Global Economics

Czech Reform: More Needed


Promised tax and spending cuts are finally a reality, but the weak coalition government has not succeeded in adopting any real reforms

The Czech government of Prime Minister Mirek Topolanek scored a major political victory at the end of August when Parliament's lower chamber approved a hard-fought package of financial and tax reforms by a vote of 101 to 99.

The reforms have dominated domestic politics all year. But even after months of argument and backstage bargaining, the final result was anything but coherent, reflecting the weaknesses of the current government coalition.

The aim of the reform package originally was to cut budget deficits, which chiefly are due to high mandatory expenditures for various social programs. Indeed, economic analysts emphasized in the negotiation process that any real reform had to tackle bloated state expenditures -- if only because the Czech Republic otherwise will not meet the criteria for adopting the euro any time soon.

According to analysts, the Czech economy's recent solid growth in the neighborhood of 6 percent annually represents a good opportunity for making painful but necessary structural changes in the country's finance, pension, and health-care systems.

Perhaps it should have been no surprise that the government coalition, led by the conservative Civic Democrats and joined by the centrist Greens and Christian Democrats, proved to be too weak to make truly unpopular spending cuts. After all, the government initially controlled only 100 seats -- exactly half the body -- in the Chamber of Deputies. In January, the government survived a vote of confidence only with the help of two Social Democratic deputies, who revolted against the party leadership only to be expelled subsequently from their party.

Speculation over the two deputies' defection -- inevitably, rumors of graft were floated -- and ideological differences among the three coalition parties, made it very difficult for the Topolanek government to defend its raison d'etre unless it could show some serious common objective that the three parties and the two defectors shared. The government's reform agenda became such a declared objective.

The rhetorical emphasis on reforms was even more important in light of the coalition's genesis -- it came together as an alternative to a grand coalition between Topolanek's Civic Democrats and the Social Democrats, the two parties that came out on top in last year's elections. By rejecting the grand coalition, the Civic Democrats also rejected the moderate reform plan that had been part of the coalition's negotiations.

Yet, the reform agenda of a weak government could have been more impressive had the ruling coalition adhered to its original promise to resign if its reforms were not approved by Parliament. Soon after the package's creation, however, the government made it clear it would not tie the fate of its reforms to a vote of confidence and retreated from some of its more radical promises.

TIPTOEING INTO REFORMS

Most importantly, the government decided to put more emphasis on political symbolism than on real reforms. As a result, the most daring changes were proposed on the side of state revenues in the form of an overhaul of the tax system. The legislation approved by Parliament will see each Czech citizen paying a 15 percent flat tax on gross income and health and social payments -- which means the real income tax works out to about 23 percent.

While such a tax restructuring at least partly reflects the Civic Democrats' electoral pledge to introduce a flat tax, the cut in income taxes had to be compensated by an increase in consumer taxes across the board. Despite this fact, there is still the possibility that budget deficits will skyrocket in the absence of real cuts in state expenditures, as government experts keep arguing about the real impact of the new tax system. Some economists openly warn that unless sweeping cuts in state spending take place next year, the country's deficits could be out of control by 2009.

Thus, a political victory for the ruling coalition easily could turn into political problems. The Social Democrat and Communist opposition parties already seem to be winning a battle for public opinion with their claims that the new taxes will benefit only the richest, while hitting the middle class by increasing consumer taxes, such as higher VAT on food and medicines. Because the coalition also introduced symbolic fees for doctor visits and hospital stays, the leftist parties can accentuate the supposed asocial nature of the reform package even more.

In fact, the new stipulation for medical services' payments is a good example of how real reforms were sacrificed in favor of political symbolism. Although people will have to pay only very moderate fees for health care, the measure has caused much opposition among the general public in a country in which people are used to the idea of "free" medical care. It looks as though the government could have afforded to introduce more substantive measures -- higher fees for instance -- because it would not have lost much more support than the largely symbolic measures have cost it already anyway.

ANXIOUSLY AWAITING DEVELOPMENTS

A lack of resolve on part of the weak government also created serious tension within the Civic Democrats. Vlastimil Tlusty, who served as finance minister in Topolanek's first government last year, strongly opposed the final version of the reform package. Tlusty argued that unless the government increased tax deductions, most people would end up paying more in taxes than they paid before the reform. In the end, Tlusty was promised that the government will submit amendments on higher deductions next year.

But his revolt against Topolanek continues. A faction Tlusty formed within the party now counts about 10 followers among the party's 81 deputies, and he undoubtedly will cause more problems for the prime minister in the near future.

In sum, the government managed to push through a reform package that seems to make almost no one happy. Economic liberals see it as not radical enough, while the political left attacks it for seriously damaging social solidarity. In fact, the Social Democrats and the Communists have vowed to send the law to the Constitutional Court for review after it is approved by the Senate, in which the Civic Democrats have a majority, and signed by President Vaclav Klaus.

Although the government has bold plans for other reform initiatives, the story of the recently adopted tax and spending package suggests that the government may find it next to impossible to pass further reforms. In fact, it may be fortunate to survive the next year -- particularly if the consequences of the half-baked reforms prove to be more negative than positive for state finances.


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