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Czech Republic: Selected Issues

Author(s):
International Monetary Fund
Published Date:
May 1998
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III. Public Finance: Recent Developments and Outlook17

A. Fiscal Developments

Overview

35. Since the beginning of the transition, the primary fiscal policy goal of the central government has been to maintain a balanced budget. Within this framework, however, a number of specific budgetary operations have been carried out by the state’s extrabudgetary funds or financed from the National Property Fund (NPF) and State Financial Assets (SFA, the central government’s account at the Czech National Bank, in which the state budget surpluses from previous years are deposited).18 If the budgetary and extrabudgetary operations of the central government are consolidated with the finances of the local authorities and the public health insurance funds,19 the accounts of the general government so defined were in deficits of 1-2 percent of GDP during 1994-96, after having posted a small surplus in 1993 (Table 4 and Figure 9, and Tables A15-A23, SM/98/30, Sup. 1 (1/30/98)).

Table 4.Czech Republic: Summary of Fiscal Operations, 1993-98(In percent of GDP)
199319941995199619971998
BudgetPrel. Est.Budget
General government
Total revenue46.044.943.842.744.540.738.8
Total expenditure45.546.045.743.944.742.839.8
Balance0.5-1.2-1.8-1.2-0.2-2.1-1.0
State Budget
Total revenue34.933.332.431.232.730.428.8
Total expenditure34.532.431.931.332.731.328.8
Balance0.40.90.5-0.10.0-1.00.0
Local authorities’ budget
Total revenue8.49.79.88.98.38.47.2
Total expenditure8.09.89.99.58.28.87.7
Balance0.5-0.1-0.1-0.60.1-0.4-0.5
Balance of extra-budgetary funds0.00.00.00.10.00.00.0
Net spending from State Financial Assets account (-)-0.2-0.2-0.9-0.20.0-0.3-0.3
Use of privatization revenue (-)-0.5-1.6-1.1-0.2-0.2-0.4-0.1
Balance of the health fund0.3-0.2-0.3-0.1-0.1-0.1-0.1
Sources; Ministry of Finance; and staff estimates.

Figure 9CZECH REPUBLIC: FISCAL OPERATIONS OF THE GENERAL GOVERNMENT

(in percent of GDP)

Sources: Czech Ministry of Finance, and Fund staff estimates.

1/ Projections.

36. Another priority of fiscal policy has been to reduce the role of the state in the economy. Thus, revenue as a ratio to GDP has fallen progressively over the years, mainly owing to discretionary cuts in the rates for direct taxes and changes in tax regulations. Accordingly, consistent with the balanced budget objective, expenditures have been restrained across the board; the impact, however, has been felt more by spending on goods and services and by investment, and the share of transfers to households in total expenditure has increased.

37. The public finances experienced considerable strain in 1997. The fiscal outturn in the first quarter was weaker than expected, taking into account the normal seasonal pattern and the annual budget target, on account of severe revenue shortfalls. In response, the authorities initiated two rounds of expenditure cuts around midyear with the objective of achieving a balanced state budget. However, the July floods dealt a severe blow to this prospect. As a result, the consolidated budget deficit of the general government in 1997 widened to slightly more than 2 percent of GDP.

38. The tighter fiscal stance of the second half of 1997 is expected to be sustained in 1998. Thus, although the negative impact of the floods is likely to carry over into 1998, it is envisaged that the general government deficit will fall to 1 percent of GDP. With revenue growth forecast to be sluggish, this is to be achieved through major policy initiatives on the expenditure side.

1997 Budget

39. The 1997 budget aimed at the general government accounts being close to balance, implying a fiscal contraction equal to 1 percent of GDP. The state budget and the accounts of the extrabudgetary funds were designed to be balanced, the local authorities’ budget was expected to show a small surplus, and hardly any use of the SFA account was envisaged. However, the health insurance funds were expected to be in a small deficit and a token use of NPF resources was also foreseen.

