Nobody loves the taxman

29 March 2010

 I remember my first paycheck, crisp, warm, reward for my first month’s blood, sweat and tears. The number at the bottom looked right, I felt good, a part of the system, then a shrill blood-curdling yelp of despair was heard……. taxman!!! An economics degree had taught me the societal value of tax, redistribution of wealth etc etc blah blah, but why me?

In modern times the theory goes that a capitalist, profit oriented market system should act as the engine of a country, employing it’s citizens and allocating goods and services among individuals. As the private market is not always capable of doing this in a socially acceptable manner, governments impose taxes on this engine and with this, provide public services, infrastructure, welfare and regulation. In this symbiotic relationship the more vibrant, growing and healthy the economy, the more funds the government has to spend on improving our lives. In simplified terms, when one side is malfunctioning, for example the economy goes into recession, as in the recent global crisis, or if the tax system and government regulation are inefficient or excessive and interfere with economic activity, tax revenues are less, budget deficits and government borrowing rise, the country is worse off.

A good tax system is characterized by low taxes, a wide tax base, a simple and efficient tax administration with electronic filing and payment systems. Recent studies for example show that higher tax rates are associated with lower private sector investment and fewer businesses per capita.

Poland moved to a market economy in the early 90s and as a result had a high level of public spending in order to support workers who were made redundant by this change. While the need to support such a system has tended to act as a drag on Poland’s public finances, much progress has been made in reforming and modernising the system. Poland quickly introduced standard market oriented taxes such as corporate (CIT), personal (PIT) incomes taxes and VAT. Pre EU membership, CIT was reduced to a level that would encourage new businesses (Currently 18%). More recently the Polish government has also reduced PIT, with the previous 3-tier system (19%, 30% and 40%) reduced to a 2-tier system (18% and 32%). In December 2008 Poland completed pension reform, raising the retirement age to 63, reducing the country’s costly pension debt and the large social security contributions.

Despite relatively low income taxes, typically the Polish system has high social security costs for employers and employees. This produces a ‘tax-wedge’ that has been much discussed. A country’s ‘tax wedge’ is the difference between labor costs to the employer and the net take home pay of the employee. The cost of a worker to an employer is key in terms of hiring and thus affects unemployment. The IMF has previously warned that Poland’s high tax wedge would continue to act as a drag on economic growth but noted that significant steps have been taken in 2008-9 to reduce this to around the EU average.

In the World Bank’s publication ‘Doing business 2010’ Poland ranks 151 out of 183 countries, in terms of corporate tax systems. Hardly a glowing report card and this reflects Poland’s ongoing delays in improving tax administration.

However improvements now mean large numbers of tax returns can be submitted electronically (‘e-deklaracje’ project), tax audits are required to give 7 days notice and an amnesty on Polish workers abroad was introduced.

My own personal experience comparing taxes in the UK, US and Poland is that tax codes in the US and UK are generally significantly more complicated in number and spread, for the individual and company. The US tax code is for example six times longer than ‘War and Peace’ but even that doesn’t match the UK code, which is the longest in the world. The codes have grown longer and longer during successive governments as each one introduces new taxes or tax credits depending on the needs and political motivations of the day. Such complexity increases the cost of tax submissions (Accountants, lawyers, finance department time) and encourages tax avoidance. While in the UK, US and Canada taxes that target properties are more widespread, it should be noted the OECD has actually put forward higher and wider property and environmental taxes, as a possible way for the Polish government to raise tax revenue and reduce distorting labor related taxation.

Everyone loves to hate the taxman, and Poland is no exception justified in the past by high taxes, poor administration and paper and people intensive processes. Much has since been done to improve the system, but further reform is needed, to move it up from 151st place and support and not impede a vibrant, fast growing economy.