Hungarian Prime Minister Viktor Orbán, slammed by opposition leaders and market analysts for his secretive approach to policymaking, has now removed all doubt. Ten days after the governing Fidesz party racked up an overwhelming victory in the October 3 municipal elections, Orbán unveiled the controversial details of his economic action plan. These measures are not “reforms” in the classic sense, since all of them strengthen the state at the expense of private enterprise.

 

 

Fidesz leaders had openly alluded to many of these measures in the run-up to the October 3 local elections.  Party leaders had outlined concepts concerning a number of major issues and identified the social groups that were likely to benefit.

 

The political environment could not be more propitious for launching fundamental highly controversial policy changes. The Orbán administration enjoys a stronger mandate than any other government since 1990 and has three and a half years to go before the next election.

 

Our analysis will examine five aspects of Fidesz’s plans: The restructuring of the division of labor between municipalities and government; welfare cuts; anticipated measures with respect to utility companies; the reorganization of the income-tax system; and surtaxes on business sectors that are highly profitable.

 

 

1. Centralization: Reducing municipal governments’ scope of power


 

 

 

In the local-election campaign, Orbán said several times that he wants to rethink the division of labor between municipalities and the state. In other words, centralization would be the first step toward reforming an often wasteful and inadequate public-service system (especially in the areas of healthcare and education). The government would assume supervision of these areas and implement reforms from above.

 

At face value, this appears reasonable, especially considering that all government reform efforts since 1990 have been dashed by local interests and fragmented administrative structures. Moreover, the centralization of the education system may be indispensable for the implementation of much-discussed Roma integration programs, educational authorities say.

 

However, such changes would eventually diminish the political power of municipalities, leading to possible clashes between the central government and local authorities – even though almost all local administrative units are currently controlled by Fidesz.  Moreover, local governments are facing serious financial problems: The total municipal debt portfolio amounts to HUF 1.4 trillion, equivalent to 18% of 2009 GDP, according to central bank data. Healthcare institutions, most of which are owned by municipalities and counties, had run up debt of around HUF 40 billion as of August 2010, according to a survey by the Ministry of National Resources. Consolidating these debts would seriously dent the national budget.

 

Since the healthcare system is already financed by the central government, further centralization would not automatically lead to savings. The perpetuation of debts could be prevented by a “regional and functional integration” – but this would amount to nothing less than closing and merging institutions. This would lead to intense political conflicts between healthcare-sector leaders and Fidesz, which has pledged not to close new medical institutions.

 

 

 

 

2. Welfare Cuts


 

 

Welfare-related anomalies and fraud have become the focus of hot political debate over the past few years. With the exception of Politics Can Be Different (LMP), all parliamentary parties have urged welfare reform.

 

The economic crisis has increased the number of people who receive benefits, as well as public hostility toward them. Some 76% of Hungarians above the age of 15 say they think many welfare recipients access benefits illegally, according to the 2009 European Social Survey. Clearly, reducing the scope of benefits and widening the gap between paychecks and welfare checks is a popular issue these days. Welfare cuts would bring undeniable macroeconomic benefits and would improve Hungary’s reputation among international investors. Moreover, reducing benefits would also help Fidesz cut into support for the ultra right-wing Jobbik, which is a magnet for people who are angry about the current system. (Fidesz has already dealt Jobbik several political blows by expediting the process for ethnic Hungarians to obtain dual citizenship, by establishing a memorial day for the Trianon Treaty, and by “calling to account” (elszámoltatás), a euphemism for investigating Socialists in connection with corruption accusations.

 

 

However, welfare reform would require coordinated action between the central government and municipalities, which may be a difficult feat. Also, the social impact of welfare cuts is unclear. The number of welfare recipients has increased substantially since the onset of the global financial crisis, climbing to nearly 330,000 people today (163,000 receive unemployment benefits and 167,000 get regular welfare payments, according to Hungary’s Central Statistics Office (KSH)).

 

Although a large number of welfare recipients are politically inactive, a drastic restructuring of the welfare system will inevitably lead to social conflicts. Since the overwhelming majority of welfare recipients are Roma, the measure could easily fire up ethnic tensions.  Pandemonium broke out in Slovakia’s impoverished eastern regions when the government of former Prime Minister Mikulas Dzurinda slashed welfare payments in 2004. Members of the Roma population staged hunger strikes and the region experienced a surge in crime. It took strong and concerted police action in order to re-establish order.

 

Number of persons seeking employment, receiving unemployment and regular welfare benefits


 

 

 

3. Placing utility companies back under public control


 

 

 

The Hungarian government’s decision to take over the MAL aluminum plant has raised fears of a nationalization boom in Hungary. These fears are exaggerated (see Political Capital’s related analysis). Still, the Orbán government appears determined to usurp at least part of private companies’ role in the economy.

