treatment thus creates economic inefficiencies, leads to (legal) tax avoidance strategies, and reduces the tax base.

59. Inequity among taxpayers also arises between dependent workers and self-employed workers. Although the self-employed have to pay personal income tax and social security contributions at the same rates as dependent workers, they have more opportunities to underdeclare income and also benefit from generous deductions for operating costs. Furthermore, in contrast to the social security contributions for employees, there is a ceiling for social security contributions of the self-employed, which affects, however, only highincome earners (earning more than 15 times the minimum wage). If the self-employed are organized as corporate firms, they also benefit from the lower capital taxation vis-à-vis labor taxation. For example, some medical doctors are organized as corporate entrepreneurs and pay their income out as dividends rather than as wage, thus avoiding the higher labor tax. The gap between capital and labor taxation also encourages managers of firms to transform part of their wage into capital income and distribute it as dividends. According to estimates by EMTA the revenue loss caused by paying dividends instead of salaries amounted in 2007 to 193 million kroons (0.1 percent of GDP). The Estonian financiel newspaper Äripäev (June 31, 2009) reported that Estonian top lawyers earn most of their income as dividends and pay social tax only on 10-20 percent of income.

# **8.2 The Case of Slovakia**

60. Acccording to the Statistical Office, undeclared work in Slovakia was 13-15 percent of GDP in 2000 and declined only moderately in recent years, which places Slovakia in a middle position among the NM-EU countries with respect to the size of undeclared work.. According to the IMD World Competitiveness report, tax evasion in Slovakia is less important for hampering business activity than in most other NM-EU countries (with the exception of the Czech Republic).

61. Slovakia has been successful in implementing profound economic reforms. As a result, framework conditions for firms in the formal sector are favorable. In the World Bank ́s Doing Business report, it ranks a bit lower than the three Baltic States, but above the other NM-EU countries. In 2004, Slovakia implemented a fundamental tax reform, which was part of an overall economic reform including a reform of the labor market and a reform of social benefits. The reform package aimed at promoting growth and employment by increasing investment and incentives to work following the slogan ―making work pay‖. The main tax measures were the introduction of a flat personal income tax and the unification of its rate with the corporate income tax and the VAT at 19 percent. Before, the personal income tax had a progressive rate structure ranging from 10 to 38 percent, the corporate income tax had a standard rate of 25 percent and 15 and 18 percent reduced rates, and the VAT had a standard rate of 20 percent and a reduced rate of 14 percent. The flat personal income tax has a basic personal tax exemption, which is linked to the subsistence level and is reduced gradually at higher incomes and phased out if the tax base is equal or higher than 100 times the subsistence level. As a result the average tax rate increases with rising income thus making the income tax slightly progressive. However, as social security contributions are subject to a ceiling, the overall tax on labor becomes regressive at higher income levels. Furthermore, the tax bases of the personal and the corporate income tax were broadened by eliminating or reducing exemptions and deductions. Excises on mineral oil, beer, and tobacco were increased while the tax on the transfer and assignment of real estate was abolished in 2005.

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