The Slovak Fiscal Paradise Ends in a Hotel Ballroom
With 13.5% out of work, crumbling infrastructure, a widening revenue and spending gap, Slovakia faces changes in tax law
On 13 November, Slovak Prime Minister Robert Fico was scheduled to speak at the Forbes Business-Government Dialogue conference in Bratislava. Instead, Fico sent a video to the business and diplomatic leaders, astonishing the influential blue chip group painstakingly assembled by the American Chamber of Commerce. Fico's enormous projected image told the room he was too busy meeting with the Bulgarian prime minister to meet with them. In any case, Fico wished to deliver a simple message to the business community: Prepare yourselves to pay more as Slovakia’s days as a tax haven are over.
This message is a strange one, as Fico was already prime minister from 2006 to 2010 during the build up to the crisis, when he had plentiful opportunities to end the flat tax. Since the uniform rate of 19% was introduced in 2004, Slovakia has enjoyed more than €38 billion in foreign investment. After the Netherlands, Austria is Slovakia’s second most important foreign investor, making up 12% of all foreign direct investments.
The haven’s history
After the Slovak introduction of the flat tax, French and German leaders from Schröder to Sarkozy openly attacked Slovak economic policy. However, the country persevered. During these eight years, economic growth averaged more than 6% apart from a short contraction during the crash of 2009, but unemployment has remained high, never falling below 8% and currently at 13.5%. Public infrastructure has continued to deteriorate, particularly in the health care sector. The chasm between revenues and spending has grown ever wider.
Officially, what is driving the Slovak change of heart on tax rates is pressure from the Maastricht convergence criteria. No country’s annual budget deficit should be greater than 3% to meet Maastricht. Slovakia is currently on track to run a 4.6% deficit in 2012. Fico plans to meet the criteria rather than risk the consequences. Larger states like France and Germany have been able to avoid the consequences of non-compliance with convergence by granting themselves exceptions. A small country like Slovakia does not have the same leverage in either EU meetings or in bond markets.
In a subsequent finance panel at the Business-Government Dialogue conference, Slovak Deputy Minister of Finance Peter Pellegrini joked about foreign investors: "You want to pay the taxes of Romania and enjoy German infrastructure and social programmes."
Will these changes put an end to foreign investment in Slovakia? According to the senior corporate solicitor Soňa Hanková at Salans international law firm in Bratislava, the answer is, partly.
"Most of those already here will stay," she said. "But without the flat tax, we expect far fewer newcomers to our market. For corporate lawyers, there will be more competition for less business. On the plus side, there will certainly be more demand for tax optimisation."
Collecting and enforcing
Those optimising had best be careful. Pellegrini took great care to outline Slovakia’s plan to meet Maastricht criteria, despite both lower growth and lower foreign investment: The answer is tougher tax enforcement and collection. The Ministry of Finance has hired thousands more tax inspectors to comb through records and has its own commandos who undertake "Tax Cobra" operations, such as the round-up of a smugglers’ ring on 18 July on the Ukrainian border. All cash businesses will face particular scrutiny.
"There are large publicly traded companies avoiding paying their legal taxes in Slovakia, names you all know, some who may even be sitting in this room," said Pellegrini. "Our message to you is start paying your taxes now, before we must force you to."
The response of Slovak business leadership after eight years of flat tax seems exaggerated, if not hysterical. An emotional BMB Leitner Tax Audit founder Renáta Bláhová dismissed Pellegrini’s presentation: "We are already paying at the level of Austrian citizens and getting no services. Now we will have to pay even more. I cannot even take my three children to the doctor here. The state is setting out to screw us and juice us as much as possible in exchange for nothing."
While right wing parties in Slovakia decry Fico’s populism as shallow pandering, this did not stop his SMER party from sweeping to the first absolute majority in the history of the Slovak Republic on 10 March, with 83 of 150 seats in Parliament. Fico and Pellegrini have another three and a half uninterrupted years to carry out their reforms.
For the moment, if Fico gets his wish, the tax paradise in the heart of Europe is at an end.
Austrian and other European companies seeking a tax haven will likely have to venture into riskier offshore territories like Cyprus. Those in Slovakia who don’t like to pay taxes will have to follow the example of Bifrost Investment Group (owners of the Carlton and Danube hotels) who, even during the flat tax years, set up holding companies in Luxembourg to manage their Slovak assets.
And hire more lawyers.