 

Fidesz has already applied such policies in Pécs, where it won control of the city government in a spring 2009 by-election. As Political Capital noted in the autumn of 2009, Fidesz decided to use Pécs as a “pilot project,” testing out its ideas and expanding the successful ones to the entire country after the 2010 elections. For example, Fidesz “re-municipalized” the city water works by literally kicking out the private utility operator, France’s Suez Environnement; the move played well in Pécs, whose residents were promised lower water prices.

It is now likely that more municipalities will follow suit – and Orbán’s statement to InfoRádió, cited above, makes it abundantly clear that Fidesz and the government would support them. In a September 2010 interview with Heti Válasz magazine, Budapest Mayor István Tarlós explicitly referred to the option of immediately terminating contracts with private utility operators in Hungary’s capital.


While such actions are certain to be domestically popular, it remains to be seen whether Fidesz is prepared to deal with the resulting diplomatic strife – especially since Hungary will assume the European Union presidency in January 2011. Since France’s Suez and the German RWE and E.ON companies all own stakes in Budapest utility companies, Orbán would be taking on the most powerful countries in Europe. Fidesz knows that further contract terminations will generate diplomatic friction, so the party probably has a plan to make amends through other means. However, some overzealous mayors may cause the process to spin out of control, leaving Fidesz with some angry EU partners.

 

 

 

4. Planned tax cuts


 



In its first five months in power, the Orbán administration tried everything to persuade the EU to allow a higher budget deficit for 2011. It failed. Hungary will have to stick to the budget-deficit targets that former Prime Minister Gordon Bajnai worked out with the EU and the International Monetary Fund for 2010 and 2011.  The option of immediate and drastic tax cuts is therefore a nonstarter.


Unconfirmed reports on the 2011 budget indicate that Fidesz will implement a 16% flat-tax rate for 2011, but will also keep the Bajnai administration’s “szuperbruttó” policy (a fiscal sleight-of-hand that expands the basis for calculating income taxes). Actual income-tax rates will thus be around 21%. Also, tax-refund policies will essentially remain untouched. The upshot is, most Hungarians’ personal-income taxes will go down less than 1% in 2011. Families with children will benefit from higher tax allowances starting at a single child, while high-income earners will profit from the elimination of the top tax bracket.

 

Fidesz’s measures will invite criticism from opposition parties who will claim that the government is only concerned with improving the lot of the most affluent segment of society. However, the government's message of a “simpler and fairer” tax system appeals to voters; this may make it difficult for the opposition’s attacks to gain traction.

 

A genuine 16% personal income-tax rate will materialize by 2013 through a step-by-step process: The “szuperbruttó” multiplier will be reduced gradually, while tax credits and number of people eligible for them will diminish. Presumably, the government will try to execute the tax cut in a way that ensures that workers will not experience any decline in income; in this sense, talk of a “tax reduction” will be justified.


Next year, the tax cuts will be financed by special surtaxes on banks, energy companies, telecommunications companies and chain stores. The government will reduce spending. What’s more, GDP is forecast to grow by as much as 3%, increasing the tax base. Nonetheless, the new tax system will obviously have winners and losers. The relative losers will include low-income earners: These will see no substantial reduction in their tax burden because any cuts will be offset by the elimination of tax rebates. High-income taxpayers will be the biggest beneficiaries because they never used tax rebates and their personal income tax-rate will go down by more than 50%.

 

In short, tax reform (including welfare cuts) can be viewed as the continuation of a key element of the 1998-2002 Orbán administration’s social policy. The measures indicate that Fidesz hopes to rely primarily on the support of economically active members of the middle- and upper-middle classes during its current term in office.

 

 

 

5. Surtaxes on telecommunications companies, energy companies and chain stores


 

 

Fidesz’s surtax on banks and other financial institutions, passed in July, has proven to be a political success: The government found a way to raise revenue without causing pain for the population at large. Additional surtaxes now appear to be the least-painful method for the state to raise cash, even if some of the costs will be passed on to consumers in the form of higher energy and telephone bills – not to mention consumer prices. From a political standpoint, the surtaxes are easy to sell to the public because the affected companies are mostly foreign owned. Also, these measures are meant to be temporary: The government is essentially buying itself time until the economy turns the corner and its economic-reform program begins bearing fruit.


The introduction of special taxes requires the government to perform a fine balancing act, because the new burdens may trigger the departure of some players in the energy, telecommunications and the chain-store industries. The taxes may also discourage new investment, since any industry that enjoys high profit will fear becoming the target of extra tax levies.