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Is It Possible to Adjust ‘With a Human Face’? Differences in Fiscal Consolidation Strategies between Hungary and Iceland

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Abstract

Although Hungary and Iceland suffered a similar fall in GDP, their respective governments decided to follow different strategies of adjustment. Each country cut spending according to different priorities. Moreover, the Hungarian government implemented a flat tax reform, while the Icelandic government replaced the previous flat tax system with a progressive structure. As a result, Iceland met the objectives of the IMF program, while worsening economic conditions forced Hungary to ask for additional external help. In terms of income distribution, social transfers contributed to reducing inequality in Iceland but not in Hungary, while the different tax strategies operated in contrary ways.

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Notes

  1. Over the period 1997–2010, the deficit was close to 5.5% of GDP.

  2. OECD (2012a) shows that the sensitivity of fiscal policy to the electoral cycle was also common in the 1990s. The only exception to this tendency was shown in relation to the national elections of 2010.

  3. As a consequence of these developments, Hungary was placed under the Excessive Deficit Procedure after its formal entry into the European Union in 2004.

  4. For example, Islandsbanki started to offer 100% LTV in November 2004 (European Mortgage Federation, 2011).

  5. Despite positive comments on Iceland’s economic conditions (eg Mishkin and Herbertsson, 2006; Portes et al., 2007), the outlook of Iceland was downgraded by Fitch at the beginning of 2006 generating the ‘mini crisis’ (Wade and Sigurgeirsdottir, 2012).

  6. It is necessary to remember, however, that Iceland applied for EU membership in 2009. This produced positive signals and increased the credibility of Icelandic institutions in international markets. Nonetheless, after the recent years of crisis, the potential resentment of Icelandic people to EU institutions over the Icesave dispute, led to a suspension of the process (Gylfason, 2014).

  7. ‘Bilateral creditors also provided substantial financial support, with the Nordic countries (Denmark, Finland, Norway, and Sweden), contributing $2 1\2 billion, Poland $200 million, and the Faroe Islands $50 million’ (IMF, 2012b, p. 3).

  8. In Europe, only Baltic countries followed a similar strategy.

  9. The Regular Social Benefit was a social benefit aimed at ensuring a basic income to cover living cost to people without any other source of finance (Kopasz et al., 2013).

  10. For example, taxes on the banking sector are supposed to provoke credit rationing (OECD, 2012a).

  11. Data for Iceland are extracted from Central Bank of Iceland (2012); data for Hungary are from the Hungarian Central Statistical office (https://www.ksh.hu/?lang=en)

  12. Indeed, ‘the average effective retirement age in Hungary was about two and a half years lower than the legal one according to OECD data. In addition, there was also the option of retiring on health grounds and drawing disability pension, which was the equivalent to a regular old age pension after 25 years of work’ (EEAG, 2012, p. 120).

  13. Tax wedge ‘is defined as the difference between the salary costs of a single “average worker„ to their employer and the amount of net income (“take-home-pay„) that the worker receives. The taxes included are personal income taxes, compulsory social security contributions paid by both employees and employers, as well as payroll taxes for the few countries that have them. The amount of these taxes is expressed as a percentage of the total labor costs for firms, i.e. the sum of gross earnings, employers’ social security contributions and payroll taxes’ (OECD, 2007, p. 60).

  14. Each income share is computed as the ratio of the specific income component of disposable income. Moreover, income is equivalized applying the modified-OECD equivalence scale. ‘This equivalent scale gives a score of 1 to the household head. Each of the other household members aged 14 and more receives a score of 0.5, while each child with age less than 14 receives a score of 0.3. The sum of the individual scores gives the equivalent household size’ (Bradshaw et al., 2012, p. 4).

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Acknowledgements

I thank Giovanni Andrea Cornia, Jonathan Bradshaw, Sudhanshu Handa, Marco Sanfilippo and Peter Whiteford who read an earlier version of this paper. In addition, I am grateful to Stefán Ólafsson for his careful comments and suggestions on the Icelandic case and Fruzsina Albert, Andras Gabos, Katalin Nagy and Peter Vakhal for their useful suggestions on the Hungarian case. I also thank three anonymous referees, the editor, the Advisory Group of the Innocenti Report Card Project and participants at the 21st International Conference on Issues in Social Security, Sigtuna (Sweden), June 2014, for their helpful suggestions.

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    Bruno Martorano

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Martorano, B. Is It Possible to Adjust ‘With a Human Face’? Differences in Fiscal Consolidation Strategies between Hungary and Iceland. Comp Econ Stud 57, 623–654 (2015). https://doi.org/10.1057/ces.2015.22

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