The energy crisis and the Hungarian tax regime

Can a tax reform help in preventing recession?

energy crisis

Can companies operate productively in the current Hungarian tax environment? Should the Hungarian tax regime be changed in the wake of the energy crisis and if yes, which part of it? What can the government and the central bank do, and what can companies do, to avoid the threat of recession? These are just some of the questions I want to answer in my current analysis.

Whether companies are able to operate successfully in the current Hungarian tax environment is not primarily an issue of corporate decisions made in response to changes in the tax environment. It is much more about the tax regime being able to ensure the necessary revenues for the state budget alongside a fair share of public burdens in this changed macroeconomic environment (energy crisis, soaring inflation, rising loan interest, high HUF exchange rate).

The tax regime has not actually changed substantially in the past 10-12 years after it was transformed from a system aimed at taxing income into a system focusing on taxing consumption. And although the implementation of new sector-specific taxes and the significant restriction of the preferential taxation of low tax bracket entities will mean an extra burden for many, it is not these changes that represent the main challenges for the majority of companies.

What solutions can a Hungarian tax reform offer for the challenges of the energy crisis?

For a real discussion of the issue and to take the necessary measures it is worth examining the changes expected in central budget revenues in the wake of the changes in macroeconomic conditions, and the responses to be given to this through the tax regime.

The multiple increases in energy prices represent the greatest challenge for companies now, not least because other factors of the macro-environment (inflation, interest rate levels, HUF exchange rate) are also changing, primarily due to the energy crisis.

The energy crisis – the rise in gas and electricity prices – has almost brought certain companies to their knees, but the majority of businesses are building these increases into the prices of their products and services, which will lead to overheated inflation pressure affecting not only Hungary but also the whole of Europe. The Hungarian tax regime will be the first to profit from this change since high inflation will chiefly generate extra revenues in a system that focuses primarily on VAT and consumption tax revenues. However, a system taxing income with low tax rates cannot really deliver additional benefits for companies or private individuals that could even partially compensate for the extra costs caused by inflation. Falling income will result in decreased investment by companies and postponed or reduced consumption by private individuals which, in the end, will have a negative impact on the VAT revenues that are the main source of Hungarian state revenues.

In the longer term this all may stall economic growth, and according to certain market analysts, tip the economy into recession. What can the government and the central bank do, and what can companies do, to prevent this negative process?

To keep taxes on consumption – its main revenue source – at the same level, the government can do most by taking measures facilitating the retention of workplaces. Taxing the extra profit has served the short-term interests of the state budget and enabled a partial upkeep of utility cost cuts. In the medium and long term, the job-keeping subsidies tried and tested during the Covid period may become necessary.

What is the reason for the increase in the Hungarian base rate?

The central bank, as the main authority over monetary policy, is not in an easy position. The energy crisis blighting Europe the most has had a significantly negative effect on the EUR/USD exchange rate, but the exchange rates of the Central Eastern European currencies, including the forint, have suffered even greater losses and fluctuated more than usual because of market uncertainty. The highest EUR/HUF exchange rate of the past 12 months exceeded the lowest rate recorded on 16 September 2021 by almost 20%, and in terms of the volatility of the exchange rate, it speaks volumes that the daily maximum (426.33) of the EUR/HUF exchange rate was more than 8% higher than its daily minimum (393.04) in the past six weeks alone.

No wonder then that the central bank is seeking to harness the exchange rate and thus inflation by continuously increasing the base rate and the benchmark deposit rate. Although this has not been fully achieved even by raising the base rate to 13%, it is definitely the right approach that the inflation-mitigating measures of the central bank and the government are in harmony. The drastic increase in the interest rate will obviously not facilitate economic growth, but it plays an important role in maintaining an equilibrium. However, once the recession pressures fade (which depends greatly on developments in the global economy of course), it is pivotal that the opposing, growth-inducing measures of the central bank and the government are taken at the right time, in a concerted manner.

How can companies react to the challenges?

The leeway of companies is rather limited due to the reasons listed above. The first measures taken in response to the initial signs of the energy crisis were often double-digit price hikes. Measures cutting costs and postponing projects were also taken simultaneously. In the medium and long term we need to prepare for a change in the labour market. To limit potential redundancies induced by declining profitability, the government may need to put together a package of subsidies to help retain jobs. Companies may contribute to this with responsible long-term workforce planning.

In short, coordinated action by market players can give the right answers to the challenges that lie ahead of us. The government can do the most to keep economic processes on track by leaving the basic pillars of the Hungarian tax regime unchanged, or potentially fine-tuning them, while bearing the importance of predictability in mind.

Our tax advisers have been drafting proposals to streamline the Hungarian tax regime since our company was formed to facilitate and optimise the taxation of our clients. We have successfully pushed our proposals through the Hungarian tax administration systems and decision-makers several times. Although the current macroeconomic situation and the energy crisis raise more serious questions than ever before, we will do our best to offer up-to-date and tailored economic and tax solutions for our clients. Feel free to contact us.

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