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The Decline of Domestic Politics and Other Taxing Problems in Eastern Europe

Hilary Appel, Associate Professor of Government, Claremont McKenna College

Date & Time

Wednesday
Oct. 19, 2005
12:00pm – 1:00pm ET

Overview

In most advanced democracies, tax reform is among the most contentious political issues debated in domestic politics. After all, taxation affects reallocation of wealth, a subject upon which many party ideologies are based. In postcommunist Eastern Europe, however, Hilary Appel was surprised to find that regional and international policy, not domestic politics, were driving tax reform. This is due to a number of factors related to the opening of markets in the postcommunist world to the influence of globalization. In her presentation, Appel elaborated on these factors in an attempt to answer the question: do domestic politics still matter in a globalized world, where state action is driven by external constraints?

Appel began by analyzing consumption taxes. Policies in Eastern Europe on consumption taxes moved quickly towards emulating the Value Added Tax (VAT) required in the EU, with a view to eventual European integration. Once the accession process began in earnest, informal pressure from the West turned into a hard requirement not only for acceding countries to adopt a VAT, but on matching the tax rate on VAT and excise taxes with that of the EU. As a result, the prices of highly consumed items increased substantially: for example the cost of cigarettes raised 80 percent overnight. More troubling was the fact that items that were previously not taxed, such as textbooks and medicine, not only became taxable due to EU requirements, but also were taxed at rather high rates. Hungary, for instance, taxed all consumables, including pharmaceuticals at the rate of 20 percent. Thus, the EU enlargement process took the question of what could and could not be taxed out of the domestic political forum.

The international influence on income tax policy in postcommunist Europe was less direct, since the EU has no authority to impose income tax rates on its members. Nevertheless, in order to remain competitive given the increase in global economic integration, East European countries found little room for maneuver when determining income tax policy as well. Given the importance of attracting Foreign Direct Investment and the high mobility of capital, East European countries have felt a strong pull toward allocating taxes away from corporations and toward individual citizens. Changes in income tax rates across the region show a clear pattern in that direction, regardless of the political ideology of the parties controlling the government. The fact that corporate tax rates have dropped to 16 (in Hungary) and 19 (in Slovakia) percent have created tensions between the new member states and the EU-15, which have accused the East European countries of "tax dumping" and have threatened to decrease structural funds if the governments do not raise taxes.

Individual taxes, conversely, have not lessened the tax burden for citizens in East Europe. Yet, individual taxes are one of the few areas that are still contested in domestic politics. This debate is particularly visible at election time, when candidates compete for votes, not necessary on income tax rates, but by attracting voting blocks through what deductions candidates will introduce once elected. More dramatic still are debates over the flat tax, a policy that has become seriously debated throughout the region. Currently Romania, Georgia, Ukraine, Russia, Slovakia, Serbia, Latvia, Lithuania and Estonia have no progressive taxation and impose a flat tax. In most countries this has actually increased revenues, in part because state capacity to collect taxes is limited and flat taxes are easier to collect than complicated progressive tax systems. A bandwagon effect has followed as countries watched as Slovakia's 19 percent flat tax rate coincided with high FDI and soaring economic growth.

Of great concern is the fact that the flat tax rates mean that the poorest people in Eastern Europe carry the largest tax burden. Without international pressure, the fact that in a democratic country the largest voting block suffers the most from tax policy would be improbable, or at least unsustainable. Nevertheless, globalization and economic integration means that tax policy is being driven by policy trends in the international community, rather than by domestic concerns. In conclusion, Appel asked: "If citizens cannot affect policy, what does this mean for democracy?"

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Global Europe Program

The Global Europe Program addresses vital issues affecting the European continent, US-European relations, and Europe’s ties with the rest of the world. We investigate European approaches to critical global issues: digital transformation, climate, migration, global governance. We also examine Europe’s relations with Russia and Eurasia, China and the Indo-Pacific, the Middle East and Africa. Our program activities cover a wide range of topics, from the role of NATO, the European Union and the OSCE to European energy security, trade disputes, challenges to democracy, and counter-terrorism. The Global Europe Program’s staff, scholars-in-residence, and Global Fellows participate in seminars, policy study groups, and international conferences to provide analytical recommendations to policy makers and the media.  Read more

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