The OECD has published a Working Paper entitled “Moving beyond the flat tax: tax policy reform in the Slovak Republic”. The paper looks at the Slovak tax system and how it has developed in recent years, and makes various policy recommendations.

With regard to indirect taxation the OECD recommends maintaining a broad value added tax (VAT) base and continuing to tackle the low level of VAT compliance which has been a factor in keeping the revenue collection low.

The Working Paper also recommends that a low corporate income tax rate should be maintained with a broad tax base. The current 22% corporate income tax rate is in line with the average for the other smaller OECD countries. Tax is one of the factors affecting foreign direct investment (FDI) flows and further rate increases should be avoided to ensure that mobile foreign investment is not diverted to other locations.

The corporate tax incentives should be reviewed as the incentives for investment are poorly targeted and the high minimum investment requirement means that very few companies can benefit from them. The approval process is not transparent and is too complex. The new relief for research and development (R&D) is a positive development but it means that there are now two R&D reliefs, and this leads to an increase in compliance costs. The new relief also provides opportunities for tax planning and evasion and it therefore needs to be closely monitored by the tax authorities.

The impact of the corporate minimum income tax should also be re-assessed as it creates inefficiencies and increases compliance costs.

Thin capitalization rules were introduced in 2015 and further efforts should be made to combat base erosion and profit shifting. Also domestic transfer pricing rules have been introduced to combat profit shifting from profitable to loss-making companies or to companies benefiting from investment tax incentives. The OECD recommends that further measures should be introduced to combat international tax avoidance based on the proposals of the action plan on base erosion and profit shifting.

The OECD recommends that the tax burden on labor income should be reduced, in particular for lower income workers. The high burden of taxation is caused by high employer social security contributions which price low-skilled labor out of the market. The tax mix should be shifted from labor taxes to less distortive taxes such as recurrent taxes on immovable property, environmental taxes and taxes on income from capital at the level of the individual.

A temporary exemption from employers’ and employees’ social security contributions was introduced in 2013 for workers who were previously long-term unemployed and are earning low wages. This has had an uncertain impact and it might be better to replace this with a similar exemption for all low income workers that could be introduced on a permanent basis.

Consideration could also be given to financing social security benefits through personal income tax rather than social security contributions. As social security contributions are levied at a flat rate up to a particular ceiling they reduce progressivity in the tax system. It might be advisable to consider the type of benefits and how they should be financed. For example, pensions or unemployment benefits are to some extent dependent on earnings and could be financed through social security contributions. Where the link between benefits and earnings is not so strong the benefits could be financed through the personal income tax.

Another suggestion of the OECD is that Slovakia should consider introducing tax incentives for training. This could be done by offering a tax deduction or a tax credit for expenditure on education. For workplace training corporate income tax incentives could be introduced. This would be complex to administer and should be accompanied by improvements in tax administration.

The cash transfers from government to low income families should be redesigned. The income-tested social benefits are reduced steeply as income rises and this means that there are high marginal tax rates for certain types of family. This high rate of withdrawal of incentives is a disincentive to work and can create a low income trap. Part of the cash transfers for low income groups could be integrated into the refundable employee tax credit to strengthen the incentive to work.

The OECD suggests that the taxation of self-employment could be further aligned with the taxation of employment. The tax administration should also strengthen its ability to detect situations where employment is disguised as self-employment.

Currently the Slovak Republic taxes all income from self employment as labor income. This creates an additional incentive for business owners to incorporate and distribute profits as dividends rather than paying wages. This minimizes the liability for tax and social security contributions. In the case of self-employment the Slovak Republic could therefore consider taxing the income from capital and the income from labor separately. This would require strengthened tax administration, so an alternative approach could be to increase the tax imposed at an individual level on income from capital. The combined tax on income from capital at the corporate and individual levels would then be more in line with the high taxation of labor income.

Other tax policy suggestions made in the OECD working paper are:

• Increase the dividend tax and phase out tax incentives for home ownership;
• Increase environmental taxes and improve neutrality of taxation of energy; and
• Increase property taxation and link it to market value.

The final policy recommendation made in the OECD Working Paper is to strengthen the ability of the tax administration to deal with non-compliance. Both VAT and corporate income tax non-compliance are important issues. Non-compliance is concentrated in a few sectors, especially with regard to VAT. The tax administration should therefore gain a better understanding of the components of the VAT gap and target the controls and anti-fraud policies at the activities and businesses that are high risk.