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Hard sell

Proposed public finance reforms could radically reshape Czech taxes and social subsidies — or lead to early elections

By František Bouc
Staff Writer, The Prague Post
April 11th, 2007 issue

ISIFA/Pavel Wellner
Finance Minister Miroslav Kalousek, left, and Prime Minister Mirek Topolánek are staking the future of their Cabinet on the reforms.
After months of warnings from politicians and economists on the Czech Republic’s dire future financial health, Prime Minister Mirek Topolánek, of the Civic Democratic Party (ODS), revealed the Cabinet’s cure for deteriorating public finances April 3.
The Cabinet is proposing a unified bloc of reforms that promise to radically restructure tax and social welfare policies in an effort to halt a growing deficit and put the country on firm fiscal footing.
Source: Czech Statistical Office, 2005 revenues
Taxing Changes
Topolánek has staked the legitimacy of the governing coalition on the passing of these reforms, saying that if they don’t clear Parliament — which the coalition controls by a narrow margin — it would be tantamount to a vote of no confidence and lead to early elections.
The reforms include cuts in corporate taxes and a flat income tax, and also promise to significantly cut the social subsidies paid by the government.
By 2010, corporate income tax would be slashed from the current 24 percent to 19 percent, while starting next year individual income tax would be set at a flat 15 percent, in contrast to the current graduated income tax, which varies from 12 percent to 32 percent.
While reducing income taxes, the reforms would increase taxes on consumption, raising the lower bracket of the value-added tax (VAT) from 5 percent to 9 percent. This could raise prices on a variety of items, from food to real estate.
The reforms are needed both to set the Czech Republic on the right path to adoption of the euro by 2012 and to halt the quickly rising national debt. Last year, the public finance deficit grew to over 1 trillion Kč ($48 billion).
“This is the only way we can avoid a crash in our public finances,” Topolánek said.
The draft reform has received mixed responses from politicians and economists.
One group, including Miroslav Singer, a board member at the Czech National Bank, hails the reforms as a step in the right direction. Others, such as Aleš Michl, an analyst at Raffeisenbank, say the government’s draft is shallow and does not represent true reform.
“The government came up with a helter-skelter style on tax cuts,” Michl said. “The proposed changes are not a reform of public finance or a way to simplify the system.”
Income rewards
The idea behind the reforms is that they will encourage people to work rather than rely on subsidies from the state, Topolánek said.
HVB Bank’s chief economist, Pavel Sobíšek, supported this position, saying the reforms should help halt the deficit and would motivate people to prefer earnings from work to social subsidies.
“The VAT rise will be particularly reflected in increased food prices, which could cause inflation to grow up to 1.5 percent,” Sobíšek said.
Economists seem to be in agreement that the steps proposed by the Cabinet could raise inflation by about one percent, while the gross domestic product would increase by no more than 0.5 percent.
Raiffeisen’s Michl said the proposed flat tax on income would be of least benefit to the middle class — those with monthly earnings between 20,000 and 30,000 Kč — while it would be a boon to those earning more than 80,000 Kč per month.
Opposition leader Jiří Paroubek, chairman of the Social Democrats (ČSSD), called the reform “anti-social” and predicted that it could accelerate inflation 3.5 percent.
Representatives of corporations were not thrilled about the reforms, either.
“We expected something different,” said Radim Jančura, owner of Student Agency, the Brno-based coach service.
Most disappointing for the corporate sector is the slow pace of lowering the tax burden, with companies waiting until no earlier than 2010 for the 19 percent tax rate.
On the other hand, HVB Bank’s Sobíšek said, the lowered level of corporate taxation combined with another proposed measure — the elimination of a tax on dividends — could encourage multinational corporations to keep their profits in the Czech Republic. So far, foreign companies have preferred to take their profits abroad because of the high corporate tax levels.
All or nothing
The future of the reform remains unclear. The ČSSD and Communist Party of Bohemia and Moravia have announced that they will not vote for the reforms in Parliament, and several members of the ODS, the senior party in the governing coalition, have also questioned the reforms.
Vlastimil Tlustý, who was the finance minister in Topolánek’s first Cabinet, from September to December of last year, said the reforms presented were just a shadow of what the ODS originally planned.
Four other ODS deputies also admitted they may not eventually support the reforms.
Topolánek has said the Cabinet will not allow deputies to vote on particular measures in the reform. Instead, he said, they should vote either for or against it. Topolánek also said the result of the reform vote will determine the future of his Cabinet.
“A negative vote in Parliament would most likely send this country to early elections,” Topolánek said.
The date of the vote remains unclear. The Cabinet is expected to pass the reforms on to the Parliament sometime this spring.
“We’ll work toward forwarding the draft of the reform to Parliament as soon as possible,” Finance Minister Miroslav Kalousek said.

František Bouc can be reached at fbouc@praguepost.com


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Reader's comments:

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[17:42 13/04/2007] : A bit of perspective on the failings of the 'magic of the market', privatization and the flat rate income tax may be in order. In my jaundiced opinion, the only thing magical about the 'free market' is that it is indistinguishable from what might be called 'predatory capitalism.' Privatization in America has benefited 'corporate capitalism' by enhancing profit margins to the benefit of stockholders and corporate executives at the expense of working people who create capital by their work. The notion of a flat rate income tax has gained no 'traction' in America as it is manifestly obvious that 15% of a working person's income is of more importance in that person's everyday life than 15% of a wealthy person's income. The Czech voter had best think long and deep before abandoning the progressive income tax in the CzRep.
wayne soukup
david city ne
[14:29 16/04/2007] : As usual, Prague Post's interviewers never seem to delve very far beneath the surface.

The 15% "flat tax" is not what it seems. The tax base will be increased to include both the employer's and the employee's social security contributions. The actual rate will be 23%, which for an average worker is a big increase.

In addition, the increase in the lower rate of VAT will have a major impact on the cost of food, short-term accommodation and other essential items.
Sally Amis
Prague
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