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Impact of Possible Social Tax Cut on Health System

Country: 
Estonia
Partner Institute: 
PRAXIS Center for Policy Studies, Tallinn
Survey no: 
(16)2010
Author(s): 
Priit Kruus, Risto Kaarna
Health Policy Issues: 
Funding / Pooling
Current Process Stages
Idea Pilot Policy Paper Legislation Implementation Evaluation Change
Implemented in this survey? yes no no no no no no

Abstract

According to most political parties and different expert opinions, income tax (Social Tax, which is 33% of the gross wage) for entrepreneurs is too high and needs to be cut. This brings up numerous questions about the impact of such a policy on the social system (including health care), which is funded by Social Tax contributions. This report will analyze this policy idea and tries to assess to what extent lower Social Tax would impact on the health care system.

Purpose of health policy or idea

Almost half of the tax burden in Estonia is on income. The effective tax rate on income is around 35% and different groups of society (entrepreneurs, politicians and also experts) regard taxation on workforce as too large.

Although Estonia managed to come through the economic recession quite well (in terms of fiscal policy), the issue of high unemployment remains. In August 2010, registered unemployment was 11.1%, and by ILO definition unemployment was 19% in the second quarter of 2010. Therefore, the purpose of the reduction of Social Tax is to make it less costly for entrepreneurs to hire employees, to enhance job creation and, thus, reduce unemployment. The goal of the cut could also be to increase productivity by promoting the creation of high cost jobs (high value-adding jobs in areas where economic margin in international trade is bigger (eg information technology, bio-medicine, financial services etc), and jobs with new skills in traditional sectors that facilitate the structural change of the Estonian economy in order to move upward in the value chain), which could attract a highly qualified domestic or foreign workforce.

Social Tax (33% of gross wage) consists of two parts: 20% is used to fund the pension system and 13% goes to the Estonian Health Insurance Fund (EHIF). The questions that remain are, which part the cut should affect, and whether a ceiling or a reduction in the tax rate should be set.

Main points

Main objectives

To raise employment and productivity by reducing Social Tax.

Type of incentives

The incentive is to make it less costly for entrepreneurs to hire employees, to reduce labour costs, and to attract foreign investors to Estonia.

Groups affected

Employers, employees, unemployed people, patients (insured by EHIF), pensioners

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Characteristics of this policy

Degree of Innovation traditional rather traditional innovative
Degree of Controversy consensual highly controversial highly controversial
Structural or Systemic Impact marginal fundamental fundamental
Public Visibility very low high very high
Transferability strongly system-dependent rather system-neutral system-neutral

The degree of innovation is low as only small changes are made to the current system. Although there is a rather wide political agreement and understanding that taxation on workforce should be cut, the degree of controversy should still be regarded as controversial, as the social expenses are expected to rise and the funding of social expenses depends on the Social Tax contributions. The main principles of the system should probably be changed when Social Tax is cut and thus the structural or systemic impact could be vast. Public visibility can be high as the tax collection is rather transparent and the pooling of funds is clear cut. As the taxes on workforce are very common in many countries this policy can be regarded as rather system neutral.

Political and economic background

The main reason for the policy is high unemployment, which is now the most critical macroeconomic problem in Estonia. Unemployment increased as a result of the economic crisis and has stayed at a high level, with no expectation of a fast decrease. The economic crisis was the result of the collapse of the housing market and the reduction in export demand which was caused by the global financial crisis.

Although the policy affects the health care system, the policy goals have no relation to health care goals in Estonia, as Social Tax contributions are the main financing source for health care. On the contrary, a recent report about the sustainability of health care financing stated that the health care system is not financially sustainable in the long term and extra sources of funding should be considered, e.g increasing (not decreasing) Social Tax. 

Purpose and process analysis

Current Process Stages

Idea Pilot Policy Paper Legislation Implementation Evaluation Change
Implemented in this survey? yes no no no no no no

Origins of health policy idea

The main advocates for the reduction of labor tax for companies are the employers. There was no good reason for politicians to cut tax in the situation of an economic boom, but since 2008 there has been a steep rise in unemployment which is expected to stay high. According to many experts, structural reforms are needed and there is a shortage of qualified specialists in the labor market. Thus, entreprenerus have to either find workers abroad or make investments in education. Either way the costs are high.

It should be stressed that the financial sustainability of the health care system of Estonia has been doubted by many experts, and the discussed policy is in contrast with this fact. Alternative sources of financing have to be found before such a policy is implemented.