40. The state budget was formulated on the assumption that real economic growth would be maintained around 5 percent and that revenues from the direct taxes would increase broadly in line with nominal GDP growth. Unlike the 1996 budget, the 1997 budget included no proposed changes in the rates for profits tax and the personal income tax, though the permitted deductions for personal income tax were adjusted for inflation. On the expenditure side, transfers to enterprises and subsidized organizations and capital expenditures were budgeted to remain broadly unchanged in nominal terms. However, within the framework of overall restraint in expenditures, relatively large increases were budgeted in a number of areas such as pension payments, transfers to the health insurance funds representing payment for “unproductive” persons, and housing policy.

Developments in 1997

41. The general government deficit in 1997 is estimated at CZK 35 billion (2.1 percent of GDP), compared with the original target of near balance and a revised deficit target of CZK 12 billion (0.7 percent of GDP) established in midyear. The deficits of the state budget and the local authorities are estimated at about CZK 16 billion (1 percent of GDP) and CZK 6 billion (0.4 percent of GDP), respectively, and expenditures financed by transfers from the SFA account amount to about CZK 10 billion. The overshooting of the general government budget deficit from the midyear target is explained mainly by the adverse impact of the floods, amounting to CZK 21 billion (1.2 percent of GDP). In the absence of the negative impact of the floods the general government deficit would have been the equivalent of 0.9 percent of GDP.

42. The authorities realized early in the year that the budget tax revenue projections would not be achieved once it became apparent that (i) the macroeconomic performance in the second half of 1996 (the base for the 1997 projections) was worse than anticipated at the time of budget formulation and that, against this background, the macroeconomic assumptions underlying the budget projections were overly optimistic; (ii) the utilization of tax deductions was running ahead of expectations; and (iii) that tax administration was weak. Thus, based on the outturn in the final months of 1996 and the first five months of 1997, the state budget tax revenue projections for the year as a whole were lowered by CZK 42 billion. The tax revenue projections were revised downward by a further CZK 12 billion following the July floods. In the event, the actual shortfall in tax revenue in 1997 was CZK 46 billion (2¾ percent of GDP)—somewhat smaller than expected by the authorities.

43. In view of the substantially weaker revenue prospects, a package of expenditure cuts was announced in two rounds (in April and May 1997), amounting to CZK 42 billion (about 8 percent of the originally budgeted expenditure, equivalent to 2.5 percent of GDP). The cuts were across the board: wages and salaries (the so-called fourteenth wage was not paid to civil servants in December), expenditure on goods and services, subsidies to enterprises and subsidized organizations, transfers to households (the bulk of this saving was achieved by delaying the payment of the automatic indexation of pensions by two months), and, especially, investment. Investment cuts alone accounted for about 40 percent of the total expenditure cuts. However, some mandatory expenditures (such as interest payments, payments for property loss of banks, and calling in of state guarantees on loans) were increased by a total of about CZK 5 billion. As a result of the July floods, there was additional expenditure of about CZK 9 billion, financed almost entirely from extrabudgetary resources.20

44. Preliminary data on the local authorities’ budget outturn are not yet available; because of the large number of municipalities involved there is a long delay in reporting. The deficit estimated for the local authorities (CZK 6 billion) is based on the outturn in the first three quarters of the year and is predicated on the assumption that the central government was successful in its efforts to persuade local authorities to limit expenditures in the fourth quarter. Specifically, it is assumed that (i) like the central government, the local authorities did not pay the so-called fourteenth wage to their employees in December; and (ii) capital expenditures were restrained.

Proposed 1998 Budget

45. The tight fiscal stance adopted in the second half of 1997 is intended to be sustained in 1998. On this basis, the authorities project a general government deficit of about CZK 18 billion (1 percent of projected GDP) in 1998, implying a fiscal contraction equal to about 1 percent of GDP. A balanced state budget has been proposed; for the local authorities’ budget, a deficit of CZK 9 billion is foreseen by central government officials; a drawdown of the SFA account by about CZK 6 billion is envisaged; and the health funds would continue to show a small deficit. Ministry of Finance officials estimate that the July floods would have a negative impact on the 1998 budget by about CZK 13 billion (0.6 percent of GDP). Thus, excluding the negative impact of the floods, the general government deficit would be in a deficit of 0.4 percent of GDP.

