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The Center for International Private Enterprise (CIPE) would like to improve access to information for researchers on topics related to small and medium enterprises and draw attention to areas where there is greater need for further information. CIPE is currently compiling a comprehensive bibliography of works related to small- and medium,-sized business (SME) development as well as certain macro-economic areas which affect the environment for SME growth. Specific topics include: local and central government relations, SME financing, cross-border business cooperation, corruption, the role of government in enterprise ownership and industrial policy, access to market information, management training, and improving services of business organizations such as MVA, Chambers, and others.
This reference guide will be used as an resource by analysts, policymakers, and project funders to further SME progress through greater understanding of the available material and to identify new project ideas. To have your organization and its papers, publications or projects listed in this bibliography, please send CIPE a list before January 10 which includes the title, date, and author. In return, you will receive the comprehensive listing for your own reference and use. For more information contact Gábor Géczi, project manager, at (36-1) 269-5654
Detailed Description of Research Project Sponsored by CIPE and the KOPINT-DATORG Foundation for Economic Research
TAXATION AND MARKET ENVIRONMENT OF SMALL AND MEDIUM SIZED ENTERPRISES IN HUNGARY -Research Project
The KOPINT-DATORG Foundation for Economic Research carries out a research project sponsored by CIPE entitled 'Taxation and Market Environment of Small and Medium Sized Enterprises in Hungary'.
Head of the Research Team:
László Csaba, Scientific Advisor, KOPINT-DATORG Ltd.
Tel.: (36-1) 210-1550/2825
Members of the Research Team:
Mária Lackó, Senior Research Fellow,
Institute of Economics, Hungarian Academy of Sciences
Tel.: (36-1) 319-3119, currently: (431) 503-4152
E-mail: gacs@iiasa.ac.at
Katalin Nagy, Managing Director,
KOPINT-DATORG Foundation for Economic Research
Tel.: (36-1) 210-3037
E-mail: katalin.nagy@found.datanet.hu
András Semjén, Senior Research Fellow,
Institute of Economics, Hungarian Academy of Sciences
Tel.: (36-1) 319-3119
E-mail: semjen@econ.core.hu
István János Tóth, Senior Research Fellow,
Institute of Economics, Hungarian Academy of Sciences
Tel.: (36-1) 319-3119
E mail: h13591tot@ella.hu
Research Co-ordinator:
Júlia Orbán, staff member,
KOPINT-DATORG Foundation for Economic Research
Tel.: (36-1) 210-1550/2827
E mail: jorban@mail.datanet.hu
Research Assistants
Mr. Antal Csiszár, student, College for Finance and Accounting
Mr. Zoltán Matheika, staff member, KOPINT-DATORG Ltd.
Mr. Balázs Majer, PhD student, ELTE Hungary
Miss Monika Monori, PhD student, BUE Hungary
Introduction
Small and medium sized enterprises play a key role in economic transformation. While in the early nineties the set-back of the transformation process affected the entire enterprise sector, since 1995, the nadir of the decline, SMEs have been faced with new challenges marked by hopes concerning a prospective upswing. Most of the entities concerned are Hungarian-owned private companies: the entrepreneurial activity of the domestic capital-owning middle strata focuses on this enterprise segment above all. Their role is of exceptional importance as their current market and liquidity positions, credit options, investment activities and attitude to taxation will, to a large extent, determine their technological development/innovation capacity and contacts with export-oriented (mostly foreign-owned) companies using state-of-the-art technology or their integration (as suppliers) into the latters' production processes in the near future.
The present research aims at investigating this enterprise segment to identify the impacts of their market environment in the broad sense, including market relations, technology transfer between SMEs and larger companies, and elements of the taxation system on their costs structure (i.e., distribution and level of labour/capital related costs), long- and short-term economic decisions and future market position.
Objectives
The research project has two purposes: first, to analyse the nature of intra-SME market and technological relations and, second, to define the potential contribution of the sector to the productivity of the national economy.
It will proceed by exploring the new network of market relations having taken shape after the economic transformation of the country from the point of view of the small and medium sized enterprises and will strive to define the characteristics of inter-company relations with the help of the conceptual framework and experiences offered by market sociology. The analysis of the market environment, performance and development capacity of market players is considered a priority objective.
The investigation of the market environment must include an analysis of the influence of environmental elements determined by institutional conditions, rules and standards of behaviour and legislation concerning the SME sector. As for the institutional conditions, it is especially important to study the impacts of the taxation system on enterprise behaviour and market decisions. Several empirical surveys suggest that minor enterprises involved in what are, in general, labour-intensive activities often lose their competitive edge owing to the high unit labour costs determined by the taxes and allowances associated with labour wages and expressed in function of their turnover. This is the main reason why some of the enterprises concerned choose tax avoidance opportunities that may imply higher administration costs, but allows to reduce their tax burdens. This state of affairs, however, is a serious drawback for small and medium sized enterprises when it comes to sharing the benefits of prospective economic growth that could, in view of the proprietary structure of this segment, also influence the long-term development of social structure overall.
In addition to providing a stimulus for the scientific community, we intend to use our findings to call the attention of economic policy organs (the central and local self-governments), interest representation organisations and the enterprises themselves to the typical features of the new challenges and problems to be faced by the small and medium sized enterprises, and to provide this enterprise sector assistance to meet these by a systematic exploration of the problems and causes.
Project Activities
Problems of the taxation system from a SME perspective: Analysis
Economic policy options to promote the development of small and medium sized enterprises
Market relations of small and medium sized enterprises
Stimulating effects of the taxation system
Relationships between the hidden economy and the segments of the labour market - empirical analysis based on Hungarian regional data of 1994-1995
On 26-27. June 1998 an international conference took place in the frame of the CIPE-KOPINT project with the title: Taxation and Market Environment of Small and Medium Sized Enterprises In Hungary.
Information regarding the conference was published in Külgazdaság and also in the web chapter Research Findings - Brief overview. The papers were published in a volume: The Hungarian SME sector development in comparative perspective" and it can be ordered at KOPINT - DATORG Foundation for Economic Research at a price 1100 Forint/copy (plus postage).
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Research Findings - Brief overview
1. The first study has been completed by Mr. András Semjén, the title of which is: "An Analysis of the Problems of the Taxation System from the Perspective of Small and Medium Sized Enterprises"
Summary
The study approaches its subject from several angles: first, it provides a brief overview of the changes in the legal environment that have been instrumental in shaping the current tax environment. Secondly, it attempts to show the imprint of these changes based on an analysis of the revenue structure of the central and general government budget. Thirdly, it attempts to describe the main characteristics of corporate tax subjects in 1996 based on preliminary report data from the National Revenue Service (APEH). Finally, based on some earlier empirical surveys, it analyses corporate taxpaying behaviour and subjective attitudes to tax problems. The primary aim of the study has been to formulate plausible hypotheses, based on the current conditions and available empirical evidence, which will be tested in an empirical study to be conducted at a later time.
Hungary was the first Eastern-European country to introduce a market-oriented tax system. The Hungarian tax system, and consequently the structure of budget revenues, is by and large similar to that of developed market economies. (This is mostly due to the 1987/88 tax reforms.) The fact that the establishment of a tax system meeting the demands of a market economy preceded the formation of the market economy itself resulted in certain problems besides the numerous beneficial effects. The conflict between the administrative demands of tax laws and the administrative capacity of tax authorities has had a prolonged unfavourable effect on general tax morale and on the attitudes of taxpayers and tax administration. An inherent problem of the current tax laws and bookkeeping rules stems from the fact that the reformed tax system does not take inflation into account adequately.
The decade since the launching of the tax reforms has been devoted to continual "fine-tuning." By and large, this process has followed the well-known guidelines derived from the international experience with comparable tax reforms; yet, the constant instability of tax regulations imposes a significant extra administrative burden on corporate entities. The share of corporate tax payments (excluding tax payments from the financial sector) within central budget revenues shrank significantly, roughly to its half, parallel with repeated tax rate cuts; the share of the total payments of corporate entities in the central budget also showed a marked decrease over the six-year period 1990-96. The share of consumption-related taxes was quite stable in the central budget until 1995, with the decrease in the share of excise taxes compensated by an increase in the share of VAT. Following a significant drop earlier on, the share of social security contributions in public finance stabilised at 21-22%. Unlike in the case of corporate tax, the drop in the share of social security contributions occurred with legal contribution rates remaining unchanged, and was due to a massive decrease in employment and to social security tax evasion/avoidance. The share of personal income tax within central government budget revenues showed a slight increase until 1994, then it returned to its previous level. Its role in general government budget revenues, however, has been stabilised and even begun to grow during the same period.
The analysis of corporate tax returns reveals that a significant number of the relatively small enterprises which have opted for single entry bookkeeping have probably been established for tax avoidance (to avoid excessively high wage-related taxes). This is indicated by the fact that the share of these companies in wage costs is disproportionately lower than in total costs, while at the same time their share in dividend payments exceeds their share in costs or in value added, though their share in subscribed capital is negligible. Among smaller companies, a significant number of even those who chose double entry bookkeeping may probably also use dividend payments as a means of tax avoidance. However, due to a lack of proper administrative capacity, the government strategies aimed at reducing tax avoidance within smaller enterprises and expanding revenues by increasing tax and contribution bases can lead to an effect contrary to their intentions, namely a deteriorating tax morale; moreover, the costs of these measures may also exceed the expected increase in revenue.
