Discussion Papers 1998. No. 25.
Future Perspectives for Local
Government Finance in Hungary
CENTRE FOR REGIONAL STUDIES
OF HUNGARIAN ACADEMY OF SCIENCES
DISCUSSION PAPERS
No. 25
Future Perspectives for Local
Government Finance in Hungary
by
Mihaly LADOS
Series editor
Zoltan GAL
Pecs
1998
Discussion Papers 1998. No. 25.
Future Perspectives for Local
Government Finance in Hungary
Publishing of this paper is supported by
Strategic Task Force for European Integration
ISSN 0238-2008
© 1998 by Centre for Regional Studies of the Hungarian Academy of Sciences
Technical editor: Dombi, Peter
Typeset by Centre for Regional Studies of HAS
Printed in Hungary by Siimegi Nyomdaipari, Kereskedelmi es Szolgaltato Ltd., Pecs
Discussion Papers 1998. No. 25.
Future Perspectives for Local
Government Finance in Hungary
CONTENTS
1 Introduction /5
2 Normative subsidy versus task financing /7
3 The increase of the financial interdependence of local goverments
through the regulation of the resources /9
3.1 The transition of the distribution of personal income tax /9
3.2 System of surtaxes /14
3.2.1 Traditions in Hungary /15
3.2.2 International outlook /18
3.2.3 A review of the recommendation of experts for the
system of surtaxes /20
3.3 The system of local taxes in Hungary /32
4 The system of supplementary subsidies /35
5 Summary, recommendations /42
Notes /46
References /48
Lados, Mihály: Future Perspectives for Local Government Finance in Hungary.
Pécs: Centre for Regional Studies, 1998. 51 p.
Discussion Papers, No. 25.
1 Introduction
The aim of the study is to review those systems of resources which, on
the one hand, promote the increase of the financial independence of local
governments in Hungary, on the other hand, allow equalisation among the
local governments with different income capacities. The first objective be-
longs to the issue of the regulation of the tasks and resources of local gov-
ernments, while equalisation is only partially dealt with by the regulation of
local governments. These tools are mainly designed to moderate the present
differences in the income generating capacity, partly by the redistribution of
the resources (e.g. personal income tax, supplementary subsidy), partly by a
more efficient cost control of the supply of tasks (e.g. the stimulation of as-
sociations): Another set of tools are to increase the income generating ca-
pacities, these belong, however, to the issue of regional policy, in which lo-
cal (county, municipal) governments are also important actors.
The impact of the socio-economic transition was different in the large
regions of Hungary. In the period of the 1990s passed so far, regional dis-
parities increased, but this is the result of a multi-factor process. Due to the
centrally supported programmes, equalisation processes took place in the in-
frastructural provision. At same time, the winners of economic restructuring
— mainly as a consequence of the activity of foreign capital — are the tradi-
tionally more advanced Hungarian regions: the capital city and its agglom-
eration, (North-west) Transdanubia, and the large towns. This can be seen in
the differences of the income generating potential, e.g. personal income tax,
local tax potential.
The change of the regional disparities, either strengthening or reduction,
is dominantly determined by the change in the income generating capacity of
Hungary, the expected growth rate of the gross domestic product. A signifi-
cant reduction, however, can only be expected if induced by a strong growth
of the GDP. Independent of this, the tools and institutional system of re-
gional development have to be made capable of the promotion of both eco-
nomic modernisation and regional equalisation. This objective is served by
the Act on Regional Development and Physical Planning, passed in the
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Discussion Papers, No. 25.
spring of 1996, by the institutional system established according to the act
(regional development councils at different levels), and by the system of
central and decentralised resources allocated to the institutional system.
However, there has been but a little harmony so far among the funds which
directly or indirectly (by sectoral developments) serve regional development.
Both kinds of support are available for the local governments and their re-
gional development associations, but the support system, which also re-
quires own resources, usually favours settlements with better income posi-
tions.
After the systemic change, the regulation of the local governmental sys-
tem was motivated by a comprehensive effort for decentralisation. This is a
double process, if we look at public services. On the one hand, with building
out the local governmental system, a decentralisation of tasks started be-
tween the central government and the local governments, on the other hand,
state participation was gradually put into the background in those fields
where the market and the private enterprises can work more effectively (this
is privatisation in the broader sense of the word). Within the frameworks of
the reform of the state budget, the objective, in order to achieve the eco-
nomic balance, is to hold back communal consumption and as part thereof,
to decrease the deficit of the central budget. This means a decrease in the
amount of distributable resources, parallel to which the number of state
tasks — and within that local governmental tasks — also decrease, and they
are taken over by non-state (market and non-profit) service institutions.
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Discussion Papers, No. 25.
2 Normative subsidy versus task financing
After 1990 a local governmental institutional system was born which had
to fulfil its tasks besides shrinking financial resources. In addition, these
tasks were not clearly defined and they even changed during the years. The
unfavourable conditions, however, were escorted by a large-scale independ-
ence, which allowed, in fact, forced some local governments to improve the
efficiency of their operation and increase their non-central incomes.
There seems to be a consensus — at least from the side of the local gov-
ernments — that the tasks of the local governments are not clearly defined in
the Act. The reason for that is not a legal inaccuracy, but the fact that there
is no political decision on what tasks belong to the state and the local gov-
ernments in the different fields of public services. During the transition to
the market economy, the clear and well defined division of the tasks and
competences only gradually takes form (Hegedus-Peteri, 1996). Even when
that is achieved, the question still remains what extent of the central sup-
ports is appropriate in the field of tasks accepted by the state but carried out
by the local governments (e.g. public education). It is also an issue how this
support guaranteeing an acceptable level is allocated among the local gov-
ernments. This can take place either by a distribution method with general
objectives but a normative basis, or by supports given for definite individual
tasks, providing for a certain per cent of the estimated expenses.
One of the most progressive elements in the finance system created at the
systemic change is the transition from the expenditure-oriented planning
method to the resource regulation. In this system, because of their weight,
normative subsidies are key elements. This model of financing basically
works as a distribution mechanism of the government supports allocated to
the local governments. However, the more keys are used for this distribu-
tion, the more vulnerable this principle. As soon as in the first year of the
allocation of the general Hungarian support (in 1990), a system consisting of
more than 10 elements was used in the recommended budget. The number
of these elements doubled by the year 1995. In 1996, the ground on which
one could be eligible for support, decreased to 14, but, as a consequence of
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Discussion Papers, No. 25.
the differentiated support system of public education, the total of the norma-
tive elements is over 200. Their number decreased to some extent by 1997,
but it still exceeds 100 (Darazs, 1996). No wonder that the individual nor-
matives are slowly losing the meaning they should have (i.e. rates promoting
the distribution of support for general purposes) and they are more and more
treated as a partial financing for the tasks written in the specification of the
given normatives. This can start a strong restoration towards the expense-
oriented planning.
The system of local supports has to follow four main guidelines (Bird
and Wallich, 1992):
1. The support is for gap-filling, as local governmental revenues
are almost never enough to cover all expenses. So the supports are
meant to "fill the financial gaps".
2. Supports should promote the formation of a vertical balance of
the budget. The lack of balance comes from the different structure of
tasks at the different levels of local governments, touching even the
richest ones.
3. The supports have to deal with the differences among the set-
tlements at the same level (horizontal balance of the budget).
4. Supports have to stimulate efforts made from local budgets in
order to make settlements grow their own resources of income.
Thus it has to be decided on what grounds tasks which are accepted by
the state but carried out locally shuold operate and how the distribution of
the state part in the financing of the voluntary local governmental tasks
should take place. Two major concepts have been crystallised by the experts.
Basically, both of them recommend the elimination of the present normative
system in which equalisation and performance-linked normatives are mix-
ing.
One solution starts from the estimated demand of the local expenditure
and the local income capacity, while the other from the definition of the
tasks which also involve state participation (public education, social care
and benefits, health care), and from the share of state and local expenditure
in these tasks. The first suggestion, in which the need for the support is de-
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Discussion Papers, No. 25.
fined as the difference of the demands of expenditure and the income capac-
ity, contains all the above-mentioned characteristics of the supports. In the
second model, the task-oriented support and the support designed to de-
crease and alleviate the significant differences in the incomes of the local
governments are separated. The two versions are also identical in the sense
that the so-called centralised preliminary estimates and the other individual
targets of the supports (theatre, fire brigade, bankrupt local governments)
should also be built into the uniform support system. Both solutions empha-
sise the importance of increasing the local income capacity and thus the fi-
nancial independence of the local governments.
3 The increase of the financial independence of local
governments through the regulation of the resources
3.1 The transition of the distribution of personal income tax
The disputes over the regulation of the resources in the recent two years —
especially in the period when the support system for the local governments
from the state budget is defined for the following year — has often reached
their climax about the division of the personal income tax between the cen-
tral and the local level. Those who urged that local governments should re-
ceive a higher share, considered the decrease of their share as a decline in
the financial independence of the local governments, and the increase as a
strengthening of this independence.