46. The proposed state budget for 1998 is premised on the following assumptions: GDP growth of 2.2 percent; inflation of 9 percent; increase in the total wage bill in the entire economy of 7.6 percent and average wage growth of 8 percent; and the average unemployment rate increasing from 4.2 percent in 1997 to 5.4 percent in 1998. Revenues are projected to increase by 7 percent (about CZK 34 billion), of which nearly 60 percent is expected to come from social security contributions. Expenditures are projected to increase by only 3.8 percent (CZK 19.5 billion).

47. The budget includes several discretionary revenue measures with an estimated positive net impact on a fiscal year basis of CZK 7.1 billion for the state budget and a negative net impact of CZK 2.6 billion for the local authorities’ budget (reflecting revenue-sharing arrangements). It also assumes significant improvements in tax collection efficiency for the VAT and social security contributions. Nevertheless, tax revenue as a ratio to GDP is projected to decline further. This mainly reflects the seeming inelasticity of the tax system, and to a lesser degree the negative impact of the July 1997 floods.

48. The discretionary measures include a lowering of the corporate profits tax rate from 39 percent to 35 percent; indexation of the nontaxable minimum income threshold for physical persons, child allowances and other permitted deductions, and of tax brackets for personal income tax; increase of VAT on fuels (electricity, gas, and coal) from the lower rate of 5 percent to the standard rate of 22 percent; and increase of excise duties on cigarettes, alcohol, and motor fuels. The increase of the VAT rate on fuels is an important step toward harmonizing the regulations with the European Union, while the increase in excises would maintain their share in GDP. A breakdown of the estimated impact of discretionary measures is shown in Table 5 below.

Table 5.Czech Republic: Impact of Discretionary Revenue Measures in 1998(In billions of koruny)
Increase of VAT rate on fuels+6.0
Impact of measures with regard to profits tax and personal income tax on fiscal year basis-9.5
Of which:
State Budget-6.9
Local Authorities’ Budget-2.6
Increase of excise duties+8.0
Of which on:
Cigarettes+3.2
Gasoline+2.3
Alcohol+1.0
Other (wine, beer, diesel, etc.)+1.5
Total+4.5
Of which:
State Budget+7.1
Local Authorities’ Budget-2.6

49. On the expenditure side, the major policy initiatives are (i) a freeze of the nominal wage bill;21 (ii) changes in the legislation on pensions and other social security benefits, which together are estimated to yield a saving of CZK 10 billion (see Section B below);22(iii) freezing in nominal terms the expenditures on goods and services of most ministries, with the exception of Ministry of Defense (where expenditures are set to increase by CZK 6.7 billion), scientific research and development (up by CZK 5.2 billion), and general reserves (up by CZK 1 billion); (iv) cutting back noninvestment subsidies by 13 percent;23 and (v) replacing investment subsidies to enterprises and subsidized organization amounting to CZK 7 billion by loan guarantees (i.e., shifting from expenditures to a contingent liability). The authorities also project that flood-related expenditure financed from the drawdown of the SFA account will amount to CZK 4 billion.

B. Selected Fiscal Issues

Fiscal Relationship Between the State and the Local Authorities

50. In the Czech Republic, there are about 6,000 self-governing municipalities with a substantial degree of fiscal autonomy. The municipalities receive formula-based shares of central direct tax revenue, as well as appropriations from the state budget for selected investment and noninvestment programs (education, health care, housing policy, repair for environmental damage, water supply, etc.) that may be partially or fully state financed.24 Municipalities also derive revenues from property taxes, leasing out properties, and fees and fines, and are entitled to issue bonds (subject to approval of the Ministry of Finance) and borrow from banks.

51. The formula for revenue sharing between the central government and the local authorities was changed in 1996. Prior to that, revenues from the personal income tax on wages and entrepreneurial income were wholly assigned to the local authorities, while corporate profits tax revenues were wholly assigned to the central government. Since 1996, local authorities have received 64 percent of personal income tax revenues and 20 percent of corporate profits tax revenues. The change in the revenue-sharing formula dampened the revenue prospects for local authorities, because until then, with strong and continued wage growth but less buoyant profits, revenue shares had been shifting in favor of the local authorities.

