## _wp05133

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---

### Introduction
- Reviews Slovakia’s 2004 tax and welfare reforms and interactions affecting incentives to work in context of high unemployment.
- Reforms form part of a wider agenda including pensions, healthcare, labor market, legal system, and planned education reforms.
- Paper sections: overview of reforms; fiscal implications; efficiency implications for work and investment incentives; distributional implications and welfare effectiveness; conclusion.

### Fiscal context and objectives
- Government aim: meet the Maastricht fiscal deficit criterion of 3 percent of GDP by 2007.
- Fiscal deficit: between 3 and 4 percent of GDP in both 2003 and 2004.
- Tax reform designed to be broadly revenue-neutral within a tight expenditure envelope given EU accession costs and introduction of a second pension pillar.

### Tax reform: design and key changes
- Reform principles (Slovak Ministry of Finance):
  - Broad revenue neutrality with shift from direct to indirect taxes.
  - Low standard rates financed by eliminating special treatments and exemptions.
  - Minimize non-fiscal tax distortions; minimize double taxation of income.
- Major structural changes:
  - Personal income tax: single rate of 19 percent and a high tax-free threshold replacing 21 different tax rates, including a five-band wage structure ranging from 10 to 38 percent, and withholding tax rates on capital income ranging from 5 to 25 percent.
  - Corporate income tax reduced to 19 percent; dividend taxation abolished.
  - Most income tax exemptions cancelled, including tax holidays for newly established firms.
  - Value-added tax: single VAT rate of 19 percent replaces dual rates of 14 and 20 percent.
  - Excise taxes increased and aligned with EU requirements.
  - Several smaller taxes abolished.
  - Separate reform: overall social contribution rates modestly reduced by 2.4 percentage points and ceilings for pension and unemployment insurance contributions increased.
- Reform described as greatly simplifying the tax system; conforms to core IMF recommendations on tax system design.

### IMF recommendations on tax system design (summarized)
- Heavy reliance on broadly-based sales taxes such as VAT with a single rate and minimal exemptions; excise taxes on petroleum products, alcohol, tobacco, and a few luxuries.
- No reliance on export duties or small nuisance taxes with ineffective administration.
- Import taxation at as low levels as possible with limited dispersion of rates.
- Administratively simple personal income tax with limited deductions, a moderate top marginal rate, an exemption limit large enough to exclude modest incomes, and substantial reliance on withholding.
- Corporate income tax at one moderate-to-low rate aligned with the top personal rate; uniform depreciation and non-cash expenditure provisions across sectors and minimal sector-specific incentives.

### Welfare reform: objectives and main features
- Goal: promote employment by addressing benefit dependency and disincentives to work.
- Social assistance: paid to individuals and families with incomes below the national poverty line (“subsistence minimum”).
- Key changes:
  - Introduced an “activation program” tying an activation allowance to demonstrated effort (e.g., community volunteer work, retraining).
  - Basic benefit significantly reduced; activation allowance conditional on effort.
  - Benefit tapering softened: several types of income deemed exempt in social assistance calculation, including 25 percent of individual income from dependent services.
- Child support restructuring:
  - Sk 500 monthly flat, universal allowance (no means-testing).
  - Sk 400 monthly tax bonus, conditional on at least one parent being employed (no phase-out as income rises).
  - Child support via income tax: up to Sk 4,800 annually per child when at least one parent is employed.
- Activation allowance and program participation:
  - Activation allowance initially Sk 1,000, raised in April 2004 to Sk 1,500; protective allowance paid to those unable to participate.
  - Municipalities and NGOs receive Sk 400 monthly for each activated person.
  - Ministry reports just over 100,000 individuals participated in activation programs by October 2004, compared with 56,000 in April 2004; over 90,000 in community-based services; just under 4,000 in further education or retraining.

### Fiscal effects of the reforms: first results — Tax reform (cash-basis and accrual indicators)
- Overall impact on revenue in 2004: modest.
- Tax revenues fell as a share of GDP in 2004: tax revenues in 2004 declined by 0.7 percent of GDP from 2003.
- One-off adjustment: 1 percent of GDP in one-off VAT refunds paid in 2003 increases the measured decline.
- 2004 calculations based on different projections of nominal GDP: Sk 1,293 billion (budget) versus Sk 1,325 billion (outcome).

Key cash-basis tax outcomes (Table 1):
- Taxes on income: Budget Sk 52.0 billion; Outcome Sk 60.5 billion; Margin over 2004 budget: 0.7 (percent of GDP).
- Taxes on employment income: Budget Sk 14.8 billion; Outcome Sk 21.6 billion; Margin: 0.5.
- Self-employment tax: Budget Sk 3.8 billion; Outcome Sk 3.7 billion; Margin: 0.0.
- Corporate income tax: Budget Sk 22.0 billion; Outcome Sk 29.6 billion; Margin: 0.6.
- Withholding income tax: Budget Sk 11.4 billion; Outcome Sk 5.7 billion; Margin: -0.4.
- Taxes on goods and services: Budget Sk 138.6 billion; Outcome Sk 143.0 billion; Margin: 0.3.
- Value-added tax: Budget Sk 97.7 billion; Outcome Sk 99.6 billion; Margin: 0.1.
- Excise duties: Budget Sk 40.9 billion; Outcome Sk 43.4 billion; Margin: 0.2.
- Other taxes: Budget Sk 4.6 billion; Outcome Sk 6.0 billion; Margin: 0.1.
- Total: Budget Sk 195.2 billion; Outcome Sk 209.5 billion; Margin: 1.1.
- Sources: Slovak Ministry of Finance; and IMF staff estimate of nominal GDP.

Estimated impact of the 2004 tax reform (Table 2, ESA 95 basis, in percent of GDP):
- Taxes on income: MoF projection -1.5; IMF projection -1.8; Change from 2003 outcome -1.8.
- Taxes on employment income: MoF -0.9; IMF -1.2; Actual -0.8.
- Self-employment tax: MoF -0.2; IMF -0.2; Actual 0.0.
- Corporate income tax: MoF -0.6; IMF -0.5; Actual -0.6.
- Withholding income tax: MoF 0.2; IMF 0.2; Actual -0.3.
- Taxes on goods and services: MoF 1.9; IMF 1.8; Actual 1.4.
- Value-added tax: MoF 1.4; IMF 1.3; Actual 1.2.
- Excise duties: MoF 0.5; IMF 0.5; Actual 0.2.
- Other taxes: MoF -0.1; IMF -0.1; Actual -0.2.
- Customs duties: MoF 0.0; IMF 0.0; Actual -0.2.
- Total: MoF 0.3; IMF 0.0; Actual -0.6.
- Notes:
  - Projections assumed revenue impact in 2005 from abolition of dividend taxation.
  - Estimates subject to offsetting distortions: 2003 collections lower by 1 percentage point of GDP owing to one-off refunds; 2004 collections may be lower owing to EU accession.
  - Following EU accession, customs duties became EU rather than national revenue.