One of the main elements in the tax reform introduced in 1988 was the
introduction of the taxation of private personal incomes in order to promote
a general expansion of the paying of common charges. From the start, this
type of tax was meant to help the financing of the local governments. The
Parliament voted for the general introduction of personal income tax in the
autumn of 1987 with the condition that after 1990 (with a two-year delay
allowed for the technical implementation) the total of the incomes from the
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Discussion Papers, No. 25.
personal income tax will be allocated to the councils, in a way that the Tax
and Financial Auditing Office (the Hungarian name of which is APEH), re-
sponsible for the administration of the taxation, will transfer the total
amount of the personal income tax paid by the individual taxpayers to the
council of their place of permanent residence.
The background of this situation is that in the early 1980s, there were
several attempts to divide the so-called urban and village development con-
tribution among the councils. It could have been carried out already at that
time, according to the registration of the employees by their place of resi-
dence, but given the level of the current technology it would have been too
much administrative work for the employers. It was simpler to pay this
amount to the council of the headquarters of the given companies. This way,
however, this income dominantly functioned as an urban income. At the
same time, it was also the period when strong efforts were made in order to
strengthen the income resources of the villages and to equalise the income
possibilities of the urban and village councils. The introduction of the per-
sonal income tax allowed that, as tax had to be paid to the central tax
authority, and the registration of the taxpayers by their place of residence of-
fered an easy solution for the transfer of the tax to the individual councils.
The distribution mechanism of the personal income tax according to the
original intentions — giving back 100% of the personal income tax to the
councils, from 1991 to the local governments — only worked for one single
year, until 1991. There were huge differences in the amount of personal in-
come tax revenues per one inhabitant: while in Tiszaujvaros almost 15.000
HUF was the personal income tax revenue per capita, in Gagyapati no tax-
able income was made. The difference between the settlements with the
highest and the lowest tax revenues was forty-fold. By the mid-1990s, this
difference typically grew to more than a hundred-fold. The specifically
"richest" settlement — in the beginning Tiszaujvaros, after 1993 Szazhalom-
batta — exceeded the countryside average more than three times in tax reve-
nue per capital.
At the same time, in 90% of the settlements, the specific personal income
tax index does not reach the countryside average (Table 1).
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Pécs: Centre for Regional Studies, 1998. 51 p.
Discussion Papers, No. 25.
Table 1.
Personal Income Tax potential per Capita, 1988-1996
1988 1989
1990 1991
1992
1993
1994
1995
1996
Settlement with the highest
specific personal income tax
14,9
20,8
26,6
37,8
41,7
58.8
67.8
87,4 113,7
payment
(thousand HUF per capita)
Budapest
12,6
17,1
22,0
29.1
36,6
43,9
50,6
63,0
78,7
(thousand HUF per capita)
Countryside average
5,3
7,0
9,6
12,4
15.5
19,0
21,4
27,6
34,9
(thousand HUF per capita)
Highest figure/countryside
2,8-
3,0-
2,8-
3,0-
2,7-
3,1 -
3.2-
3,2-
3,3-
average
fold
fold
fold
fold
fold
fold
fold
fold
fold
Number of settlements with
less than 1.000 HUF personal
65
32
11
8
7
3
4
3
1
income tax per capita
Number of settlements with
less than 10.000 HUF per-
3.066 3.013 2.848 2.539 2.026 1.417 1.205
711
396
sonal income tax per capita
Number of settlements below 2.755 2.792 2.804 2.810 2.844 2.849 2.863 2.799 2.808
the countryside average
Proportion of settlements be-
89,4
90,5
90,7
91,0 90,7
90,9
91,0 89,5
89.7
low the countryside average
Source: own calculations based on data from the Ministry of Finance
The reduction of such big differences in the income potential within an
equalising or normative subsidy system was only possible by distributing
personal income tax revenues between the central and local governmental
level and spending the part remaining in the centre on equalisation purposes.
The share reserved for equalisation changed several times: it was 50% in
1991-1992, 30% in 1993-1994, 30+5% in 1995, 25+11% in 1996, 22+16%
in 1997 and 20+20% in 1998. The part that remains in the centre is not an
income deprivation, as it is more and more serves as a coverage for the
normative subsidies (Table 2.). While the centralised personal income tax
covered hardly one-third of the normative grants in 1991, this share is over
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Discussion Papers, No. 25.
80% these days. According to the figures in the recommendation for the
1998 budget, in 1998 the total amount of personal income tax remaining in
the centre will serve as a coverage for the normative state contributions, in
fact, it will exceed that by some 5 billion HUF. This is not a negligible
amount, especially when we consider that in 1997 this much was devoted by
the Government, within the decentralised regional development fund, for
that part which serves regional equalisation purposes and can be applied for
by the local governments.
Table 2.
Personal Income Tax Coverage for Normative Subsidies in 1991-1998
1991
1992
1993
1994
1995
1996 1997* 1998*
Normative state contribution 148,5 169,8 207,5 210,6 232,7 231,7 260,2 275,4
(in billion HUF)
Central part of the personal
47,0
63,0 120,0 148,8 173,9 180,1 221,4 280,5
income tax (in billion HUF)
Normative support covered
31,6
37,1
57,8
70,7
74,7
77,7
85,1
101,9
from the personal income tax
(in per cent)
* 1997 — planned, 1998 — legal reconunendat'on for the budget (7)
Source: own calculations based on the database from the TAKISZ (Regional Data Service)
The coverage part of the personal income tax shown in the table would be
even higher if equalisation grants were not listed sometimes among the
normatives and among the personal income tax items remaining in place
other times. The seemingly increased local share from the personal income
tax sounds good politically to some of the local governments. It would be
more reasonable, however, to feature the +5, +11, +16 and +18% shares re-
maining in place in the normative subsidies block or in a separate equalisa-
tion support block. The argument for the first solution — in case that the
system of normative subsidies lasts for a longer period of time — is that the
total amount of the part of the personal income tax which remains in the
centre is still a resource for normative subsidies, and for the latter solution is
that the equalisation grants could be simplified and standardised this way.
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Discussion Papers, No. 25.
This also requires that the remaining equalisation type elements — municipal
administration, communal and sports tasks, tasks of public education — be
taken out from the normatives.
Sometimes it is argued that the tension in the financing would be less if
local governments did not have to wait for two years to obtain their personal
income tax revenues. As a result of different effects (tax rates, tax brackets,
allowances, exemptions, inflation etc.), in the first part of the 1990s the
revenues coming from the personal income tax grew by 40-50 billion HUF
annually, so a transition from a system with a two-year delay of the acquisi-
tion of the resources to a system where the currently paid taxes could be
used would result in an extra 100 billion HUF personal income tax revenue.
This gain is only a seeming one in the present situation, as the paying out of
the personal income tax paid two years ago in the same monthly instalments
can evidently take place from the current advance personal income tax pay-
ments. This means that the paying out of resources adjusted to the estimated
personal income tax payments appears as an extra demand within the state
budget in the given year. This extra demand could only be met by increasing
the deficit, taking up approximately 100 billion HUF public loan. This
would, on the one hand, disturb the expectations concerning the level of the
deficit of the state budget, on the one hand, increase the outstanding total
debt with a large item. The transition would also make the administrative
procedure more complicated, as the supplementary settlement of the ac-
counts of the transfers would be a new task (paying out according to the es-
timated revenue, minus settlement of the accounts according to the real
revenues).
Summing up the possibility of keeping up the personal incomes as a di-
vided revenue, the following statements can be made:
the divided personal income tax can be a stable resource of in-
come for the local governments in the long run, which, because of the
amount of resources known from the two-year technical delay, can be
easily planned. Given the present trends, the personal income tax re-
maining in the centre will totally cover both normative subsidies and
personal income tax supplementary subsidies;
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Discussion Papers, No. 25.
planning would be made even easier if, one the hand, the system
of personal income tax itself (tax rates, tax brackets, exemptions etc.)
was more stable, on the other hand, if the proportions of the division
remained unchanged for longer periods of time or if the schedule of
the annual changes was made for four-year cycles;
it is not advised to mix the "clear" part of the personal income
tax remaining in place and the personal income tax "burdened with
tasks". The latter one should either be built in to the normative subsidy
system or into a uniform and simplified equalisation system;
In the system of the divided personal income tax, local govern-
ments are interested in a passive revenues (?). Their share from this
resource depends on their positions gained in the change of the rates of
division, and in the rates of the normatives and equalisation grants fi-
nanced from the central personal income tax. In case of an active eco-
nomic development activity, however, the provision of the unem-
ployed with jobs can amount to a surplus personal income tax re-
source, and parallel to that, the tension in the field of social care
(benefits) can decrease.
3.2 Systems of surtaxes
In the following chapter, the possibilities of the application of surtaxes in
the Hungarian local governmental finance system will be discussed in three
sections. The first section is an introduction to the historical traditions in
Hungary; the second one provides an international view in this field, while
the third section sums up the recommendations of some expert groups con-
cerning the levying of surtaxes on personal incomes.
