Impact of government reform and tax measures

The re-elected government has announced a comprehensive package of austere tax measures and reform proposals to redress budget imbalances and to prepare the path towards European Economic and Monetary Union (EMU). The initiative includes state and local public sector reforms, as well as reforms in healthcare, education and public transport. A range of taxes will be increased, and energy and transport costs will also rise. However, concerns have been raised about whether the reforms will be successful in the long term; moreover, the severity of the measures will challenge the position of the trade unions and of employers.

Political background

The parliamentary elections held in April 2006 were won by the coalition of the Hungarian Socialist Party (Magyar Szocialista Párt, MSZP) and the Alliance of Free Democrats (Szabad Demokraták Szövetsége, SZDSZ). Since the democratic transition in 1989, the current socialist-led coalition government has been the first to be re-elected for a second term. The elections were preceded by intense competition between the various parties.

In 2002, the socialist-liberal coalition won the elections by a small margin, and the whole period of 2002–2006 was characterised by the right-wing populist tone of the opposition party, the Alliance of Young Democrats–Hungarian Civic Party (Fiatal Demokraták Szövetsége–Magyar Polgári Szövetség, FIDESZ-MPSZ). As a result, during its first term, the government feared an electoral backlash and did not have the courage to implement any of the major reforms badly needed to redress the increasing budget deficit and to join the European Economic and Monetary Union (EMU).

In the 2006 election campaign strategy, FIDESZ-MPSZ criticised the government for not improving the life of the average citizen, while at the same time pursuing a generous budget expenditure policy. The tone of the campaign prepared the ground for reform initiatives, which were also demanded in a manifesto entitled ‘Agreement for our future’, issued by several employer organisations (HU0605019I); in addition, international financial institutions and the EU highlighted the need for reform.

Economic background

Although it was clear that major reforms would be necessary, it came as a surprise when the government announced the actual extent of the budget deficit. Even with a drastic austerity measure package, the 2006 year-end budget deficit would be as high as 8% of gross domestic product (GDP). According to Finance Minister, János Veres, the deficit would be HUF 1 trillion (€3.63 billion) over the target figure; about half of this amount was due to one-off capital expenditure, such as purchasing Gripen fighter jets and funding motorway construction, the expenses of which had to be included in the budget figures on the grounds of a Eurostat decision to that effect.

The official government target for 2006 was a deficit of 4.7%, excluding pension reform costs. Ultimately, Hungary has to reduce the budget deficit to 3% by 2008 in order to meet the Maastricht criteria by 2010, which was the original target year for Hungary to join the euro-zone.

Main features of government package

The government package, entitled ‘New Balance’, primarily envisages tax increases to ensure increasing revenue for the state budget. Secondly, the government announced plans for wide-ranging reform programmes, targeting the state administration and public services in healthcare, education and transport.

Reform of state administration

The reform of the state administration includes measures to reduce the number of ministries from 17 to 12 departments. The forthcoming closure of several hundred government agencies and institutions was also announced. At the same time, the planning of public investments and specialised policies has been transferred to three new bodies, the State Reform Committee (Államreform Bizottság), the National Development Agency (Nemzeti Fejlesztési Tanács) and the Government Services Centre (Kormányzati Szolgáltató Központ). The latter body is a sort of unified technical support and human resource centre for the entire national state administration.

By eliminating political and administrative state secretaries, the number of top administrative positions in ministries will be reduced by 47%. This is expected to lead to cuts in the number of state civil servants by 12,500 employees. An additional income of HUF 200–250 billion is expected from the sale of properties belonging to government agencies.

Regional and public service reforms

Alongside cuts in state administration at national level, the government announced that it would initiate the regional reorganisation of Hungary, namely the dissolution of the traditional county system and the creation of seven regions. The government also announced that it would reform the healthcare and higher education systems as well as privatise public transport companies.

Tax increases

Fiscal measures announced include increasing the rate of value added tax (VAT) from 15% to 20% for certain consumer goods like food, public transport, gas and electricity. The rate of EVA, (‘Simplified Entrepreneurial Tax’ for certain small businesses), will also increase from 15% to 25%.

From the beginning of September 2006, employee contributions to healthcare will be raised from 4% to 6%, and increased further to 7% in 2007. A 20% tax on interest and stock exchange gains will be introduced from September. A new 4% ‘solidarity tax’ will also come into force for companies and private entrepreneurs on 1 September; private individuals earning more than HUF 6.05 million (€22,000) per year will be subject to this tax from 1 January 2007. The tax base for companies will also be adjusted upwards. In addition, the introduction of a property tax is planned for 2008.

Rising household costs

These tax measures will result in an extra revenue of HUF 350 billion (€1.27 billion) in 2006, and HUF 1 trillion (€3.63 billion) in 2007. Moreover, household energy prices will increase as some state subsidies will be eliminated. The price of natural gas will rise by 30% in August, while that of electricity will go up by one percentage point to 14%. There will be an increase of 5.7% in excise duties on cigarettes and alcoholic beverages. Prices for public transport will also increase, and ticket price differences between bus and railway transport will be eliminated.

Continuing social dialogue

Despite these sweeping measures, the government assured the social partners that it would continue to support tripartite social dialogue and the social partner organisations. In accordance with this policy, the New Balance programme was submitted to the National Interest Reconciliation Council (Országos Érdekegyezteto Tanács, OÉT), the national-level tripartite forum, for consultation.

Initial responses to package

Following the announcement of the measures, the value of Hungary’s national currency has dropped by 10% (to HUF 280 against €1 from the earlier rate of HUF 250).

On 10 July 2006, the parliament passed the amendments of laws necessary for the austerity measures. However, lacking the support of the opposition, the amendments necessary for the reform of state administration – namely the introduction of regional structures instead of the current county system – failed to get sufficient backing. The Hungarian constitution stipulates that such changes need a qualified majority of two thirds of the parliament.

According to the National Bank of Hungary (Magyar Nemzeti Bank, MNB), the austerity measures may reduce the state budget deficit to 3% by 2008; however, its negative impact on inflation is likely to jeopardise meeting the euro-zone criteria by that year. Furthermore, as many analysts highlighted, the package mostly consists of revenue generation through tax increases, and its major side-effect would be a slowing down of economic growth from the current 4%–4.5% level to 2%–3% in the following years. There are also concerns about the long-term sustainability of the measures.


It seems that the six years of budget overspending policies – pursued by the political left and right-wing governments alike – have come to an end. The increasing state budget deficit reached such levels that it threatens the country’s economic stability. It is feared, however, that revenue generation will only bring about short-term alleviation of the state budget deficit, while macroeconomic recovery cannot be sustainable without implementing major structural reforms.

As far as the impact of the government package on industrial relations is concerned, it should be borne in mind that inflation will rise to 6%–7% due to these measures and that in 2007 there will be a drop in real wages of 2%–3%. The package poses a challenge for the trade unions in how to handle conflict with a government that supports social dialogue and that has close ties with major unions. The challenge for the employers lies in the fact that the government has finally begun to redress budgetary imbalances but in a way that puts the competitiveness of companies at risk, namely by increasing taxes.

András Tóth and László Neumann, Institute of Political Science, Hungarian Academy of Sciences

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