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Politicians fought a hard battle for a soft reform

Law will update taxes and benefits, but analysts say lack of vision hurts package

By Victor Velek
Staff Writer, The Prague Post
August 29th, 2007 issue

KURT VINION/THE PRAGUE POST
Critics accuse Prime Minister Mirek Topolánek's government of ignoring the opposition in order to placate ODS voters.
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VLADIMÍR WEISS/THE PRAGUE POST
Former Health Minister David Rath says the bill will hurt society's neediest groups.
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Public finance key changes

Health care
Patients to pay a 30 Kč ($1.45) fee per visit to a doctor
30 Kč fee charge per prescription
60 Kč fee per day spent in hospitals, spas or medical recreational facilities
90 Kč fee for using a medical emergency facility
Medical fee waivers available for people in destitution, the chronically and seriously ill, pregnant women, orphans, blood and bone marrow donations, infectious disease treatments
Ceiling for medical payments set at 5,000 Kč a year (excluding fees for hospital stays and emergency facility use)

Personal income taxes
Flat income tax of 15 percent in 2008, 12.5 percent in 2009, calculated from the "super gross income" (The current progressive taxation ranges from 12 percent to 32 percent of gross income)
Abolition of joint taxation of spouses
New system of tax exemptions

Other taxes
The lower VAT rises from 5 percent to 9 percent, pushing up prices of new houses and flats, public transportation, hotel accommodation, cinema and theater tickets, books and newspapers
The price of a pack of cigarettes will go up approximately 7 Kč
An environmental tax will favor power from renewable energy sources
The inheritance tax exemption will include more distant relatives of the deceased
Cancellation of tax exemptions on mortgage bonds will make mortgages more costly

Family
Birth allowance for each child is reduced from 17,760 to 13,000 Kč
Introduction of a new parental-leave system of two-, three- and four-year periods, each with different monthly allowances ranging from 3,800 to 11,400 Kč
Child benefits amounting to between 500 and 700 Kč a month only to families with incomes under 2.4 times the poverty line (the current quota is set at four times the poverty line)
Introduction of a cap on social security and health insurance payments set at four times the national average salary
Abolition of a 1,000 Kč benefit for first graders' parents

Employment
Lower sickness benefits: No benefits for the first three days of illness, then 60 percent of income up to 30th day of illness, rising up to 72 percent of income for longer sickness leave (currently, workers get 25 percent of income on first three days of illness, then 69 percent thereafter)
People unemployed for more than a year get the lowest possible allowance
Stricter punishments for people found to be working illegally while taking unemployment benefits
No unemployment benefits for people sacked due to misbehavior
Social and health insurance no longer tax-deductible for the self-employed

Corporate taxes
Corporate income tax decreases from today's 24 percent to 21 percent in 2008, 20 percent in 2009 and 19 percent in 2010
Abolition of tax on sales of shares and on dividends coming from outside the EU
Tax administrators to offer binding rulings concerning some tax-related issues (subjected to 10,000 Kč fee)
Closely interlinked firms entitled to group registration for the VAT
Taxation of debts more than 36 months overdue

— Viktor Velek

The Civic Democrat-led coalition won a hard battle over public finance reform after pushing its package bill through the Chamber of Deputies Aug. 21.
With the Senate and President Václav Klaus expected to make the reforms law, a series of wide-ranging changes are on the horizon — income taxes cuts, a rise of the value-added tax, medical-care payments and a less generous system of social benefits, among others.
While politicians are sharply divided in the assessment of the reform, economic analysts are weighing its costs and benefits. Although they praise some of the measures it introduces, many say the reforms are too weak. In short, the public witnessed a hard battle for a soft reform.
ČSOB analyst Tomáš Sedláček is among those who argue that the reform was diluted through political negotiations.
“I’m under-impressed,” Sedláček says. “The decrease of the state budget deficit, originally the main goal of the reform, disappeared.”
Raiffeisenbank analyst Aleš Michl agrees. “It’s not a reform. It’s just a package of remedies,” he argues. “Its main flaw is the lack of vision.”
The Economic Chamber is less critical. “It’s a step in the right direction. However, the increasing state budget deficit is still a problem,” says chamber spokeswoman Viktorie Plívová.
Cutting personal expenses
Once passed, the reform will introduce a flat individual income tax rate of 15 percent in 2008 and 12.5 percent in 2009. This replaces the current progressive taxation system, with four tax bands ranging from 12 percent to 32 percent. The changes will also raise the lower VAT, the tax on food and some goods and services, from 5 percent to 9 percent.
This increase in VAT means new flats and houses, train and bus tickets, books, museums, cinemas, theaters and hotel accommodation will all become more expensive starting in 2008.
In contrast, stiff competition among retailers is likely to keep prices for food and nonalcoholic beverages down, according to estimates from the Czech Food Chamber.
The reforms also introduce changes to how taxes are calculated. A given person’s tax will be determined by his or her “super gross income”— an amount that includes not only income but the cost of insurance paid by an employer on behalf of the employee.
Given this package of changes, analysts estimate the middle class will fail to see many benefits.
“People with low and very high incomes will benefit the most from tax cuts,” Sedláček says. “The middle class will gain nothing. The burden of the reform is to lie on its shoulders.”
“A slight tax decrease for middle-income groups doesn’t compensate for the raised VAT,” he adds.
Therefore, people who earn the nation’s average salary — slightly more than 20,000 Kč ($970) a month — are likely to save a negligible amount of money through the tax cuts.
The higher VAT rate will swallow more money than will be saved on taxes, while newly introduced medical payments will also impact the average person.
“In 2008, nobody will see a benefit of more than 5 percent of his or her income, except people with monthly remuneration of 80,000 Kč or more,” Sedláček argues. A person with a monthly income around 100,000 Kč will save approximately 10,000 Kč.
The cap on employees’ social and health insurance payments brings high-income groups additional savings.
Corporate income tax is to drop from 24 percent to 21 percent in 2008, and is set to decrease to 20 percent in 2009 and 19 percent in 2010. The draft also cancels tax on dividends flowing from non-EU countries to Czech-based companies.
“These changes will decrease the motivation of Czech firms to go abroad,” Plívová notes.
Ultimately, changes in the tax system are wide-ranging, but the current complicated scheme, full of deductibles and exemptions, has not been simplified, according to both Michl and Sedláček.
Slashing state expenses
While analysts have been reserved in praising the tax changes, they commend cuts to government spending. “In fact, the ideal option would have been to cut social benefits, wait several years and then make tax cuts,” Michl suggests.
Changes to social benefits are most visible within the healthcare sector. People will have to pay a 30 Kč fee for each doctor’s visit and each prescription. Days spent in hospitals, spas or medical recreational facilities will require a co-payment as well.  Pensioners will likely suffer the most from these payments.
Changes in sick benefits are to disadvantage short-term sick leaves. A stricter unemployment benefits system will target people who stay unemployed for a long time. The reform also squeezes birth allowances and child benefits.
Although some analysts praise these changes, they argue more money could be saved by focusing on inefficient, even lavish, spending within the government.
“Public money is wasted. For example, tenders are often manipulated,” Michl says. “A tougher competition system for state tenders should save lots of money.”
“Corruption causes major leakages from the public budget,” Sedláček adds.
For now, the No. 1 task for Topolánek’s pro-reform, center-right Cabinet is to stabilize public finances and make them sustainable in the long-term, analysts agree. The government must also find a way to move forward with its original plan — to reduce the deficit.

Victor Velek can be reached at vvelek@praguepost.com


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