3.2.1 Traditions in Hungary
Before the introduction of the council system, the surtaxes on the central
taxes were an important element in local governmental management. In the
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period of the Compromise, those taxes that the towns could not cover from
its resources, had to be paid from the borough-rates. Borough-rates were
levied after the royal direct taxes in a per cent that was enough for paying
the uncovered expenses (Biikki, 1991). After 1870 the situation changed, in-
asmuch as tax revenues became the basis for the coverage of the expenses
and other revenues became supplementary. The rates of the borough-rates
were defined together with the expenditure forecast and they were jointly
approved of by the Ministry of Interior. The real volume of the tax revenues
could be influenced by the base and the rate of the central tax, the rate of the
surtax and the efficiency of the collection of the taxes. The collection of the
taxes was the responsibility of the local governments at that time, and its ef-
ficiency was rather poor in the discussed period (Table 3).
Table 3.
Tax Revenues and Overdues in City of GyOr 1873-1876
1873
1874
1875
1876
Rate of the local tax (%)
55
75
60
50
Amount of approved local tax (HUF)
94.000
131.200
105.000
94.000
Total of overdues gathered by the end of the year
113.600
74.000
83.000
88.000
(HUF)
Share of the overdues at the end of the year (%)
120
56
79
93
Source: BUkki (1991) based on Tables 1. and 2.
Between the two world wars, the major part of the revenues of the mu-
nicipalities came from taxes resigned by the state, and from local taxes,
municipal duties and contributions. When the above-mentioned revenues
were not enough to cover the expenses of the budget of the town, a local
surtax could be levied, depending on the deficit, but not exceeding 50% (in
the counties, 30%) of that, based on the amounts of the direct state taxes
(land, real estate, ..., and corporate taxes). It was a general rule that the total
amount of state taxes and local surtaxes could not exceed 75% of the total
income of the taxpayer. The joint expenses of the associating villages were
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divided among the individual villages according to the share from the
amounts flowing in from the direct state taxes and the general income tax, or
according to the burden bearing capacity of the villages. The royal tax su-
pervisor or the Ministry of Interior made sure that the rate of the surtax
should not exceed the maximum level. It was a rule that the budgets had to
be handed in to the above-mentioned organs for approval (Pall, 1991).
In the second half of the 1920s, the state decreased the revenues of the
local governments with some minor modifications. These included the de-
crease of some items of the direct taxes, which automatically decreased the
amount of the village surtax, too. It was also typical of this period that the
state tried to shift a part of their burdens to local governments, without
transferring the coverage for them. These individually would not have meant
a problem, but their total sum amounted to 7.5% of the annual expenditure
of local governments by the late 1920s, without these extra local govern-
mental expenses increasing the quantity or quality of the services connected
to these expenses. Practically the state freed itself from some burdens and
blocked local governments from the free disposition of their own revenues
(Eberth, 1931).
The supporters of the local governmental system disputed the system in
effect. They approved of the principle that the state and the villages (towns)
should decide upon the volume of the taxes based on the tax paying capaci-
ties of the citizens in the future too, but they urged a taxation based on the
individual interests in the villages (towns), because of the nature of the
needs of the local governments and their effect on the welfare of the indi-
viduals.
It was raised that the system of the village surtax and the share from the
direct taxes not only do not meet the demands of the villages (towns), but
they also make a significant part of the revenues dependent on the system of
state taxes. Among other things, they argued that the applied system did not
make the inhabitants of the villages (towns) realise that they had to make
their financial contribution to the maintenance of their public institutions.
Those who were for the independent public services argued that the reve-
nues of the local governments should primarily come from the supply of the
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interest and from the independent town taxes and duties. The following
guidelines were stated (Eberth 1931):
• freer movement in local governments;
• independence of the town taxes;
• decrease in the importance of the village surtax.
However, the crisis of the world economy interrupted these disputes and
put these efforts aside for a while.
Summarising the preliminaries of the surtaxes in Hungary, we can say the
following (Lados, 1997):
local governments could typically levy surtax, in a per cent of the cen-
tral taxes limited from above, in order to achieve the balance of the lo-
cal budget, if their other regular revenues did not cover the expenses
of the public services carried out by the local government;
direct taxes, usually property or corporate income taxes served as the
basis for the surtaxes;
the rate of the surtax to be applied in the given years — together with
the budget of the local government — was approved of by the govern-
ment organs (Ministry of Interior);
the local tax administrators administered both the taxes that could be
burdened with surtax and the taxes divided between the state and the
local governments;
local governments urged that the importance of the surtax be de-
creased, as its application was extremely sensitive to the changes of
the central tax bases and tax rates — they urged the introduction of lo-
cal taxes on independent bases, instead.
Conclusions for the introduction of surtaxes, based on the Hungarian
traditions:
1. From the formerly used tax bases, central land tax ceased to exist in
1995, and the operating property-related taxes are all local taxes. The
surtax of the tantiem tax (essentially a dividend tax) and the corporate
tax (essentially corporate income tax) would only be resources for one
part of the local governments today, as in the majority of the settle-
ments, there are very few taxable enterprises. According to the tax lit-
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erature, the local taxation of the businesses distorts their competitive-
ness, so their application is less desirable. At the same time, the indus-
trial tax can be interpreted as a surtax of the VAT. From all central
taxes, presently only the surtax of the personal income tax can be a
resource for all local governments.
2. Presently the central taxes — with the exception of the vehicle tax — are
administered by the APEH, so it is practical to allocate the admini-
stration of the surtax of any central tax to the APEH, too.
3. The introduction of a surtax on any base presumes that the total
amount of the tax burdens does not change. This means that the intro-
duction of the surtax can only be implemented parallel to an adequate
decrease in the rates of central taxes.
3.2.2 International outlook
The international system of the surtaxation follows the same principle as the
system applied in Hungary before World War II, inasmuch as the role of the
surtax is the supplementation of the resource side of the local budget to the
level necessary for the expenses. The base of the surtax, however, is quite
different in the former Hungarian than the present international practice. The
Hungarian system surtaxed the property taxes and the corporate income tax.
Both of them were direct taxes. The present international practice typically
surtaxes the personal income tax. This means that the two systems do not
only differ in the use of different tax bases but also in the fact that the tax
selected for surtaxation is a non-linear, usually a progressive tax, although
this does not necessarily mean bracket rates of tax in case of the surtax.
The local governmental surtaxes can have two basic types:
• a uniform increase of the central rates of tax, or
• a surtax defined in a standard percentage form, which is levied after
the rates of tax in each tax bracket.
The first solution is used for example by the Nordic states, while the sec-
ond one by Switzerland. In Sweden, the starting rate of tax is zero, so those
who fall into the lowest brackets only have to pay the local surtax, which
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can reach 30% of the net tax base. The central government only taxes in-
comes in the higher brackets. However, the indicated maximum rate of the
surtax is a combination of three elements, as each local governmental tier
can levy surtax on the personal income tax. Each tier has a limited sphere of
action as regards the rates of the taxes. The municipalities have the broadest
field of action, they typically set the rate of the surtax from 14 to 20%.
County governments can define a bracket of 8-12%, while the smallest local
governmental units, the so-called parishes cannot go beyond 2%. Thus the
total of the paid tax is combined of four elements, including the national tax.
The multiple tax increases the administrative burdens of the employers and
the tax authorities.
The other method defines the rate of the surtax in a standard per cent of
the rates used in the individual tax brackets, i.e. the rates of the surtax show
a similar progressivity as the central tax. This means that if the majority of
the local governments chose the same rate for the surtax, the regional dis-
parities of the tax revenues would increase.
Summarising the international experiences of the surtaxation of the per-
sonal incomes, we can say the following:
all of the surtax systems applied for the personal incomes define the
rate of the surtax adjusted to the brackets of the central tax, and the
same rate is used in all brackets;
in the Scandinavian model there is an upper limit built into each tax
bracket and the same rate is used to increase the rate of the central tax,
while in the Swiss model the rate of the surtax is defined in the same
per cent of the adequate tax rate in each bracket;
the Scandinavian model allows each local governmental tier to levy
surtax on the personal income tax.
Conclusions for the introduction of the system of surtaxes on the personal
incomes, based on the international experiences:
1. it can provide an income for all local governmental tiers;
2. it is a possibility to expand the resources of local disposition;
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Discussion Papers, No. 25.
3. the generation of independent resources of tax is available this way for
the different types of local governments (municipality, county, or mi-
nority governments);
4. if an upper limit is built into the system, this surtax does not distort
considerably the competitiveness of the local economy;
5. whatever form the surtaxation of the personal income tax takes, the
supplementation of the personal income tax will be necessary in the
long run, as the surtaxation can only change the regional distribution
of the personal income tax to a limited extent. The main objective of
the surtaxation of the personal income tax is not regional equalisation,
but the increase of the financial independence of the local govern-
ments by the use of locally defined tax rates.
3.2.3 A review of the recommendations of experts for the system of
surtaxes
The almost annual change of the division of the personal income tax makes
the local governments defenceless and makes any financial planning for sev-
eral years impossible right in the beginning, although that is required by the
Act on State Finance. So from the early 1990s, recommendations and mod-
els have been made by foreign and Hungarian experts which would redeem
the divided system of the personal income tax by the surtaxation of the per-
sonal income tax. We are only going to discuss those solutions in details
which not only describe the advantages and disadvantages of the system of
the surtaxation of the personal income tax but also try to model the effects
of the transition.