Initiators of idea/main actors

  • Government: The Ministry of Social Affairs is directly affected by the cut and thus opposed, as well as two of its subordinate institutions whose income comes straight from Social Tax contributions.
  • Providers: The providers could be regarded as opposed to the policy idea due to the fact that most of their revenues come from EHIF and a reduction in budget would mean serious financial difficulties, also taking into account the recent cut of service prices.
  • Payers: There is no public dissatisfaction yet, but it could be anticipated that negative opinions emerge if no alternative sources are found for financing health care or pensions and when the relevant stakeholders suffer from it.
  • Patients, Consumers: Decrease in health care expenditure could mean less accessible and lower quality health care, thus current and future patients can be regarded as opposed to the idea.
  • Scientific Community: Several experts stated their concern about the high level of Social Tax and pointed out different possible solutions, while also turning attention to broader impacts on public expenditure, entrepreneurship, FDI and fiscal sustainability.
  • International Organisations: OECD suggested lowering Social Tax in a recent report about Estonian economy. IMF on the other hand advocated structural reforms and broadening the tax base.
  • Media: The current position of the media in the discussion is rather neutral or varied - no clear opposition or support has been expressed so far nor has there been a broader public debate on the subject.
  • Political Parties: The main parties have advocated the policy idea, but no detailed promises were stated for the upcoming elections. The ruling coalition of the Reform Party and the Union of Pro Patria and Res Publica is expected to stay in power after the elections.

Approach of idea

The approach of the idea is described as:
amended: Amendments are made to Social Tax Law. The exact proportional cut or ceiling have not been stated.

Stakeholder positions

As the policy is cutting taxes, the most straight forward opponents to the idea would be the social system counterparts (Estonian Health Insurance Fund and Estonian National Social Insurance Board), which directly depend on Social Tax contributions. A report led by EHIF, written about Estonian health care financing, states that the financial sustainability of the Estonian health care system is problematic. Thus, cutting Social Tax without providing other sources of financing could make the situation worse, taking into account the aging of the population. 

Actors and positions

Description of actors and their positions
Government
Governmentvery supportivesupportive strongly opposed
Ministry of Social Affairsvery supportiveopposed strongly opposed
Ministry of Financevery supportivesupportive strongly opposed
Estonian Health Insurance Fundvery supportivestrongly opposed strongly opposed
Social Insurance Boardvery supportivestrongly opposed strongly opposed
Providers
Specialized care providersvery supportiveopposed strongly opposed
Family practitionersvery supportiveopposed strongly opposed
Private providersvery supportiveneutral strongly opposed
Payers
Employeesvery supportivesupportive strongly opposed
Central governmentvery supportiveneutral strongly opposed
Local governmentsvery supportiveopposed strongly opposed
Entrepreneursvery supportivesupportive strongly opposed
Patients, Consumers
Patientsvery supportiveopposed strongly opposed
Scientific Community
Expertsvery supportivesupportive strongly opposed
International Organisations
OECDvery supportivesupportive strongly opposed
IMFvery supportiveneutral strongly opposed
Media
Mediavery supportiveneutral strongly opposed
Political Parties
Reform Partyvery supportivevery supportive strongly opposed
Central Partyvery supportivesupportive strongly opposed
The Union of Pro Patria and Res Publicavery supportivevery supportive strongly opposed
Social Democratsvery supportivesupportive strongly opposed
The Green Partyvery supportiveneutral strongly opposed

Influences in policy making and legislation

The policy idea has not been included into any formal piece of legislation.

Legislative outcome

n/a

Actors and influence

Description of actors and their influence

Government
Governmentvery strongstrong none
Ministry of Social Affairsvery strongstrong none
Ministry of Financevery strongstrong none
Estonian Health Insurance Fundvery strongneutral none
Social Insurance Boardvery strongneutral none
Providers
Specialized care providersvery strongweak none
Family practitionersvery strongweak none
Private providersvery strongnone none
Payers
Employeesvery strongweak none
Central governmentvery strongvery strong none
Local governmentsvery strongneutral none
Entrepreneursvery strongweak none
Patients, Consumers
Patientsvery strongweak none
Scientific Community
Expertsvery strongweak none
International Organisations
OECDvery strongnone none
IMFvery strongnone none
Media
Mediavery strongweak none
Political Parties
Reform Partyvery strongvery strong none
Central Partyvery strongweak none
The Union of Pro Patria and Res Publicavery strongstrong none
Social Democratsvery strongweak none
The Green Partyvery strongweak none
The Union of Pro Patria and Res PublicaReform PartyOECDEmployees, Entrepreneurs, Experts, Central Party, Social DemocratsGovernment, Ministry of FinancePrivate providers, IMFMedia, The Green PartyCentral governmentSpecialized care providers, Family practitioners, PatientsLocal governmentsMinistry of Social AffairsEstonian Health Insurance Fund, Social Insurance Board

