Following the Slovak model?

Disappointed economic analysts were in quick agreement earlier this month with a warning from Miroslav Kalousek, the Czech Minister of Finance, that stated that that the Czech Republic needs to be saved from a "debt trap." The statement was issued after the government's presentation of the proposed tax and public-finance reform package. While the package is said to provide measures to prevent the economic disaster skeptics envision, analysts found the plan modest at best.

According to the government's April 3 presentation, state expenditure on mandatory social benefits will overtake overall tax revenues by as early as 2009. "[These reforms] won't fix the problem, but they will make the problem less acute," said Pavel Sobíšek, a macroeconomic analyst at HVB Bank Czech Republic. Without reforms, Czech markets could take a serious hit as early as 2009, Sobíšek said. Last year, government debt grew by 7.8 percent - among the fastest-growing rates in the EU.

Slovak similarities?

A number of analysts compared the reforms to reforms implemented in Slovakia in 2004, but they stressed the lack of political initiative to accomplish the strategy on as great a scale. Some acknowledge the possibility that the government will slowly edge toward the Slovak model. "I would prefer these reforms to look more like the Slovak reforms," said Kamil Janáček, head economist at bank Komerční banka (KB). "My perception is the government is heading there in [a series of] steps," he added.

The Slovak public-finance reform implemented a flat 19-percent rate on personal income tax, corporate income tax and value-added tax (VAT). It also included large cuts in social subsidies, along with expansive pension and health care reform. That year, the World Bank named Slovakia the top economic reformer.

Since then, Slovakia's unemployment rate has dropped from 18 to 10 percent, while gross domestic product (GDP) growth in 2006 rose to 8.3 percent, nearly three times the European average and almost double that of the CEE region.

By comparison, the Czech reform sets different rates for personal income tax, corporate income tax and VAT. It's also less ambitious in cutting social subsidies, although the government promises that pension reform and the cancellation of dividend, capital gains and property transfer taxes will follow the approval of this initial reform package.

Flat-tax target

If the package is approved, income tax will be flattened to a single 15-percent tax rate, calculated from an individual's "super-gross income." Currently, the tax is claimed from four tax brackets ranging from 12 to 32 percent of an individual's gross income. The super-gross income is calculated by adding health insurance and social insurance payments to the state to the standard gross income. Though a number of commentators have written this off as double taxation, many analysts say it's just a marketing tool to hide that the real tax rate will be 23 to 23.5 percent. Slovakia's income tax rate would be 12.5 percent if calculated from the super-gross wage.

Alternately, corporate income tax will decrease incrementally from the current 24 percent to 19 percent in 2010. David Marek, a macroeconomic analyst at brokerage Patria Finance, said this move has the most potential for helping the Czech economy by attracting foreign direct investment (FDI). Following its reform, Slovakia saw its FDI surge from SKK 40.6 (zł.4.7) billion in 2004 to SKK 59.2 (zł.6.8) billion in 2005 and SKK 123.8 (zł.14.2) billion in 2006.

The tax reform's third major strategy is to raise the VAT rate of five percent on food, medicine and selected goods and services to nine percent. VAT for most products would remain at 19 percent. Increasing indirect taxation by pushing up consumption taxes, and decreasing direct taxation by lowering income taxes are intended to encourage micro-economic activity. However, opponents of the reform, including former Finance Minister Bohuslav Sobotka, say increasing VAT will translate to a large tax on the poor who spend a greater proportion of their money on food.

Net effects

Kalousek stated that the tax changes' net effect would be a CZK 9 (zł.1.2) billion tax revenue growth in 2008 initally, followed by a CZK 3.8 (zł.0.52) billion loss in 2009 and a CZK 28.2 (zł.3.9) billion loss in 2010, as corporate taxes decreased. The government plans to save on social benefits by cutting a majority of programs.

Aleš Michl, macroeconomic analyst at Raiffeisenbank, said further reform of corporate subsidies, social benefits and the health care system could save the government CZK 50 (zł.6.9) billion. He finds that the reforms announced so far are only worth a few billion crowns and the deficit still hovers at the level of CZK 100 (zł.13.7) billion

Two Civic Democrat (ODS) MPs, the former Minister of Finance Vlastimíl Tlustż and Jan Klas, have expressed concern that the reform doesn't extend as far as it should. Tlustż said he would have a group of tax experts analyze the reform before he he makes a decision on whether to vote in favor of the reform.

Sobíšek sees Tlustż's statement as an attempt to grab media attention. "He knows it's unlikely that any greater reform would pass in the current political environment," Sobíšek says.

Sobíšek and Michl both give the reform a 50-percent chance of passing, but Janáček is more optimistic. "The Prime Minister [Mirek Topolánek] said he's confident he has enough votes, and my guess is he knows something we don't," he says.

Bradley Gardner

This is an edited version of a story published by Czech Business Weekly