workers may not pick up without further reforms to reduce the cost of employing such workers. With respect to equity considerations the assessment is less clear cut. On the one hand the flat personal income tax has benefited both low income earners and very high earners, particularly those with families, while middle-income earners, particularly single earners appear to be somewhat worse off. The increase in VAT and the welfare reform also have distributive effects. The net result of these reforms has been a significant cut in the real incomes of social beneficiaries who are not working. On the other hand, by raising labour productivity and reducing structural unemployment the reforms have the potential to benefit the low-skilled population also – provided other public policies are in place to facilitate this outcome. This Working Paper relates to the 2005 OECD Economic Survey of the Slovak Republic (www.oecd.org/eco/surveys/slovakia)