A) Recommendation of the World Bank experts
2
Bird and Wallich placed the emphasis in their recommendation on the in-
crease of the resources of local disposition and on the transformation of the
support system when developing the finance system of local governments in
Hungary. In their system it is not the local government that adjusts to the
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Discussion Papers, No. 25.
centrally distributed supports but the support system is derived from the dif-
ference of the estimated demand of expenditure and the local income capac-
ity. The simplification of the support means that the present itemising ca-
pacity norms should be replaced by supports connected to the "consumers".
The support system that considers the income capacities is built on the fact
that the supports from the central budget (S) should be defined by the differ-
ence of the estimated demands of expenditure (E) and the local income ca-
pacity (I) (S = E — I).
Following this logic, if the calculation of the average demands of ex-
penditure is done in a normative way, by indices following consumer de-
mands (number of population, age groups etc.), then the incomes exceeding
the estimated capacity of the budget does not decrease state support. At the
same time, the local governments really have to collect the estimated in-
comes, as the under-average "efforts" of the budget are not supported from
the central budget.
The introduction of this model depends on whether the local governments
have really significant local revenues. In the period of our study (in 1991)
this was not typical, that is why the introduction of the local surtaxes im-
posed on the personal income tax was recommended. In our opinion this
would not increase the tax burdens of the population, as the rate of the cen-
tral tax could decrease, depending on the locally permitted rates of tax. So
practically only the principle of the division of the personal income tax
would change: the division of the resources would not take place subse-
quently, but it would depend on local decisions how much the local gov-
ernments would "add" to the lower rates of tax.
Considering the foregoing, the authors recommended the following con-
struction of the local government finance, as an alternative possibility:
• surtax of the central personal income tax;
• normative subsidy supplemented by an equalising personal income tax
support (based on the simplified formula of the distribution of the
supports, which involves the income capacity);
• increased local tax and duty capacity;
• other supplementary supports.
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In the recommended model, considering the then current proportions of
the division of the personal income tax, a 50% increase in the central rates
of tax is necessary. The central personal income tax would completely form
the basis of the normative support, which would include the supplementary
personal income tax support, too. If a local government levies a 100% direct
surtax on the national tax, then it would actually collect the former 50% per-
sonal income tax share from the surtax, instead of acquiring that as a divided
revenue. In the calculation of the support, this rate of the surtax would be
considered, but the local governments would have the possibility to levy
surtaxes exceeding 100%, too. Any further increase in the local personal in-
come tax would not change the support system but would increase local
revenues. The surtax would be collected and transferred to the municipali-
ties by the APEH. The general central/local tax burdens would not change.
On the basis of the simulation, the proportion of the personal income tax
compared to the "total" of the revenues varies, but it is usually higher in
large towns, urban districts and in bigger settlements than in the smaller set-
tlements (Table 4).
Table 4.
Proportion of Personal Income Tax in the Total Revenue
Share of personal income
Division ofthe personal
tax within the total reve-
income tax
nue, in per cent
By administrative status
Town (169)
27,7
78,5
Village (2900)
17,5
21,5
By size of the population
-
1.999
13,8
7,5
2.000
-
4.999
18,2
8,2
5.000
-
9.999
19,6
5,9
10.000
- 49.999
21,3
20,2
50.000
- 99.999
24,9
9,3
100.000
-
34,1
48,9
Average/Total
24,7
•
100,0
* Total revenue = personal income tax + normative support + supplementary support
Source: based on Bird es Wallich (1992), p. 99.
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The personal income tax is essentially a revenue that favours towns, as it
is mostly collected in industrially developed regions. The seeming unbal-
ance between the urban/village personal income tax is caused by the system
of the personal income tax itself (exemption from taxes on personal incomes
from agriculture). The network of settlements also influences the personal
income tax revenues. The network of smaller villages is denser in the North
and South Transdanubian regions.
In the villages, rural areas and small towns, the proportion of the personal
income tax within the expenditure is lower than in the big settlements. The
decrease of the central rates of the personal income tax and the parallel levy
of surtaxes on the personal income tax by the local governments leave local
incomes intact, provided that a uniform (100%) surtax is levied. In the mu-
nicipalities with less than 2.000 inhabitants, the 100% surtax would make
14% of the revenues. In the second group of settlements (2.000-10.000 in-
habitants) the present revenues from the personal income tax are higher,
making approximately 18-20% of the total revenues. The local surtax would
mean more than 20% of the total revenues in the towns with more than
10.000 population. The simulation resulted in a different division of the re-
sources than in the target figures for the 1991 budget. The simulated reve-
nues of towns and other settlements with more than 10.000 inhabitants are
lower than in the target figures, on the other hand, smaller municipalities
win, as their financial situation is defined by the supports that make the
larger share of the local revenues. In the smallest settlements, where the
proportion of the personal income tax is low, the locally levied surtax could
only be increased at the expense of political losses. In these places a kind of
equalisation of the differences in personal income tax is necessary.
B) Recommendation of the IMF experts 3
The expert committee visited Hungary in a period when the Government
decided to increase the share of the personal income tax given to the local
governments, instead of decreasing it. The experts emphasised that this was
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Discussion Papers, No. 25.
more favourable for the local governments with higher revenues, and did not
mean a general increase — concerning all local governments — in the finan-
cial independence of the local governments. Instead of disputes over the
proportions of the division, this group of experts also argued that the per-
sonal income tax should be surtaxed and the local income tax applied. The
committee mainly referred to the examples taken from the Scandinavian
countries (Sweden, Denmark). In their opinion, the introduction of the local
income tax would be made possible by a uniform 10-12% decrease in the
rates of the individual brackets of the central personal income tax.
As the committee only spent two weeks in Hungary, they did not have the
possibility for model calculations. Thus in their recommendation they out-
lined the technical structure necessary for the application of local income
tax, and the timetable (schedule) preparing the application of this tax. The
committee favoured the single-bracket rate of tax, because this does not en-
large the effects of the disparities coming from the per capita tax base, the
marginal rate of tax increases at the same volume both at the high and the
low incomes, thus providing a protection against the appearance of ex-
tremely high upper marginal figures.
The IMF delegation also found that the administration of the local in-
come tax should be allocated to the APEH. They did not think either that the
system of advance tax payments should be changed by the introduction of
surtaxation. They considered the local definition of the tax rates as an issue
of higher significance. The called the attention to the fact that the definition
of an obligatory standard rate of surtax is necessary, which has to be applied
even by the local governments with the most unfavourable income condi-
tions. They consider it as important because they do not think it is appropri-
ate to start a negative tax competition with the low rates of tax among the
local governments in order to create an attraction for the location of entre-
preneurs. They also think that the minimal rate of surtax should be used be-
cause it guarantees a minimal effort by the local government to create local
resources, which can serve as a basis for the application of supplementary
subsidies. The experts did not initiate the definition of an upper limit for the
rate of surtax.
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The report also contained some considerable technical recommendations
concerning surtaxation. In order to guarantee that the next year revenue of a
local government and the connected rate of tax should be plannable, the
central government has to finalise (by the end of July) the calculations about
the expected tax base concerning the given local government. Then the local
government has to make a decision concerning the rate of tax, about which,
together with the calculated revenue, they have to inform the central gov-
ernment (by the end of September), partly because of the monthly transfer of
personal income tax in the next year, partly in order to inform the employers
(the payers of the advance tax payments) in time. As there will be differ-
ences between the transferred personal income tax instalments and the actual
tax revenue, a supplementary settling of the accounts according to the actual
tax payments is necessary between the local government an the tax admini-
stration.
C) The recommendation of Davey-Petert 4
The authors made their calculations by the actual data of 1993, but for the
redemption of the local governmental part (25%) of the personal income tax
valid for 1995. They used the following presumptions when modelling the
shift from the division to the surtaxation:
1. local governments would obtain 25% of the actual personal income
tax revenues, if surtax were levied besides a normative rate;
2. the central rates of taxes would be decreased to such an extent that in
case of an average rate of the surtax the position of the taxpayers does
not change;
3. the local governments would be given authority to levy surtax between
a minimum and a maximum rate.
The authors talked about two kinds of supplementation. In the first case,
the supplementation takes place by the uniform increase in the central per-
sonal income tax rates. In order for the local governments to keep their 25%
proportion within the total of the personal income tax revenues, they should
use a rate of approximately 7%, according to the authors, so the rates for the
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brackets of the central personal income tax should be decreased by so much
(Table 5). In the second case, the supplementation related to the rates of the
individual tax brackets is standard. In order to keep the 25% proportion of
local governments in the personal income tax revenues, the rates of each tax
bracket should be decreased by 20%. This method would keep up the pro-
gressivity of the personal income tax at the level of the local taxes, in a dis-
tribution identical with the central personal income tax.
Table 5.
Changes in Personal Income Tax Rates in course with Supplementary
Taxation %
Tax brackets
Uniform increase of the cen-
Uniform surtax in per cent of
tral tax rate
the personal income tax
(HUF)
Central rates
Rate of local
Central rates
Rate of local
surtax
surtax
0 - 110.000
0
0
0
110.001 - 150.000
13
+7
16,0
+4,0
150.001 - 220.001
18
+7
20,0
+5,0
220.001 - 380.000
28
+7
28,0
+7,0
380.000 - 550.000
33
+7
32,0
+8,0
550.000 -
37
+7
35,2
+8,8
* based on the tax table for 1993
Source: after Davey-Peteri (1995), p. 18-19.
