Show Me Your Taxes, and I’ll Tell You If You’re Central European

CEE countries keep their taxes lower than Western states. In this way, they effectively bridge the gap in economic development between the two parts of Europe.

central europe taxes
Photo: Daenin / stock.adobe.com

“In this world, nothing can be said to be certain, except death and taxes,” wrote Benjamin Franklin in a letter in 1789. Nothing has changed in this respect for the next two centuries. And just as for the years to come, we have virtually no influence on deaths, whereas we have a great deal of influence on taxes. Therefore, there is virtually no discussion about death, while discussions about how much of our earnings we should hand over to the tax office continue.

Joseph Stiglitz, the 2001 Nobel Prize in Economics winner, recently proposed that a 70% tax should be imposed on the wealthiest. He also agreed with the idea of putting an extra 2% tax on people with assets of more than USD 50 million and 3% on those with more than USD 1 billion. According to him, this is the best way to fight wealth inequality in the world. “Our society gains in having a more egalitarian, cohesive society,” said Stiglitz during an interview.

The proposal put forward by Stiglitz is just an example of how tumultuous the tax discussion can be. For it is also this tribute paid to the state by citizens that constantly stir emotions, often controversy. It also generates divisions between countries. An analysis of the tax systems of the European Union countries reveals differences between the states of the “old Union” and its new members, who became members of the Community after 2004. What are the reasons for these differences?

Taxes vs. economy

Generally, EU member states shape their fiscal policy independently. The European Union, which attaches so much importance to regulation and likes to put its bureaucratic stamp on different areas of life, has very little to say in this case. While it is often heard that the EU should have a greater say in tax matters and work to harmonize (or at least approximate) tax rates across countries, this concept has so far failed to take shape. Although 19 of the 27 EU countries use the same currency (the euro), Brussels only keeps an eye on the general framework within states.

With regard to direct taxation, the EU’s role boils down to activities related to harmonizing national decisions – that helps, for example, prevent tax avoidance or double taxation. In terms of indirect taxation, the EU has a bigger authority, ensuring that the tax systems of individual countries do not interfere with the principles of free competition and the free movement of goods and services within EU countries. But here, too, the relevance of the Brussels regulations is severely limited, coming down to VAT height. The EU has set its minimum rate of this tax at 15% – precisely so as not to disrupt economic relations within the community.

As a general rule, however, the burden of regulating tax lies with the member states. Each country can compose its own tax system exactly as it sees fit. And each country frames it in such a way as to support its own society and economy as effectively as possible. This can be described by the principle: show me how high taxes are in your country, and I will tell you how dynamic the economy is. Indeed, there is a clear correlation between the GDP per capita and the level of taxes in each country. And this is also seen in the difference between the old member states and the countries that joined the EU after 2004.

When taxes are beneficial for GDP

This difference is precisely seen when analyzing rates of personal income taxes. Most EU countries have a progressive tax structure, meaning citizens pay higher rates when they earn more. And when considering the maximum personal income tax rates, the line between Central Europe and the rest of the EU is very clear. At the bottom of such a list are the former communist countries and at the top (except Slovenia) the former European Economic Community (EEC, the name of EU before the Maastricht Treaty in 1992) countries. The highest personal taxes are paid in Finland (56.95%), Denmark (55.9%), Austria (55%), Sweden (52.9%), and Belgium (50%). The lowest – in Romania and Bulgaria (both 10%), Hungary (15%), Estonia and Lithuania (both 20%).

The picture is more mixed when considering the corporate tax rates in the EU, but here, too, the difference between post-communist member states and old member states is maintained. Countries with the highest corporate tax rates are Malta (35%), Germany (30%), France (26.5%), Austria (25%), Belgium, Netherlands, and Spain (all 25%). The nations with the lowest are Hungary (9%), Bulgaria (10%), Cyprus (12.5%), Ireland (12.5%), Lithuania (15%), Romania (16%), and Croatia (18%). Stark contrast.

A similar contrast between EU countries is observed when their GDP per capita is compared. Western countries top the list, while Central European countries are at the bottom. Thus, the ranking opens Luxembourg (268%, when 100% is the EU average). Later go Ireland (219%), Denmark (133%), Netherlands (130%), and Austria (123%). At the end of this ranking are Bulgaria (57%), Greece (64%), Slovakia (69%), Croatia (70%), Latvia (72%), and Romania (74%). Post-communist countries have yet to achieve the level of the European average. The Czech Republic comes closest to this goal with 92% of GDP per capita.

But by analyzing per capita GDP data, one can see the pace at which the former post-communist countries are developing. For instance, in 2016, Czechia achieved 89% of the EU average. Bulgaria – 49%. Romania – 59%, Croatia – 62%, Latvia – 66%. Lithuania has made the most significant progress (apart from Romania), jumping from 76% of the EU average in 2016 to 89% in 2021. This is what it looks like in practice to overcome the backwardness of civilization after years of the central planning characteristic of communist systems.

Central Europe taxes – to catch up with the West

This progress of most Central European countries (between 2016 and 2021, only Slovakia recorded a slight decrease in GDP per capita measured against the EU average) is related to the tax system in these countries. “There is also evidence that flattening the tax schedule could be beneficial for GDP per capita, notably by favoring entrepreneurship,” posited a report by the Organization for Economic Cooperation and Development (OECD).

Obviously, tax levels alone – however perfectly regulated – will not create an efficient, dynamic economy. But it is also easier to achieve the goal of rapid growth with properly composed tax rates. Low taxes often act as an incentive for entrepreneurial people. Post-communist countries, having to catch up with civilization, stick to this rule. They are not leaders in discussions about taxes for the richest as Joseph Stiglitz – it is not their pair of shoes. Instead, they try to keep their tax system enhancing people to earn money. And in this way, it bridges the gap separating them from the most developed countries of the continent. With each year, they are closer and closer to that goal.

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