The international literature suggests a competitive, optimal tax system: OECD research shows that taxes on capital are the most harmful to economic growth, followed by taxes on labour in distorting economic decisions the most, while taxes on consumption are less harmful and should therefore be emphasised. Each year, the Tax Foundation examines the tax systems of OECD countries and ranks them according to their competitiveness and efforts to be neutral; this is the so-called International Tax Competitiveness Index. In 2023, Estonia topped the ranking for the tenth year running, with Latvia in second place. Colombia and Italy finished at the bottom of the ranking last year. Hungary was ranked 11th out of 38 countries last year, a favourable result by global standards. The Hungarian tax system has evolved significantly in recent years, with the weight of labour taxes decreasing and the share of consumption taxes increasing, in line with economic theory guidelines. In addition, significant steps have been taken to reduce the administrative burden.
An economy’s tax system is a major determinant of the given country’s international performance. A well-structured tax system is easy for taxpayers to comply with and can promote economic development, while providing sufficient revenue to achieve the government’s objectives. In contrast, poorly structured tax systems can be costly, distort economic decision-making and harm economies.
Against this background, we can ask whether there is a competitive tax policy. Is there an optimal distribution of taxes on different activities? According to the international literature, there is an optimal tax system, with a low tax on capital, followed by a tax on labour and its reduction as the focus of fiscal policy, while the tax on consumption is the least distortive of economic agents’ decisions and of the market-based functioning of the economy. The optimal (or neutral) tax system is one that seeks to raise the most tax revenue with the least distortion to the economy.
What is the theory behind this “ranking”? In today’s globalised world, capital is highly mobile. Businesses can invest in any country in the world in search of the highest return. This means that businesses seek countries with lower tax rates to maximise their after-tax rate of return. If a country’s tax rate is too high, it can discourage investment, distort savings and investment decisions, and hinder capital accumulation, leading to slower economic growth. It also increases the propensity to avoid taxes. In addition, high marginal tax rates can discourage domestic investment. At the same time, taxes on consumption (e.g. value added tax, which in Hungary is VAT) have the advantage of not distorting the saving and investment decisions of economic agents and generally entail relatively low administrative costs. In view of the above, as summarised earlier, OECD research suggests that corporate taxes (i.e. taxes on capital) are the most harmful to economic growth, followed by labour taxes (e.g. personal income taxes) in terms of being the most harmful to economic activity, while consumption taxes are less harmful and taxes on real estate have the least distortive effect on growth.
Note that it is also worth noting that transfer pricing and tax avoidance, i.e. a high degree of tax optimisation between countries, is a common practice for multinational companies in relation to taxes on capital.
Each year, the Tax Foundation publishes its International Tax Competitiveness Index (ITCI) and ranking of OECD countries. It measures and ranks the tax systems of each economy according to the extent to which their structure supports the given country’s competitiveness through tax neutrality and low tax burdens. ITCI examines more than 40 tax policy variables each year. These variables measure not only the level of tax rates, but also how taxes are structured. The index looks at a country’s corporate taxes, personal income taxes, consumption taxes, property taxes and international regulatory taxes.
The Tax Foundation is a leading US tax policy research institute and has a long history of investigating how well tax systems provide the right environment for investment, workers and businesses.
In 2023, Estonia topped the tax competitiveness ranking for the tenth year running, with Latvia in second place. At the bottom of the ranking were Colombia and Italy in 2023. Hungary was ranked 11th out of 38 countries last year, the same as in 2022, which is a good result by global standards. Among the Visegrad countries, only the Czech Republic performed better, ranking 5th at OECD level, while we ranked ahead of both Slovakia (12th) and Poland (33rd), as well as several other European countries (e.g. Austria, Germany, Sweden).
The figure can be referenced here: https://infogram.com/eng-eu-ado-versenykepesseg-1hnq41ok5d0vp23?live
Perhaps unsurprisingly, the first aspect the Tax Foundation highlights in relation to Hungary is that its corporate tax rate is the lowest among OECD countries (9%, compared to the OECD average combined corporate tax rate of 23.6% in 2023). They also consider the single rate personal income tax of 15% one of the strengths of the Hungarian tax system. However, they highlight the high VAT rate of 27% as a disadvantage of the tax system (it’s the highest rate among OECD countries) and the fact that Hungary levies taxes on inheritances, real estate transfers, financial transactions and banking assets. Beyond the Tax Foundation’s analysis, but related to it, it is worth noting that the Hungarian tax system has visibly improved over the last decade or so, and thereby its competitiveness has also improved: in 2016 it ranked 23rd among OECD countries, while in 2022-2023 it ranked 11th. What changes have taken place in the Hungarian tax system?
From 2008 to 2021, the weight of labour taxes decreased and the share of consumption and sales taxes (e.g. VAT, excise duties) in the Hungarian tax system increased significantly – just as the theory presented at the beginning of this article marks the way towards a more competitive tax structure. In contrast, the weight of both taxes has increased slightly in the EU.
The figure can be referenced here: https://public.flourish.studio/visualisation/16669356/
- Hungary also encourages employment by reducing and simplifying taxes on labour and by making tax administration easier (e.g. single-rate tax system, family tax benefits, simplification of personal income tax returns).
- The taxation of employers and businesses has also been simplified in recent years; for example, the merging of social contribution tax and vocational training contributions (as well as the reduction of the tax rate) has helped businesses with their tax administration and reduced its costs (Banai, 2024).
- Moreover, the share of capital tax in total tax revenue in Hungary had been reduced from 0.2% to 0.1% by 2021, which facilitates the free flow of capital.
- In addition, online administration and e-government are increasingly taking over in the field of taxation too, including the introduction of the online cash register system, the electronic trade in goods verification system (EKÁER), and the introduction of online invoicing. These measures have also improved the efficiency of tax collection in Hungary (MNB, 2022).