In our opinion, the introduction of the surtax is the simpler solution, if its
effect is neutral for both the taxpayers and the local governments, given a
standard rate (second version). This means that the local governments would
levy a stndard percentage of surtax on the total amount of the tax paid. If the
standard rate were 25%, then each bracket of the central tax should be de-
creased by 20% in order to keep the former central-local proportion. At the
same time, the local governments would be free to define rates higher or
lower than the standard rates, so they could have surplus revenues of loss of
revenues compared to the tax revenues generated by the standard rates. This
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would mean higher or lower tax burdens for the taxpayers of the individual
settlements than before. If a standard rate different from 25% were used, this
would result in the redistribution of the resources between the central and
the local governments. This can also make the transformation of the support
system necessary.
The deviation from the standard rate is possible with the total freedom of
decision of the local governments, or with building limits into the system.
The authors suggested that the rate of the surtax range from 20-35%. This
way the extreme rates of the surtax would range from 80 to 140% of the pre-
sent share from the personal income tax. The calculations were made by
using the estimations at the extremes, with the assumptions that
1. all local governments where the share of personal income tax per cap-
ita is higher than the average, would levy the maximum 35% rate of
the surtax, and
2. all local governments where the share of personal income tax per cap-
ita is lower than the average would levy the minimum 20% rate of the
surtax.
3. Budapest was neglected in the model, because of the uncertainties of
the division between the two local governmental tiers.
Given the above conditions, the personal income tax revenues of the local
governments with weaker income generating capacity would decrease by
20% compared to the present situation, while those local governments with
more favourable situation would increase their tax revenues by 40%. On the
whole, the total of the personal income tax revenues of the local govern-
ments would increase by 19% compared to the resources that they are given
from the division of the personal income tax, and the local proportion would
increase from 25 to 37%. (The authors emphasise, however, that the main
argument fro the introduction of the surtax is not the possibility to create
supplementary revenues, but the accountability of the decisions concerning
local taxation and expenditure).
The authors also dealt with the issue of the administration of the taxation.
Based on consultations with officers responsible for personal income tax
matters, they stated that the introduction of the surtaxation would not require
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a significant modification of the present procedure of tax administration.
Administrative burdens would mainly appear at the employers, as the ad-
vance personal income tax payments would have to be drawn from the sala-
ries of the individual workers at different rates, because of the different
places of residence. On the other hand, this cannot be a problem for those
employers that use a computerised wages accounting system.
Summarising the recommendations of the experts concerning the sur-
taxation of the personal incomes, we can say the following:
the starting point of each recommendation is to replace the share of the
local governments from the actual central/local government division
of the personal income tax by a surtax on the personal income tax with
local disposition, by decreasing the central marginal rates to an extent
resulting in the required division of the revenues. It was emphasised
that this way the total of the personal income tax burdens would re-
main the same.
At the same time, local governments would have the possibility to
deviate in both directions from the standard (normative, average) local
surtax rate of the personal income tax, defined by the centre.
A) The deviation from the standard rate downwards results in the de-
crease of the total tax burdens of the individual taxpayers, which can
further reinforce the tension between the present demand of the ex-
penditure and the income capacities (own resources + state trans-
fers). In case of an unchanged demand of the expenditure, the de-
creasing personal income tax revenues have to supplemented. This
strengthens the need for the increase in the other elements of re-
sources (supplementary personal income tax support, or a more in-
tensive increase of the normative subsidy, increase of the income ca-
pacities of other local taxes, consumption of the assets etc.). A solu-
tion for the problem can be the requirement of a minimum marginal
tax rate, which would mean a minimal tax effort which could be ex-
pected from the local governments. In other words, the surtax on the
personal income tax would increase the number of the optional local
taxes, as it would be obligatory. The decrease of the general marginal
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personal income tax rate could have positive effects, as well, e.g. the
willingness of taxpaying can improve, as can the efficiency of the tax
co Ilection. 5
B) The deviation from the standard rate upwards can result in a sur-
plus revenue for the individual local governments. However, as the
starting point of the surtaxes has always been the system of the ac-
tual marginal rates, a raise of the taxes above the standard rates
would amount to marginal rates higher than the actual ones. The
political price of that might be bigger than the visible advantages
coming from the improving services. It can also happen that the tax-
paying willingness and the efficiency of the collection deteriorate
because of the increasing rates. A solution for the problem can be the
definition of the maximum rates of the surtax. (The experts of the
World Bank and the Davey-Peteri recommendation define the upper
limit for the system of the surtax on the personal income tax, but the
IMF report does not impose such an upper limit for the local sur-
taxes.)
C) The solutions for the division of the personal income tax are dis-
cussed by each expert group embedded into the general frameworks
of the local government financing. They emphasise the possible ex-
pansion of the own resources. In addition to the surtax on the per-
sonal income tax, they emphasise the development of the real estate
tax based on the local value. This tax is a kind of property tax, but
the taxpaying is influenced also in this case by the paying capacity of
the taxpayers, as the tax is mostly paid from incomes that do not de-
rive from the use of the taxable real estate. If the surtax levied on the
personal income tax and the development of the taxation of the local
real estates are done at the same time, then both taxes have to be
taken into consideration in the modelling of the decrease of the cen-
tral personal income tax rates, as the real estate tax can mean an
additional tax burden for the personal income tax payers. This im-
plies that in case of the parallel development of these two tax cate-
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gories we can only start from a total of personal income tax reve-
nues lower than before.
All three recommendations allocate the administration of the surtax to
the central tax office, which shows that the shift is more likely to
cause problems in the beginning at the employers transferring the ad-
vance personal income tax payments. At the same time, the two-year
delay of the appearance of the tax revenues in the local budget can be
a problem (the surtax is meant to serve the balance of the budget in the
given financial—planning period), as can be the date of the decision on
the rates of the surtaxes valid for the following year.
A) Problems coming from the two-year delay
In the present system, this problem is a bit overrated, as it is an es-
tablished system. It as acceptable from the aspect of planning, as it is
a stable resource which does not change during the year. In theory,
the financing cannot be a problem, either, as its coverage is the cur-
rent payments, the monthly instalments of which evidently exceed
the current transfers which the local governments are eligible for
based on their payments made two years ago. The problem is caused
by the annual changes of the proportions of the division, about which
the Parliament only decides in November. This conflict, however,
can be well solved with programmes announced for several years
(e.g. the method applied for the 1996-1998 period), or at least for the
periods between the election cycles, the division should not be
changed.
B) The date of setting the surtax rates
The IMF experts recommended that these rates be set by 30 Septem-
ber the latest, allowing each concerned party to have enough time to
prepare for the change. The implementation is strongly influenced by
the fact that the frameworks defining the rules of the game will
probably change a lot in the coming few years. These frameworks,
however, are only defined by the Parliament in November—Dcember
every year. The date written in the recommendation would only be
realistic if the general frameworks of the regulation (changes in the
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central taxes, state budget) were available as soon as the end of
August in each year.
Problematic points concerning the surtaxation of the personal income tax:
• in Hungary there are significant allowances decreasing the tax base or
the tax itself;
• the concealment of taxable incomes is common;
• the incomes of the agricultural employees are only taxed to a limited
extent.
All three factors distort the regional distribution of the tax revenues. The
first two factors are concentrated in the economically stronger areas (capital
city, large towns), while agricultural population is more concentrated in the
villages on the one hand, on the other hand, in the settlements of the Great
Hungarian Plain. The above-mentioned distortions are reproduced by the
surtaxation of the personal income tax. The tax burdens would be suffered
by the same layer — dominantly those employees who live on salaries and
wages.
3.3 The system of local taxes in Hungary
The reformed system of the local taxes is just becoming mature. This is be-
yond doubt, despite the rates relatively low in the beginning. It can be seen
in several municipalities that they are starting to consciously shape their tax
policies, and — often on the pressure by the local taxpayers (transparency,
accountability) — they are starting to harmonise it with the local settlement
development and economic development policy. The revenues flowing in
from the local taxes are also more and more significant, but the rapid devel-
opment of the tax revenues is dominantly the result of the industrial tax
revenues (83.9% in 1997), aside from the gradual increase in the number of
local governments introducing local taxes and the number of different tax
categories (Figure 1). However, this kind of tax means — ever more signifi-
cant — revenues only for the municipalities with considerable economic ca-
pacities.
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On the other hand, several problems can also be raised in connection with
the otherwise successful system of the local taxes. These are the following:
• half of the local taxes that can be levied tax the population, the other
half the enterprises. Unfortunately, the present system — partly because
of the heavy central tax burdens — makes the local governments tax the
enterprises instead of the inhabitants. Industrial tax, the communal tax
of the enterprises and the property-based taxes paid after the buildings
and sites of the enterprises make more than 90% of the local taxes.
• Unfortunately it cannot be defined how much tax the population and
how much the enterprises pay, because the central software which is
obligatory to use for the summary of the taxes does not pay attention
to that. The software should be transformed in a way that it should be
able to treat separately the payments coming from the real estate tax,
land tax and the communal tax of both the inhabitants and the enter-
prises. The central report still could be made in a division according to
the five tax categories, but this information, which is very important
for the formation of the local tax policy, would not be lost at least at
the local level.