Additional observations:
- PIT (wage tax and self-employment tax) collections were significantly better than projected, reflecting higher-than-projected growth in economy-wide wages in 2004.
- CIT collections were slightly stronger than projected.
- Collections of withholding taxes on capital income were significantly less than projected; some revenue may have been diverted to CIT as firms reported income as profits rather than capital income; companies apparently retained earnings in 2004 to avoid the final year of dividend tax.
- Indirect tax collections were higher in 2004 but increased by less than previously projected; EU accession shifted tax administration causing delays and lower efficiency; lowering the VAT registration threshold required administering many extra small taxpayers.

### Social contributions and public receipts
- Social contributions fell by more than expected following the reduction in rates.
- 2004 budget implied a 0.8 percent of GDP reduction in social contributions from 2003.7
- Collections fell short of budget by a further 0.2 percent of GDP, with the shortfall mainly in collections by the Social Insurance Agency.
- Revenue losses from lower social contributions are of similar magnitude to the losses from the reform of state budget taxes.
- Footnote: If based on actual GDP, the reduction would be 1 percentage point of GDP.

### Efficiency, incentives, and labor-market implications
- Reforms provide efficiency gains by reducing distortions and simplifying the tax system; welfare reform should significantly improve work incentives for lower-income earners.
- Labor taxes have fallen only modestly for many taxpayers; the tax burden has been shifted towards labor and away from capital, so improvements in incentives to work and to hire may be marginal for some groups.
- Benefits from simplification:
  - Reduced exemptions imply more efficient resource allocation and higher revenue for a given tax rate.
  - System is simpler and easier to administer; single-rate VAT should help address refund issues.
  - Single personal and corporate income tax rate reduces arbitrage opportunities.
  - Risk remains of income form-shifting (self-employed converting employment income into capital income).

Composite marginal tax rate (measure used)
- C = 100 × [1 – (1-t)(1-c)/(1+v)(1+p)]
  - where t is marginal income tax rate on wages; c is rate of employee social insurance contribution, in percent of gross wages; v is marginal (tax-exclusive) rate of indirect taxation on net wages; p is rate of employer social insurance contribution, in percent of gross wages.
- Findings:
  - At very low income levels, marginal tax rate is above zero because of indirect taxes; initial increases reflect minimum thresholds for social contributions.
  - Highest marginal tax rates are at middle-income levels under the previous system, with a flattening after Sk 32,000 monthly due to social contribution ceilings.
  - Following the reform, composite tax rate falls sharply after income reaches the maximum assessment bases for social contributions.
  - Single vs married taxpayers:
    - Single taxpayers: composite marginal tax rates increased on gross monthly incomes between Sk 8,000 and Sk 13,000 in 2004—modest income tax relief at low levels was more than offset by increases in employee social contributions and indirect taxes.
    - Married taxpayer with a non-working spouse and two dependent children: reform implies cuts in composite marginal tax rates (except at high incomes affected by increased social contribution ceilings) because of large tax-free threshold from including the non-working spouse.
  - For a married taxpayer, the exemption for a non-working spouse implies the spouse faces a high marginal tax rate upon entering the workforce.

Payroll taxes, tax wedge, and regional comparisons (Table 3)
- Slovak Republic (2003): Employee 12.8, Employer 38.2, Total 51.0
- Slovak Republic (2004): Employee 13.4, Employer 35.2, Total 48.6
- Czech Republic: Employee 12.5, Employer 30.0, Total 47.5
- Hungary: Employee 12.5, Employer 32.0, Total 44.5
- Poland: Employee 25.0, Employer 20.4, Total 45.4
- EU-15 average: Employee 12.5, Employer 24.1, Total 36.6
- OECD “Taxing Wages” measures show Slovakia’s tax wedge remains above the OECD average at multiple points on the wage distribution.

### Welfare reform and Marginal Effective Tax Rates (METRs)
- METR definition (following Disney (2000)):
  - METR = 1 – [w(1-t_w-c) – b(1-t_b)]/w(1-t_w-c)
    - where b = level of benefit; w = gross wage; t = income tax rate; c = employee payroll tax rate.
- High METRs create:
  - Unemployment trap: benefits high relative to potential wage discourage participation.
  - Poverty trap: individual cannot increase disposable income by increasing work effort.
- Pre-reform: “top-up” assistance withdrew benefits one-for-one as non-welfare income rose, implying an METR of 100 percent.
- Reform outcome: Authorities aimed to reduce METRs from around 100 percent to around 75 percent by allowing welfare recipients to keep 25 percent of non-welfare income (Slovak Ministry of Labor, 2004).
- Household examples indicate METRs of 100 percent for welfare recipients with no other income or earning minimum wage have been reduced.
- Distributional concern: families with five children faced METR of 100 percent before reform even at monthly incomes approaching double the minimum wage; reform narrowed this income range.

### Recent employment developments and risks
- Employment response modest:
  - Economy-wide employment growth stagnated in first three quarters of 2004 despite strong economic growth; public sector layoffs in 2004 partly explain weak employment growth.
  - Fourth quarter data suggest employment has started to recover.
- Key risks:
  1. Shift in tax burden could entrench bias of economic growth toward capital-intensive activity.
  2. Reforms increase labor supply, but labor demand remains weak—especially in high-unemployment areas.
- Long-term unemployment: roughly two-thirds of total unemployment of nearly 18 percent.

### Corporate taxation and investment implications
- CIT changes:
  - New CIT rate: 19 percent (compares to 40 percent in 1999).
  - Abolition of dividend taxation implies investment income now taxed only once.
- CIT revenue: Slovak CIT revenue as a share of GDP was 2.3 percent of GDP in 2004, close to EU-15 and EU-25 observations (2.4 percent each).
- Loss carryforwards: losses can be deducted over following 5 years; annual write-off installments no longer required to be equal.
- Previous restrictions led to effective tax rates of 35 percent or more (sometimes 80 percent) despite statutory rates; new law remedies this.