52. In 1998, with direct tax revenues projected to decline and appropriations from the state budget also affected by the restrictive measures adopted by the central government, it is expected that the revenue of the local authorities will stagnate. It is the expectation of the Ministry of Finance that the local authorities would adjust their spending in accordance with the poor revenue outlook, and that the deficit would not exceed CZK 9 billion (½ percent of projected GDP). In particular, it is expected that the local authorities would follow the state budget example and freeze the nominal wage bill, and also not increase investment expenditure.

53. So that the fiscal adjustment at the central government is not offset by expansionary policies on the part of the local authorities, the Ministry of Finance has taken steps to limit discretionary expenditures of local authorities and to restrict their ability to borrow. Discretionary investment subsidies (i.e., excluding subsidies for central government projects for which local authorities are the implementing agency) will be punitively scaled back in 1998 if local authorities do not moderate wage growth and do not achieve a balanced budget. A new law is to be introduced in 1998 to regulate the debt of local authorities. The main features of the proposed law are as follows: (i) debt-service payments should not exceed 20 percent of current revenue; (ii) borrowing to finance current expenditures would be prohibited; (iii) debt contracted in any particular year could not exceed 50 percent of the projected revenue for that year without explicit approval by municipal residents through a referendum; (iv) all decisions on selling property and extending loans to third parties would have to be approved by three fifths (instead of one half) of the council members; and (v) and municipalities would no longer be allowed to give guarantees for loans contracted by third parties.

Taxation

54. Tax revenue as a percentage of GDP has fallen progressively over the years, and the composition of taxes has shifted away from enterprise profits taxes and toward personal income and consumption taxes. This is mainly a direct result of the tax reform initiated in 1993 and the subsequent changes in the tax rules and the rates.

55. The statutory tax rate for corporate profits has been lowered by 2 percentage points every year, from 45 percent in 1993 to 39 percent in 1996. After a pause in 1997, the rate is scheduled to fall by 4 percentage points to 35 percent in 1998. The tax reform of 1993 provided new tax breaks for the enterprise sector by introducing a more accelerated schedule for asset depreciation, allowing a tax credit for investment in selected equipment, and permitting carry forward of losses incurred in a fiscal year for a period of seven years. From 1995, enterprises are also allowed to make deductions for bad debts under specified conditions. Reflecting the discretionary cuts in the tax rate, maximum exploitation by enterprises of the tax breaks, and declining enterprise profitability owing to rapid real wage growth, the corporate profits tax relative to GDP has fallen by more than one half since 1993.

Table 6.Czech Republic: Structure of Tax Revenue, 1993-98
199319941995199619971998
Est.Budget
(In percent of GDP)
Tax revenue41.340.540.039.037.836.0
Direct taxes10.110.410.19.48.67.3
Corporate profits7.15.65.04.13.32.4
Personal income tax3.04.85.15.35.34.8
Indirect taxes12.213.112.612.511.911.8
VAT7.07.57.17.27.17.0
Excises3.74.14.24.03.94.0
International trade1.51.51.31.30.90.8
Social security contributions10.911.411.511.411.611.4
Health fund contributions4.24.34.44.54.54.3
Other3.91.31.31.211.91.1
(Share in total tax revenue, in percent)
Tax revenue100.0100.0100.0100.0100.0100.0
Direct taxes24.425.725.324.122.820.2
Corporate profits17.113.912.610.68.86.8
Personal income tax7.211.812.813.514.013.5
Indirect taxes29.732.331.532.031.533.0
VAT17.018.617.718.418.819.4
Excises9.010.010.610.310.311.2
International trade3.73.83.23.32.42.3
Social security contributions26.528.128.829.330.631.8
Health fund contributions10.110.611.011.511.911.9
Other9.53.23.43.131.63.1
Source: Data provided by the Ministry of Finance.

