VAT hike

Unlike last year, when massive consumer spending allowed shops and stores to enjoy record sales, Czechs do not expect to continue with their shopping sprees in 2004. A drastic value added tax increase that came into effect on January 1, 2004, has forced them to dig deep into their wallets and think twice before spending another crown. The VAT was raised from 5 percent to 22 percent on numerous goods and all services including the post office, telecommunications, the Internet, hair dressers, plumbers, lawyers, accountants,...the list goes on. Economist David Marek from Patria Online says it is a drastic step, but one that cannot be avoided:

VAT hike

"Prices should be increased because of changes in the tax practise and that is done because of the harmonisation of our legislation with EU laws. The second reason is to bring more money into the state budget."

In other words, the VAT was raised so that goods and services in the Czech Republic carry a rate that's standard in the EU. Furthermore, in order for the country to be able to adopt the Euro in 2009, it has to get its public finance deficit down to three percent of the GDP from over six percent expected this year. The best way to do that is to give the state budget a financial injection through a higher tax system.

But what does the ordinary Czech think about this measure?

Man: "What I don't like is that we will always be behind our neighbours in Germany or Austria. When we join the EU, they will be able to come here and spend a lot of money because the Czech Republic is a very cheap place for them. When we go there, we can't spend as much. Last year, our financial situation improved a little bit but now that they have increased tax, we will be the poor neighbours again."

Woman: "I do not like it but I know it has to be done in order for us to be able to become EU members. So, I prepared early. I called all my friends and family around the country to wish them a new year and catch up on news before January 1st. I also went to the hair dresser and called the plumber before the New Year to check my heater and boiler. Unfortunately, I had to decide not to buy a car, because petrol too has become expensive and it will cost more to have it serviced."

Man: "I own a small graphic design studio in Brno and so it is difficult to save costs."

But if you own the studio, then you provide a service, I guess...

"Yes. Maybe I will have to increase the price of my services too."

Photo: European Commission

Woman: "I'm a student and depend on the Internet for my research. During Christmas, I spent many hours researching on the web so that I will not have to do it now. I have not really felt the increase in prices but that is because I will get my bills at the end of the month."

There is no doubt that the wallets of Czech citizens will be dealt a heavy blow in 2004. Besides the VAT hike, an increase in consumer taxes on tobacco, alcohol, and fuels has seen prices of cigarettes, spirits, and petrol go up too and despite this, several towns and cities have also made dog licences, rubbish collection fees and some public transport more expensive.

Man: "So many things are more expensive now. I calculated how much I will have to pay every month in additional costs because I have a dog and live in a smaller town near Prague, and drive to the city to work. I also smoke! All of this will raise my bills by at least 1,000 crowns a month. But it will probably be more."

One thousand crowns is a little over 30 Euros. It may sound like an insignificant increase but for those who get the average monthly salary of around 550 Euros and want to live a comfortable life, an extra 30 Euros in costs certainly makes a difference. Fortunately, prices of foodstuffs, medicines, books, newspapers, and magazines are not to be affected. Or will they? Some fear that overall prices will rise automatically as the cost of petrol is raised.

Woman: "If you look at it logically, they say that food will not be expensive. But how does it get to the shops? It gets there by car, which runs on petrol that is more expensive. So the bakery will have to increase the price of its goods because it has to pay for the journey from the bakery to the shops."

Nevertheless, economist David Marek says there is no cause for concern:

"We can expect some secondary effects from, for example higher oil prices and higher tax rates on gasoline. But these secondary effects should spread over time and shouldn't be dramatic. If you look at the impact of the Consumer Price Index, which is the best way to show the impact on ordinary people, you can see that the changes in tax rates and in regulated prices should increase the consumer price level by around two percent. So, it's nothing dramatic. It should be possible for almost all families to sustain without any problems."

Woman: "I know many young couples, some of them even have children, who bought a lot of things on loan during the Christmas season. With so many prices being raised at once, they won't just have to pay higher bills. They have to pay back their debt as well."

A point that many ordinary citizens have raised. But despite all of this, figures show that we are still better off than much of the western world.

"When you compare the debt of Czech families with the level that's usual in Western Europe or the USA, you can see that the level of indebtness of families in the Czech Republic is still very, very low. So, there should not be a problem for the banking system or the whole economy. When looking at the structure of consumer loans, we can see that the amount of the usual loan is very small. So, if there should be any financial problems in the family sector, it's possible to resolve it in a very short time without any dramatic changes in the financial situation or living standard of families."

Even though they've been making use of their credit cards and buying things on loan, meaning that they've entered 2004 with quite a large debt already?

"I would guess that the debts of Czech families will be growing next year but the reason is that we are learning to live in the same way as the people in Western Europe. So, we are using consumer loans as a buffer to sustain disproportion in disposal income through time. So, it's something usually used to smooth consumption over time. We probably will see some low-earning families have problems but that shouldn't be a problem that is generalised."

But the bad news is that the VAT hike is only in its early stage. In order to raise budget revenues even further, the government announced it was considering introducing a third VAT bracket in 2005, where higher tax is applied to services such as public transport, theatre tickets and health club services, that have been enjoying the five percent tax rate. Despite EU norms allowing the lower rate (5%) to be applied to necessities such as food, the government is also considering to tax food at seven percent in the 2005 VAT bracket. However, the good news is that this step may see some lowering of the standard rate of 22 percent.