Hungary Recognizes Budget Risk as Orban Overturns Flat Tax

Hungary’s surprise decision to effectively scrap its flat rate of income tax may show Premier Viktor Orban has recognized the threat to public finances from weaker economic growth and heeded criticism he favors the rich.

From next year, a “temporary contribution” will be levied on gross monthly incomes of more than 202,000 forint ($964) to compensate those worse off under the 16 percent flat rate, overturning Orban’s flagship tax policy, the Economy Ministry said late yesterday in an e-mailed statement. It didn’t specify the size of the contribution or how long it would last.

As Hungary’s economy slows, Orban is raising taxes and cutting spending to trim the 2012 budget deficit to 2.5 percent of gross domestic product. Critics say his policies cater to the wealthy after a plan to allow homeowners to repay mortgages denominated in foreign currencies ahead of schedule at below- market exchange rates, providing they have the full amount.

“The surrender of the flat tax was a logical recognition that, much like the early repayment plan, it favors the rich,” Zoltan Torok, a Budapest-based economist at Raiffeisen Bank International AG, said in a phone interview. “There has been a huge revenue drop because of the flat tax.”

Minimum Wage

Even after announcing the new contribution, the Economy Ministry reaffirmed plans to enshrine the flat tax later this year in a so-called cardinal law that would need the support of two-thirds of parliament to change.

To blunt the tax’s effect on the poor, the government yesterday proposed raising the minimum wage from 2012 by 18 percent to 92,000 forint, the biggest increase in a decade. It also wants private companies to raise salaries by 5 percent next year, above the government’s 4.2 percent inflation estimate.

The proposed increase in the minimum wage would be “unbearable and unpayable for the business sector,” Ferenc David, secretary-general of the National Association of Entrepreneurs and Employers, said yesterday, the Origo news portal reported.

The government will “partly compensate” employers for wage increases above the level it determines with employers and employees, the Economy Ministry said yesterday.

The scope of the proposed wage increases “undermines the business climate” and together with the mortgage plan, may cause the forint to weaken to 300 per euro, Benoit Anne, London- based head of emerging-markets strategy at Societe Generale SA, said in an e-mail. The forint dropped to as low as 293.64 per euro today, the weakest since April 2009.

Erosion of Confidence

“We are seeing a significant erosion of investor confidence in Hungary,” Anne said. “The risk of policy error has risen dramatically after the misguided policy moves on the part of the government over the past few days.”

Hungary is raising excise taxes this year and will increase value-added tax to a European Union-high 27 percent from 25 percent in 2012. Economic growth is forecast at 1.5 percent in 2012, down from an earlier prediction of 3 percent.

The revision of the flat-tax rate highlights the failure of economic policies aimed at fueling domestic consumption and growth through tax cuts, Csaba Toth, a political analyst at the Republikon Institute in Budapest, said by phone. Retail sales fell 1.3 percent in July, dropping for the fourth time this year.

‘Appears Confused’

“The flat tax showed economic policy based on high economic growth rates generating sufficient budget revenue doesn’t work,” Toth said. “The government looks like it’s starting to lose its footing, it’s rushing and appears confused.”

The tax plan isn’t the first controversial measure Hungary has imposed. As it seeks to narrow this year’s budget shortfall, the eastern European nation has levied extraordinary taxes on energy, financial-services, retail and telecommunication companies, and effectively nationalized private pension funds.

The government also is allowing early repayment of Swiss- franc denominated mortgages at a fixed exchange rate of 180 forint per franc, more than 20 percent below market rates, and forcing banks to swallow the losses.

All three opposition parties have criticized the government for helping those who can muster funds to repay the mortgages, while hurting the less well-off who suffered as the measure sparked declines in the forint, raising borrowers’ monthly repayments.

Mortgage Plan

About 10 percent of Hungary’s 1 million foreign-currency mortgage holders will be able to take advantage of the program, the government estimates. The central bank sees 20 percent taking part.

The plan, which has weakened the forint and boosted country-risk levels to their highest in two and a half years, may also hurt borrowers who are unable to repay mortgages ahead of schedule, the Hungarian Banking Association said today.

“The increasing sovereign risk and deteriorating forint exchange rate will most probably lead to an increase in interest rates, causing an increase in the funding costs of national debt and a rise in corporate and retail lending rates,” it said in a statement. “This may adversely affect millions of Hungarian corporate and retail debtors with forint loans.”

To contact the reporters responsible for this story: Zoltan Simon at zsimon@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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