An opportunity for real economic stimulus
Arkadiusz Garbarczyk is senior economist in the financial markets department of BRE Bank.
At the beginning of June the president of the Central Statistical Office (GUS) presented an economic report to the government. The report indicated signs of a recovery in domestic economic activity. According to GUS, in April 2003 industrial production output was higher than the previous month, also posting an 8.3-percent year-on-year jump, but at the same time the construction sector showed signs of deep recession, with a 20-percent year-on-year fall in activity. This and some other data allowed GUS to conclude that Poland's GDP may grow by 3 percent in 2003 - the same forecast as the market consensus. But the problem with this report is that it contains only numbers, and in no way does it explain the economic mechanism which may have produced such a "strange" set of statistical numbers.
First of all, it's true that we have put the trough of the recession behind us. It's worth considering for a moment the nature of the business cycle. In the boom phase, with its attendant high demand levels, it's relatively easy to survive on the market, meaning that the minimal required level of efficiency for a firm to survive is decreasing. A recession period is a time of verification; unprofitable enterprises go bankrupt, unit labor costs decrease, the unemployment rate rises. This pattern matches exactly Poland's situation in 2001-2002. But for the last few months cost reduction in enterprises, together with the appreciation tendency of the euro, resulted in strong export growth. Polish exports became the main source of GDP growth in last few months, and this is even more significant when taking into account that GDP growth in the euro zone is very low - just about zero.
But the economy has gone one step further. For the last few months output capacity utilization has been increasing, as have the financial results of enterprises (especially in the first quarter of 2003). Higher capacity utilization will result in a higher investment dynamic in the future and better financial results will supply another source of investment financing. Hence the conclusion that the government should focus on investment support is a little bit strange. Of course it is obvious that investments are very important for long-term growth, but on the other hand an increase in the tax burden to finance state investment could cause a slowdown in GDP growth in the long term. In my opinion, a much more useful activity, from the point of view of stimulating economic growth, would to be to review the application processes for things such as setting up a company or obtaining the necessary permits to build a home. Today's system wastes a lot of time and is quite irritating, due to all the documentation you have to provide and forms you have to fill out.
Nevertheless the flat-rate tax idea presented by entrepreneurs - despite the fact that it is rather unpopular within the ruling SLD party, government and parliament, and probably completely unpopular with tax officers (simpler taxation means lower demand for tax officers) - is not only worth considering but it may significantly boost GDP growth in the future. For me personally, two arguments are crucial in assessing this proposal: First, a simpler tax collection system would shift resources to the production or services sectors of the economy; second, the unit cost of labor would decrease, implicitly meaning improved competitiveness of goods produced in Poland. Additionally, if you happen to be a fan of that school of economics that emphasizes the importance of government intervention, this should provide you with another argument: adoption of a flat-rate tax will generate significant fiscal stimulus for the economy. Nominal disposable income will grow by around 2 percent for those who pay the 19-percent tax. According to Finance Ministry estimates, this would apply to 95 percent of those who pay taxes and for other groups the fiscal gain will be even higher. GDP growth in 2004 would be above 5 percent, provided that Economy, Labor and Social Policy Minister Jerzy Hausner's flat-rate tax proposal is adopted.
Nonetheless, there are no free lunches in modern economics. I have no doubt that, if the flat-rate tax is adopted, the budget deficit will jump to around 7 percent of GDP, and this would only happen with some cuts in expenditures. This will postpone Poland's entry into the euro zone at least until 2009 (as budget deficit reduction is quite time consuming), which is, by the way, the preferred date of the European Commission. In this scenario, inflation would also increase, but from today's perspective this seems not to be the most significant problem, with the consumer price index hovering around 0.5 percent year-on-year.
It's not impossible that the flat-rate tax proposal will be accepted by parliament, but it seems to me very unlikely to happen, and not sooner than 2005. Unfortunately the flat-rate tax is not a social-democratic solution to the country's fiscal problems, and therefore tax reform will probably end with an increase in the initial tax-free amount. This would also generate a demand stimulus, but the chance to make the tax system more clear and understandable for people will be lost again - as always.