Positions and Influences at a glance

Graphical actors vs. influence map representing the above actors vs. influences table.

Adoption and implementation

As far as the health care system is concerned, the most important issue is whether the income of the EHIF will be sufficient to cover the expenses in the short term and in the long term. Also, depending on the exact policy, the Social Insurance Board is an important stakeholder, as it is responsible for the financing of pensions through Social Tax (20/33). A cut would put the sustainability of the pension systems under pressure.

Monitoring and evaluation

N/A

Expected outcome

Depending on the specifics (extent, form) of the cut, several possible impacts should be discussed. The macro-economic impacts could vary to a great extent, but in case of a reduction or setting a ceiling to Social Tax some short-term impacts to the EHIF can be assessed. As the complexity and unpredictability of the impact of setting a ceiling are greater this approach is discussed first.

Ceiling to Social Tax

The size of the impact would depend on the level of the ceiling. If the ceiling was set at twice the average wage, Social Tax revenue for health and pensions would fall by 8.4% (see Table 1). This short-term negative effect has to be weighed against potential positive behavioural effects such as increased employment as labour costs decrease. Nevertheless it is rather doubtful that the positive impacts could outweigh the negative impacts.

In the view of Estonian Development Fund and the Estonian Taxpayers' Association (presented in the recent report about health-care system sustainability by Thomson, Võrk et al 2010), a ceiling would have the advantages of allowing rich people to spend the money 'saved' to buy private health insurance (PHI), reducing the impact of health financing on the labour market (as long as PHI is not purchased by employers), preventing highly skilled staff from looking for work in other countries, and attracting skilled workers from other countries.

On the other hand, by increasing the tax burden of poorer people and providing relief for richer people, it would make the Social Tax regressive and would therefore lower equity in financing. An upper ceiling would be difficult to implement for people with multiple employers and involve quite high transaction costs. It could also increase the tax system's complexity, which goes against a key objective of Estonian fiscal policy.

More than half of health care costs in Estonia are costs on workforce. Thus the cut of Social Tax would also have a significant impact on the costs of health care providers. Depending on the nature of the cut (proportional decrease, ceiling set) the impacts could be different but on the whole a net decrease in Social Tax expense could be seen for the providers.

If a ceiling for the Social Tax is set to 2 times average wage the decrease of cost for service providers due to lower Social Tax payment on high salary specialists' (doctors) wages would be approximately EEK 85 m = EUR 5.4 m. If the ceiling is set at 3 times average wage, the decrease of costs is less than EEK 10 m = EUR 0.6 m. This derives from the fact that the average salary of doctor is 2.2 times the average wage. The minimum salary of doctors is EEK 112 = EUR 7.2 per hour.

Level on ceiling

Reduction in total Social Tax revenue for health system ( %)

Reduction in EHIF revenues (based on 2009 EHIF budget) in m EEK / m EUR*

2x average wage

-8.4

944 / 60

3x average wage

-4.1

461 / 30

4x average wage

-2.5

281 / 18

 

 Table 1 - Annual short-term impact on revenue of capping the Social Tax (Thomson, Võrk et al 2010)

*author's calculations

On the basis of above mentioned impacts and the 2009 EHIF budget, the following estimates could be made about health-care system financing. In the case of a ceiling set at 3x and 4x average wage the impact of a reduction in provider's cost is very little so in the short term the amounts in column 4 of Table 1 represent quite accurately the net loss in revenues for EHIF budget. But in the case of a Social Tax ceiling of 2x average wage the reduction in provider's payroll costs could be transferred (by the EHIF) to the health service prices and result in a proportional reduction in prices and less revenues for hospitals in the short term. Thus the estimated short-term net effect on EHIF revenues would be EEK 944 m - EEK 85 m = EEK 859 m = EUR 55 m.