• The revenues from the industrial tax are concentrated in the capital
city, the big towns and other settlements with more advanced eco-
nomic base. Because of the large-scale concentration, it was raised that
a part of the industrial tax should be withdrawn for equalisation pur-
poses (French example). Another version recommends the transfor-
mation of this kind of tax into a surtax of the corporate income tax
(ffies, 1996). Neither recommendation is acceptable within the present
frameworks, because the levying of a tax — according to the present
regulation of the local taxes — is only a possibility which the local
governments can use. This would practically punish those local gov-
ernments which try to expand their own resources. The transformation
into a surtax is problematic also because the levying of the industrial
tax is not obligatory. In addition, local governments are free to define
the tax rates up to the upper limit set by the law.
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• Within the narrow possibilities of the taxation of the population, the
taxation of the real estates is still very rare. The possibilities that lie in
this kind of tax is worth reconsidering. As there are real estates in each
settlement, this is the type of tax that covers the widest layer of the
population, besides the personal income tax. In addition, as real estates
are visible, and the owner can be easily found, this tax can involve
those layers of the inhabitants into the taxation who managed to evade
the personal income tax. It is also an argument that the value of such
real estates involves the level of the services provided by the local
governments. It is considerable that the real estate property of the
Hungarian population is very large compared to the development level
of the economy and the (known and admitted) income level.
• We have discussed several times the measures to be done in connec-
tion with the development of the taxation of real estates (Nes, 1994,
1996; Lados, 1993, 1995). They are still valid, with one exception (the
significant decrease in the exemptions, which was made possible by
the amendments of the Act on Local Taxes in 1995):
modernisation, upgrading of the registrations of real estates,
completion of the computerisation (it should be assessed how far the
implementation of the land office programme, which was started
years ago with support from the German government, has got, as the
originally planned deadline was 1998, and it is extremely important
from the aspect of the development of real estate tax);
the establishment of reliable and generally accepted value assess-
ment procedures is necessary (in the United Kingdom, the system of
poll tax could be replaced within a year by the taxation of the real
estates based on their fair market value, using the method of mass
value assessment);
both local governments and the population have to be prepared
for the paying of real estate taxes, and this is the most urgent of all
the tasks connected to the introduction of the system — a good prepa-
ration takes three to five years, so the introduction of the value-based
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Discussion Papers, No. 25.
taxation of the real estates is hardly possible before 2002, given the
present conditions.
The local governments less frequently use the possibility that lies in the
land tax. The majority of the local governments start from the fact that they
have little of such areas, where higher tax revenues could only be collected
by using high tax rates which could be defended with difficulties politically.
So this kind of tax is seldom used, due to its weak income potential. In pre-
paratory programmes it should be emphasised that the objective of the
levying of taxes does not necessarily have to be to gain revenues, but it can
be used as a tool of settlement policy, a very good example for which is the
land tax, which can accelerate the development of some underdeveloped ar-
eas and can also be used to prevent the speculation-led land purchases in the
neighbourhood of major community investments. (The tax decreases the
price of the lands and the real estates.)
4. The system of supplementary subsidies
When increasing the role of local resources — e.g. local taxes, surtax sys-
tems —, it is necessary to examine to what extent the distribution of the own
resources of the local governments contributes to the reduction or strength-
ening of the disparities among the regions and the settlement types. So the
construction of the supplementary subsidies, their transparency and the
maintenance of the stimulation to use the local resources are issues of pri-
mary importance. In the resource-oriented financial planning, the divided
personal income tax and the normative subsidies are complementary ele-
ments. The part of the personal income tax which remains in the centre be-
comes the basis of the subsidies distributed in a normative way.
Does the decrease of the present proportions of division really amount to
equalisation? It seems that in the recent years it was mostly the resource
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Discussion Papers, No. 25.
breakdown of the richest local government, the capital city, which has fol-
lowed this principle. Parallel to the decrease in the share from the personal
income tax, the weight of Budapest in the normative supports decreased, too
(Table 6).
Table 6.
Personal Income Taxes and Normative Subsidies by Levels of Territorial
Administration, in per cent
personal income tax +
Normative state contri-
personal income tax
bution
supplementation
1993 1994 1995 1996 1993 1994 1995 1996
Budapest
30,8
31,6
28,3
27,5
16,9
16,8
16,4
15,8
Counties
0,0
0,0
0,7
2,5
9,0
9,1
9,3
10,1
Big towns**
21,3
21,9
21,0
20,4
21,0
20,7
21,3
20,8
Other towns
22,4
21,9
22,7
22,3
23,9
24,0
24,5
24,6
Villages
25,5
24,6
27,3
27,4
29,2
29,5
28,5
28,7
Total
100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0
* According to the administrative division in effect in the given year;
** All county seats and other towns with county rank.
Source: own calculations after the database of the TAKISZ (Hungarian Regional Informa-
tion Service)
It is worth noting that this phenomenon can only be seen in case of the
personal income tax, because of the supplementary subsidy of that. In case
of the normative subsidies, the resources are mostly relocated towards the
local governments of the counties and the towns. This is the consequence of
the normative system which in many respects takes the urban, or medium
level services into consideration, and usually sets the rates of those services
in the range closer to the average level of the given service. At the same
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Discussion Papers, No. 25.
time, in case of the responsibilities also present in the village environment,
the normative is further away from the average expenses.
In reality, there are several subsidies in the finance system of local gov-
ernments which totally or to a significant extent serve equalisation purposes.
In a sense, the task-oriented subsidies can be taken here, as they provide the
same amount of grants after each student, or person in need of social bene-
fits or health care. Besides these effects, however, these subsidies are mainly
connected to individual tasks taken up by the state, and their main purpose is
not equalisation but the completion of concrete tasks.
In another part of the subsidies, the equalisation function is dominant.
These subsidies, however, are fragmented are dislocated. Some factors could
be found in 1997 in that group of the personal income tax "remaining in
place" which is, so to say, burdened with tasks. These are the following:
• supplementary subsidies for the personal income tax (19.0 billion
HUF — villages: up to 7.073 HUF per capita, towns: up to 8.643 HUF
per capita;
• general support for the villages (5.8 billion HUF — 2 million HUF per
village);
• subsidy for the municipal administration, communal and sports tasks
of the local governments (19.3 billion HUF — 1.842 HUF per capita);
• subsidies for those local governments — defined in a government de-
cree — which are underdeveloped from socio-economic and infrastruc-
tural aspects, and for those with serious employment problems (2.7
billion HUF — 1.600 HUF per capita).
The latter three purposes were elements in the former normative support
system. On the above-listed equalisation purposes, thus within the frame-
works accountable from the personal income tax, 46.8 billion HUF would be
spent. The personal income tax remaining in place is burdened with some
subsidies given to the county governments, which seems to be a bit strange,
an odd man out here. It would be more reasonable (but it does not sound so
nice politically) that the proportion of the division is 22%. The 78% that re-
mains in the centre serves as the basis for the financing of certain elements
of the normative subsidies. In the present construction, the central govern-
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Discussion Papers, No. 25.
ment could account for 16% of the personal income tax in 1997 and 20% of
that in 1998, but the channels where the remaining 62 and 60% of the per-
sonal income tax was spent is unknown, without transparency. (Naturally, as
we have already mentioned in the chapter dealing with the divided personal
income tax, we calculated the personal income tax remaining in the centre as
if it all served as the basis of normative subsidies 6 . From this aspect, the
coverage of the normative subsidies is not transparent, either, as we have not
seen yet a division where e.g. 80% of the resources divided under the head-
ing "normative subsidies" was covered by the centralised personal income
tax and 20% by the VAT payments.)
From the normative state contributions, two objectives can be listed
among the equalisation elements in the narrower sense:
• subsidy for the municipal administration, communal and sports tasks
of the local governments (3.0 billion HUF — 312 HUF per capita);
• subsidy for public education (1.5 billion HUF — 157 HUF per capita).
Different subsidies assisting developments and operation are listed as in-
dependent items in the state budget, making a further 69.0 billion HUF:
• targeted and addressed grants (39.0 billion HUF);
• subsidies with development purposes, serving regional equalisation
(8.0 billion HUF);
• supplementary subsidies for bankrupt local governments (6.0 billion
HUF);
• subsidies for local governments in handicapped situation, with lack of
funds through not their own fault (6.0 billion HUF).
This fragmented system, consisting of some 10 support elements, allo-
cated approximately 110 billion HUF for the local governments in 1997,
which is more than 10% of the expected total resources of the local govern-
ments. This amount can further grow with resources awarded from the Re-
gional Development Fund, at the same time, the targeted grants should not
be put into this category, as they typically demand own resources up to at
least 60% of the developments, which could hardly be fulfilled by the local
governments with weaker income positions, so they would get into a disad-
vantageous position in the competition. (It can cause further problems if
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Discussion Papers, No. 25.
they manage to collect the coverage of the investment, but there is no cover-
age for the operation in the future.)