56. Profits tax collections have persistently fallen short of budgeted levels in recent years, and the deviation was particularly large in 1997. This is perhaps because predicting the behavior of corporate profits tax revenues has been complicated by the changes in the tax rules and the rates. In particular, there is considerable uncertainty regarding the extent to which tax deductions would be exercised by enterprises, and also the timing. It is likely that taxpayers have started taking greater advantage of their tax obligation options as they have become better acquainted with the regulations. The initial projection of corporate income tax for 1997 was based on the premise that GDP growth would be a reasonable proxy for the dynamics of profits, and the expectation that enterprises would not make use of deductions for loan write-offs to a greater extent than in the previous year. As it turned out, profits declined significantly in 1996 and this trend continued in 1997;25 in part this reflected lower operating profits, but higher non-operating costs due to greater application of deductions were an equally important factor.

57. Revenue from wage and personal income taxes remained broadly stable at around 4¼ percent of GDP during 1994—97. Rapid wage growth kept revenues buoyant and dominated the impact of some reductions in the tax rates. Since 1993, the top marginal rate for personal income tax has been reduced progressively from 47 percent to 40 percent in 1996. However, the number of individuals affected by the top rate has been small, owing to relatively generous exemptions and deductions. Personal income taxes are projected to decline relative to GDP in 1998, as the wage bill growth targeted by the government is below the projected growth of nominal GDP.

58. The performance of the value-added tax (VAT) suggests continued deficiencies in tax administration, especially the inability to capture a significant proportion of the increase in private activity. Contrary to the expectation that VAT revenue relative to GDP would increase as the initial implementation problems of the new tax were resolved over time, it fell in 1995 to about 7 percent of GDP—below the performance level of the initial years—and has remained about this level since then. It is likely that the importance of non-registered traders (those with an annual turnover of less than CZK 3 million) and the self-employed has increased, as recent evidence shows that declared final consumption (i.e., as obtained from the tax returns of the VAT payer) has grown at a slower pace than actual final consumption indicated by national accounts data.

59. Tax administration in the Czech Republic is experiencing a problem of eroding taxpayer discipline. Recorded tax arrears have mounted in recent years, partly reflecting an increase in the number of audits of taxpayers carried out by tax inspectors. At end-July 1997, the total stock of arrears amounted to CZK 63.8 billion (3.9 percent of GDP), of which CZK 13 billion represents arrears accumulated under the old tax system prior to 1993 and is deemed uncollectible, and CZK 44 million represents arrears of principal tax categories incurred since the tax reform of 1993. Nearly one half of the tax arrears incurred since 1993 concerns the VAT. Developments in arrears for the principal tax categories in recent years are shown in Table 7.

Table 7.Czech Republic: Cumulative Arrears of Principal Tax Categories Since 1993(End of period; in billions of koruny)
19931994199519961997
July
Principal tax categories8.413.723.335.844.2
Of which:
Corporate profits tax2.52.93.86.27.5
Wage and personal income tax1.52.22.85.06.8
VAT3.97.512.819.022.7
Excise taxes0.51.03.85.67.2

60. In addition, the stock of arrears in social security contributions is estimated by the Ministry of Finance to have reached about CZK 32 billion (2 percent of GDP) at end-1997. Arrears in social security contributions have been increasing at a faster rate than in the wage tax, although the tax base is the same for both and employers are responsible for passing on both taxes to the government. Total outstanding arrears at end-July 1997 as a percent of total collections since 1993 is estimated at 4 percent for social security contributions and 1 percent for the wage tax. From 1998, the government intends to carry out a stricter review of installment payment requests and a more prompt collection of amounts owed, in order to address the problem of growing arrears in social security contributions and other taxes.

Expenditure

61. A striking feature of the structure of expenditure of the state budget has been the growing share of mandatory expenditures, particularly social insurance transfers to households. The share of such transfers (these include pensions, sickness benefits, family benefits, unemployment benefits, and general income support) in total expenditure has increased from 34 percent in 1993 to an estimated 41.5 percent in 1997 (Table 8). The share is projected to rise further in 1998, despite the changes in legislation aimed at limiting the growth of social insurance transfers. Given the generally sluggish revenue growth outlook for the coming years and the continued increase in social insurance transfers projected under the current system of benefits, the maintenance of a balanced budget policy will put a further squeeze on discretionary expenditures.