### Distributional implications of the reformed tax and benefit system
- Two guiding questions:
  1. Is the reformed tax system progressive, neutral, or regressive?
  2. Is the reformed welfare system still effective at protecting the most vulnerable?
- Income tax progressivity:
  - Excluding social contributions, the tax system remains progressive overall, though less so than previously.
  - Average income tax rate rises with income over the whole income distribution, though less steeply than before due to a significant tax-free threshold.
  - Married taxpayers with a non-working spouse face a slower rise in average effective tax rate.
- Indirect taxes:
  - Single VAT rate yields estimated VAT burden around 14-15 percent for most income groups, slightly lower for highest income decile.
  - Excise taxes broadly proportional across household income; motor fuel tax mildly progressive; tobacco excises mildly regressive.
- Social contributions and regressivity:
  - Social contributions payable up to a “maximum assessment base”; marginal social contribution rate falls to zero above these maximums, implying average effective social contribution rate falls as income rises (regressive component).
  - Following reform, composite marginal rate declines for incomes above Sk 40,000 per month (nearly 3 times the average wage), implying overall tax burden turns regressive in the high-income range.
- Share of high-income taxpayers (2003 returns):
  - Some 25,000 taxpayers filed returns for the tax bracket above Sk 396,000 (Sk 33,000 monthly).
  - Some 14,000 filed returns for the bracket above Sk 564,000 (Sk 47,000 monthly).
  - Labor force survey comparator: total employment 2.2 million in 2003.
  - On this basis, 0.6 percent of taxpayers have monthly incomes above Sk 47,000.
- If only health contributions are included, the overall tax burden becomes proportional at higher incomes and system remains mildly progressive overall.

### Adequacy of the reformed safety net and distributional findings
- Pre-reform poverty mitigation:
  - World Bank (2001): canceling social transfers except pensions would imply poverty rate of 19 percent vs actual 10 percent; for households whose main earner unemployed, poverty would rise to nearly 80 percent vs actual 45 percent.
- Recent Ministry estimates:
  - Slovak Ministry of Labor (2004) estimates risk-of-poverty rate of 28 percent before social transfers, and 21 percent after all social transfers.
  - Earlier Ministry estimates (2003b) reported 19 percent before and 5 percent after; data problems imply caution.
- Subsistence minimum (Table 4; July 2003 and July 2004):
  - One adult: Sk 4,210 (July 2003), Sk 4,580 (July 2004).
  - Plus second adult: Sk 2,940 (July 2003), Sk 3,200 (July 2004).
  - Plus dependent child: Sk 1,910 (July 2003), Sk 2,080 (July 2004).
  - Example: 2 adults, 4 children = Sk 14,790 (July 2003), Sk 16,100 (July 2004).
- Gap observations:
  - Gap between subsistence minimum and social assistance benefits increased following reforms, especially for families not participating in activation programs.
  - For families with five children, typical benefit reductions of around 10-20 percent if parents participate in activation programs; if parents do not participate, benefit reductions and gap with subsistence minimum can exceed 50 percent.
  - Subsistence minimum is uniform nationwide while wages and living costs vary regionally; in-kind benefits may fill some gaps.

### Impact on Roma communities and concentrated disadvantage
- Roma population estimates and indicators:
  - Roma estimated up to 10 percent of Slovak population.
  - In some isolated Roma settlements, unemployment rates around 90 percent observed.
  - OECD (2002) estimates Roma account for up to a fifth of overall unemployment in Slovakia.
  - UNDP (2003) found Roma unemployment rates around 70 percent in Slovakia.
- Analysis:
  - Benefit dependency contributed to marginalization of some Roma communities.
  - Many Roma with large families were particularly subject to poverty traps before reforms and face some of largest benefit cuts after reforms.

### Appendix I — social assistance benefit table (Table A2) key figures
- Basic benefit (New system Jan 2004): Individual/Single person Sk 1,450; Current Sk 1,530.
- Individual parent with up to 4 children: Previous Sk 2,160; New Sk 2,450.
- Individual parent with more than 4 children: Previous Sk 3,160; New Sk 3,640.
- Dependent minor child (Previous): Sk 1,000.
- Parents with up to 4 children: Previous Sk 3,210; New Sk 3,630.
- Parents with more than 4 children: Previous Sk 4,210; New Sk 4,850.
- Maximum per family (Previous): Sk 10,500.
- Activation allowance / protection allowance: Previous Sk 1,000; New Sk 1,500.
- Housing bonus 1-person household: Sk 780; multiple-person household: Sk 1,330.
- Healthcare allowance, per person: Sk 50.
- Notes:
  - Basic monthly benefit reduced in January 2004 from Sk 2,900 to Sk 1,450.
  - Activation allowance increased in April 2004; basic benefits indexed in September 2004.
  - Housing and healthcare allowances paid only to single person or couple without children.

### Other labor-market benefit reforms
- Unemployment insurance:
  - Eligibility reduced to up to 6 months (from 9 months until end-2003).
  - Beneficiary must have contributed for 24 of previous 36 months.
  - Replacement rate: 50 percent of past gross income (previously 55 percent then 45 percent).
  - Ceiling raised to 60 percent of the average wage in 2004; ceiling to increase further in 2005 and 2006.
- Sickness benefits:
  - From 2004, employers pay first 10 days of sickness benefits (shift from public sector), lowering public sector costs and giving employers incentive to verify claims.
- Pension reform:
  - Gradual increase in retirement ages to 62 years for both men and women from earlier levels.
  - First increase effective from January 2004.
  - Mandatory privately funded second pillar started operations in January 2005.

### Overall conclusions and trade-offs
- Reforms emphasized simplicity, low standard rates, and reliance on broad-based consumption taxes, aligning with IMF recommendations.
- Welfare changes aim to activate beneficiaries and reduce disincentives to work through conditional allowances and softer benefit tapering.
- Initial evidence: tax reforms had a limited revenue cost and did not compromise objectives of fiscal consolidation toward the Maastricht deficit criterion by 2007, though EU accession introduced one-off effects on indirect tax collections in 2004.
- Distributional effects:
  - Tax system less progressive than previously; stays progressive excluding social contributions but progressivity depends on treatment of social contributions.
  - Flat-rate 19 percent personal income tax with large tax-free thresholds keeps tax progressive rather than proportional for many.
  - Social contributions—payable only up to a ceiling—remain a regressive component; their classification affects progressivity assessment.
- Trade-offs and short-run risks:
  - Welfare reform traded addressing benefit dependency against risk of deteriorating poverty for some vulnerable households, notably large families and regions with weak job opportunities.

*Source: _wp05133 (IMF working paper content unit).*

### 1. IMF Recommendations on Tax System Design ...........................................................5

### 1. IMF Recommendations on Tax System Design

### Introduction
- Paper reviews Slovakia’s 2004 tax and welfare reforms, and interactions affecting incentives to work in context of high unemployment.
- Reforms are part of a wider agenda including pensions, healthcare, labor market, legal system, and planned education reforms.
- Sections covered: II (overview of reforms), III (fiscal implications), IV (efficiency implications for work and investment incentives), V (distributional implications and welfare effectiveness), VI (conclusion).

### Fiscal Context and Objectives
- Government aims to meet the Maastricht fiscal deficit criterion of 3 percent of GDP by 2007.
- Fiscal deficit was between 3 and 4 percent of GDP in both 2003 and 2004.
- Tax reform designed to be broadly revenue-neutral within a tight expenditure envelope given EU accession costs and introduction of a second pension pillar.

