Hungary's unorthodox solution to a European economic problem

The first decade of the 21st century marked the biggest enlargement in the history of the EU, between the year 2005 and 2007, as a result of which Europe finally put behind it decades of division. However, this period also brought the most serious economic crisis in the EU's history, which caught many countries, including Hungary, unprepared.

Drawing on lessons learned is an important task for the Hungarian EU presidency and for Hungary itself, which had been proceeding on the wrong track as a result of bad decisions made over the past 10 years. Hungary now has to cope with the legacy created during those years.

Dire straits

Between 2002 and 2006, Hungarian economic policy became a symbol of irresponsibility and unreliability. Instead of exploiting the strong growth of the global economy to reduce the budget deficit or state indebtedness, the country's deficit was significantly increased, approaching 10% of gross domestic product (GDP), while the state indebtedness reached almost 80% of GDP. From the end of 2006, 'loosening' was followed by the now all too familiar 'tightening'. Taxes were increased and austerity measures were introduced to cut the budget deficit. While other countries were trying to alleviate the crisis by energising their economies, Hungary moved in the opposite direction. 

The government that was formed after the elections last April inherited a country in dire straits, which was in debt, vulnerable and had lost its competitiveness. Furthermore, due to erroneous economic policies, Hungary today has high unemployment and the second lowest rate of participation in the workforce among the EU countries.   

Tough measures

Orthodox solutions alone could not have remedied such a tough situation in anything other than the long term, so the government began an economic programme that uses both orthodox and unorthodox methods, and which focuses on the creation of jobs and increased employment through incentives to both the supply and the demand sides of the labour market. We have to tread a very narrow path to break out of the debt trap and reduce the high budget deficit at the same time.

We had no time to lose, so we rolled up our sleeves and began. In place of the opaque, complicated tax system that punished work, we introduced a simple, proportional, flat-rate tax system, which supports work and the family with the country's lowest tax rate ever of 16%. Besides providing an incentive for the supply side of the labour market, this tax reduction and simplification will also contribute to economic growth through increased consumption, while higher public savings will decrease the country’s vulnerability.

Budget management

We have also taken steps to establish predictable, stable budget management and to reduce debt. We have set the firm objective of keeping the budget deficit – for the first time since the change of the political system – at less than 3% of GDP in 2011. To achieve this we have temporarily introduced new types of crisis taxes that affect the service sectors – banking, telecommunications, energy and retail networks.

These companies achieved substantial profits during the boom years even by international standards, but their tax burdens are extremely low, their market prospects continue to be good and they are still stable and profitable business sectors in Hungary. The crisis taxes do not impact the manufacturing industry, thus their distortive effect on the real economy is lower.

Next on the list of actions requiring immediate attention was the transformation of the pension system, the privatisation of which we reversed. Hungary introduced the obligatory private pension fund system in 1997, which is atypical by international standards. The fund system has not fulfilled what we had hoped it would over the past 13 years and its operation was characterised by high costs and low real rates of return. Meanwhile, the deficit of the state pension fund was growing because of the decreased revenues in the social security system, which the state had to supplement from other revenues. Thus, the system increased financial tension, the budget deficit and the state debt at the same time.

Burden of recovery

The temporary crisis taxes, levied upon specific groups for a period of three years, and the transformation of the pension system provided an opportunity for government to begin structural reforms that would come to fruition in the long term. The Széll Kálmán plan was drafted with this in mind. All its measures focus on the struggle against indebtedness and the reduction of the debt burden. We first looked at ourselves, the politicians, and cut the political elite by half with the reduction of the number of parliamentary and local government representatives. We also reduced the salary of ministers, cut their paid leave period by half and froze state subsidies given to political parties.

We do not expect to make big savings in this field but we found it important to send the message that there will be no exceptions; we all have to share in the burden of recovery.

The measures introduced so far make it possible for Hungary to return to the path of growth, reduce the debt burden and stabilise the budget, meaning that phasing out the crisis taxes at the scheduled time will not cause new financial tensions.

Our tasks are numerous but Hungarians have never been deterred by large tasks. We have to perform in an exciting and eventful period, to rethink the future of our country and that of our wider home, Europe.

Viktor Orban is the prime minister of Hungary.