In the 1991-1994 period, the more developed counties (e.g. Gyar-Moson-
Sopron) essentially did not receive any resources from the 18.5 billion HUF
of the Regional Development Fund. At the same time, their share is consid-
erably high from the system of targeted grants requiring substantial own re-
sources, which used 52.3 billion HUF in the given period. (In the period in
question, Western Transdanubia, which consists of Gyor-Moson-Sopron,
Vas and Zala counties, only received 2.7% of the grants awarded from the
Regional Development Fund, while 17.7% from the targeted grants.)
This fragmented system should be put into a more comprehensible
framework, or collected into a single equalisation support fund. The order of
magnitude of the subsidies is as much as is covered by the local and the
central part of the personal income tax in both the divided and the surtaxing
system of the local personal income tax.
A) Separate development and operational equalisation support system
The equalisation support objectives listed above could be divided into two
main groups. One of them would provide resources of equalising character
for the continuous operation of the local governments, while the other would
equalise the chances for the access to development possibilities.
1. The local governments that are awarded equalisation grants on differ-
ent grounds usually overlap each other. Thus in the first case it is ad-
vised to integrate into the supplementary subsidy of the personal in-
come tax the former elements of the subsidies: supplementary subsidy
for the personal income tax, general support for the villages 7, subsidy
for the municipal administration, communal and sports tasks of the lo-
cal governments, subsidies for local governments in handicapped
situation, with lack of funds through not their fault, and supplementary
subsidies for bankrupt local governments. This amount of approxi-
mately 60 billion HUF should be distributed through a support form,
the supplementary subsidy for the personal income tax.
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In the present personal income tax equalisation mechanism, more
than 90% of the local governments are involved, so this circle is wide
enough to cover all the settlements belonging to the former frag-
mented system of equalisation purposes. After this, only the average
personal income tax per capita should be defined, with which the sub-
sidy distributed through the equalisation of the personal income tax
would triple.
2. Development supports could still be operated as targeted grants. The
category called addressed grants is not necessary by all means, if the
grants are rendered individually to the objectives to be supported. A
matrix could show the level of the subsidies that the objectives to be
supported could reach at the individual local governmental types. This
way both horizontal and vertical fairness can be asserted in the sup-
ports, as each local government can get support for development pur-
poses, but the extent of the support can vary, taking the special situa-
tions into consideration.
It could be declared that the basis of both supports is the part of the per-
sonal income tax which remains in the centre. On the whole, the personal
income tax revenues should be spent on four kinds of purposes by clear di-
vision principles, if we maintain the pattern of the divided incomes:
• personal income tax remaining in place: because of the equalisation
concerning an extremely wide circle, the 20% from the direct personal
income tax planned for 1998 seems a bit too little. From 1999, this
figure should be raised to 30 or 40% of the net personal income tax
8.
revenues ,
▪ supplementary subsidies: essentially this is the total of the operational,
and development equalisation supports gathered in the individual sup-
port labels, the supplementary subsidy of the personal income tax and
the targeted grant. This total makes 35 or 30% of the net personal in-
come tax revenue. (The higher figure would be the proportion in case
of the lower share of the personal income tax directly remaining in
place and vice versa.)
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• normative or task-oriented supports: they make 35 or 40% of the net
personal income tax revenue. (The higher figure would be the propor-
tion in case of the lower share of the personal income tax directly re-
maining in place and vice versa.) If this should not cover the total of
the necessary supports, the missing part could be filled from the VAT
revenues,
• coverage of the expenses of the central tax authority: the APEH is a
central budgetary organisation, thus its operation is financed from the
tax revenues. That is why it is reasonable to expect that a part of the
personal income tax revenues, which appear as a local governmental
resource but is administered centrally, should contribute to the main-
tenance costs of the APEH. The maximum amount of this contribution
can be the difference between the gross and the net personal income
tax.
If the central and the local personal income tax were separated, the for-
mula would only change inasmuch as a clear proportions of division among
the individual support types should be declared.
B) Standard equalisation fund
The distribution of the support fund serving equalisation purposes could
take place based on relatively few indices, which characterise well the situa-
tion of the local governments. Five such indices could be taken into consid-
eration (/l/es, 1996):
1. The difference of the operational costs of the local government and the
realistic coverage that can flow in from the local resources;
2. population of the settlement, or the municipality;
3. properties of the local government which require maintenance, reno-
vation and management;
4. non-real estate property of the local government, which is a potential
material—financial resource;
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Discussion Papers, No. 25.
5. length of the inner roads, which is more or less proportionate to the
road, public utility, lighting and public area maintenance tasks and the
tasks of the local transportation.
The other branch of the subsidies could be task-oriented grants, which is
different from the equalisation grants both in function and economic politi-
cal character:
• In case of the task-oriented grants, the central government takes re-
sponsibility for and a certain share of the expenses from the provision
of a concrete task. In this case it might be reasonable to define the
guidelines for the proportion of the burdens, e.g. in the branches that
are state responsibilities (public education, health care, social care) the
division could be 2/3 state subsidy and 1 /3 own resources of the local
governments.
The equalisation grant is a "monetarised" support, in which the central
budget does not take any responsibility or burden in one concrete task or
sectoral development, all they do is to contribute to the maintenance of the
operation and the reduction of the differences. The indices and the norma-
tives are only rates, based on which the individual support funds — defipend-
ing on the burden bearing capacity of the national economy and the budget —
can be divided among the individual local governments.
5 Summary, recommendations
Starting point:
The role of the governmental (budgetary) participation in regional devel-
opment at territorial and local level are:
• the reduction of regional disparities;
• the stimulation of processes desirable at national level.
A real equalisation only takes place if the local governments in the back-
ward regions have development resources, too. The precondition for that is,
however, the stable provision for the running operational needs.
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The desirable situation in the future could be guaranteed by the applica-
tion of a resource system at local governmental level which, on the one
hand, promotes the increase of the financial independence of the Hungarian
local governments, on the other hand, enables the equalisation among the
local governments with different income capacities. The first objective could
be guaranteed by the expansion of the resources of free discretion, in the
second case the fragmented system should be made more comprehensive,
transparent and efficient.
The experts' opinions seem to reach a consensus that two ways are rec-
ommended for the increase of the financial independence in the given Hun-
garian conditions. One direction is the transformation of the divided per-
sonal income tax revenue system into personal income tax of central and lo-
cal discretion, the other is the development of the local real estate tax and
the use of value-based tax on real estates. Lately the role of the industrial tax
in the long run has been appreciated. According to the Hungarian traditions,
local surtaxes were levied in a certain per cent, approved of by the Ministry
of Interior, of the central direct taxes. These included both property taxes
and (personal and corporate) income taxes. The presently accepted interna-
tional practice favours the surtaxes levied on the personal incomes. This can
be a resource for all of the local governments, at the same time, it could ex-
pand the right to levy taxes to the medium level of the local governments, as
well.
The system can be created in a year or two. The years of 1997 and 1998
are enough for the preparation, as the rules of the division of the personal
income tax has been set for these years in a three-year programme, and this
should not be disturbed. This would allow enough time for the introduction
of the surtax on personal income tax from 1999.
It is not recommended to levy surtax on the corporate sales tax and cor-
porate income tax, as this would deteriorate the competitiveness of the local
economy in the long run. It should be set, instead, to what extent the indi-
vidual governmental transfers are financed from the individual central taxes.
The surtax on the corporate income tax is also not recommended, among
other things because in the list of local taxes we find the industrial tax,
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Discussion Papers, No. 25.
which can operate as a kind of local corporate sales tax. Its role, however,
should not be increased but decreased in the long run. The industrial tax op-
erating with higher and higher rates distorts the competitiveness of the local
enterprises on the one hand, on the other hand, it can spur the tax competi-
tion among the settlements to an unjustifiable level.
Among local taxes, the development of the tax on real estates, within that
the tax on the residences is recommended. Certain element necessary for the
shift to a value-based taxation of the real estates have been realised
(elimination of central exemptions), others are under implementation
(computerised real estate registration, expiration of former exemptions, pri-
vatisation of the real estates of the local governments), while there are some
elements which are still missing (act on the assessment, training pro-
grammes, preparation of the inhabitants). The shift can last for a period of
four or five years, during which the preparation of the population for this
type of tax is the most essential task (this should be implemented similar to
the expansion of the personal income tax to the whole circle of income-
earners in 1998). Presently it is important from the aspect of the value-based
real estate tax to look at where we are in the implementation of the recom-
mended processes and the often mentioned strategic programme measures.
The personal income tax will remain one of the fundamental elements in
the financing of the local governmental 'management in the long run. In the
1990s, as a consequence of the processes connected to the transformation
(unemployment, regional differences of the economic decline or growth) and
for demographic reasons, an increase is expected in the coming medium-
term period of time in the disparities of the incomes of the population in the
different regions and settlements. This emphasises the importance of the op-
eration of the income equalising mechanism in the field of local government
finance.
The resources of equalisation are extremely fragmented and scattered in
the present system of financing. Their transformation can take place the
following way: the beneficiary local governments largely overlap each other
as regards the equalisation grants received on different grounds. Only two
types of equalisation grants should be used. One of them could serve the
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equalisation of the financial conditions of the operation, in the frameworks
of the personal income tax equalisation support, while the other one would
promote developments through the system of targeted grants. The resource
for both supports would be the central personal income tax (or the part
thereof that remains in the centre).
