Winds of change in Warsaw

It seems that Poland will change its government after parliamentary elections on October 25. Ruling Civic Platform may lose to Law and Justice, but it’s unlikely it will significantly change the Polish economy.
Winds of change in Warsaw

Warsaw (Kamil Król, CC BY)

Recent polls have consistently put the opposition party ahead of Civic Platform by anything from 4 to 12 percentage points. Barring any dramatic turnarounds in the final weeks of the campaign, Law and Justice thus looks set to be the party that will form Poland’s next government, most probably in a coalition with one of the smaller right-wing parties likely to make it to parliament.

Poland has been the star economic performer in Europe in recent years. It was the only European Union country to avoid recession after the 2008-09 financial crises, enjoying a cumulative GDP growth of 23.8% in the years 2008-14, by far the best result in the EU. For comparison, Malta was second with 16.3% growth in the same period. This year, the IMF expects Poland’s GDP to expand by a healthy 3.5%. But what could an eventual Law and Justice-led government mean for the Polish economy?

Unapologetic populism

Law and Justice is an unabashedly populist party. Its campaign rhetoric is littered with nationalist slogans and promises of economic giveaways. For instance, it wants to lower the retirement age to 60 for women and 65 for men reversing a recent overhaul of the pension system, which increased the retirement age for both to 67. The opposition party has also promised PLN500 monthly for all parents for the upkeep of each subsequent child after their first, free medication for citizens over the age of 75, a PLN 12 hourly minimum wage and an increase in non-taxable income from PLN3081 to PLN8000. It wants to reduce corporate tax for small companies (with annual turnovers of less than €1.2m) from 19% to 15% and to decrease VAT from 23% to 22%.

To pay for all this, the party plans new taxes for hypermarkets (0.5-2% of turnover), banks and other financial institutions, an increase in government receipts from VAT and tax and a clampdown on the transfer of funds to tax-havens, especially by foreign corporations. Law and Justice is unhappy with what it sees as the excessive influence of foreign capital in the Polish economy.

Beata Szydlo, their candidate for prime minister, says Poland has the sixth-largest GDP in the EU but the structure of its economy resembles that of a “dependent” country. “Two-thirds of our exports come from foreign-owned firms, over 60% of our banking sector is in the hands of foreign capital. More than half of our processing industry takes its orders from headquarters abroad and foreign investors transfer roughly PLN100bn to their countries each year and much more if you include corporate costs,” she said at a party congress in July. “This is Poland’s reality today, but we can change that,” she added.

The government says Law and Justice’s campaign promises would cost PLN90bn but the opposition party puts the figure at PLN39bn, insisting it would raise PLN73bn from more efficient tax collection and from its planned taxes on financial institutions and large-scale retailers.

New taxes

One thing is clear. Whatever new taxes an eventual Law and Justice-led government might want to implement could go into effect by 2017 at the earliest. According to Polish law, new taxes for the next fiscal year have to be approved by parliament and published in the Journal of Laws by November 30 at the latest.

Considering the elections are on October 25 and it will take some time to form a government, it is highly improbable that Law and Justice could get new taxes passed in time for 2016. The party also seems unclear on whether it wants to tax financial institutions on assets or introduce a tax on financial transactions, an idea it has also floated. “I think a tax on financial transactions would be much more probable than a tax on the assets of financial institutions,” says Jaroslaw Janecki, chief economist at Société Générale.

Indeed, Jaroslaw Kaczynski, leader of Law and Justice, has suggested a 1% tax on financial transactions on the primary market and 0.5% on the secondary market. Janecki points out countries such as France and the UK have such a financial transaction tax in place. Regarding the possible 0.5-2% tax on the turnover of hypermarkets, Janecki says this would likely lead to a “slight acceleration in service prices for clients” if implemented.

But Marek Dietl, expert for the Business Centre Club, a private employers’ association, agrees with Law and Justice that there is a problem with tax payment by foreign corporations. “Poland has the highest level of corporate tax evasion in Europe. Global companies simply tend not to pay taxes here.” He cited the example of a major global automobile manufacturer with significant operations in Poland, which has paid a total of “0.01% of its turnover in taxes in the past 20 years it has been here.”

“Companies are taxed on profits but then their financial statements show no profits and they end up not paying any taxes at all. I thought the reason companies were in business in the first place was to make profits,” Dietl added wryly. Jan Filip Stanilko, analyst at the Warsaw Institute of Economic Studies, says large foreign retail chains “mostly German and French, don’t really pay taxes in Poland. The problem with FDI is while countries want it, the price they often have to pay for it is to not be, shall we say, strict, when it comes to controlling corporate transfers, especially intra-border transfers within the EU.” Stanilko though thinks a new government would be better off trying to raise money by enforcing stricter transfer controls on foreign retail chains rather than implementing a new tax on them.