While smaller enterprises are more likely to avoid wage-related taxes than the bigger ones, the analysis of 1996 corporate tax returns also shows that, despite the uniform legal tax rate, corporate tax is less avoidable for this group and means a greater burden (measured as a ratio of corporate tax payments to total expenses) for them than for the bigger enterprises. This is due to the unequal distribution of tax benefits and adjustments of company income for tax purposes. Within enterprises with double entry bookkeeping, companies with a significant share of foreign ownership are also clearly in a favourable position regarding their access to corporate tax benefits: their effective tax rate is substantially lower than the average and the legal rate. Excluding small enterprises with single entry bookkeeping, the presence or dominance of foreign share in the ownership structure of an enterprise shows a positive correlation with dividend payments and with the ratio of the latter to wages paid. This may be related (through transfer prices) to the favourable tax conditions of this group of enterprises. Amongst enterprises with double entry bookkeeping not only those with a significant foreign ownership share but also large enterprises (where size reflects the number of employees) are likely to have below-average effective tax rates.
According to earlier empirical studies, approximately half of the enterprises surveyed named VAT, pension insurance contributions and corporate tax as their greatest burdens, in that order. Since the different components of the social security contributions (pension and health insurance contributions) were separated in our questions, the above results in no way contradict the generally held view that social security contributions are the greatest tax burden on enterprises.
Enterprises incur additional costs related both to the uncertainties resulting from unclear tax rules and to disputes arising from these uncertainties. The disputes related to the interpretation of tax rules, the procedures for handling corrections necessitated by a taxpayer's error, and the operation of the tax administration are all significant factors in the overall effect of the tax system on enterprises. The ratio of those expressing or partly agreeing with views complaining about overly complicated tax rules increased significantly between 1994 and 1996.
A positive correlation has been found between planned layoffs and deferred tax payments. It can be assumed that enterprises have a tendency to combine different methods of crisis management, namely the postponement of the problems via a deferral of payments vs. facing and handling the crisis by changes in production and sales. There can be a trade-off between postponement and real crisis management as well. The presence of state ownership is in marked positive correlation with late payments of taxes. This confirms the generally held view which associates state ownership with weak tax discipline and a tendency for late payments.
VAT avoiding sales are characteristic of clients of smaller enterprises. Amongst the clients of partly state-owned or foreign-owned enterprises this practice is less typical than the average. Among enterprises with a small number of employees the ratio of employment at very low wage levels is higher than among larger companies. This phenomenon may indicate the prevalence of a particular tax avoidance technique in this subset of enterprises: the use of employment contracts at (or close to) minimum wage and contracting out parallelly more work to the employee-entrepreneur to lower the tax burden. The significant use of fringe benefits in the remuneration package is presumably combined with employment at low wages.
The results of our survey underline the connection between the insecure market position of enterprises and the weakening of financial and contract discipline. Our analysis demonstrates that the uncertainties of market and contractual relations and of the (tax-related) regulatory environment have a stronger effect on smaller enterprises; consequently, these enterprises are more motivated to use various legal and illegal methods of minimising tax payments.
2. The second study is István János Tóth: "Market Networks and Perspectives of Hungarian Enterprises in 1998."
The paper analyses the ability of growing and the interfirm business networks (market influence, buyer-supplier relationships, market competitors, the safety of market networks, ownership relations) among Hungarian enterprises. The data of 290 enterprises are based on a postal survey which concerned basic economic figures (number of employees, net sales, investment), other economic indicators (e.g. ownership structure), estimates and opinions of managers (e.g. division of sales by market segments, competitors, type of market networks) and their future expectations (concerning the growth of wages, number of employees, net sales).
According to our figures, 42% of the firms were founded before 1991 and nearly 80% of them were created before 1994, which shows that the majority of the presently working firms started in the first period of the economic transformation. In 52% Hungarian individuals, in 20% other Hungarian firms and in 12% foreign corporations are the major owners of the firms, meanwhile the ratio of enterprises owned in majority by State institutions or local governments are under 4%. In case of the other firms (12%) there is no major owner.
The survey shows that the number of employees did not increase in 1997. However, the managers expect a considerable growth (3.4%) in 1998. The growth of wages was about 20% in 1997, and the managerial intentions predict an increase of 15% in 1998, therefore we do not expect an exaggerated growth. According to our data, 80-87% of the firms made some investment in 1996 or 1997. However, about half of these investments (1996: 56% and 1997: 47%) did not surpass HUF10m. Thus the average value of investments was low in both years and will probably stay so in 1998.
Net sales expectations for 1998 are more pessimistic (a nominal increase of 19%) than was the record of 1997 (36%). In this respect, there is no significant difference between groups be formed by major owners. Nevertheless, thanks to the exceptional growing rate of some multinational corporations, net sales of firms owned by foreign investors increased much above the average (54%). Meanwhile medium sized and large firms owned by Hungarian private enterprises and foreign companies will be able to increase their net sales much above the average in 1998, the real turnover of firms owned by Hungarian individuals will stagnate or decrease. (In this respect, the impact of industrial branches are not significant.) Therefore we expect that not only the multinational corporations, but also the medium-sized or large domestic firms will play a determinant role in the dynamics of growth.
There is a positive correlation between the size of firms and the dominant market segment. Although a significant amount of small firms (29%) produce mainly to foreign markets, most of the export producers work with more than 100 employees. Foreign buyers are over-representative for the firms in foreign ownership and under-representative for enterprises owned by Hungarian individuals. On the other hand, small firms maintain business relationships typically with other small enterprises. Small firms sell their products and services directly for households or they are the subcontractors of larger, mainly domestic corporations. This picture indicates a three-layered structure: the bottom consists of small enterprises which produce for the local market; in the middle there are the companies which are present in regional markets or in the whole domestic market; the top is formed by the large export producer corporations. Small enterprises owned by Hungarian individuals are rarely subcontractors of large multinational corporations. Even if they export a part of their products, their buyers are directly the households. Consequently, interfirm relationships with foreign companies concern only medium and large Hungarian enterprises.
The analysis shows that Hungarian enterprises work in different market segments. Small firms compete with other small enterprises as large corporations have large competitors; there are rare market networks between firms of different size. Among large firms the main competitors and the most important buyers are selected from the same type of firm.
Only 13% of the analysed firms' business partners did not hurt any financial obligation, while the average ratio of financial rule breakers is 27.2%. Like in 1994 and 1996, foreign companies are concerned less by bad financial discipline of their partners, meanwhile the business relationships of enterprises owned by other Hungarian firms or individuals involve much higher risks in this respect. Public companies were over-representative among firms suffering from liquidity problems, and they also broke the tax rules more frequently; not surprisingly, the are more rule breakers among their partners. In contrast, privately owned companies (Hungarians as well as foreigners) are more disciplined.
The 1997 figures indicate that foreign ownership has a positive, while public ownership has a strong negative impact on the demand of labour and the growth of output. Local market producers could increase the number of employees with significantly less probability than other enterprises. On the other hand, subcontractors of multinational corporations have some more chance (the odds are greater in 3%) to hire new employees. According to the managerial expectancies, the number of employees will increase especially in case of regional market producers, which indicate a small modification of the tendencies of 1997. Foreign ownership probably will have positive impact on market perspectives in 1998 also. Among foreign corporations, the growth of turnover is expected to be much higher than the average. In contrast, the expected turnover of enterprises owned by Hungarian individuals predict a stagnating or even a decreasing result.
3. Mária LACKÓ (MTA Research Center for Economics at the Hungarian Academy of Sciences): Hidden Economy and the Segments of Labour Market in Hungary ( Empirical Analysis Based on Data of Hungarian Counties )
Since the beginning of the 1990s secular events of transition have occurred not only in the ownership patterns but also in the labour market of the Central and East European countries.
A much discussed problem of the economic theory and related empirical research is the effect taxes levied on labour (i.e. income taxes, employers' and employees' social security contribution) have on the labour market. Is it true that at the given total wage cost higher taxes reduce the labour supply, or at given net wages, additional taxes, by increasing labour costs, cut demand for labour in the official economy?
In this work an estimated model helped us to show which factors explain the high level of the hidden economy in Hungary in the middle of 1990s. It was also investigated whether these factors influenced certain other segments of the labour market such as registered unemployment, the ratio of the inactives, the size of passive unemployment and of the self-employed.
According to our hypothesis, the high and increasing ratio of the hidden economy in Hungary can be explained by the high and increasing burden of taxes (income tax, employers' and employees' social security contributions) as well as by the lack of traditions of the tax system and the inefficiency of tax enforcement. At the same time these factors strongly affect various other segments of the labour market: the rate of unemployed and those leaving the labour market on the one hand and the rate of self-employed, on the other, are, ceteris paribus, kept higher by the high tax rates then they would be at smaller tax obligations.
The basic assumption of our model was that electricity is used for production and services in the hidden economy the same way as it is used for production and services in the registered economy. The elaborated model divided electricity consumption into two parts, one of serving final consumption and production in the registered economy, and the other furnishing the hidden economy with electricity.
