Jan Macháček

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Czech Business Weekly

Reform package ranges wide, fails to hit deep

03. 09. 2007
The reform package of the coalition government has made it through the lower house of Parliament. Nobody is anticipating a presidential veto or trouble in either the Senate or Parliament, where the ODS has a comfortable majority. So this is a good time to start evaluating this hastily stitched together patchwork of amendments to our legislation.

Let’s start with the positive. It’s perhaps no coincidence, that some of the more important steps in this reform package have not received much media attention. Nearly all the focus so far has been on the changes to income tax and the potential winners and losers.

Among the overlooked measures of the reform package is the increase in the lower rate of VAT from 5 to 9 percent. This shifts the burden of taxation from a direct one to an indirect one—and most economists would agree that indirect taxes are less damaging to the economy. But pushing the two rates of VAT closer together also moves us nearer to creating a single rate sometime in the future. A single rate is a declared policy goal of the European Union that, ironically, only a few countries fulfill. It makes business more transparent and diminishes the influence of bureaucracy and politicians.

Another significant reform is the cap on social security payments. Foreign investors had been complaining for some time about the lack of these caps, which forced them into complicated schemes of tax optimization and made it difficult for them to hire and pay the best professionals. We were the last country in Europe to be able (or perhaps willing) to implement them.

The reforms will also save billions of crowns in sick leave. The first three days of absence will now not be paid at all. Savings are positive, but this step also has a downside. It penalizes those who are working, rather than those who habitually misuse social security payments. In the first few days of illness, infectious diseases can also be spread very quickly around the workplace. Is this really in the best interest of employers?

The introduction of payments for visits to the doctor is also a positive step and will bring some savings. It is also unpopular (politicians usually should be praised for the willingness to do something unpopular). On the other hand, we cannot call it a health care reform—which obviously must go much deeper.

Now the bad news

One of the weaker aspects of the reforms is that they will improve the public finances only temporarily. After two years the effects of these legislative measures will be fully exhausted: deficits and debts will likely go back to their current levels.

The reform package could have been much bolder in cutting spending on social and welfare programs. After two years the ratio of mandatory welfare spending against the rest of budget expenses will grow again. Most of the parties, representing a wide range of the political spectrum (including the ODS and KDU-ČSL), voted to increase social expenditure before the last elections. So it is perhaps no surprise that few are now willing to cut it. The very same people, including ministers Nečas and Kalousek who were then MPs, are responsible for the inflation of these costs approved before the elections.

The government says more systematic reforms lie ahead, but it has become almost axiomatic for democratic governments not to push through anything painful or courageous in the second half of an electoral cycle. Of course, miracles could occur, but they would surely require a more promising catalyst than Topolá-nek.

A tax on taxation

The reform package also introduces a new idea of mandatory social security taxes. These will be discounted from the “supergross wage,” which is effectively a tax on taxation. The system does not exist in any other European Union country. Systemically it would make more sense to tax “social security consumption” or payments (pensions), not the social security tax itself. The real reason for it is that the ODS wants to fulfill its electoral promise of a 15 percent flat tax. In reality the effective tax will be much higher. The opposition ČSSD is complaining to the Constitutional Court about taxing the tax and we are yet to see the results.

But there is a positive side to this system of taxation. People will really start to feel the burden of the tax that they and their employees pay. It might be an incentive for voters to demand more effectiveness and austerity from politicians regarding what they do with taxpayers’ money.

The reforms will also reduce corporate tax and, to an extent, personal income tax, but it is questionable whether these will be instruments for stimulating the economy, which is currently running on the verge of its full capacity.

A flat tax of sorts has been implemented, but it is a flat tax only on paper. There are dozens of exemptions, such as tax relief for families with children, and various discounts that can be claimed if you read the small print carefully. In this respect the reforms are very weak and have certainly not helped to simplify the tax system. Vlastimil Tlustý, the so-called rebel within the ODS, has already pointed this out.

The reform package means victory for a policy of power at all costs, for a policy of no discussion with the opposition. It serves the present government well enough for now and they will hold on to power. But the deep reform that is needed—especially cuts and savings— will need a wider political base than a minority government propped up by two political tourists.

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