Modest Changes, Beautifully Wrapped

The Polish government has announced a set of planned economic changes, reducing some taxes and increasing social spending. This move came immediately after a serious blow for the ruling Law and Justice party connected with the mishandling of the issue of high bonuses paid to ministers.  The issue itself was greatly exaggerated. Nevertheless, the public reaction was quite angry, and the opinion polls indicated a painful fall of support for the government.

As local elections are scheduled for the autumn, Law and Justice seemed to be determined to repair the PR damage. Therefore, Prime Minister Mateusz Morawiecki immediately announced a proposal of a five-pack of pro- business and pro-social moves. The package included: reduction of the CIT rate paid by small firms (from 15 per cent to 9 per cent, one of the lowest CIT rates in the EU), reduction of the social security contributions for small firms, a benefit of 300 zloty per year for every child (to help cover expenditures connected with the education), a special 5 billion zloty fund for the development of local roads over next few years, and a multi-annual programme of support for the mobility of elderly and handicapped people (23 billion zloty in 2018-25).

At first glance, the five-pack looks impressive.  However, closer examination reveals its reduced scale – presented in a very big PR box.

The best example is the CIT reduction. Indeed, the reduction of the tax rate is quite aggressive.  However, it applies to a limited number of firms only. In Poland small firms have a choice of registering either as commercial law partnerships taxed through the CIT, or in a form of personal economic activity taxed through the PIT.  The CIT rate for small firms currently stands at 15 per cent (and this rate is going to be cut to 9 per cent) against the PIT flat rate of 19 per cent for personal economic activity. However, the attractiveness of the CIT for small firms is reduced by the fact that profit is double-taxed, as the dividends are subject to the PIT flat tax rate of 19 per cent. Altogether, the profitability of choosing the CIT or PIT form of taxation depends on many factors that may be specific for a firm, that include the profit to costs ratio and the share of the profits that are normally paid in dividends.  Another factor that plays a role is a much more tiresome (and costly) administrative burden in the case of commercial law partnerships.  The bottom line is that, with the current tax rates, only 10 per cent of small firms have chosen to pay taxes in the form of the CIT.

Therefore, the effect of the proposed CIT tax cut is quite small. The minority of small firms currently opting for the CIT will definitely pay less, and a certain number of small firms may decide to shift from PIT to CIT.  However, the total cost of such changes for the budget is estimated at 0,4-0,5 billion zloty, or the equivalent of 0.02 per cent of GDP (or 0.15 per cent of the total tax revenue).  A loss that the minister of finance will hardly notice.

The story is quite similar for the other elements of the five-pack.  The reduction of the social security contributions, quite desirable but selective, is likely to cost even less than the CIT reduction.  The new child benefit, albeit costs 1,5 billion zloty, replaces an existing programme of free textbooks for pupils.  The fund for local roads may be financed from various sources, not only from the budget, and may lead to the extra expenditure of 1.5-2 billion PLN per year.  And the mobility program is going to be financed mainly form the EU funds.  Altogether, the whole five-pack may lead to the extra expenditure or revenue loss for the public finances adding up to a maximum of 5-6 billion zloty per year (0.25% of GDP), or even less if more funding is found outside the budget.

Given that the economy is booming, mainly due to growing consumption and increasing exports, and the public finances are in quite a good shape, with the deficit of -1.7 per cent of GDP, financing the expenditure of such a scale is not a big problem.  As far as the government has full control over spending, it is not difficult to offer modest, but beautifully-wrapped tax reductions or expenditure increasing proposals.  The risk is somewhere else: the policy aimed at stimulating consumption on the one hand, and the fast-growing wages in the private sector on the other will, undoubtedly, lead to a wave of wage increase demands in the public sector.  If such demands combine with the economic slowdown, the situation of the Polish public finances may rapidly deteriorate.

The views expressed in this opinion editorial are the author’s own and do not necessarily reflect Emerging Europe’s editorial policy. 

About the author

Witold M. Orłowski

Witold M. Orłowski

Professor Witold Orłowski is Chief Economic Adviser for PricewaterhouseCoopers in Poland, Director of the Warsaw University of Technology Business School and a former Member of the Prime Minister’s Economic Council. In 2011, he was appointed Special Adviser (budget) to the European Commission. He was adviser to Leszek Balcerowicz and Head of Economic Advisory Council to the Polish President, Aleksander Kwaśniewski.
Twitter: @WitoldOrowski

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