The model was based on the analysis of cross-sectional county data. A not very strong assumption applied was that in 1994-1995 a uniform model of hidden economy existed across Hungary. The estimation of the model was carried out by the OLSQ method on panel data of Hungarian counties for the years 1994 and 1995.
According to the estimation of the model we found that the share of the electricity consumption of the hidden activities in the broad sense (including household production) were rather similar across the counties. Budapest showed, however, a value more than 30 % above the average of the regions.
Further calculations with the estimated parameters of the model resulted in the share of the hidden economy (in the narrow sense) in GDP on the macro level. According to the calculations this share proved to be 29.8 % in 1994 and 31.3 % in 1995.
It was also shown that taxes levied on employment and wages affected in these years not only the hidden economy, but also the supply of and demand for labour in the official economy. Data did not contradict the hypothesis that the rate of unemployment, the ratio of inactives and passive unemployed were pushed up not only by the low level of GDP but also by high tax obligations of employees and wage costs of employers. It also became clear that the ratio of sole proprietors was also influenced by taxes: while the tax-obligations of employees suppressed this ratio, the wage costs of employers pushed it up.
4. The joint research of István János Tóth and András Semjén "Tax behaviour and financial discipline of Hungarian enterprises" was also completed
Background and objectives
In transition economies the depth and the extent of progress are indicated by the relative importance of the emerging new institutions of the market economy and the share of the private sector within the national economy. Inter-enterprise relations, especially the nature of business relations and changes in financial and contractual discipline can also indicate the advances made in transition. Financial discipline covers two aspects: the discipline of payments (meeting the terms of payments in business transactions without in due time) and fiscal discipline (meeting tax liabilities fully and in due time). While the discipline of payments relates to inter-enterprise (market) relations, fiscal discipline informs us about the relationship between two types of economic agents: businesses and the government.
Due to underdeveloped capital markets and banking sector and the high level of information asymmetry (a typical consequence of the transformation in the enterprise sector) the financial situation of enterprises is known to be much more vulnerable in transition economies than in full-blown market economies (Cornelli et al., 1996). Short-term liquidity problems might lead to grieve long-term repercussions for enterprise survival. In a situation where enterprises lose their markets to a dramatic degree the survival of the enterprise may depend on the temporary relief provided by delaying the payments to suppliers, or to the tax authority (Laki, 1994). Tax arrears became more prevalent in the first years of transformation1. An increased reliance on tax avoidance and evasion can provide another survival strategy: the management's efforts to minimise tax liabilities in a legal or illegal way (i. e. by taking advantage of loopholes in tax laws or by shifting part of the enterprise's output from the visible to the hidden economy) may be of crucial importance. Unreported or underreported economic activities are included in the concept of the hidden economy (Feige, 1989): there is some empirical evidence showing that the share of the hidden economy increased during the first phase of transition (Lackó, 1998).
The above mentioned strategies are micro-level behavioural responses to macroeconomic problems and to changes in the tax environment. As the tax system differentiates between certain enterprise groups treating them rather differently when allocating the access to tax breaks and benefits, there might be important differences in effective tax rates and the perceived tax environment: this will also generate significant differences in the fiscal responses of enterprises. The trends of enterprise level tax behaviour and financial discipline in general deserve a great deal of attention: the interplay between these and certain institutional and/or macroeconomic developments seems to offer an interesting field for research as well.
The present paper is a new phase in an ongoing research process investigating the issues mentioned above. This process was started by the authors about four years ago: the main earlier steps were covered by Semjén, 1995, Tóth and Semjén, 1996, Semjén and Tóth, 1996 and Semjén, 1998. At the beginning the authors' main goal was to investigate the tax behaviour (including attitudes, compliance and awareness) of enterprises at a given point of time using survey techniques. The first enterprise survey was conducted by the authors in 1994 for a rather special sample of small and medium size private enterprises2. A similar survey was made for a more general sample representing medium and bigger enterprises in 1996: 293 enterprises were selected from manufacturing, construction and commerce, having more than 50 employees in each case. In 1998 we conducted a new survey of 300 enterprises. In the present paper we are going to focus on a few selected issues or areas on the basis of these survey data and some other micro data available from tax returns and company balance sheets. (A more detailed comparison of survey and sample characteristics of the data sets used can be found in Table A1.1 in Appendix 1.)
Scope, hypotheses and methods of research
Here we outline the scope of the present research, form some basic hypotheses, and set out the methods of the present research. We want to analyse the interrelations between some objective characteristics and some behavioural responses of enterprises on the basis of empirical data, using a survey method. Many different fields of tax behaviour will recovered, and in each field the researcher can test several interesting hypotheses: some of these were already dealt with in (Semjén, 1998). We are not going to repeat all those here; we will rather concentrate on a few crucial issues instead, and enumerate our detailed hypotheses concerning these issues only at a later stage (when we present our main findings).
There is an issue that will not be dealt with here separately but that will recur from time to time when analysing other issues: this is the impact of changes in business conditions, in macroeconomic environment on behaviour (contractual and fiscal discipline, compliance, etc.) and opinions. Although the main emphasis in this study is on recent trends in tax behaviour based primarily on a 1998 survey, the fact that three similar surveys were conducted by the authors in the last four years allow us to make intertemporal comparisons and draw some interesting conclusions on the development of tax morale and compliance over time. We expect to find that there has been a significant improvement in tax compliance, parallel with better expectations due to an improved business climate.
An important issue relates to the tax environment itself: the differences in the access to tax benefits3, effective tax rates, or the distribution of tax benefits between various enterprise groups will be investigated on the basis of tax return data. Such differences may serve or promote some economic policy objectives; at the same time they might distort the system and can always be criticised on equity grounds.
Contractual and fiscal discipline, tax arrears, delayed payments will also be dealt with in detail. These indicators are expected to reflect the hardening of the budget constraint of enterprises, the consolidation of the institutions of the market economy and the diffusion of the norms prevailing in market economies (cf. Kornai, 1993 and Kornai, 1997).
Legal strategies of enterprises to reduce or minimise tax payments will also be analysed. Earlier research (Tóth - Semjén, 1996) as well as conventional wisdom suggest that such strategies aiming at tax avoidance are especially important to reduce wage-related taxes, to combat the tax wedge. Fringe benefits, employment at substandard wages are commonly used methods in medium or bigger enterprises.
Tax evasion, unreporting or underreporting of economic activities and corporate incomes are also known to be common in the Hungarian economy. Tax evasion is the fiscal aspect of the hidden economy. This is a rather delicate issue, and its analysis requires the use of rather sophisticated methods - however, such difficulties should not deter us from trying to analyse this area.
Changes in the prevailing opinions or subjective judgements of managers about the tax system are expected to reflect not only changes in the legal environment but macroeconomic trends, changes in general business conditions and expectations.
As it was made clear before, the analysis presented below will be based on empirical data, stemming from consecutive enterprise surveys. Some issues will be analysed using tax return data for an enterprise population selected according to similar (though slightly different) criteria4 as the recent survey samples. The samples used for the surveys were randomly selected; to ensure representativity some weighting was used where necessary. Naturally, simple and more sophisticated methods of statistical inference will be used: the distribution of the main variables will be presented and statistical relationships between variables will be analysed using simple cross table results as well as more sophisticated models. Most of our indicators are not continuous and their distribution is far from normal, so the necessary conditions for using the most popular statistical methods (such as regression analysis and correlation) do not hold. However, allowing for some unavoidable compromises and with caveats and precautions, we are going to use analysis of variance to detect statistical relationships between variables. The results of some more sophisticated methods (such as logit and ordered logit estimations) will also be presented where appropriate
5. Main findings
Business climate, macroeconomic conditions and expectations of firms
After 1993 there was a graphic shift from drastic decrease to a modest or moderate increase in investment, production and value added. After the success of the 1995 stabilisation package there was a spontaneous acceleration in business dynamics; growth rates and especially investment growth became more ambitious and even household consumption started to grow. Inflation rates started to diminish gradually, following the drastic rise in l995. It is interesting to see, how these macroeconomic trends are reflected in our survey data. Quite in line with the macro trends, there is a dramatic increase according to the 1998 survey in the share of those companies that expect or witness investment growth. The share of profit making firms also higher in the 1998 survey than in the 1996 data, and the time horizon of company planning also expanded. These signs unambiguously show a better business climate and more optimistic expectations. As mentioned above, we expect that these changes in macro trends and expectations will be reflected in tax behaviour, fiscal and contractual discipline and also in the subjective opinions on the tax system. We will test these hypotheses later, when the above issues come up separately.
It is also worth mentioning that a closer look at the 1998 data would show that there is a relationship between company size (employment) and the time horizon of planning: the smaller the company, the shorter its planning horizon. 52 per cent of companies with 201-300 employees plan for a 3-5 year horizon, while in the whole population this share is estimated only at 31.4 per cent. However, for the few companies above this size the relevant share is somewhat smaller, 43 per cent, but still well above average.
The data also show clearly the increasing openness of the Hungarian economy. Both the share of exporting firms and the share of exports in net sales increased: exports seem to be positively related to company size, and they also depend on sector (manufacturing).
Distribution of the tax burden: effective tax rates and access to tax benefits
Here we can confront or combine survey results with data from the tax return database. Before turning to the results let us recall some of our hypotheses made in (Semjén, 1998):
Despite its uniform legal tax rate the relative burden of the corporate income tax is significantly higher for smaller enterprises than for the big ones (through the uneven distribution of tax allowances and items correcting the operating balance).