The latter number could decrease in mid- or long-term due to abovementioned macroeconomic reasons (rise in employment and wages, less tax evasion, therefore larger Social Tax contributions to EHIF revenue). Nevertheless, it is a basis of great discussion, what would the impact on workforce market be.

Proportional cut of Social Tax

In the case of a proportional reduction of Social Tax the short-term monetary impacts to EHIF budget are presented below. Again, a cut in service prices could also be implemented by EHIF due to lower workforce costs for providers. Then again, the recent cut in prices (6%) has put the providers under considerable financial pressure and such a cut would be politically hard to implement.

Based on the 2009 EHIF budget the decrease in revenue according to 3 scenarios is presented in Table 2. Assuming the division of Social Tax contributions to pensions and health care will stay proportionally the same and the work force costs (subject to Social Tax) of providers constitute 52% of all costs, the net reduction of EHIF revenues would be as follows:

Social tax set at

Reduction in providers' workforce cost in mEEK / mEUR

  %

Reduction in EHIF revenues  in mEEK / mEUR

  %

Net reduction in EHIF revenues (if service prices cut) in mEEK / mEUR

  %

32%

32 / 2

-0,8

340 / 23

-3,0

309 / 20

-2,7

31%

63 / 4

-1,5

681 / 44

-6,1

618 / 40

-5,5

30%

95 / 6

-2,3

1021 / 65

-9,1

927 / 59

-8,2

 

Table 2 - Annual short-term impact of implementing a proportional reduction to Social Tax

*It is important to point out that current calculations are rough estimates modelled as static and future trends in Social Tax contributions are not taken into account.

Preliminary calculations about the impact of Social Tax cut on job creation (assuming that increasing the proportional tax rate by 1 percentage reduces total employment by 0.35 percentage points (Staehr 2008)) show that the policy's impacts on employment and therefore change in Social Tax contribution can be assessed. It can be shown that reducing Social Tax by 1% would raise employment by 3600 persons which means a rise in annual EHIF revenues by EEK 44 m = EUR 3 m.

Thus corrections to net decrease in EHIF revenues (based on 2009 budget) would be as follows:

Social tax set at

Rise in Social Tax (health care part) contibutions  mEEK / mEUR

Net reduction in EHIF revenues (if service prices cut and rise in employment taken into account) in mEEK / mEUR

32%

44 / 3

265 / 17

31%

88 / 6

530 / 34

30%

132 / 8

795 / 51

Table 3 - Annual impact on EHIF revenues (adjusted with employment growth)

Thus cutting Social Tax or setting a ceiling, either way means substantial decrease in revenue for the EHIF. If no alternative financing mechanisms are implemented or sources found, the impacts on public health could be very problematic, a decrease in both, accessibility and quality could be inevitable - the financial and social sustainability of Estonian health care system would be put at risk.

Impact of this policy

Quality of Health Care Services marginal rather fundamental fundamental
Level of Equity system less equitable system less equitable system more equitable
Cost Efficiency very low high very high

The policy of cutting Social Tax (proportionally or setting a ceiling) could have rather fundamental effects on both equity and quality of health care. If no adequate sources of funding are found or new sustainable mechanisms implemented, then the reduction in EHIF revenues would result in less health care services and possibly the emigration of most qualified doctors, which in turn has impacts on quality. The impact on cost efficiency can be high in terms of cost cutting, but substantial cost cuts can also lead to inefficiency when operational costs are financed by credit or qualified staff is let off - the financial sustainability of providers could be altered substantially.

The impact of cutting Social Tax has to be assessed more thoroughly and it is important that alternative sources of funding are discussed while assessing both short- and long-term effects of such a policy. Current governing coalition parties claim that the increase in economic activity will soon restore healthily the temporary drop of health system funds. No specific measures to mitigate the impact of a tax cut are proposed though. However, the Ministry of Finance has induced a major study, which is investigating all possible solutions to improve fiscal and social sustainability of social security financing in Estonia. It should be ready by autumn 2011. Among others broadening of the health financing base to reduce direct dependence on payroll taxes is analyzed.

References

Sources of Information

Author/s and/or contributors to this survey

Priit Kruus, Risto Kaarna

Suggested citation for this online article

Priit Kruus, Risto Kaarna. "Impact of Possible Social Tax Cut on Health System". Health Policy Monitor, Oct 2010. Available at http://www.hpm.org/survey/ee/a16/3