Table 8.Czech Republic: Social Insurance Transfers of the State Budget, 1993-98
199319941995199619971998
Est.Budget
In percent of total expenditure34.037.037.238.241.542.6
In percent of GDP11.812.011.812.013.012.3

Pensions

62. Pensions account for about 70 percent of social insurance transfers to households, and amount to about 9 percent of GDP.26 The funding of pensions is managed on a pay-as-you-go basis; i.e., expenditures for benefits to current pensioners are covered from premiums collected from economically active persons. During 1993-95, income from pension premiums exceeded the expenditure on pensions, mainly as a result of wages increasing at a faster rate than that assumed in determining the premium tariff. Hence, beginning in January 1996, the premium tariff for pension insurance was reduced from 27.2 percent of taxable wages to 26 percent.27

63. Since 1993, a major effort has been underway to reform the pension system. The main aims of the reform are: to improve the long-term viability of the system in the face of an aging population structure through a gradual increase of the retirement age;28 to rationalize the treatment of individuals in different professions; and to remove the distortions that existed under the old regime by linking benefits more directly to contributions. At the same time, however, an important objective is to forge a more automatic link between pensions and the development of wages and prices. Prior to 1996, pensions were adjusted on a discretionary basis. In 1996, the principles of pension increases were legislated: pensions would be fully adjusted for inflation whenever the rise in the CPI exceeded 5 percent from the previous adjustment, and they would be also adjusted upward by one-third of the average increase in real wages during the previous two years. Faced with the prospect of sluggish growth of revenues of the state budget in 1998, new legislation has been proposed that seeks (initially on a temporary basis for 1998 only) to raise the inflation threshold before indexation is triggered to 10 percent, lower the indexation coefficient to 70 percent, and make the linkage of pensions to real wage increases more flexible.

64. The Czech authorities have prepared long-term scenarios of the financial position of the pension system for 1997-2020, on the basis of specific assumptions on wages, inflation, and unemployment, and taking into account demographic developments.29 If the current replacement rate is maintained and the retirement age increases in accordance with the pension law, the premium tariff would need to increase from the current 26 percent to 36 percent in 2020. If the premium tariff remains unchanged at the current level, it is projected that expenditure for pensions would exceed income from 2005. The long-term funding of the pension system would be assured if one of the following were implemented: (i) an increase of the premium tariff to 29 percent from 1997; and (iii) annual capital contributions of CZK 40 billion, starting in 1997.30

Other social security benefits

65. In view of the resource constraint, some benefits will be reduced and eligibility criteria tightened from 1998. Because of the significant increase of unemployment that is anticipated, it has been proposed to lower unemployment benefits to 50 percent of the last salary for the first three months (60 percent currently), and to 40 percent for the subsequent months (50 percent currently). From 1998, child benefits will be given only to families whose income is less than 2.2 times the minimum living standard (3 under the old law). It is expected that with this change, the proportion of Czech families receiving child benefits will fall from 95 percent to 75 percent. The amount of child benefit will be set at 0.27 times the minimum living standard (MLS) for those whose income is below 1.8 times the MLS, and at 0.14 for those whose income is 1.8-2.2 times the MLS. The minimum living standard was increased by about 5 percent from July 1997. Thus, for a one-person household the MLS went up from CZK 2,890 to CZK 3,030.

Prepared by Biswajit Banerjee.

Typically, the transfers from the SFA account are recorded as revenues of the state budget, while transfers from the NPF and the associated expenditures are excluded. This practice has been followed in Table 4 for the operations of the central government. However, in the presentation of the consolidated general government accounts, quasi-fiscal spending from the NPF is included as expenditures, and the transfers from the SFA and NPF are treated as financing.

The mandatory public health insurance system is mainly financed by payroll-based contributions (4.5 percent for employees and 9 percent for employers), which cover about two-thirds of public expenditure on health care. These contributions are channeled through the state health fund to the 11 public health insurance companies.