Access to tax allowances and tax benefits correlates positively with the share of foreign ownership: effective corporate income tax rates are below average and much smaller than the legal tax rate for companies with a majority foreign ownership stake.
Access to tax allowances and tax benefits correlates positively not only with foreign ownership but with company size (employment) as well.
We expect these hypotheses to hold because giving tax breaks or allowances to foreign investors was a significant feature of Hungarian economic policy from the late eighties for a long time (even at the expense of the transparency of the tax system). Anecdotic evidence also supports that bigger investors were more successful in getting tax preferences than the small ones, despite all the lip service paid to the idea of developing a strong SME sector.
The results from the logit models based on tax return data also show clearly the expected effect of majority foreign ownership: belonging to this ownership category will diminish the effective tax rate by 4 percentage points ceteris paribus as compared to the reference case. Although the effect is clearly significant it does not seem to be as strong as shown in Semjén, 1998, where a 9 per cent effective tax rate was estimated for firms with majority foreign ownership. The explanation may be that other factors (e. g. size, sector and region) also have an effect and these effects may add up: if there is a stochastic relationship between these factors (let's say ownership type and company size), the effects may reinforce each other. As the models explain little of the variance of the dependent variable, we can suspect that some possible explanatory variables are missing: may be a political dummy variable (measuring lobbying power or political contacts) could improve the fit of the models.
The foreign ownership category will significantly increase the tax benefit rate (the rate of tax benefits to the theoretical tax base) or the probability of taking advantage of tax allowances. The expected impact of company size (measured here by employment) can also be demonstrated on these tables.
Contractual and fiscal discipline
In this subchapter we are going to analyse some aspects of contractual and fiscal discipline: the breach of contractual obligations by the respondent firms or by their clients, and the occurrence of tax arrears. To capture fiscal discipline we will use tax arrears. This approach defines fiscal discipline rather narrowly: one could also argue that besides a delay in the payment of tax liabilities an open impingement of tax laws (i. e. tax evasion) should also be considered a breach of fiscal discipline. Nevertheless, this latter phenomenon will not be analysed here: we are going to deal with it somewhat later, in the subchapter on the hidden economy.
As it was expected before, an increasing and impressively high share of companies reported to have met all their contractual obligations. Although there was no explicit hypothesis made in (Semjén, 1998) on the change of contractual and fiscal discipline over time, there was one hypothesis that could probably be closely related:
Tax compliance is being enforced as access to legal credit and capital markets is tied to previous tax compliance records.
The share of those companies that had no payroll tax arrears at the time of the survey decreased by more than ten percentage points and was below 7 per cent6. This decrease reflects the improved macroeconomic conditions as expected. The 6.9 per cent level of companies with payroll tax arrears is especially impressive if we consider that 27.1 per cent of firms reportedly had payroll tax arrears in a longer period (during the two previous years).
If we take a closer look at contractual discipline in the 1998 survey, we find that 15 per cent of the companies reported to have had breached their contractual obligations in 1997. Publicly owned companies as well as companies where the majority of the company is owned by foreign owners or by other domestic companies performed well (better than average) in this respect, while companies with Hungarian private persons as majority owners performed close to the average. Companies in mixed ownership (without any ownership category holding a majority stake) performed rather poorly. The breach of obligations seemed to be far more prevalent in manufacturing than in the other two sectors (the respective rates of "deviant" companies were 12.5; 3.1 and 4.0 in the three sectors).
15 per cent of sales revenues was reportedly received late. While manufacturing companies are close to the average figure, construction companies fare much worse in this respect: they received 24 per cent of their sales revenue late.
Payroll tax arrears occurred in 6.8 per cent of the companies surveyed: they are more typical amongst manufacturing companies than in the other two sectors. Payroll tax arrears are above average amongst companies below 100 employees or with 201-300 employees; and they are least likely for big companies. Ownership type also has an effect in this respect: while "majority foreign" companies met the payroll tax deadlines practically completely, companies with a majority stake in the hands of Hungarian private persons and companies without any kind of clear majority ownership pattern (those in "mixed ownership") seem to have rather low payroll tax discipline (10.5 and 12.8 per cent of companies in these groups had payroll tax arrears). Tax arrears in general occurred at 27 per cent of companies during the last two years; companies in "majority foreign" hands (arrears found in 24.3 per cent of the group) or with a majority stake owned by domestic companies (arrears found in 13.5 per cent of the group) are more disciplined than the others. If we compare the effect of ownership type in 1996 and 1998 on fiscal discipline, we can see that the strong difference between foreign and domestic ownership disappeared from 1996 to 1998. This might indicate a catching-up effect, although the results should be interpreted with some precaution.
Tax avoidance, tax evasion and involvement in the hidden economy7
Tax rules, rates and schedules obviously have a consequence on the behaviour of economic agents. Basically there can be three "pure" types of behaviour, namely tax compliance, tax avoidance and tax evasion. In practice, however, most economic agents take advantage of the possibilities of individual tax planning when selecting the mix of the three behaviours. Tax compliance, avoidance and evasion all have substantial costs: in the case of avoidance one has to employ tax consultants or study the ever changing tax laws; in the case of evasion there is a probability of being caught and there is an expected penalty, and there are also the subjective costs of worrying. The benefits appear mainly as a reduction of tax payments.
Our previous chapters on the scope and the main hypotheses of research and on the change in macroeconomic conditions and business climate already made clear that we expect to find visible and significant changes in the tax behaviour of enterprises as we suppose that there is a relationship between the overall business climate (or economic prosperity) and tax compliance.
We suppose that there is a certain trade-off between macroeconomic conditions and tax rules: if this is true, tighter macroeconomic conditions can have a very similar effect on tax behaviour to tighter tax rules, and, consequently, when there is a significant improvement in macroeconomic conditions this should provoke similar behavioural responses to a relaxation of tax rules. As there has been a significant positive change in business conditions and expectations during the two years between the 1996 and 1998 surveys (and an even more significant change if we include the 1994 survey in the picture), we expect to find better tax compliance, less avoidance and evasion in 1998 than before.
Beside checking this expected development pattern we can also test using the 1998 data some hypotheses that were set out earlier in (Semjén, 1998) based on a preliminary analysis of the 1996 tax returns.
The predominant role of foreign ownership in the ownership pattern of a company is expected to correlate positively with the importance of dividend payments. If the dividend rate (dividends/profit after tax) is found to be above average in this ownership category, this might indicate that such enterprises take advantage of the favourable tax environment through transfer pricing.
A personalised planning of the remuneration package (including devices like employment at substandard wages, subcontracting to businesses operated by employees, wide-spread use of untaxed fringe benefits8 instead of monetary payments, an increased reliance on dividend payments to employee-owners, etc.) is used as a tax planning device to reduce wage related costs, i. e. to avoid taxes.
The share of employment at substandard wages dropped form 1996 to 1997 as could be expected; however, as the same nominal wage level was used in both surveys to determine what is and what is not below the standard, the data are not directly comparable due to inflation, so this is not a decisive result. The ratio of fringe benefits to wages increased: this is the opposite direction. However, this could hardly be interpreted as a disproval of the hypothesis: in the first place, the hypothesis was about tax avoidance through untaxed fringe benefits, while in Hungary most fringe benefits are gradually included in the tax base. On the other hand, an improvement in business conditions might trigger a more generous enterprise behaviour in connection to fringe benefits without any second thought of tax avoidance. So the first and the second questions figured in Table 5 are inconclusive. The interesting one is the third question, and the answers to this clearly demonstrate that improved business climate has a diminishing effect on the relative importance of tax planning through personalised remuneration package.
Our results are somewhat blurry and far from convincing: although the relationship between the occurrence of dividend payments and ownership type can be detected. The odds ratio for companies owned by Hungarian individuals is of the expected sign and size, but it is not significant. Foreign ownership seems to have a significant impact on odds but not in the expected direction. All in all, the hypotheses on the use of dividend payments as a tax avoidance device could not be supported.
The model on fringe benefits does not work well: not only it has very low pseudo R2-s for both years, but the significance level is also unacceptable. The supposed negative relationship between company size and an abuse of fringe benefits cannot be substantiated: the odds do not show the expected tendency. The only promising results came from the estimations for employment at substandard wages. Here we have the expected results both for foreign companies (they are less likely to use this device than the others) and for companies owned by Hungarian individuals (in this group we get very high and significant odds ratios): so we can conclude that companies where a majority ownership stake is in the hands of Hungarian individuals tend to rely on this practice. Nevertheless the data do not confirm that this reliance was intended as a tax avoidance device. It may well be the a consequence of the limited financial possibilities of these companies. So in this case again logit results are somewhat inconclusive.