### Tax Reform: Design and Key Changes
- Reform principles (Slovak Ministry of Finance): broad revenue neutrality with shift from direct to indirect taxes; low standard rates financed by eliminating special treatments and exemptions; minimize non-fiscal tax distortions; minimize double taxation of income.
- Major structural changes:
  - Personal income tax: single rate of 19 percent and a high tax-free threshold, replacing 21 different tax rates, including a five-band wage structure ranging from 10 to 38 percent, and withholding tax rates on capital income ranging from 5 to 25 percent.
  - Corporate income tax reduced to 19 percent; dividend taxation abolished.
  - Most income tax exemptions cancelled, including tax holidays for newly established firms; future investment incentives to comply with EU state aid rules.
  - Value-added tax: single VAT rate of 19 percent replaces dual rates of 14 and 20 percent.
  - Excise taxes increased and aligned with EU requirements.
  - Several smaller taxes abolished.
  - Separate reform: overall social contribution rates modestly reduced by 2.4 percentage points and ceilings for pension and unemployment insurance contributions increased.
- Reform described as greatly simplifying the tax system; conforms to core IMF recommendations on tax system design.

### Welfare Reform: Objectives and Main Features
- Goal: promote employment by addressing benefit dependency and disincentives to work.
- Social assistance paid to individuals and families with incomes below the national poverty line (“subsistence minimum”).
- Prior to reform, benefits were high relative to wages; OECD (2002) noted that for a family with two children, welfare payments could exceed the net average wage.
- Key changes:
  - Introduced an “activation program” tying an activation allowance to demonstrated effort (e.g., community volunteer work, retraining).
  - Basic benefit significantly reduced; activation allowance conditional on effort.
  - Benefit tapering softened: several types of income deemed exempt in social assistance calculation, including 25 percent of individual income from dependent services.
- Distributional impact varies by family size:
  - Slovak Ministry of Labor (2004) estimates (assuming participation in activation programs and accounting for tax-welfare interactions) indicate smaller families can maintain benefit levels near pre-reform levels and may increase household income if they earn the minimum wage.
  - Families with four or more children face greater benefit reductions.

### IMF Recommendations on Tax System Design (Box 1)
- Recommended characteristics:
  - Heavy reliance on broadly-based sales taxes such as VAT with a single rate and minimal exemptions; excise taxes on petroleum products, alcohol, tobacco, and a few luxuries.
  - No reliance on export duties or small nuisance taxes with ineffective administration.
  - Import taxation at as low levels as possible with limited dispersion of rates.
  - Administratively simple personal income tax with limited deductions, a moderate top marginal rate, an exemption limit large enough to exclude modest incomes, and substantial reliance on withholding.
  - Corporate income tax at one moderate-to-low rate aligned with the top personal rate; uniform depreciation and non-cash expenditure provisions across sectors and minimal sector-specific incentives.

### Links to Efficiency, Incentives, and Distribution
- Tax-welfare interactions highlighted as central to work incentives, especially given high unemployment.
- Flat-rate income tax (19 percent) is a focal policy element; regional context: Estonia (1995), Russia (13 percent in 2001), Romania (16 percent from January 2005), and policy discussion in Poland.
- Welfare reform’s activation features and income deeming intended to reduce abrupt benefit withdrawal and improve incentives to accept paid work.
- Reform framed as broadly revenue-neutral to meet medium-term fiscal consolidation goals.

### Figures and Quantitative Illustrations (selected numeric highlights from the content)
- Single personal and corporate income tax rate: 19 percent.
- Prior personal income tax structure: 21 different tax rates; wage bands from 10 to 38 percent.
- Prior capital income withholding tax rates: 5 to 25 percent.
- VAT: single rate 19 percent replacing 14 percent and 20 percent rates.
- Social contribution reduction: 2.4 percentage points.
- Maastricht fiscal deficit ceiling: 3 percent of GDP.
- Fiscal deficit in 2003 and 2004: between 3 and 4 percent of GDP.
- Average earnings, 2003: Sk 172,380 (as shown in figure captions).
- In social assistance calculation, 25 percent of individual income from dependent services is deemed exempt.

### Conclusions
- The 2004 reforms in Slovakia emphasize simplicity, low standard rates, and reliance on broad-based consumption taxes, aligning with IMF recommendations.
- Welfare changes aim to activate beneficiaries and reduce disincentives to work through conditional allowances and softer benefit tapering.
- Reforms are implemented in a constrained fiscal environment with the objective of meeting the Maastricht deficit criterion by 2007.

*Source: _wp05133 - 1. IMF Recommendations on Tax System Design ...........................................................5*

### 7.5 percent.

### 7.5 percent.

### Fiscal effects of the reforms: first results — Tax Reform
- Overall impact on revenue in 2004: modest.  
- Cash-basis data: significantly better than budgeted collections of most taxes, notably income taxes (Table 1), but implying a small reduction in taxes as a share of GDP.  
- Accrual-basis data: mixed picture due to delays in collections of indirect taxes following EU accession.  
- Tax revenues fell as a share of GDP in 2004: tax revenues in 2004 declined by 0.7 percent of GDP from 2003.  
- One-off adjustment: 1 percent of GDP in one-off VAT refunds paid in 2003 following a change in the VAT law in 2002 increases the measured decline.  
- Figure 4 notes:
  - 2003 total adjusted to include about 1 percent of GDP in one-off VAT refunds paid in 2003.
  - 2004 calculations based on different projections of nominal GDP: Sk 1,293 billion (budget) versus Sk 1,325 billion (outcome).

Key cash-basis tax outcomes (Table 1):
- Taxes on income: Budget Sk 52.0 billion; Outcome Sk 60.5 billion; Margin over 2004 budget: 0.7 (percent of GDP).  
- Taxes on employment income: Budget Sk 14.8 billion; Outcome Sk 21.6 billion; Margin: 0.5.  
- Self-employment tax: Budget Sk 3.8 billion; Outcome Sk 3.7 billion; Margin: 0.0.  
- Corporate income tax: Budget Sk 22.0 billion; Outcome Sk 29.6 billion; Margin: 0.6.  
- Withholding income tax: Budget Sk 11.4 billion; Outcome Sk 5.7 billion; Margin: -0.4.  
- Taxes on goods and services: Budget Sk 138.6 billion; Outcome Sk 143.0 billion; Margin: 0.3.  
- Value-added tax: Budget Sk 97.7 billion; Outcome Sk 99.6 billion; Margin: 0.1.  
- Excise duties: Budget Sk 40.9 billion; Outcome Sk 43.4 billion; Margin: 0.2.  
- Other taxes: Budget Sk 4.6 billion; Outcome Sk 6.0 billion; Margin: 0.1.  
- Total: Budget Sk 195.2 billion; Outcome Sk 209.5 billion; Margin: 1.1.  
- Sources: Slovak Ministry of Finance; and IMF staff estimate of nominal GDP.

