What can Czechs expect from the government-proposed tax and social reforms?

Photo: European Commission

The Czech coalition government last week unveiled a package of ambitious tax reforms and spending cuts. The cabinet says their reform, aiming to reduce the country's fiscal deficit and prepare it for euro adoption in 2012, comes at the eleventh hour. They say that under current legislation, mandatory expenditures would exceed state budget revenues in two years' time.

Photo: European Commission
Critics from the left say the proposed reforms would hit the worst-off, while right-leaning observers see them as too soft. But more importantly, as the governing coalition has no guaranteed majority in the lower house it remains unclear if the package will finally be approved.

Precisely a week ago, the Czech Prime Minister, Mirek Topolanek, along with Finance Minister Miroslav Kalousek and Social Affairs Minister Petr Necas, presented a package of tax and social reforms to the public. The event was not held on the government's premises, but instead in one of the upscale hotels on Prague's Wenceslas Square before a gathering of mostly well-to-do businessmen and less well-to-do journalists.

The audience, munching on Belgian pralines compliments of the organisers, listened to the speeches of the three politicians for almost two hours, looking forward to the lavish buffet waiting in the lobby. The thought came to mind that the setting was perhaps a hint at who is going to benefit the most from the proposed reforms...

"Well, the business community should definitely welcome it because first of all, the advantage for high-paid employees should benefit them the most. People above four times the average income - that is 80,000 Czech crowns - will have a triple advantage. First of all, decreasing of the tax level itself, secondly a cap on social and health insurance that is going to be the most advantageous benefit for them, and thirdly a capping of the whole tax base. So that's the biggest advantage for the corporate sector and, of course, the decreasing of the corporate taxation will also benefit the sector."

Economist Tomas Sedlacek of CSOB bank who was also invited to give a speech at the forum.

But apart from the highest income group, the fathers of the reform say the poorest should benefit as well. Miroslav Sevcik of the right-wing think tank the Liberal Institute.

Miroslav Sevcik
"This government is very socially sensitive to the group with gross monthly incomes below 12,000-15,000 crowns. The reforms will be less advantageous for the average income group, but even they will be better off by a few dozen crowns a month. It will be much more advantageous for the high-income group with the highest education. Finally their investment in education will pay off."

At the news conference last Tuesday, the Belgian pralines were slowly turning sour in the mouths of the average earners present as it dawned on them that there was not much in the reforms for them. A fact economist Tomas Sedlacek sees as a shortcoming.

"The disadvantages are that the burden will be carried extensively by the middle-income workers. Another disadvantage is that it will not bring a serious reduction in the budget deficit. Unfortunately, one of the strongest disadvantages is the decrease of expenditure side of the government budget."

Since its introduction last week, the government-proposed reform has been given a number of names: a rucksack, an omnibus, a mock-up, a travesty, a so-called reform. Let's take a brief look at what's in store for Czechs, from newborns to old age pensioners.

First of all, the reform introduces a flat 15-percent income tax which is supposed to simplify the tax system and also boost state coffers. The lower VAT rate would almost double, from five to nine percent, resulting in rises in the prices of food, medicines and public transport, among other things. The proposal reduces certain parental benefits, abolishes sickness benefits in the first three days of an illness and introduces food coupons instead of welfare payments for some. Labour and Social Affairs Minister Petr Necas, however, hesitates to speak about the "abolishing" of benefits.

Petr Necas
"We would like to create a situation when the tax system will be directly connected with social benefits. That means that we are strongly in favour of tax benefits rather than social benefits. When we take into account the current situation within our social system, it is necessary to boost our effort to slow down some kind of explosion of social expenditures. This is the first step. The second step is to start with a system reform, especially regarding the pension system because when we take into account the demographic development in this country, it is simply necessary to reform the pension system."

Some analysts say the proposed reform does not fully reflect the fact that the Czech population is aging and only mitigates the implications of the demographic development rather than addressing them while the Czech economy is growing. But in general, economists agree that the reform is a step in the right direction though it doesn't go far enough. Tomas Sedlacek again.

"By and large I would say that this is a step in the right direction which could and should have been much larger and much more dramatic. So let's see what the government comes up with next."

Economic analyst Ales Michl of Reiffeisen Bank is much more critical.

Ales Michl
"I think it is a pseudo-reform because you have a cut in personal income tax on the one hand but on the other hand the tax base has been enlarged and value-added tax has been increased. So overall I don't think there's any tax cut. This reform is neither a liberal reform like in Slovakia or nor a modern social reform like in the United Kingdom."

It would appear that while preparing the reform its creators were only working within the realm of the possible - with regard to the situation in parliament. The current coalition government of the Civic Democrats, the Christian Democrats and the Greens would like to see the changes in place as of January 2008. A vote on the reform package could take place during the summer recess but the government does not have a guaranteed majority.

The opposition Social Democrats and Communists have already said they would not support the package and a few critical voices have also appeared in the coalition's own ranks. The government had pledged to step down if it fails to push the reforms through.

The ministers have now put on a brave face and say they are confident the package will be passed. But there is no doubt they are facing some tough negotiations. Finally, I asked economist Tomas Sedlacek to look into his crystal ball to try and predict the chances of the reform package in parliament.

"That is very difficult to see because as I've mentioned it is regressive, so the more you earn, starting from 80,000 crowns a month, the less of a tax percentage you pay. This is a sensitive issue, especially for some members of the parliament. Also the fact, that a certain cohort of the population, namely people around the average income, will be hit by the increase of value added tax. So these will be two points that the government will have to advocate with their colleagues in order to win their support."