So far we have dealt with tax avoidance; let us see if we have better luck with an even more delicate issue, tax evasion. It is known from everyday experience that besides company-level tax planning and tax avoidance (i. e. legally acceptable responses to the tax environment) some illegal techniques of minimising tax liabilities (e.g. unreporting or underreporting of sales, employing unregistered labour, etc.) are also used in the Hungarian economy. There is also some evidence (both international and Hungarian) that sector, size and the ownership pattern of businesses may significantly influence the affinity of enterprises to rely on tax evasion. However, owing to the very nature of tax evasion one has to rely mostly on indirect estimations, as no exact direct data can be collected on the occurrence and incidence of these techniques.9
One way to get around the problems of insincere answers for such a touchy question is if we do not ask the enterprises directly about their own behaviour but we ask them to evaluate the behaviour (tax compliance or evasion) of their suppliers and competitors. In this case there is no clear motivation top lie; however, it is impossible to tell to what extent are the answers based on real knowledge or reflect gossips and malevolent hypotheses. The results for unreported sales amongst the firm's suppliers are based on the answers of such questions. The results are again rather poor: the model seems to work for 1996 but not for 1998. The most important of the results apply to the suppliers of firms in majority domestic ownership (owned by domestic company or Hungarian individuals): they were reported to have been more likely to have unreported sales than the suppliers of other categories and this effect is clearly significant for 1996. Actually the failure of the model for 1998 can indirectly prove that there was a significant overall improvement in tax morale: the detailed data allow some interesting comparisons as they contain data from the 1994 survey as well, also corroborate this. It is ironic that competitors reportedly have much worse tax morale than trading partners.
We will not be content with evaluating the rather dubious information given by the firms about their trading partners and competitors, but we will also make an attempt here to estimate the share of tax-evading enterprises in our sample and in the enterprise population somewhat more directly, and we will compare our results with some earlier results to check again if there has been a significant improvement in fiscal discipline or tax compliance recently.
The incidence or frequency of tax fraud (or the share of tax-evading businesses) within the enterprise population can show the extent to which the norms prevailing in full-blown market economies are accepted and observed. If the share of tax fraud is high, it can indicate the prevalence of "wild capitalism" and the relative weakness of tax administration. Changes in this frequency may reflect changes in behaviour or may be due to changes in the composition of enterprise population. Behavioural changes may reflect internal changes in tax morale and law abidance or may as well be triggered by changes in the overall business climate, the perceived risk of tax fraud, the capacity of tax administration to detect unlawful behaviour, etc..
Needless to say once more that tax evasion cannot be estimated directly: one cannot ask a direct question in a survey concerning such a delicate issue and expect the respondent to give a sincere answer. Obviously, some indirect and more sophisticated method must be chosen. The randomised response technique was used here. This technique allows the researcher to estimate the true frequency of replies to especially delicate survey questions in a sample and use statistical inference to arrive at valid statements for the population the sample was selected from. This way delicate issues (such as unconventional sexual behaviour, AIDS infection, drug abuse, or for that matter, tax fraud) may be successfully analysed using survey data.
The method is based on the following: the respondent is given a pack of cards. Each card contains one of two opposite statements (one admitting and one denying the unobservable behaviour or characteristic: in our case one statement admitted and the other denied that the enterprise ever committed tax evasion or fraud). The respondent is then asked to shuffle and draw a card randomly and tell the interviewer without letting him know what the statement on the card actually was, whether the statement is true or false in his case. The proportion of admission (p) and denial cards (1-p) must be determined beforehand in such way that p must not be equal to 0.5; in our survey p= 0.7 was used. The technique allows the researcher to determine the incidence of the studied hidden phenomenon in the population using an estimator based on the relative frequencies of "true" and "false" answers and the given share of cards containing the admission statement10.
In our 1998 survey the estimated rate of tax evasion was 8.8 per cent, and the estimated variance allowed us to estimate a ( 14 per cent 95 per cent confidence interval. As the rate of tax evasion cannot be negative, these results suggest that the true rate of tax evasion in the enterprise population surveyed must be with 95 per cent probability in the (0; 22.8) per cent interval, with a 8.8 per cent mean. These results suggest that there exist some tax evasion, though at 95 per cent probability level these data would not allow us to exclude even the - rather unlikely - case of complete tax compliance in the studied population. If one considers tax evasion a serious crime (in accordance with the Penal Code) even such a low mean crime rate might seem rather high. However, if we contrast this with other estimates on the prevalence of the underground economy in Hungary, the result is quite low.
We are in a fortunate situation as we also made an estimation of tax evasion four years ago that can serve as a natural comparison to our present results. In a previous enterprise survey conducted in 1994, using the same method for a somewhat different sample of small and medium businesses we estimated the incidence of tax evasion at 35.8 ( 15.0 per cent at a 95 per cent confidence level. (cf. Tóth and Semjén, 1996) This led us then to the conclusion that tax evasion is a fairly widespread phenomenon among small and medium-scale entrepreneurs in the Hungarian economy, as this suggests that even in the best case more than 20 per cent of the enterprises have already evaded taxes, while one could not even exclude that more than half of the business population was engaged in such illegal activities to some degree at some point .
So, according to the 1994 survey the conclusion in the best (most optimistic) case was only slightly better than the worst or most pessimistic results in the 1998 survey (20.8 versus 22.8 per cent). What can be the reason of such a drastic change in such a relatively short time?
It is tempting to conclude that these results show that there has been a drastic strengthening of tax morale in the Hungarian economy during this four year period. There are many reasons lending reasonable support to such a belief: first of all, there has been a very significant reduction in the statutory tax rate (The corporate income tax rate was gradually reduced to 36 per cent in the first years of the decade, then from 1995 onwards to 18 per cent. Parallel to this rate reduction the tax base became more comprehensive, so effective tax rates did not diminish that much.). There was also an undeniable improvement in business climate: the move from recession to boom allowed the businesses to breathe more freely, so more and more of them could realise that they can survive even without breaking the rules. Also there might probably have been some improvement in the effectiveness of tax administration during these years (the probability of being caught and punished is likely to have increased), so the expected private "costs" of tax evasion could be higher while the "benefits" were lower in 1998 than in 1994.
Unfortunately there are some crucial differences between the two samples that might be partially responsible for the improvement in tax compliance results. The 1994 sample contained smaller enterprises than the 1998 one, while there prevails a widely accepted belief that there is a positive correlation between business size and tax compliance. Earlier research pointed out that effective tax rates seem to be negatively correlated with business size, and this hypotheses is also supported to some degree by the regression and variance analyses of the 1996 tax return data. So it seems to be justified to argue that the bigger the enterprise the less it is tempted to commit tax fraud. Smaller incentives for evasion might explain better compliance.
Opinions about the taxes and tax regime
Managers' opinions concerning some well-known problems of the Hungarian tax system on the one hand are not very informative as it is always very difficult to avoid the trap of stereotypes and commonplaces; on the other hand, comparing the answers for the same questions in 1996 and 1998 gives an interesting opportunity to measure the level of subjective "satisfaction" with the tax system. There has been no dramatic changes in the tax system during this two year period. If there were any, they made the system only more complex and introduced some extra burdens, while at the same time tax administration improved, became more stringent, loopholes were closed and avoidance became more difficult. So if we find better opinions amongst managers these will have to do with better business climate and not with increasing laxity or an enterprise-friendly change in tax policy.
It is a well-known problem of the Hungarian tax environment that despite lasting and considerably high inflation depreciation rules do not allow for inflation, while asset lives are relatively long. This situation obviously leads to the taxation of illusory profits as real costs of assets cannot be fully be deducted. The significant changes in the answers to the related question (a much smaller proportion considered this a major problem in 1998 than before, while the share of "no problem" answers is also up) show clearly that the seriousness of inflation and the perception of this problem go hand in hand: even a slowly diminishing level of inflation had a beneficial effect on the satisfaction with the tax environment from this particular aspect. The share of opinions mentioning that tax rules change too frequently decreased by two percentage points only - at the same time the share of those enterprises who feel that the extent and frequency of these changes jeopardise of the reliability of their business calculations went down by 20 percentage points. Enterprises having domestic companies as majority owners are the least unhappy about the frequent changes of tax rules ("only" 85.3 per cent of these reported this opinion), and only 35.7 per cent of such enterprises felt that their business calculations were jeopardised by the extent of this changes - at the other end of the scale are companies with Hungarian private persons as majority owners: 59 per cent of these firms felt being jeopardised by the speed and extent of changes. We also tried to detect what are the main factors behind subjective opinions complaining on tax changes jeopardising the reliability of business calculations: The model proved to be a complete failure: fit is extremely bad and none of the variables are significant. This failure could perhaps be explained if we could believe that answers to the respective question reflected more stereotyping than actual personal experience. However, in the light of some results (supporting that there exists a considerable incongruence between personal perception and reflections to general statements on the tax system) this sounds rather unlikely. Perhaps a more valid explanation can be that there are practically no structural differences within the enterprise population as far as opinions on general statements or stereotypes are concerned: the variance of opinions does not show any particular pattern.
It is interesting that although the previous results clearly showed that a smaller percentage of businesses feel personally that the tax system itself puts them at jeopardy, the general opinion about tax legislation is not becoming better. The percentage of firms finding tax legislation overly complicated and tax forms too difficult to understand has been growing steadily. A positive sign, however, that businesses are more satisfied than before with the level of information provided by the tax authority. The share of those thinking that personal contacts with tax officers do matter in settling disputes went down somewhat but much of this change can probably be attributed to differences between the 1994 and 1996-1998 samples (smaller firms might have different experiences that the bigger ones). At the same time the share of those definitely disagreeing with this opinion changed little, and stayed practically the same in the 1996-98 period.
