Pension reform draft proposes lower contributions, individual accounts

The Czech pension system is to undergo a major overhaul in the coming years. On Wednesday, government appointed experts unveiled a pension reform draft that would enhance the current pay-as-you-go system with individual savings accounts. If approved, the plan will be in effect when today’s generation in their 20s and early 30s reach retirement age.

There has been a general agreement for quite some time among Czech politicians and experts alike that the country’s pension system requires a thorough makeover. The Czech population is ageing, and the current pay-as-you-go system would inevitably lead to ever higher deficits: an estimated 4 percent of the country’s GDP by the year 2050.

Pavel Kohout

After years of work, a government-appointed commission on Wednesday came with a draft of the pension reform. The main differences include lowering pension contributions by individuals from 28 to 23 percent of gross wages, retiring at a later age, and setting up of individual pension savings accounts. Economist Pavel Kohout is a member of the panel of experts who drafted the reform.

“The other important change is that the so-called second pillar would be introduced – a mandatory savings pillar. That means that people participating in the pension system will pay three percent of their gross wages to a fund of their choice; if someone decides that he or she does not want to take the risk, they can invest into government bonds.”

To make up for the lower contributions, the experts are suggesting bringing the VAT rates up to 19 percent. This would affect the price of food, some services and other goods.

Illustrative photo: Archive of Radio Prague

“If we cap the contributions paid from wages, it’ll make the workforce cheaper, and will be a stimulus for employment. That’s one good thing about it. The other thing is that levelling up the VAT rate on 19 percent will make the income into the pension system robust because VAT is one of the most stable income sources for the state budget.”

The parties currently in talks on forming a centre-right coalition have said the draft would be a good starting point for implementing the reform. They also want to involve the Social Democrats – which might prove difficult.

Social Democrat Vladimír Špidla is a former European Commissioner for employment, social affairs and equal opportunities, as well as a former Czech prime minister. He has two major criticisms of the draft: a hike in VAT would be unfair as it would also affect socially challenged people; and individual savings accounts might be too risky.

“Another problem is that these funds will be investment funds and there is a risk to every investment. I can’t see the state making people take risks without providing corresponding guarantees. But these cannot effectively be provided because the sums will be too high.”

The experts on the panel believe, however, that VAT is the fairest tax of all because it affects everybody according to his or her consumption. Also, the pension funds would only operate under the supervision of the Czech National Bank to prevent them from going under.

Politicians believe that the pension reform could eventually be implemented around 2015; if it indeed happens, Czechs in their early thirties and younger would already save up for their pensions under the new system.