Europe's economy pulled to the East

1.00pm - By HAMISH McRAE

The tail does not wag the dog, or at least not as a rule. But there are signs that policies in the new EU member states will have an important impact on the "old" EU countries.

A brief visit to Budapest last week demonstrated the evident success of the most advanced new members.

The statistics may say that living standards are less than half those of Western Europe but the divergence looks much less when gauged by the clothes, cars and shop-windows, and it is narrowing fast.

Growing at Hungary's 4 to 5 per cent simply feels different to growing at 1.5 per cent, all that Germany manages even in a good year.

You would expect economic convergence, with the central and eastern European countries being pulled towards the standards of western Europe.

More surprising is that economic policies may be heading in the opposite direction.

One early example has been Austria cutting its corporate tax rates because of competition from Slovakia.

As a result of low tax rates, companies have flocked there, with the effect that Slovakia will soon be the highest per capita car producer in the world.

Now Hungary seems set to put pressure on its neighbours with personal tax reforms.

The new prime minister designate (he takes over in the next few weeks) plans to make radical reforms to the income tax system.

This will be simplified into two rates, 18 per cent and 38 per cent. This is much lower than that of any of the established EU members.

But this is not designed to hand money back to the rich: the greatest gainers will be middle-earners.

Further, many tax deductions will be abolished with a tax on capital gains re-imposed (at 12.5 per cent) and higher taxes on rental and other income.

The three Baltic states, Estonia, Latvia and Lithuania have gone further, cutting top personal tax rates to 26 per cent, 25 per cent and 33 per cent respectively, while Slovakia has a flat rate of 19 per cent.

It raises the basic question: how do the new - and relatively poor - member states manage to construct a less onerous tax regime than their more established neighbours?
At a business tax level the tail is already wagging the dog. Next step: at a personal tax level too?

- INDEPENDENT