The personal income tax would serve four purposes altogether. The local
or surtaxed personal income tax would make 30-40% of the total of the net
personal income tax, while the centralised or central personal income tax
would be divided equally between the equalisation grants and the normative
or task-oriented supports. In the latter case the proportion should be defined
which the government will cover not from the personal income tax but from
other tax revenues. The difference between the gross and net personal in-
come tax revenues would contribute to the coverage of the budget of the
APEH.
The reform of the state budget concerns the management of the local
governments in several places. The reform of the large systems of provision,
such as public education, social care, health care, influences the local gov-
ernmental tasks and the macro-level resources allocated to these, and also
the transformation of the distributing and regulating system. This is the most
palpable for the local governments through the system of normative sup-
ports. It is necessary to decide in which direction the system of normative
supports should be developed. If normativity is meant to handle the regula-
tion of the resources and the equalisation together, then a distribution for-
mula consisting of only four or five indices would be enough. If task-
oriented financing is given the priority, then this form of financing only has
to address three fields, namely those in which state participation is signifi-
cant: public education, social care and health care. All other fields — with the
exception of the financing of the ethnic and minority local governments,
which requires a special regulation — would be taken out of the system of the
normative rates of distribution. Their coverage has to be achieved by the in-
dividual local governments, from the local personal income tax or the part
thereof remaining in place, from the local revenues and though the equalisa-
tion systems assisting the operation.
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The pressure on the resource side could be alleviated by the more rational
organisation of the services. This does not necessarily mean the forced crea-
tion of larger local governmental units. The effective operation is promoted
mainly by two processes: one of them is the decentralisation of the local
governmental tasks, i.e. the strengthening of the private sphere in certain lo-
cal community services; the other one is the stimulation of the formation of
local government associations for the common implementation of tasks.
This should be achieved by financial regulation and not by administrative
means, by obliging the local governments to associate with each other.
Notes
If we did not consider the capital city as a whole but looked at the districts separately, then
District 2 would lead the list of the settlements in each year. The personal income tax per
capita generated here exceeds the countryside average by more than fivefold.
2 The report of the World Bank on Hungary, made in 1992, focused on the budget and the
operation of the sector of public services. The report ("The Financing of Local Govern-
ments in Hungary") was made by Richard Bird and Christine Wallich. Their work was
assisted by Gabor Merl, expert of the financial matters of Hungarian local governments.
3 In representation of the Department of Tax Affairs of the IMF, a four-member delegation
visited Budapest and a few countryside settlements in 28 August — 14 September 1994.
The aim of the visit was to provide technical assistance for the reform of the financing
systems of the Hungarian local taxes and local governments. The members of the commit-
tee were Emil M. Sunley, Deputy Director of the Department of Tax Affairs; P. Bernd
Spahn, fellow of the Department of Tax Affairs; Robert D. Ebel from the World Bank;
and Jorgen Lotz, member of the experts body on tax affairs. The work of the committee
was assisted by the Varoskutato Kft. (Urban Research Ltd.), as an expert group of the fi-
nancing of local governments in Hungary.
4 The recommendation ("Reform of the Hungarian Local Governmental System") was done
by the authors on request of the Ministry of Interior, in the frameworks of the British
Know-How Fund, in 1994-1995.
5 In connection with the recent raises of the rates of tax, those who are against the raises like
to refer to the so-called Laffler-curve, according to which after a certain point the increase
of the tax rates does not increase but decrease the total of the tax revenues. In their opin-
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Discussion Papers, No. 25.
ion, in Hungary the upper margins of the tax schedule have exceeded this point, so in in-
ternational comparison the concealment of the taxable incomes is higher in Hungary.
However, no published analyses have been conducted examining how the decreases of the
marginal tax rates to different extents can change the attitude to taxpaying and whether the
personal income tax revenues can grow even with decreasing rates. Naturally, the volume
of the tax revenues is defined not only by the rates and the connected willingness to pay,
but also the width of the tax brackets, the scales of the items decreasing the tax base or the
tax, and inflation.
6 As a matter of fact, the division of 100% of the personal income tax among the local gov-
ernments is unrealistic, as in this case this income is not burdened by administration costs.
At the same time it can be expected that a part of the budget of the APEH should be cov-
ered from the personal income tax revenues. This might work this way, but we do not
know, as the accounting is not public and transparent.
7 This support element was created at the introduction of the system of normative supports.
Its amount per village has not changed since then: 2 million HUF for each village. In
1991, this resource made approximately 50% of the revenues of some 50 local govern-
ments. By 1997, the real value of this resource dropped to one-fifth of the 1991 value.
In the essays evaluating the budget of 1997, the local governments expressed their griev-
ance that the central government, when defining the proportion of the local governments,
did not start from the gross, i.e. the total revenues, but from the net revenues, i.e. the per-
sonal income tax revenues specified for the individual settlements. In my opinion, the
starting from the net personal income tax is acceptable if it is known what happens to the
"remaining" personal income tax. This could be the easiest made transparent by the sys-
tem handling this part as a proportion serving the operation of the APEH, although it still
remains a question how they will account for the surplus personal income tax revenues
flowing in from the tax controls.
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Discussion Papers, No. 25.
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48
Discussion Papers 1998. No. 25.
Future Perspectives for Local
Government Finance in Hungary
The Discussion Papers series of the Centre for Regional Studies of the Hungari-
an Academy of Sciences was launched in 1986 to publish summaries of re-
search findings on regional and urban development.
The series has 3 or 4 issues a year. It will be of interest to geographers, econo-
mists, sociologists, experts of law and political sciences, historians and every-
body else who is, in one way or another, engaged in the research of spatial as-
pects of socio-economic development and planning.
The series is published by the Centre for Regional Studies.
Individual copies are available on request at the Centre.
Postal address
Centre for Regional Studies of the Hungarian Academy of Sciences
P.O. Box 199,7601 PECS, HUNGARY
Phone: (36-72) 212-755,233-704
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* * *
Forthcoming in the Discussion Papers series
Changes in the Politico-geographical Position of
Hungary in the 20th Century
by
49
Discussion Papers 1998. No. 25.
Future Perspectives for Local
Government Finance in Hungary
Zoltan, HAJDU
Papers published in the Discussion Papers series
No. 1
OROSZ, Eva (1986): Critical Issues in the Development of Hungarian Public
Health with Special Regard to Spatial Differences
No. 2 ENYEDI, Gyorgy — ZENTAI, Viola (1986): Environmental Policy in Hun-
gary
No. 3 HAJDU, Zoltan (1987): Administrative Division and Administrative Geo-
graphy in Hungary
No. 4 SIKOS T., Minas (1987): Investigations of Social Infrastructure in Rural Set-
tlements of Borsod County
No. 5 HORVATH, Gyula (1987): Development of the Regional Management of the
Economy in East-Central Europe
No. 6 PALNE KOVACS, Ilona (1988): Chance of Local Independence in Hungary
No. 7 FARAGO, Laszlo — HRUBI, Laszlo (1988): Development Possibilities of
Backward Areas in Hungary
No. 8 SZORENYINE KUKORELLI, ken (1990): Role of the Accessibility in De-
velopment and Functioning of Settlements
No. 9 ENYEDI, Gyorgy (1990): New Basis for Regional and Urban Policies in
East-Central Europe
No. 10 RECHNITZER, Janos (1990): Regional Spread of Computer Technology in
Hungary
No. 11 SIKOS T., Tamas (1992): Types of Social Infrastructure in Hungary (to be not
published)
No. 12 HORVATH, Gyula — HRUBI, Laszlo (1992): Restructuring and Regional
Policy in Hungary
No. 13 ERDOSI, Ferenc (1992): Transportation Effects on Spatial Structure of Hun-
gary
No. 14 PALNE KOVACS, Ilona (1992): The Basic Political and Structural Problems
in the Workings of Local Governments in Hungary
No. 15 PFEIL, Edit (1992): Local Governments and System Change. The Case of a
Regional Centre
No. 16 HORVATH, Gyula (1992): Culture and Urban Development (The Case of
Pecs)
No. 17 HAJDU, Zoltan (1993): Settlement Network Development Policy in Hungary
in the Period of State Socialism (1949-1985)
No. 18 KOVACS, Ter& (1993): Borderland Situation as It Is Seen by a Sociologist
No. 19 HRUBI, L. — KRAFTNE SOMOGYI, Gabriella (eds.) (1994): Small and me-
dium-sized firms and the role of private industry in Hungary
50
Discussion Papers 1998. No. 25.
Future Perspectives for Local
Government Finance in Hungary
No. 20 BENKONE LODNER, Dorottya (1995): The Legal-Administrative Ques-
tions of Environmental Protection in the Republic of Hungary
No. 21 ENYEDI, Gy6rgy (1998): Transformation in Central European Postsocial-
ist Cities
No. 22 HAJDU, Zoltan (1998): Changes in the Politico-Geographical Position of
Hungary in the 20th Century
No. 23 HORVATH, Gyula (1998): Regional and Cohesion Policy in Hungary
No. 24 BUDAY-SANTHA, Attila (1998): Sustainable Agricultural Development
in the Region of the Lake Balaton
51