Conclusions
We investigated in our paper the tax burden, tax behaviour and tax assessments of Hungarian companies in connection with some objective data on the economic performance of these companies. Our analysis was based primarily on consecutive enterprise surveys but tax return data were also used when necessary.
Enterprise level data corroborate what is already known from objective macroeconomic indicators: there has been a significant improvement in business conditions. Our results showed that during the last two years this had a significant impact both on tax discipline and on the subjective perception of the tax environment. Due to these changes the extent to which legal norms and contracts are duly observed in the Hungarian ecomomy has been growing. Contractual discipline has also improved. There has also been a significant drop in tax evasion, and consequently our results support that the weight of the hidden economy has been slightly falling.
There is a circular relationship between macroeconomic environment and financial discipline (consisting of the discipline of payments and fiscal discipline): an improvement in the macro environment can promote better financial discipline (as it is supported by our results). At the same time this improved financial discipline will have a beneficial effect at micro level: it will diminish the transaction costs of the companies by reducing the level of uncertainty in inter-enterprise relations and thus it will improve the companies' ability to grow and chances for survival. On the macro level this will have a beneficial effect on the growth prospects of the economy as a whole.
Subjective opinions on the effects of the tax system on the respective companies' business prospects and viability also changed for the better. Interestingly this improvement is hardly reflected in the general opinions on the tax system.
Our results support the hypothesis that large and/or foreign-owned firms have better access to tax benefits than the average, and consequently, effective tax rates are higher for smaller and domestically owned companies. This might be a policy-based obstacle to the strengthening of a domestic small and medium enterprise sector on the long run.
5. International workshop: Taxation and Market Environment of Small and Medium Size Enterprises in Hungary
International conference, 26-27 June, 1998 Budapest
Lecturers and chair(wo)men:
Silvana Malle (OECD)
Horst Brezinski (TU Bergakademie, Freiberg, Germany)
Marie Bohata (CERGE, Praha, Czech Republic)
Mária Laczkó (MTA KTK, Hungary)
István J. Tóth (MTA KTK, Hungary)
András Semjén (MTA KTK, Hungary)
Mihály Koppányi (World Bank Regional Office, Hungary)
Júlia Király (International Training Center for Bankers, Budapest, Hungary)
Mihály Laki (MTA KTK & CEU, Hungary)
László Csaba (Kopint-Datorg, Budapest, Hungary)
György Varga (First Hungarian Fund, Budapest, Hungary)
International outlook
In the Veneto region of Italy, the suitable macroeconomic framework (focusing on the interest-rate and the taxation) and the simplification of the administration processes created a favourable framework for the development of SMEs. Consequently, the present export of this region is equal to the export of Greece and Poland (Malle).
The transformation in East Germany is strongly supported by transfers from the Western part of Germany. (In 1991, half of the East German GDP resulted from net transfers, and even in 1997 their ratio overcame 30%.) However, transfers and public money did not help much SMEs which dominate the present East German economy and which could constitute the source of the future economic growth (Brezinski).
In Czech Republic, besides the claims of SMEs, such as tax burden and access to cheep credits, which are common over the world, entrepreneurs face a specific problem: the badly functioning state, which can be experienced in the ponderous registration of the firms and in the insufficient protection of ownership rights (week enforcement of law, growing criminality, corruption). However, the role of small firms - their share in production and employment - in the Czech economy is continuously growing and the competition within the SME sector is becoming more intensive (Bohata).
Hungary: descriptive analysis of the SME sector
One of the decisive factors which influences the outcome of post-socialist transformation is the adaptive (or learning) capacity of economic agents - households, enterprises as well as other economic institutions. In socialist economies the risk of market entry was relatively low, meanwhile the risk caused by the political system was extremely high (especially in anti reform periods). The efficient strategy of small businesses based on the following methods: temporary interruption of business activities, changing the legal form of the businesses, division of economic activities (e.g. being part-time private entrepreneur and part-time employed by the state), minimisation of the size of the firm and the volume of investment and, finally, the usage of multi-purpose investment (e.g. buildings, cars, infrastructural investments which can be used both by the household and by the small business). In the post-socialist period the advantages of the lower political risks did not counterbalance the increase of riskis and uncertainties on the market. For small businesses, there is less opportunity to divide activities between state and private. The flexible change of legal forms are only very short-term solutions, because the flexible Tax Office changes the rules again and again. Under the conditions of the transformational recession, the new entrepreneurs could not accumulate multi-purpose assets. The most important technology of survival is tax evasion; an other well-known method is slower or delayed paying. The socialist entrepreneurial heritage of small businesses is an important advantage during the post-socialist transformation, but it is not enough for expansion (Laki).
In Hungary the business conditions are much better in 1998 than in the earlier period of the transformation. The weight of hidden economy is slightly falling, and the contractual discipline has improved. The access to tax allowances and tax benefits correlates positively with foreign ownership and company size. The inflation is an important problem in the Hungarian tax environment (Semjén - Tóth).
From the point of view of enterprise grouping, in Hungary three dimensions of segmentation can be determined. These are: foreign vs. domestic ownership, local market vs. wider - regional, national or foreign (export) - markets (Tóth).
The weight of hidden economy correlates positively not only with the burden of taxation on employees and the employers' wage related cots per one employee, but also the number of self-employed. In Hungary this function is especially valid in Budapest.. On the other hand, the number of self-employed has a contradictory impact on the rate of unemployment (Laczkó).
Financing and policy-making
In Hungary, the SMEs are not strong enough to be the main sources of the economic growth. The lack of capital, the rather low level of the used technologies, the bad information networks, the often inappropriate education patterns and the high wage-related costs make the Hungarian SMEs rather incompetitive. The SME-supportive policies should center primarily on these fields (Kopányi).
In the first phase of the transformation corporate finance in Hungary was limited on the financing of the blue chips (multinationals and monopol companies). As the Hungarian banking sector has been consolidating, medium size firms - the future issuers on capital market - are becoming a new field of competition for banks. On the other hand, small firms are suffering from "redlining", a discrimination from the capital market: only 3% of SMEs have received loans at all. The ratio of preferential loans for SMEs are declining. However, special financial vehicles are emerging: the microcredit program of MVA Hungarian Fund for Enterprise Promotion, venture capital, special guarantee funds, network of local banks (saving co-operatives), and the idea of a central SME bank has also appeared. But the financing policy of SMEs does not require a special SME bank; it should be based rather on the local knowledge: the networks of the local enterprise promotion centres and their links with local banks (Király). On the other hand, venture capital is not an appropriate solution for financing SMEs: the "typical venture capitalist" invest in industries with high technological potential (Varga).
The unilateral favouring of large corporations, accepting monopoly positions in some cases, while imposing disproportionate administrative and consolidated tax burdens on the SME sector, are prime cases of regulatory failure which should be remedied. The position of SMEs can improve easily by the development of legislation on public procurement, public information, public finance, competition, registration, reporting and informational sovereignty. However, the growth potential of SMEs, including their coexistence and cooperation with the dominant sector of large multinational corporations are high. The ongoing disinflation and the recovery of domestic market, as well as the favourable role already played by local municipalities in much of the country has had a beneficial role (Csaba).
6. The main conclusions and recommendations of the project were summarised in a paper written by László Csaba: "Recommendations for SME-Supportive Policies in Hungary".
The main purpose of the present CIPE/USAID sponsored project was to offer an up-to-date description of the state of art of SME development and related policies in Hungary. The related international experience puts these findings in a comparative perspective. Empirical investigation proved to be useful in so far as substantially new developments and changes in previous trends could be established, and theoretically relevant statements could be formulated. The international conference, co-organised with EACES, helped produce a feedback and quality control. Also in formulating our policy recommendations we draw on the lively exchange of views provided by this forum.
SME development is generally seen as a weak point in the overall success story of Hungarian transformations. While most analysts do call for more support for SME, to better integrate start-up ventures in the overall economic development, very little is offered in terms other than pious intentions or open vested interest policies. The latter, while fully legitimate in a pluralistic democracy, can by no means accepted as macro or economic considerations, thus should not be treated in this sense. Therefore the present project has come to a somewhat sceptical view over the majority of currently fashionable policy propositions, like sectoral programmes, soft loans, enchanting the public policy role of interest representation, or supporting the regularisation of bookkeeping through special incentives/an idea contrary to the practices of the EU.
SME account for 85 per cent of enterprises and 65 per cent of employment in the OECD region. This defines SME as a major element of social intangibles both in economic and political terms. With the new trends in industrial organisation, enhanced by the spread of PCs, as well as the social disinclination against rigid giant organisations, SME turned into a most promising form. Much of innovation, as well as 70 per cent of new entrepreneurs and managers e.g. in Italy originate from among former employees in this sector. Managerial and entrepreneurial skills are thus often produced by and through this sector. As this feature is relatively weak in Hungary as yet, one of the major tasks of second generational transformation policy in Hungary is precisely in consolidating the SME sector, promoting the ongoing process of microfirms graduating into small and later medium sized ventures.
Hungarian and international experience commonly point towards the overwhelming relevance of the macroframework. When inflation is high, regulation intransparent, interest rates skyrocket or conversely, they are negative, public dues are collected from production and trade rather than from consumption-related items, further when the tax system is non-neutral and/or is captured by vested interest, no amount of targeted SME programmes are likely to overcome the obstacles posed by the inappropriate macroframe.
