1. World Bank EU8 Quarterly Economic Report April 2005 Special Topic: Labor Taxation and Employment in EU8

2. Highlights of the Report EU8 macroeconomic prospects for 2005 broadly favorable despite political instability and weaker external environment. Revision of SGP both good and bad news for EU8. Renewed reform momentum needed to sustain high growth rates and boost employment. Lower labor taxes can help, but offsetting measures needed to protect fiscal positions.

3. Macroeconomic Prospects Growth rates likely to slow across region in 2005 because of weaker activity in main export markets, real appreciation of currencies, and political uncertainty ahead of elections in several countries. Stellar export performance in 2004 may be hard to repeatand large external imbalances remain in some countries. EU-accession related inflation pressures successfully contained in Visegrad countries, but problems in the Baltics (not least Latvia). Fiscal outcomes in 2004 mostly better than expected, but further consolidation in 2005-06 elusive.

4. Revision of SGP Acceptance of pension reform costs (although only for 5 years at a declining rate) good news for Poland, Hungary, and Slovakia. If countries stick to Convergence Programs from late 2004, they could meet Maastricht criteria in 2007 and adopt Euro in 2009. But risk that general weakening of Pact will reduce its credibility, including in EU8.

5. Renewed Reform Momentum Needed Political instability has slowed reform momentum across the region. Key priorities include social spending reforms, enhancing labor market flexibility, boosting competition in network sectors, and strengthening public administration (including to make good use of EU funds). Better now than to wait for growth to slow.

6. Lower Labor Taxes Can Help Labor taxes, not least on low-income earners, are high in the EU8, even in a broader European perspective. High labor taxes on low-income earners appear to be more damaging than in EU15. Lower labor taxes can help support employment and output growth. But need to ensure fiscal neutrality. Best to cut spending, and safest to do this first.

7. In Sum…Or in Other Words… Short-term macro-prospects broadly favorable, but more needed to address internal or external imbalances. Fiscal policies need to play a larger role to support macro-adjustment and sustain good growth performance. Broader reforms also need to be accelerated, including enhancing labor market flexibility. Lower labor taxes can play an important role, also to support higher employment, but need to first (or at the same time) find off-setting measures.