The enterprise sector and emergence of the Polish fiscal crisis, 1990-91

The author analyzes the causes of the collapse of profitability in 1991 of the Polish enterprise sector. He explores how it affected the government budget and assesses the forecasts of enterprise sector performance used to prepare the government's 1990 and 1991 budgets. About half of the drop in profitability he attributes to the decrease in the inflation rate and the consequent decrease in the inflation bias in profits that results from historical cost accounting. He attributes most of the rest of the collapse in profitability to higher labor costs and higher amortization allowances. When wages are endogenized in a simple model, nearly the entire collapse of profitability is explained by the changes in inflation bias and amortization allowances. The decrease in the inflation bias and the increase in amortization allowances caused profits, and thus profit taxes, to fall, freeing up cash that could be spent on wages, causing profits and profit taxes to fall even further. This loss in government revenues was offset by increased revenues from wage taxes, which were in turn offset by an increase in wage indexed government spending, notably on pensions. As a result of all these changes, the government deficit increased about 4 to 5 percent of GDP - about half of the fiscal swing between 1990 and 1991. Policy options recommended for increasing tax revenues include: increasing the turnover tax rate and introducing the value added tax that will replace it at rates that maintain the increased level of revenue; increasing the social security tax rate; and maintaining, but not raising, the historical cost based profit tax, an automatic stabilizer. An obvious alternative to the profit tax based on historical cost accounting is to redress 1991 mistake, the indexing of amortization deductions. The author recommends drastically reducing or even abolishing amortization deductions for state owned enterprises for fixed capital acquired before 1990 (before the start of the transition from socialism). It is odd that these firms are given a tax break on top of the free use of state owned capital. If anything, they should be paying for the use of the capital.