In Hungary - like in most of OECD-Europe - high public dues, primarily high social security contribution, discourage self-employment and even more the use of legally hired workforce. The only feasible way these contributions could be lowered is through a gradual but thorough reform of overall government spending in general and social security spending in particular. In this area no conspicuous breakthrough seems possible. However strenuous efforts at expenditure reduction may result in the gradual decrease of these dues, should the savings accruing from better targeting, rationalising and of cost-efficient ways of spending practices not be misused for competing claims, especially for those not creating any externality.
A third area where SME promotion could be relevant is lowering the current institutional barriers to new start-ups. Overarching regulation of labour market is a severe problem all across the EU, except Britain and Holland. In Hungary much of the regulatory frame is around, however it is, as yet, mostly or often disregarded. Deregulation in this area may create more employment in the legal sector and discourage employment in the irregular or the grey economy. The use of buildings as a collateral should become easier; legislation pertaining to this and enabling better access to collateral is underway. However much of the seemingly unrelated regulations, protecting e.g. tenants must be eased in order to make the new legislation relevant. While maintaining an open trade regime proved to be an important plus in creating enterpreneur-friendly mesoclimate, setting up a new law on venture capital seems to have missed the point. Under continental conditions, it seems, venture capital is to promote innovative high-tech establishments, rather than the typical Hungarian microfirm, which is to graduate into small business into the legal sector. Moreover actual regulation adopted in Hungary allows for public money to compete for very risky businesses, while financable investment projects in this area are not very numerous.
A fourth area where SME promotion could be relevant is training. While Hungary used to have an edge in secondary and higher education, it is hard to oversee that all Hungarian Nobel-winners, including Oláh and Harsányi, were basically products of the interwar training system. These edges can easily be lost. Enterprise-relevant knowledge need to be produced and transmitted; special training programmes, especially in the depressed areas and particularly for new or lagging behind entrepreneurs, like those of the gypsy minority, should be organised and offered at subsidised prices, by the municipalities in a decentralised order.
Fifth, competition in the financial services sphere is only in the making as yet. While the techniques of most advanced forms of services are already available and for the wealthiest segment they are already in oversupply (Ursprung, J. et al, 1997) most of the large banks have only recently been crowded in to retail banking, and in offering services, rather than making money on T-bills. Especially in provinces most banking, including the financing of municipalities, is dominated by two dinosaurs, the National Savings Bank and Post Bank. Thus access to a most important element of competitiveness is severely limited as yet for many SME. The attitude of banks is well reflected by their angry reaction over the Constitutional Court's outruling the compulsory upper limits on cash payments (Lázin, 1998). The former ruling - as well as the obligatory bank transfer for public sector employees - has, in fact, reinforced monopolies over a captive clientele, which otherwise should have been won, in competition, via better services.
A sixth area where SME promotion could be crucial is efficient and transparent public administration. This is by no means a theoretically new finding, however its relevance has been re-stated by our own surveys, as well as concurring analyses conducted parallely to ours. What entrepreneurs find most deterring is not so much the level of public dues, as much as the intransparent way these are being administered. Retroactive legislation as well as the very high priority allotted to the personal(ised) relationship to the tax administration against open procedures and norms is a clear indication of the long way to be gone before rule of law in this area could be empirically established. Given that search costs, overheads administration fall disproportionately on SME, helping these problem could be a cost-efficient and externality-warranted way of assistance against soft money programmes of various sorts. The latter will probably foster misallocation and enhance competing claims on the grounds of a precedence.
Seventh, the role of physical infrastructure should be re-emphasised. Not necessarily building new motorways, but also modernisation of railways and generally improving physical availability through user-friendly tariffs and timetables can, and as west European experience suggest, does create miracles also in terms of regional development. The externality for the SME sector is thus by definition greater.
An eighth important finding is quite in line with developing country experience. Instead of a large centralised financial institution specialising in SME support, the present project has found, quite in line with the predominant view in the financial sector, that networking among the savings co-operatives, rather then a centrally nominated special agency which is to cope with the problem of SME financing in a cost efficient and flexible manner. Much of the informational asymmetry burdening SME finance and making it unattractive for a classical large financial institution can be overcome by decentral arrangements. Local bankers are better entrenched in local social networks, thus can gain, through informal and social contacts, much of the relevant information otherwise missing over micro and small entrepreneurs. This includes the conduct of their business and the soundness of their family finances. In so doing both risk and risk-assessment is decentralised, its conduct is not confined to processing files and hardly operational indications therein.
As the specialised collateral and farming bank (FHB) is already available, the idea to nominate a politically burdened and financially weakened Post Bank with this task seems to be misplaced. By contrast, supporting more networking among the local savings'cooperatives and encouraging the elaboration of debtors' lists and track records may be a much cheaper and more efficacious way of addressing the same task.
One of the most controversial issues in the project has been the ability and willingness of the microfirms to graduate into SME. The socialist legacy has turned most entrepreneurs of this size extremely cautious, not venturing to expand over a safely overseeable size. However, as Hungarian and international evidence suggests, growing over a certain size means not only a clear commitment in terms of money advanced, and wealth frozen, into a given activity. It also acts as an incentive to leave the irregular economy and graduate into normal business. A corner shop run by employees rather than by the owner might be the first place where selling under the counter might cease. But for this process availability or lack of the above listed institutions, costs of securing property rights, as well as of enforcing contracts might be of crucial importance.
Also this is the phase where financial services and bearable credit costs may come in. Consolidation of the Hungarian banking sector, followed by its privatisation, as well as disinflation and the growing competition in financial services, also supported by the OECD-inspired liberalisation together may bring about the previously non-existent conditions in the years to come. With a series of rulings enforcing proprietary rights, and with the threat of nationalisations vanishing, with experience and also due to OECD/EU/NATO membership, the inherited behaviour of microfirms may gradually change and their ability and wish to graduate may well improve.
Last but not least - as tenth - the favourable impact of the EU single market arrangements should be mentioned. The currently somewhat intransparent public procurement procedures may well open up a sizeable segment of domestic market for SME. Better enforced competition policy directives will also protect SME.
One of the indirect benefits from single market, inducing more transparency and more competition might be the decrease in corruption, informalism and intertwinigs between business and politics, normally by definition priviledgeing big business and disfavouring SME. These lasting factors may turn out to be more relevant than the specialised SME programmes of the EU, where the informational requirements, paperwork and the related search costs may pose next to insurmountable entry barriers to most Hungarian SME.
Against this background recent proposals elaborated by the ministry of finance (as summarised in: Várkonyi, 1998) are restrained to a mere rehash of earlier programmes (and the new governmental programme is understandably a general policy document, being rather abstract by nature). The ministerial concept foresees a decrease in administrative burdens, allow for wider use of average-based taxes (átalányadózás) and re-states the idea of granting unspecified tax benefits to those submitting their reports on diskettes. PHARE money is running out for microfirm crediting, which is to be replaced by an unspecified non-profit agency, who is to take bank credits, to be counter-insured by the Credit Guarantee Inc. Also in public procurements SME are to be priorised, and supplier programmes extended. The concept itself tackles some of the unresolved problems not having left much room for SME to graduate into subcontractors, but - as it states as an abstract normative - these are to be overcome...
The ministerial concept re-calls venture capital funds as promising sources for SME development, and theorises about the need for a public fund extending long term soft loans to SME. It also stipulates contractual agreements between chambers of trade, fulfilling public functions, and the authorities proper, including the setting up of meeting points where those looking for investments and those looking for funds could meet. The distance between our findings and the above described official deliberations is so great that is does not require further elaboration.
Involving representatives of major international agencies - such as the OECD and IBRD - at our final conference served to test whether our suggestions qualify as unrealistic or contrary to international experience, but this did not prove to be the case. Thus we see both the philosophy and the arsenal of the ministerial project as inadequate, for the reasons elaborated in detail above. This might also explain why much of the state administration and the chambers, stuck in outdated approaches to SME, see the challenge of the single market more in terms of a threat than as an opportunity. One of the most widespread myths of Hungarian SME research could be dispelled by involving the parallel experience of eastern Germany. This area looks like paradise in terms of overall transformation theory: a well-tested and clear-cut legal framework was taken over, a functioning public administration, availability of managerial skills, and last but not at all least stable currency and seemingly unlimited amounts of financing has been provided by the reunification process. Eight years of experience in eastern Germany, as documented in the chapter of Brezinski, is indicative that these may not define the heart of the problem properly. Despite an unprecedented scale of transfers, reaching up still to 35 per cent of the GDP of the eastern Ländern, the self-sustaining type of growth could not take off. Following an initial stage and having overcome trivial business bottlenecks, especially in the services sector, the macro-growth of eastern and western German provinces have been conspicuously converging, even prior to the equalisation of productivity levels. While the east German experience is subject to a variety of interpretations, one thing seems certain. Availability of money and appropriate financing plus managerial skills together are necessary, but by no means sufficient, conditions for a self-sustaining robust growth of the SME sector. Therefore in the Hungarian studies, the recurring and usual claims about underfunding and lack of money as the single cause of all evils, must be seen as of relative importance at best.