Estimated impact of the 2004 tax reform (Table 2, ESA 95 basis, in percent of GDP):
- Taxes on income: MoF projection -1.5; IMF projection -1.8; Change from 2003 outcome -1.8.  
- Taxes on employment income: MoF -0.9; IMF -1.2; Actual -0.8.  
- Self-employment tax: MoF -0.2; IMF -0.2; Actual 0.0.  
- Corporate income tax: MoF -0.6; IMF -0.5; Actual -0.6.  
- Withholding income tax: MoF 0.2; IMF 0.2; Actual -0.3.  
- Taxes on goods and services: MoF 1.9; IMF 1.8; Actual 1.4.  
- Value-added tax: MoF 1.4; IMF 1.3; Actual 1.2.  
- Excise duties: MoF 0.5; IMF 0.5; Actual 0.2.  
- Other taxes: MoF -0.1; IMF -0.1; Actual -0.2.  
- Taxes on property: MoF 0.0; IMF 0.0; Actual 0.0.  
- Road tax: MoF 0.0; IMF 0.0; Actual 0.0.  
- Customs duties: MoF 0.0; IMF 0.0; Actual -0.2.  
- Total: MoF 0.3; IMF 0.0; Actual -0.6.  
- Notes:
  - Projections assumed revenue impact in 2005 from abolition of dividend taxation.  
  - Estimate subject to offsetting distortions: 2003 collections were lower by 1 percentage point of GDP owing to one-off refunds; 2004 collections may be lower owing to EU accession.  
  - Increase in excises was brought forward to August 2003; also subject to lower collections in 2004 following EU accession.  
  - Following EU accession, customs duties became EU rather than national revenue.

Additional observations:
- PIT (wage tax and self-employment tax) collections were significantly better than projected, reflecting higher-than-projected growth in economy-wide wages in 2004.  
- CIT collections were slightly stronger than projected.  
- Collections of withholding taxes on capital income (including the tax on dividends) were significantly less than projected; some revenue may have been diverted to CIT as firms reported income as profits rather than capital income; companies apparently retained earnings in 2004 to avoid the final year of dividend tax.

Indirect taxes:
- Indirect tax collections were higher in 2004 but increased by less than previously projected.  
- Factors affecting indirect tax collections beyond reform: tax administration changes upon EU accession (shift in tax collection responsibilities from customs offices to tax offices) resulted in delays and losses in efficiency from mid-2004.  
- Lowering the VAT registration threshold required administering many extra small taxpayers.  
- Accrual-basis estimates for VAT and excises are more uncertain than those for income taxes due to these shifts.

### Social contributions
- Social contributions fell by more than expected following the reduction in rates.  
- 2004 budget implied a 0.8 percent of GDP reduction in social contributions from 2003.7  
- Collections fell short of budget by a further 0.2 percent of GDP, with the shortfall mainly in collections by the Social Insurance Agency.  
- Revenue losses from lower social contributions are of similar magnitude to the losses from the reform of state budget taxes (Figure 5).  
- Figure 5 presents tax structure including social contributions (In percent of GDP).  
- Footnote 7: Based on budgeted GDP. If based on actual GDP, the reduction would be 1 percentage point of GDP.  
- Footnote 6: Applicable for EU-source imports. Because of this shift, the accrual-basis estimates for VAT and excises are much more uncertain than those for income taxes.

### Welfare reforms
- Welfare reforms improved control of welfare spending.  
- 2001 and 2002: spending on state benefits and social assistance ran over budget by about 0.3-0.4 percent of GDP annually, reflecting benefit abuse and underbudgeting.  
- 2003 measures curbed benefit abuse, bringing welfare spending down by 0.3 percentage points of GDP and achieving savings of 0.1 percent of GDP compared to budget.  
- Following the 2004 reform, welfare spending fell by another 0.6 percentage points of GDP, and was 0.4 percent of GDP below the 2004 budget ceiling, mainly due to lower than budgeted spending on child allowances.  
- Figure 6 presents state benefits and social assistance (In Sk billion) for 2001–2004 (Budget vs Outcome).  
- Source: Slovak Ministry of Finance.

### Efficiency and incentives
- Overall: reforms provide several efficiency gains by reducing distortions and simplifying the tax system; the welfare reform should significantly improve work incentives for lower-income earners.  
- Labor taxes have fallen only modestly for many taxpayers; the tax burden has been shifted towards labor and away from capital, so improvements in incentives to work and to hire may be marginal for some groups.

Benefits from tax simplification:
- Reduction in tax exemptions reduces distortions in the economy, implying:
  - more efficient resource allocation when based on market rather than tax signals;
  - higher revenue for a given tax rate, allowing taxes to be set at lower rates;
  - greater transparency by treating many exemptions previously operating as tax expenditures.  
- The reformed system is simpler and easier to administer: taxpayers no longer face different tax rates for different types of income or commodity; tax authorities no longer enforce multiple distinctions, reducing litigation.  
- Single-rate VAT should help address long-standing problems with refunds (in 2002, VAT refunds had exceeded domestic VAT collections).8  
- Single personal and corporate income tax rate reduces opportunities for tax arbitrage (though does not eliminate them); multiple withholding rates and different rates for wage-income and profit tax previously offered scope for arbitrage (example: deducting interest expenses at a high rate while facing low withholding tax on interest assets is no longer possible).  
- Risk remains that self-employed persons have incentives to convert employment income into capital income because employment income is subject to payroll taxes.

Incentives to work — Composite tax rate
- Composite marginal tax rate measure used:
  C = 100 × [1 – (1-t)(1-c)/(1+v)(1+p)]
  where:
  - t is the marginal income tax rate on wages;  
  - c is the rate of employee social insurance contribution, in percent of gross wages;  
  - v is the marginal (tax-exclusive) rate of indirect taxation on net wages;10  
  - p is the rate of employer social insurance contribution, in percent of gross wages.  
- The reform changes tax structure but reduces labor taxes only modestly for many taxpayers.  
- At very low income levels, the marginal tax rate is above zero because of indirect taxes; initial increases reflect minimum thresholds for social contributions.  
- Highest marginal tax rates are at middle-income levels:
  - Under the previous system, composite marginal tax rate increased with income up to Sk 32,000 monthly, before leveling off; further increases in income tax scale were offset by the fall in social contributions to zero because social contributions were not payable on income above the maximum assessment base Sk 32,000.  
  - Following the reform, the composite tax rate falls sharply after income reaches the maximum assessment bases for social contributions.  
- Composite marginal tax rates moved differently for single vs married taxpayers:
  - For single taxpayers: composite marginal tax rates increased on gross monthly incomes between Sk 8,000 and Sk 13,000 in 2004—modest income tax relief at low income tax levels was more than offset by increases in both employee social contributions and indirect taxes.  
  - For married taxpayers with a non-working spouse and two dependent children: the reform implies cuts in composite marginal tax rates (except for high income ranges affected by the increase in the maximum assessment bases for social contributions) because of the large tax-free threshold from including the non-working spouse.  
- Note: for a married taxpayer, the exemption for a non-working spouse is as generous as for a working spouse; thus the spouse faces a high marginal tax rate upon entering the workforce, since income tax would be payable on the first koruna of the spouse’s earnings.

