Work Incentives and Recent Reforms of the Tax and Benefit System in Hungary

Abstract

Reducing the extent of inactivity and promoting labour supply is essential to foster labour market outcomes in Hungary in the medium term. Notwithstanding specific factors linked to education, the pension system or family and disability policies, financial disincentives play an important role in this regard. This paper describes the impact of recent reforms of the tax and benefit system in Hungary on some indicators of financial incentives to enter the labour market derived from OECD tax and benefit models. While personal income taxes were cut and the system of tax allowances for families became more generous other welfare benefits were reduced or phased out, which causes significant changes in the incentives for workers, inactive or unemployed people. Between 2010 and 2012, the average tax wedge dropped for high-income earners and/or families with two children, but increased mainly for individuals without children and income below the 80th percentile, which was partly mitigated by the implementation of compensation schemes. However, there is still a large gap in the average tax wedge with the OECD average and regional peers, notably driven by high social security contributions. The implicit tax on returning to work from unemployment remains relatively high and increased below the average wage for most family types. However, it was cut above that level. The absolute level of the implicit tax on returning to work from inactivity is significantly lower notably following across-the-board cuts for lone parents and one-earner married couples with two children, somewhat offset by increases below the average wage for families without children.