The total fiscal cost of the floods is estimated at CZK 34 billion. Of this, CZK 21 billion (1¼ percent of GDP) was borne in 1997, and CZK 13 billion (0.7 percent of projected GDP) will carry over into 1998. The bulk of the fiscal cost will be felt through lower revenues. The negative impact on revenues is estimated at CZK 12 billion in 1997 and CZK 9 billion in 1998. On the expenditure side, as of end-October, the government had decided to release CZK 13 billion in relief and reconstruction expenditure (cost of cleaning up, payment of social security benefits to affected families, repairing damage to transportation infrastructure, renovation of electricity networks, etc.), of which CZK 9 billion was spent in 1997. The flood-related expenditure will be financed almost entirely out of extrabudgetary resources as follows: CZK 5 billion transferred by the NPF from the proceeds of small-scale privatization, CZK 5 billion raised through the issuance of flood bonds, CZK 0.9 billion released by the SFA account, CZK 1.5 billion from the Czech Land Fund, CZK 0.3 billion of relief collections by the Fund of Environmental Protection, and CZK 0.2 billion direct expenditure of the state budget.

Unless Departments can reduce staffing, this will imply a freeze of nominal wages of civil servants. Judiciary personnel have been exempted however.

Of which, about CZK 6 billion will be in lower pensions, CZK 3 billion in lower family benefits, and CZK 1 billion in lower unemployment benefits.

The major cutbacks are in heating subsidies (to only CZK 0.2 billion from CZK 4.5 billion in 1997, made possible by further increases in administered prices), and the subsidy for property detriment (to CZK 1.8 billion from CZK 4.5 billion). Cuts in these subsidies would be partly offset by higher subsidies to agriculture (to CZK 10.7 billion from CZK 7.9 billion in 1997).

Hence, local authorities usually prepare their budget around the beginning of the calendar year, after the state budget has been approved by Parliament. The version of the local authorities’ budget that is included with the state budget reflects the outcome that is considered desirable by the Ministry of Finance.

Profits tax collection in any year is a function of profitability in both the current year and previous year. Enterprises make their final settlement around midyear when the audited accounts of the previous year are ready. They are also liable to make tax payments in the course of the year on the basis of expected profits, but they have the leeway to negotiate lower payments if there are clear signs that developments in the financial position are worse than earlier envisaged.

The ratio of pension payments to GDP in the Czech Republic is higher than in Canada (5.5 percent), the United States (7.1 percent), about the same as in the United Kingdom (9.2 percent) and Hungary (9.9 percent), and lower than in Poland (12.4 percent), France (12.7 percent), Germany (13 percent), and Austria (14.5 percent). Pensions are currently not subject to any tax in the Czech Republic.

Employers pay 19.5 percent (20.4 percent previously), and employees pay 6.5 percent (6.8 percent previously). Self-employed persons are required to pay 26 percent. Besides pension insurance, both employers and employees are required to pay sick-leave insurance and unemployment insurance as part of social security contributions. Social security contributions in the aggregate amount to 34 percent of the payroll, with employees contributing 8 percent and employers 26 percent.

Since 1996, a gradual increase in the retirement age has been introduced: two months for men and four months for women per year of the law, effective to 2007, when the retirement age will be 62 years for men and 57-61 years for women (according to the number of children reared).

The assumptions are as follows: (i) nominal wage growth of 11.5 percent in 2000 and declining by 0.5 percentage point per year to reach 4 percent in 2020; (ii) inflation at 6 percent in 2000 and falling to 4.4 percent in 2005, 3.4 percent in 2010, and 2 percent in 2020; and (iii) unemployment rate of 4.65 percent in 2000 and rising to 5.8 percent in 2005, 6.5 percent in 2010 and remaining at this level thereafter.

It is assumed that the return on investment would be 10 percent in 2000, 9.3 percent in 2005, 8.3 percent in 2010, and 7 percent in 2020. In theory, the same outcome could also be achieved through a single injection of capital into the pension system of CZK 400 billion.

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