The Prague Post Online: Business: Tax plan unlikely to boost growth

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Tax plan unlikely to boost growth

But reform could attract high-end businesses to ČR

By Riva Froymovich
Staff Writer, The Prague Post
April 25th, 2007 issue

The government’s new tax plan is a compromise among three parties, which means two things: It will not accomplish at least one of its intended effects — overall economic growth — but may still provide stimulus for select industries in the Czech Republic, according to observers.

Proposed by the Finance Ministry in early April and expected to reach Parliament this summer, the reforms have been characterized as a flat tax, but they are not exactly a single-rate tax system. For one, the proposed corporate, personal and value-added tax (VAT) rates are all different.

The plan includes a cut to corporate income taxes from 24 percent to a uniform 19 percent by 2010. It also calls for a single individual income tax rate of 15 percent, instead of the current graduated tax, which levies the highest income levels more than 30 percent.

The government will likely add a number of caveats to the bill for low-income taxpayers, however, to uphold the Civic Democratic Party’s (ODS) pledge not to increase charges, analysts say.

To offset the cuts on income taxes and address the current budget deficit, the reforms include a raise of the reduced VAT rate from 5 percent to 9 percent, increasing the cost of food and other goods.

Flat-tax systems were hyped as a means to spur economic growth by the ODS in the last election. But that was before party had to form a coalition.

“A single rate for personal income tax is definitely not sufficient to bring higher growth,” especially with the addition of personal allowances for low-income workers, said Peter Mach, executive director of the Center for Economics and Politics, a pro-market think tank founded by the ODS.

The center drafted the ODS’s original flat-tax proposal, which has since been reshaped by the coalition. Consequently, the bill won’t significantly boost gross domestic product, Mach said.

So, why push the bill if it won’t have the desired effect?

Though it is a shadow of the flat-tax system Prime Minister Mirek Topolánek campaigned under, the proposal has become the piece de resistance of the ODS reform movement. Its defeat would represent a loss of confidence in the party.

“It’s a very important symbolic step because it was in their pre-election agenda to introduce a 15 percent tax,” Mach said. “The problem is we have a coalition government.”

The president of the Confederation of Industry of the Czech Republic, Jaroslav Míl, summed up the sentiments of many: “This reform is better than no reform.”

But it won’t bring an impetus to the economy, he said.

The reforms, however, could create an insurance plan for the recently shaken Czech manufacturing sector, according to Jan Žůrek, a partner at KPMG in Prague.

“Up till now, the government pursued tax incentives through manufacturing, but [manufacturers] may decide to leave in five years,” he said.

Apprehension over rising labor costs and increased union confidence, epitomized in the recent Škoda strike, might have leaders looking to lure higher-end businesses, including information technology specialists, Žůrek said.

“That’s a good step, because then the government is attracting more intellectual services” by decreasing the corporate rate, he said. Also, the package will attract the well-paid people they employ, he added.

Some people avoid working in the Czech Republic because of its high tax rates. The reform will spread the tax burden and simplify the system, raising employment interest and returning revenue the government has lost to tax dodgers, Žůrek said. The simple formula will make the cost of paying taxes lower than the cost of breaching the tax law.

For example, Slovakia’s flat-tax reform yielded lower rates but higher tax revenues, from new investors and formerly evasive taxpayers.

Now, Bratislava is one of the best places to employ people in the region. The potential benefits for the Czech Republic, then, which has better highways and telecommunications, as well as a better airport, could be even greater, Žůrek said.

Shoulf the proposal pass, the Czech Republic will become the world’s 14th country — and the 10th in Central Europe — with a form of the flat tax. The trend’s geographic concentration, which began with Estonia in 1991, has a simple reason.

“Regional tax competition,” said Tomáš Bartovský, Industry and Trade Ministry spokesman. Lower income taxes in neighboring countries lure investment away from the country, he said.

Riva Froymovich can be reached at rfroymovich@praguepost.com

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