Evaluating the 2011 Budget

• Hungary’s draft budget for 2011 aims to keep the deficit at less than 3% of GDP, meeting the Maastricht criteria for euro adoption for the first time since 1995. Nonetheless, Hungary may still run into conflicts with the European Union’s power brokers. The government seems to think that its budget-deficit achievement will keep the EU quiet for the time being, leaving Hungary free to blaze its own trail in global politics. Specifically, the administration wants to establish tighter bonds with eastern countries, especially Russia and China, while putting pressure on multinational companies at home. This may run afoul of Western European economic and political interests.
• The draft budget foresees 3.5% inflation and 3% GDP growth for 2011. The inflation number matches most analysts’ forecasts, but the economic-growth projection appears somewhat rosier than most expectations: Most analysts see GDP rising 2-2.5% next year. The budget’s authors made their 3% forecast for PR reasons: If the governing Fidesz party were to lower its growth forecast, it would be admitting that the administration’s fiscal measures (especially the business-sector surtaxes) will slow the economy down. Even if GDP grows less than 3%, the government will have no trouble reaching the budget-deficit target.
• The state’s spending priorities are more or less unchanged from the previous two budgets. The government is not going to implement wide-ranging structural reforms next year – at most, it will begin preparing them.

   

  The most important changes on the spending side for 2011 are:

  1. The value of pensions will rise faster than inflation. The government wants to prove that the state retirement system is safer and offers better advantages than privately managed pension funds.
  2. The government will devote HUF 34 billion (€124.9 million) more to public security than in 2010, with a special emphasis on putting 2,100 more police on the streets (mostly outside Budapest). This will kill two birds with one stone: First, dramatically boosting the number of police officers obviates the need for public-security reforms; second, Fidesz can poach an important political issue from the law-and-order Jobbik party.
  3. The government will cut the number of public-sector workers by 5-10%. The layoffs are not part of a larger reform framework and they will only save the government a few tens of billions of forints. However, 20,000-25,000 jobless public-sector workers may provide a significant base for political attacks from the government’s opponents.
  4. Net welfare payouts will decline: The government ostensibly wants to increase the labor supply by cutting state support to inactive working-age Hungarians.
  5. Two of the most significant spending-side items are the decisions to cut funding for municipalities and to keep healthcare spending equal to 2010 levels (in real terms). These measures are a harbinger of the administration’s plans to consolidate the healthcare sector next year. The prime element will be transferring control of medical institutions from cities and counties to the central government.

• On the revenue side, the administration managed to create massive room for maneuver despite its budget-deficit obligations. The four “crisis taxes” (surtaxes on the financial, energy, telecommunications and retail sectors) will add an extra HUF 350 billion in tax receipts next year, and the decision to transfer all private pension-fund contributions to the state-retirement system will generate just as much. The most uncertain part of the government’s spending plan is the revenue it will receive from workers who transfer into the state system. The administration predicts 90% of people in the private pension system will join the government scheme, adding HUF 2.5 trillion (nearly 10% of GDP) to state coffers. Direct nationalization of private-retirement funds is unlikely, but the administration will probably change regulations and incentives to encourage as many people as possible to abandon their privately managed plans.

• The uncertainty over the number of workers who will actually join the state system does not pose a direct threat to the budget: Only a fraction of this money has been appropriated for specific items. The government would use HUF 530 billion of the total sum for next year’s budget; the rest would probably go toward reducing state debt.
• State debt is expected to decline, so it is possible that the government will improve its performance in all the Maastricht criteria in 2011. This, in turn, will bolster Hungary’s negotiating position vis-á-vis the EU.
• The other significant revenue-side element is tax cuts. The first phase of Fidesz’s flat-tax system (basically, getting rid of the top tax bracket) plus corporate-tax cuts will siphon HUF 400-500 billion out of the budget.  The crisis taxes and the withholding of private-pension contributions will more than compensate for this drop in state income.

• By increasing its room for fiscal maneuver in the short term, Hungary’s government has raised risks for the medium term: The “crisis taxes” will expire after two years and the effort to eliminate private-pension funds will mean greater burdens for the state in the long term. There is also a risk in the fact that the government wants to create the region’s most competitive tax system while keeping state spending at 8-10% higher than in Hungary’s neighbors (in terms of GDP).
• In essence, the government created greater fiscal leeway for 2011 by borrowing money from the future. This strategy can only be successful if the government’s other policy goals – raising the birth rate, job creation, higher GDP growth, curbing off-the-books employment – bring the kind of results that are capable of generating new tax income when the 2011 revenue sources eventually dry up.