Keynesian instincts

Law and Justice’s spending plans such as cash payments for parents and the significant increase in non-taxable income point to a fondness for demand-side Keynesian economics. Would this make sense in Poland’s current economic reality? “Their ideas, if implemented, would likely increase private consumption because of the boost in disposable income for low-income families,” said Janecki. Dietl concurs, saying “most of the money that would go into the pockets of lower-income Poles would be spent and a significant percentage of it would thus come back to government coffers.”

Stanilko though, says the focus should be elsewhere. “Poland doesn’t have a problem with consumption, I’d say we consume too much for our income level. What we have a problem with is investment.” Indeed, private consumption is already very strong in Poland. It’s currently worth roughly 60% of GDP and as the OECD pointed out in a June report on Poland’s economic perspectives “output growth, supported by strengthening private consumption, is projected to continue to rise, reaching 3.7% in 2016.” Meanwhile, as Stanilko pointed out, private investment is still too low in Poland. “Notwithstanding remarkable GDP increases over the past 25 years and solid investment growth in 2014, private-sector investment share of GDP has been lower than in neighbouring countries with similar income per capita,” stated the OECD in its report.

It would follow then that Law and Justice should be thinking of how to stimulate private-sector investment. Their proposal though is to embark on a state-led PLN 1 trillion 7-year investment program, details of which are very sketchy at the moment but which is supposed to involve the use of EU funds as well as profits from state-controlled firms and the treasury.

Regarding Law and Justice’s pro-family spending plans, Stanilko says they  are “necessary” because Poland has one of the lowest fertility rates in Europe at 1.3 children per woman, according to 2013 World Bank figures. “This is the last chance for us to try and initiate a concerted push to boost birth-rates among a key demographic, those born in the early 1980s when we had a population boom. For biological reasons, this is our last chance with that generation. After that it will be too late and later Polish generations are much fewer in number,” argued Staniłko. Whether Law and Justice will be able to find the money to pay for their pro-family policies is another matter entirely. As Staniłko says, the PLN73bn they plan to raise from more efficient tax collection and taxes on hypermarkets and financial institutions is “a bit too optimistic.” So what then about the danger of the populist party overspending while in office?

“The market is afraid they could overspend, but Polish law limits public spending,” said Janecki. Indeed, Poland’s Constitution limits the level of national debt to a maximum of 60% of GDP and if the debt level exceeds 55% of GDP, the government is required by law to balance its budget in the next fiscal year. In May this year, Poland exited the EU’s excessive deficit procedure imposed in 2009 in order to bring its budget deficit below 3% of GDP.

The deficit is now projected to be 2.8% of GDP this year and 2.6% in 2016. “I am quite sure a Law and Justice government would not want to have the excessive deficit procedure re-imposed with all the restrictions that involves and thus will do everything to keep the budget deficit under 3% of GDP,” said Janecki. It would seem then for now that there is little danger of a “Greek scenario” in Poland under Law and Justice.

Corporate tax and retirement age

While small business owners who qualify for Law and Justice’s planned reduction in corporate tax from 19% to 15% will no doubt be pleased, Przemysław Kwiecień, chief economist at X-Trade Brokers, says what Polish SMEs in general “really need” is a “less complicated business and legal environment so they can focus on their business. It makes no sense reducing one or two taxes without addressing the whole tax system which needs to be overhauled.”

But Law and Justice politicians have strong statist and centralist instincts and it is unlikely we would see a less complicated business environment under them. On their idea to reduce the retirement age, Kwiecień said this would only result in lower pensions in the future, which would then lead to the necessity of large money transfers to pensioners from other financial streams. “It’s a bad idea,” he said. Most economists tend to agree that reducing the retirement age in Poland now is certainly not the right direction to go.

No cause for alarm

And so to sum up, while a change of government always brings with it some uncertainty and while there are many question marks on Law and Justice regarding their attitude towards the EU and foreigners in general, it seems unlikely they will take any decision that could be significantly detrimental to the Polish economy or to those investing in Poland. Next year will see huge EU fund flows to Poland. Projects have already been planned, money allocated. “There is no risk to infrastructure investments and these will be a significant boost to the economy,” said Janecki.

It is also worth noting that while Law and Justice has always been very feisty, nationalistic and economically leftist in the sphere of rhetoric, when they were in power in the years 2005-07, they actually implemented some pro-business reforms such as eliminating the then-highest personal income tax rate of 40% altogether, leaving Poland with two tax levels of 18% and 32%. Their most likely potential coalition partners KORWiN and Kukiz 2015, while radically conservative on social issues, for instance opposing the settling of any Muslim refugees in Poland, are both far more economically liberal than Law and Justice and would probably kick against any overtly anti-business policies.

Civic Platform, meanwhile, has always been very pro-business in the sphere of rhetoric but much less so in action, which is one of the reasons they could soon be out of office despite presiding over impressive economic growth in difficult times. Most Poles don’t attribute the country’s recent economic performance to any policies or practices of the ruling party, but rather to the country’s hard-working private sector and to the significant EU funds Poland has been receiving since 2007. It seems Poles now want a new ruling party. Come October 25, we will know for sure if that is the case.

Warsaw (Kamil Król, CC BY)

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