In terms of making use of tax allowances the German experience also casts doubts about their uses. While over 800 items of various entitlements of these are known in German tax law, empirical investigations highlight the pre-eminent role of larger firms making use of these for obvious reasons. Therefore tax reliefs do not seem to be the appropriate means to foster the particular SME objective. In Germany, concentration on the local markets, on non-tradables and on the consumer goods demand created by transfers, together have brought about an SME sector which is quite unlike that modelled on the Sylicon Valley. Also the very large number of incentives must be seen as problematic. First, coherence and efficiency considerations can obviously hardly be heeded. Second, the more complex a system is, the higher are the search costs and the lower is the probability of the benefits actually accruing to the SME sector, and even less for the new start-ups and microfilms. Socially seen, the latter are the target group, where the externality argument for public spending applies.
Interestingly, the Czech experience is also supportive of the above findings. While much of the instruments advocated by most of analysts, like the special bank for financing SME and the tax relief schemes are in place, the efficiency of this could not be proved by empirical research. In the majority of cases not even those operating the special incentive schemes produce /self-justifying/ efficiency calculations; credits of the SME bank for instance are granted on a first come first served base, without measuring competing claims against one another, and without ex post control of the efficiency of using these funds. In another interesting finding, the small size of the Czech Republic, like of Hungary, is not a reason of avoiding regionally very different patterns of unemployment. This is due to a low mobility, brought about by a stagnant housing market and high costs of commuting, relative to minimum and close-to-minimum wages.
Also quite similarly to Hungary, corruption, informalism, frequently and retroactively changing rules figure high among the factors discouraging entrepreneurship in the Czech Republic. Field evidence by Bohatá and Mládek in this volume also underline insufficient protection of property rights, high costs of enforcing these as well as of contracts, among major factors hindering entrepreneurship and small business. The high share of dormant firms - about the half of all those registered - as well as inflated collateral claims of banks / a derivate of the previous ills / make the Czech case quite similar to the Hungarian one. The somewhat unexpected similarity is one of the important findings of the comparative element in the project. The empirical analyses of the interrelationship between high public dues and high involvement in the irregular economy has established an econometrically tested link between the two. This finding of Lackó is important as it implies a rather strong correlation between spending cuts and the rollback of the irregular economy. This link is policy relevant at least in two dimensions: 1. expenditure cuts do create employment ; 2. the way to eliminate unfair competition for SME is not through enhanced reliance on police methods and regulations, but via smaller, simpler and thus better enforceable burdens. While this finding, per se, says nothing about the size and timing of desirable rate cuts, it does provide a strong argument for those who believe that all possible savings from the tightened fiscal expenditure should be used for this purpose, rather than spent for other, competing claims. Regular overspending in general government thus can not be seen as an innocent mishap, worthy of tolerating for societal reasons.
Analysis of the Hungarian tax system has shown it to be captive to vested interest while lacking clear conceptualised priorities. Taxation seems to follow improvisations and allow very little for the considerations of wealth creation or neutrality, two fundamentals in any textbook view on the subject. Non-neutrality is particularly striking when comparing small and large firms, when comparing tax reliefs to the two, or actual tax burdens born by these. If we compare this with the enhanced reporting obligations of small firms, the insufficient data protection of theirs, as well as the natural competitive disadvantages of these, the finding is fairly obvious.
The non-neutrality of the tax system renders the attempts by the tax authority to act as guardian of social justice and representative of wage earners as ironic at best. Accounting rules, disregarding not only inflation, but not allowing for capital revalorisation, and disregarding any element of risk premia are simply unfounded and need to be quickly remedied as an obvious case of regulatory failure. The growing share of PIT as against excise taxes, for instance, is an example of policy decision without anybody having made a public choice, or without any respect for any principle of taxation. When 83.5 per cent of all tax reliefs actually accrues to MNC, this is per se a call for abolishing these on both social and economic grounds.
One of the important findings, having included historic and sociological aspects of SME development, has been the devaluation of both knowledge and networks originating in the reform socialist period. The star entrepreneurs of the transition period are bankrupt, marginalised or sit in jail. One of the fundamental differences which is particularly hard to cope with, is the closure of the traditional way of the entrepreneur back to the public sector, should a worst case scenario materialise. Therefore both in terms of tax policy and in terms of assistance programmes SME actors should not be treated as those having gone astray from secure and orderly paid public sector jobs. On the contrary, they deserve help to self-help, and poverty alleviation programmes, capitalising on developing country experience could do a lot to create stekeholders en masse also at the bottom of Hungarian society, and particularly among the gypsy minority and those living in depressed areas. Micro ventures are, also in the west, mostly non-bankable due to their size and short history. But the real Rubicon is crossed only when family wealth and business wealth are formally delineated, orderly bookkeeping is introduced, costs and benefits are accounted ( unlike in the traditional peasant household).
One of the obstacles hindering this organic graduation process in Hungary is the notoriously unresolved issue of protecting minority shareholding rights. This is a very severe setback in so far as this deters most attempts to pool resources and set up network based outside personal/family circles. As punishment of non-compliance is ineffective and trust is understandably low, a fundamental element of enterprise graduation is missing in Hungary. Court procedures lasting for years, unavailability of simple and cost-efficient ways of enforcing private contracts and rights, corruption and the spread of private enforcement techniques together are warning signals for what the lack of formal and informal institutions for policy imply.
The bright side of the picture is the improving financial discipline uncovered by the market relations analyses, which also had a favourable spillover effect on tax paying morale. The civilising and disciplining effects of foreign ownership proved demonstrable, as was the diminishing role of cross-ownership against foreign and Hungarian private firms. Financial discipline of publicly owned firms proved to be significantly poorer than that of their private counterparts.
The relatively underdeveloped state of competition policy was shown by the little use of the opportunities, provided by the related legal framework, by SME against dominant positions and misuses of market power. It has been typical that MNCs were the ones making use of this tool - mostly against other MNCs - whereas public policy nurturing SME, as well as representatives of the sector or the chambers of commerce have been making little, if any use of its stipulations. This is in sharp contrast with the elaborate legal superstructure ( on this c.f. Bara, 1998 ).
One of the most interesting findings is the one having emerged from the debates evolving around the role of venture capital. It seems that contrary to much of the theoretical literature generalising Anglo-American experience, in Hungary the SME sector has not developed as yet into a nucleus of R+D development, into a vanguard of technological development. This state of affairs, which is partly attributable to certain peculiarities of business culture, is unforthcoming to attempts reflected in the new law on venture capital, fostering the sector in this capacity. This might well be premature on average, whereas more down-to-earth tasks, related to nurture microfilms as alternatives to living on social transfers, or graduation to small enterprise thereby leaving the irregular economy, remain unattended. Thus in this specific area, a well-known feature of the Hungarian regulatory frame, the parallel existence of over- and under-regulation could be spotted.
This is not the place to re-iterate the policy recommendations summed up in the concluding five pages of the macrostudy. The findings presented here and our recommendations also underline, in the same vein, that SME promotion ceased to be a sector-specific task. Meaningful measures actually relieving the burden currently falling disproportionately on those trying to help themselves out of trouble, can not be formalised into a governmental programme, and should certainly not be entrusted with any centralised agency. Attempts to enhance the role of tripartite co-ordination of interests, or to delegate more public functions to chambers of trade and industry, may or may not be legitimate, on their own right. These, however, have little to do with factors actually shaping the elbow room of micro and SME firms, their growth potential, or their possibilities to create wage earning employment, or simply alleviate poverty. Decentralisation should be the superb maxim, if for no other reason, because of the inherent diversity of the SME sector. Tax consultants require something else than subsistence farmers, though both are active in the SME sector.
Measures improving the lot of those employing the majority of citizens require unconspicuous, but hard to implement, policy measures to be taken. The drive to deregulate is inherently at odds with vital interests of the civil service to ward off individual responsibility, while retaining discretionary rights and power. Likewise the pressure for more public spending is always there, and the number of purposes that may be supported is infinite. Thus the proposal to resist these and use all savings for financing cuts in public dues does require a sustainingly stable and committed policy stance. This is much advocated in theory, but is hard to implement in practice, especially if implicit fiscal overcommittments are sizeable and attempts to roll these back are timid.
There is a lot more that may be inferred from reading the individual papers thoroughly. However, a major purpose of our research project was to present new findings. Quantities and interrelationships that were previously not known, changes in trends, empirical testing of otherwise plausible but unproved propositions were all figuring high on our agenda. The findings, e.g. that the Hungarian economy is not network-dominated, but it is the weakness of networks which impede SME, is an important finding for sociology and economics alike. The changes indicating the overcoming of the dual character of the Hungarian economy is also relevant for transformation studies and classifications. Last but not least, some of our negative findings, i.e. the identification of ways of how not to promote SME may also be policy relevant for decisionmakers and analysts alike. The fact that our findings are in line with other elements of the mainstream of policy relevant theoretical literature looks reassuring anyway.
Improving the overall business environment is not an easy task and covers many areas including legal reform and social security. The more serious a government is about SME support, the more it is going to implement the related considerations in seemingly unrelated areas as well.
If you are interested in our research findings and would like to receive our partial research reports or participate in their discussion or at the closing conference of the research project, please write to the address below. Establishing contacts.