- Footnote 8: Comparable data are not available for 2003, owing to the one-off VAT refunds paid that year.  
- Footnote 9 and 10 references and discussion are presented in the source text on incentive literature and the treatment of indirect tax burden.

*Source: From calculations in Slovak Ministry of Labor, Social Affairs and Family (2004); Slovak Ministry of Finance; IMF staff estimates and IMF Staff Report for the 2003 Article IV Consultation.*

### Section V), the calculations below use the average rate of indirect taxation for simplicity.

### Section V) — the calculations below use the average rate of indirect taxation for simplicity.

### Payroll taxes, tax wedge, and social contribution rates
- Social contribution rates—and thus, the tax wedge—remain high by regional standards; payroll taxes contribute to a still-high tax wedge whether or not consumption taxes are included.
- Table 3: Social Contribution Rates (Selected European Countries, percent of Gross Labor Income)
  - Slovak Republic (2003): Employee 12.8, Employer 38.2, Total 51.0
  - Slovak Republic (2004): Employee 13.4, Employer 35.2, Total 48.6
  - Czech Republic: Employee 12.5, Employer 30.0, Total 47.5
  - Hungary: Employee 12.5, Employer 32.0, Total 44.5
  - Poland: Employee 25.0, Employer 20.4, Total 45.4
  - EU-15 average: Employee 12.5, Employer 24.1, Total 36.6
- OECD “Taxing Wages” measures (excluding consumption taxes) show Slovakia’s tax wedge remains above the OECD average at multiple points on the wage distribution.
- Literature cited:
  - World Bank (2001): high payroll taxes may bias against unskilled labor.
  - Daveri-Tabellini (2000): capital-labor substitution and attendant increase in unemployment can be significant with high tax wedges.

### Welfare reform and Marginal Effective Tax Rates (METRs)
- Definition (following Disney (2000)):
  - METR = 1 – [w(1-t_w-c) – b(1-t_b)]/w(1-t_w-c)
    - where b = level of benefit; w = gross wage; t = income tax rate; c = employee payroll tax rate.
- High METRs create two types of traps:
  - Unemployment trap: benefits so high relative to potential wage that individual chooses not to participate.
  - Poverty trap: individual cannot increase disposable income by increasing work effort.
- Pre-reform situation:
  - Former “top-up” income assistance withdrew benefits one-for-one as non-welfare income rose, implying an METR of 100 percent (actual METRs even higher accounting for transportation and other costs).
- Reform objectives and outcomes:
  - Authorities aimed to reduce METRs of around 100 percent to around 75 percent by allowing welfare recipients to keep 25 percent of non-welfare income (Slovak Ministry of Labor, 2004).
  - Household examples and Figure 10 confirm METRs of 100 percent for welfare recipients with no other income or earning minimum wage have been reduced.
- Distributional concern for large families:
  - Prior to reform, a family with five children faced METR of 100 percent even at monthly incomes approaching double the minimum wage; reform narrowed this income range.

### Activation program, child allowances, and other work-incentive measures
- Activation allowance:
  - Now accounts for a significant share of the benefit, approaching 50 percent in some instances, creating incentive to qualify through effort.
  - OECD (2003) evidence: activation strategies have boosted employment and reduced benefit dependency in several countries; success depends on labor demand.
- Child allowances restructured:
  - Sk 500 monthly flat, universal allowance (no means-testing).
  - Sk 400 monthly tax bonus, conditional on at least one parent being employed (no phase-out as income rises).
  - Child support via income tax: up to Sk 4,800 annually per child when at least one parent is employed.
  - Reforms improve work incentives though at some cost to targeting efficiency.
- Note: in-work benefits are often phased out and can increase METRs, but the new Slovak child allowance design does not phase out and thus does not create this effect.

### Recent employment developments and risks
- Employment response has been modest:
  - Economy-wide employment growth stagnated in the first three quarters of 2004 despite strong economic growth; public sector layoffs in 2004 partly explain weak employment growth.
  - Fourth quarter data suggest employment has started to recover, but recovery subject to two key risks:
    1. Shift in tax burden could entrench bias of economic growth toward capital-intensive activity.
    2. Reforms increase labor supply, but labor demand remains weak—especially in high-unemployment areas.
- Reference: Choueiri (2005); IMF (2005) discusses structural measures envisaged by the authorities to help reduce unemployment.

### Tax reform, corporate taxation, and investment implications
- Corporate Income Tax (CIT) changes:
  - New CIT rate: 19 percent (compares to 40 percent in 1999).
  - Abolition of dividend taxation implies investment income is now taxed only once.
- International reaction and comparisons:
  - The new CIT rate is low by EU standards and prompted claims of tax competition.
  - Examples of neighboring adjustments: Austria reduced its planned rate to 25 percent from 2005; Hungary reduced its CIT rate from 19.6 to 17.7 percent (Goliaš, 2004).
- CIT revenue:
  - Slovak CIT revenue as a share of GDP was 2.3 percent of GDP in 2004, close to latest observations for CIT revenues in both the EU-15 and EU-25 (2.4 percent each).
- Loss carryforwards:
  - Losses can be deducted from taxable income over the following 5 years; annual write-off installments are no longer required to be equal.
  - Previous restrictions on loss write-offs (and non-deductibility of advertising expenses) led to effective tax rates of 35 percent or more (sometimes 80 percent) despite statutory rates; new law remedies this.

