EU Commission warns Hungary on "distortionary" taxes

BUDAPEST Wed Nov 7, 2012 7:05am EST

BUDAPEST (Reuters) - The European Commission warned Hungary on Wednesday that "distortionary" taxes would dent economic growth over time even if the country was set to have a budget deficit below the 3 percent ceiling this year and next.

The EU's executive also noted there was "considerable uncertainty" regarding the International Monetary Fund and European Union financial assistance to Hungary that Prime Minister Viktor Orban's government requested nearly a year ago.

The government has said the Commission's assessment of its latest fiscal measures could have a bearing on the IMF/EU talks.

Orban's government announced two deficit-cutting packages last month, geared mainly towards tax hikes, as the indebted central European nation struggles to keep a low deficit and escape fiscal penalties after years of missed budgetary goals.

The measures, Budapest said were worth a combined 764 billion forints ($3.46 billion), included reneging on a pledge to halve Europe's highest bank levy, doubling a new financial transaction tax and special levies on public utilities.

"The net effect of these corrective packages is estimated to be around 1.5 percent of GDP, also including negative growth effects," the Commission said in its autumn economic forecasts. "These latter are relatively limited in the short run but will increase substantially over time."

"The economy is characterized by weak potential growth, partly caused by policy uncertainty and increasingly distortionary taxes, most notably very high extra burdens on the financial sector," it said.

Budapest, which hopes to avoid the loss of millions of euros of vital EU cohesion funding that could deal a further blow to its moribund economy, is aiming for a deficit of 2.7 percent of gross domestic product for both 2012 and 2013.

The Commission said even with the government's latest measures, Hungary would just scrape below the 3 percent of GDP threshold next year if extraordinary budget reserves worth 1.75 percent of GDP are cancelled to offset expected slippage.

It added that a potential adverse decision by the European Court of Justice on a special tax levied on telecommunications companies in 2010-2012 posed a further risk to the deficit.

The Commission did not accept several of Hungary's numbers, projecting lower income from enhanced tax collection and savings from an IMF/EU deal and warned of potential slippages due to implementations risks of some savings steps.

After a recession in 2012, the Commission sees economic growth of just 0.3 percent in Hungary next year, a third of the government's 0.9 percent forecast, and said the deficit could again rise above the 3 percent mark in 2014. ($1 = 220.7 Hungarian forints) (Reporting by Gergely Szakacs. Editing by Jeremy Gaunt.)