What the CIT rate cut would mean for business

Andrzej Wilk is chief of the advisory committee of the Polish Confederation of Private Employers (PKPP).

We are currently in the midst of a discussion about reducing the corporate income tax (CIT) rate, a discussion spurned by the country's very low growth rate in recent years, amounting to one percent in 2001 and 1.3 percent in 2002.

The fundamental cause of the slowdown was a reduction in the rate of consumption and savings. The last few years witnessed a 20-percent reduction in domestic investment, the source of which is primarily savings. In the public and private sectors savings reached a level of 22 percent of GDP during the high-growth years in the 1990s, consequently falling to 16 percent of GDP during the recent slowdown. Household savings amount to 10 percent, while the public sector has virtually no significant savings. In the context of advanced economies, these figures are low.

Economic development has been based on consumption of foreign savings in the form of loans, direct investment and other instruments. Foreign direct investment has played the most significant role, and that contributor to growth has been shrinking since 2000.

Research and development budgets are shrinking, and currently amount to 0.7 percent of GDP, compared to 0.9 percent in Hungary and 1.4 percent in the Czech Republic. This indicates a slowdown in the introduction of new technologies and products.

The public sector still accounts for some 30 percent of GDP, considerably higher than in most market economies. Predictably, the private sector has been recording better financial results than the public sector.

Indices of gross sales profitability and capital gains on assets have been low. Throughout the post-1989 economic transformation period, the large-company sector has been unprofitable, due to high losses posted by state-owned enterprises. The debt level in enterprises is growing, and large companies account for the lion's share of that increase. Liquidity in the economy is too low to guarantee financial security.

The debt levels of large public sector companies are beginning to exceed payable amounts, and they represent a threat to the stability of public finances. At the end of 2002, the entirety of the large and medium-sized enterprises sector, as defined by the obligation to file F-01 financial reports, recorded a total loss of zł. 1.96 billion (e89 billion), although the private sector posted a profit of nearly zł. 4 billion (e901 million), while public sector enterprises offset this gain with a loss of zł. 5.9 billion (e1.33 billion).

Gross profitability of these companies grew 0.7 percent in 2001 and 0.8 percent in 2002, while net profitability after taxes went from minus 0.3 percent in 2001 to minus 0.2 percent in 2002. Liquidity indicators for the enterprise sector were below minimum standards.

These indicators of the poor financial state of the enterprise sector are reinforced by the sector's indebtedness level, which rose from

zł. 395.6 billion (e442 million) in 2001 to zł. 406.7 billion (e91.5 billion) in 2002. The latter number is equivalent to more than 54 percent of GDP during the period. Any regulation of payment deadlines for goods and services will not change the level of corporate debt, and will only contribute to higher costs and lower income.

It is with this context in mind that we should analyze the government's decision to reduce the CIT rate from 27 percent to 19 percent. The results of this decision would be:

- an increase in net profitability, which for many firms would mean gaining the ability to draw credit lines and an additional increase in financial liquidity

- a halt to the decline in capital spending, and in the coming years a return to growth in capital spending

- reduction of payment entanglements

- stabilization of the employment rate

Budget revenue from the CIT will increase after the adoption of a lower rate, while the additional cash assets of companies will serve to increase their financial stability. However, the rate cut will not change the situation of public sector companies that continue to burden the public purse. The only way to restore these businesses to health is an acceleration of their restructuring processes through privatization.

The advisory committee of PKPP maintains its position that both the CIT and the PIT should be reduced to 18 percent.