### Distributional implications of the reformed tax and benefit system
- Two guiding questions addressed:
  1. Is the reformed tax system progressive, neutral, or regressive?
  2. Is the reformed welfare system still effective at protecting the most vulnerable?
- Income tax progressivity:
  - Excluding social contributions, the tax system remains progressive overall, though less so than previously.
  - The reformed personal income tax remains progressive: the average income tax rate rises with income over the whole income distribution, though less steeply than before due to a significant tax-free threshold (personal exemption).
  - Married taxpayers with a non-working spouse face a slower rise in average effective tax rate (double exemption plus child deductions).
  - Simplification (cancellation of different tax rates for different income types and most exemptions) contributes to horizontal equity.
- Indirect taxes:
  - VAT: under the previous two-rate VAT, the lower VAT rate provided relatively little benefit to poorer households; pre-reform VAT burden was similar across deciles.
  - At the single VAT rate, estimated VAT burden is around 14-15 percent for most income groups, slightly lower for the highest income decile.
  - Excise taxes: broadly proportional across household income.
    - Motor fuel tax is mildly progressive.
    - Tobacco excises are mildly regressive.
- Social contributions and composite tax rates:
  - Treating social contributions as taxes introduces a regressive component because contributions are payable up to a “maximum assessment base” and the marginal social contribution rate falls to zero above these maximums—implying the average effective social contribution rate falls as income rises.
  - Composite average tax rate (including employee but not employer contributions) findings:
    - Prior to reform, average composite tax rate rose with income, reflecting flattening in marginal rate for incomes above Sk 32,000 per month.
    - Following reform, composite marginal rate declines for incomes above Sk 40,000 per month (nearly 3 times the average wage), implying the overall tax burden turns regressive in the high-income range.
  - Share of high-income taxpayers:
    - 2003 tax returns: some 25,000 taxpayers filed returns for the tax bracket above Sk 396,000 (Sk 33,000 monthly).
    - Some 14,000 filed returns for the bracket above Sk 564,000 (Sk 47,000 monthly: above all social contribution ceilings even after the 2004 increases).
    - These tax-return data exclude many wage earners whose liabilities are satisfied by withholding and therefore do not file returns.
    - Labor force survey comparator: total employment 2.2 million in 2003.
    - On this basis, 0.6 percent of taxpayers have monthly incomes above Sk 47,000 (well above the ceilings for all types of social contributions).
- Narrower treatment of social contributions:
  - If only health contributions are included (excluding other social contributions), the overall tax burden becomes proportional at higher income ranges and the system remains mildly progressive overall.
- Figures and measures referenced:
  - OECD “Taxing Wages” measure: sum of central and subnational income taxes and employee and employer social contributions, measured in percent of gross wage plus employer social contributions.

*Source: IMF staff analysis and calculations, based on Slovak administrative data, OECD, and referenced studies as presented in the source PDF.*

### Section IV argued that the welfare reforms have corrected strong disincentives to work, but

### _wp05133 - Section IV argued that the welfare reforms have corrected strong disincentives to work, but

### Adequacy of the reformed safety net — empirical findings
- Previous studies found the pre-reform social assistance system to be effective at mitigating poverty:
  - World Bank (2001) Living Standards study (based on the 1996 Microcensus) estimated that canceling social transfers except for pensions would imply a poverty rate of 19 percent of all individuals, compared to an actual rate of 10 percent.
  - For households whose main income earner is unemployed, canceling non-pension social transfers would imply a poverty rate of nearly 80 percent, compared to an actual poverty rate of 45 percent.
- More recent Ministry estimates indicate possible deterioration in poverty risks:
  - Slovak Ministry of Labor (2004) estimates a risk-of-poverty rate of 28 percent before social transfers, and 21 percent after all social transfers.
  - Note: earlier Ministry estimates (Slovak Ministry of Labor (2003b)) reported a risk-of-poverty rate of 19 percent before social transfers, and 5 percent after all social transfers; data problems imply caution in interpreting changes over time.
- Social assistance benefits have been below the subsistence minimum since 2001 (Slovak Ministry of Labor, 2004).

### Impact on Roma communities and concentrated disadvantage
- Roma population and labor-market indicators:
  - Roma are estimated to account for up to 10 percent of the Slovak population.
  - In some isolated Roma settlements, unemployment rates around 90 percent have been observed.
  - The OECD (2002) estimates that Roma account for up to a fifth of overall unemployment in Slovakia.
  - Slovak Ministry of Labor (2003b) noted 1997 data showing as many as 80 percent of Roma were dependent on social assistance benefits.
  - UNDP (2003) found Roma unemployment rates around 70 percent in Slovakia (highest among five central and eastern European countries studied).
- Analysis:
  - Benefit dependency contributed to marginalization of some Roma communities.
  - Because many Roma have large families, they were particularly subject to poverty traps before the reforms and face some of the largest benefit cuts after the reforms.
  - The UNDP (2003) study attributed high Roma unemployment partly to “strong work disincentives that are built into the Slovak Republic’s social welfare system”.

### Subsistence minimum, benefit gaps, and distributional details
- Definition and indexing:
  - The subsistence minimum is a measure below which a household is considered to be in material need. It depends on family size, increases by a flat amount per dependent child, is uniform nationwide, and is indexed each July.
- Table 4. The Subsistence Minimum (as published)
  - July 2003  July 2004
  - One adult  Sk 4,210  Sk 4,580
  - plus second adult  Sk 2,940  Sk 3,200
  - plus dependent child  Sk 1,910  Sk 2,080
  - Example:  Sk 4,210  Sk 4,580
  - 2 adults, 4 children  Sk 2,940  Sk 3,200
  - 4 × Sk 1,910  4 × Sk 2,080
  - Sk 14,790  Sk 16,100
  - Source: Slovak Ministry of Labor, Social Affairs and Family.
- Observations on the gap between benefits and the subsistence minimum:
  - The gap between the subsistence minimum and social assistance benefits increased following the reforms, especially for families not participating in activation programs.
  - Example results (as discussed in text and Figure 3):
    - If one parent is employed and the other participates in activation programs, the real benefit is unchanged at zero labor income only for the one-child family, and reduced for the other families.
    - If neither parent is employed, the child tax bonus is not payable; and, without participation in activation programs, benefits are significantly lower.
    - For families with five children, Slovak Ministry of Labor staff estimate typical benefit reductions of around 10-20 percent if parents participate in activation programs; if the parents do not participate, the benefit reductions—and the gap with the subsistence minimum—can exceed 50 percent.
  - Caveats:
    - The subsistence minimum is uniform nationwide, while wages and living costs vary regionally (higher in western Slovakia, lower in eastern regions where poverty is highest).
    - Some of the gap may be filled by in-kind benefits (for example, free school meals for poor children).
    - When the child allowance is not paid to parents (e.g., child neglect or failure to attend school), the municipality determines how best to provide the child with the benefit.

### Design and implementation of welfare reform — key program features and participation
- 2003 measures:
  - Introduced a ceiling on monthly benefits per family of Sk 10,500 (binding only for very large families of six or more dependent children).
  - Administrative measures to curb abuse, including stricter enforcement of eligibility and requiring recipients to appear in person to collect benefits.
- 2004 activation-centered reform (policy design and amounts):
  - The basic monthly benefit of an individual was reduced in January 2004 from Sk 2,900 to Sk 1,450 (Table A2).
  - An “activation allowance” introduced: initially Sk 1,000, raised in April 2004 to Sk 1,500—payable to recipients who demonstrate effort to improve their situation (community volunteer work, retraining); payable indefinitely.
  - For individuals deemed unable to participate in activation programs, an equivalent “protective allowance” is paid.
  - Municipalities and NGOs receive Sk 400 monthly for each activated person; they are not required to pay wages to activated persons.
- Participation and implementation metrics:
  - The Ministry of Labor reports just over 100,000 individuals participated in activation programs by October 2004, compared with 56,000 in April 2004.
  - As at October 2004: over 90,000 beneficiaries were participating in community-based services organized by municipalities; just under 4,000 were undertaking further education or retraining.
- Treatment of labor income under the new scheme:
  - Several income types are deemed exempt income in the calculation of social assistance benefits, including 25 percent of individual income from dependent services—so benefits are reduced less abruptly when the recipient earns labor income.
- Child support restructuring:
  - The previous means-tested child bonuses (Sk 270 up to Sk 890 depending on income and child age) were replaced by:
    - A flat Sk 500 child bonus—conditional on the child being enrolled in school (the Sk 500 child bonus is universal).
    - A Sk 400 tax credit (payable only to households in which at least one parent is employed, but refundable if overall tax liability is negative).

### Fiscal, labor-supply, and distributional conclusions drawn
- Tax and welfare reforms combined effects:
  - Reforms corrected strong disincentives to work and strengthened incentives to work and invest via activation programs and lower marginal effective tax rates on incomes of welfare recipients.
  - The elimination of most exemptions contributes to better resource allocation and easier administration; the single-rate VAT helps address excessive VAT refunds.
- Fiscal implications and uncertainty:
  - Initial evidence suggests the tax reforms had a limited revenue cost and did not compromise the government’s objectives of fiscal consolidation and reducing the fiscal deficit to Maastricht levels by 2007.
  - EU accession had one-off effects on indirect tax collections in 2004; data for 2005 are required to present a clearer picture of permanent revenue effects.
- Distributional aspects:
  - The tax system is less progressive than previously; whether it remains absolutely progressive depends on the assessment of social contributions.
  - The flat-rate 19 percent personal income tax includes large tax-free thresholds, ensuring the tax is progressive rather than proportional.
  - Social contributions—payable only up to a ceiling—remain a regressive component in the tax system; their treatment (as taxes or linked to future benefits) affects progressivity assessment.
- Trade-offs and short-run risks:
  - Welfare reform faced a difficult trade-off between addressing benefit dependency and risking deteriorating poverty.
  - While reforms were arguably necessary to reduce long-term poverty and unemployment by curbing dependency and encouraging work, the short-run costs may have been high for some of the poorest Slovak families—especially large families and in regions lacking job opportunities to absorb newly willing labor supply.

*Source: IMF working paper content unit (_wp05133 - Section IV argued that the welfare reforms have corrected strong disincentives to work, but).*

### APPENDIX I

### APPENDIX I

### Table A2. The Monthly Social Assistance Benefit
- Previous system: to December 2003; New system Jan 2004; Current
- Income top-off, material need for “subjective reasons”
  - Basic benefit
    - Individual: Sk 1,450 (Previous system); Single person: Sk 1,450 (New system); Sk 1,530 (Current)
- Income top-off, material need for “objective reasons”
  - Individual parent with up to 4 children: Sk 2,160 (Previous system); Sk 2,450 (New system)
  - Individual parent with more than 4 children: Sk 3,160 (Previous system); Sk 3,640 (New system)
  - Individual: Sk 2,900 (Previous system)
  - Dependent minor child: Sk 1,000 (Previous system)
  - Couple without children: Sk 2,530 (Previous system); Sk 2,660 (New system)
  - Non-dependent child: Sk 1,600 (Previous system)
  - Parents with up to 4 children: Sk 3,210 (Previous system); Sk 3,630 (New system)
  - Maximum per family: Sk 10,500 (Previous system)
  - Parents with more than 4 children: Sk 4,210 (Previous system); Sk 4,850 (New system)
- Pregnancy allowance: Sk 350 (Previous system); Sk 350 (New system)
- Activation allowance / protection allowance: Sk 1,000 (Previous system); Sk 1,500 (New system)
- Housing bonus: 1-person household: Sk 780 (Previous system); Sk 780 (New system)
- Housing bonus: multiple-person household: Sk 1,330 (Previous system); Sk 1,330 (New system)
- Healthcare allowance, per person: Sk 50 (Previous system); Sk 50 (New system)
- Source: Based on information provided by the Slovak Ministry of Labor, Social Affairs and Family.

Notes on the social assistance system from the source text:
- The previous system distinguished between material need for “objective” and “subjective” reasons.
  - “Objective” reasons included involuntary unemployment and inability to find work despite search efforts.
  - “Subjective” reasons included an individual voluntarily leaving a job or refusing a job offer.
  - Material need was usually deemed to be for “subjective” reasons for households in the system for more than 24 months.
- The activation allowance was increased in April 2004.
- Basic benefits were indexed in September 2004.
- Housing and healthcare allowances are paid only to a single person or couple without children.

### Other Benefit Reforms
- Although the paper focuses on reforms to the tax and welfare systems, unemployment benefits and the pension system also have implications for work incentives.
- Major labor market concern in Slovakia: long-term unemployment, which accounts for roughly two-thirds of the total unemployment rate of nearly 18 percent.
- Slovak unemployment insurance benefits are payable only in the short-term and have played a much more limited role than the welfare system in sustaining unemployment.
- The World Bank (2001) found:
  - Those receiving unemployment benefits tend to spend longer unemployed periods compared to those not receiving unemployment benefits,
  - but look for work more actively than non-recipients,
  - and find private-sector jobs more often.
- Recent reforms to unemployment benefits and to the pension system should also contribute to stronger incentives to work.

### Unemployment Insurance
- Eligibility periods have been cut and the benefit more closely linked to past contributions.
  - An unemployed person is eligible for benefits for up to 6 months, compared to 9 months until end-2003.
  - The beneficiary must have contributed for 24 of the previous 36 months to be eligible.
  - The replacement rate is 50 percent of past gross income; previously, this had been 55 percent for the first 6 months, falling to 45 percent for the last 3 months.
  - Benefits remain subject to a ceiling, now being raised: the ceiling had been around half the economy-wide average wage and was raised to 60 percent of the average wage in 2004.
  - The ceiling will increase further in 2005 and 2006.

### Sickness Benefits
- Responsibilities shifted from the public to the private sector.
  - From 2004, the responsibility for paying the first 10 days of sickness benefits has been shifted from the public sector (via the Social Insurance Agency) to individual employers.
  - This measure has lowered costs to the public sector (though offset by a reduction in the sickness insurance contribution rate).
  - It gives employers much stronger incentives to verify that sickness claims are genuine.

### Pension Benefits
- The pension reform approved in 2003 reforms the existing public pension system and introduces a mandatory, privately funded pillar.
  - The reform of the public pay-as-you-go system provides for a gradual increase in retirement ages to 62 years for both men and women, from 60 (men) and 57 or less (women).
  - A closer link between future benefits and contributions is established.
  - The first increase in retirement ages was effective from January 2004.
  - The new privately funded (second) pillar started operations in January 2005.

*Source: APPENDIX I, based on information provided by the Slovak Ministry of Labor, Social Affairs and Family.*

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