Czech Republic: Selected Issues in Fiscal Policy Reform

This Selected Issues paper examines two key questions on fiscal policy reform in the Czech Republic. First, how can the fiscal institutional framework be strengthened to maintain discipline and enhance transparency? Second, what are the priorities in expenditure reform that can be implemented without sacrificing the quality of spending? The paper discusses the recent Czech experience with the medium-term expenditure framework and some proposals for strengthening it. It also discusses cross-country analyses of spending efficiency and flexibility, and proposes areas for fiscal adjustment that reduce inefficiencies.

Abstract

This Selected Issues paper examines two key questions on fiscal policy reform in the Czech Republic. First, how can the fiscal institutional framework be strengthened to maintain discipline and enhance transparency? Second, what are the priorities in expenditure reform that can be implemented without sacrificing the quality of spending? The paper discusses the recent Czech experience with the medium-term expenditure framework and some proposals for strengthening it. It also discusses cross-country analyses of spending efficiency and flexibility, and proposes areas for fiscal adjustment that reduce inefficiencies.

I. Introduction and Overview

1. The Czech Republic is currently debating the fiscal reform agenda on its path to euro adoption. An immediate priority is to identify fiscal measures, focused on expenditure– based consolidation, to lower fiscal deficits consistent with the Stability and Growth Pact. These measures are also needed to address age–related spending pressures, improve fiscal flexibility, and lower the tax burden. Yet, recent pre–election populist decisions, leading to higher mandatory spending, risk reversing earlier progress on fiscal consolidation. Strong political commitment will be needed to address these fiscal pressures.

2. Against this background, this paper examines two key questions on fiscal policy reform. First, how can the fiscal institutional framework be strengthened to maintain discipline and enhance transparency? Second, what are the priorities in expenditure reform that can be implemented without sacrificing the quality of spending?

3. Adhering to the reform program calls for firm commitment to the fiscal framework. Chapter II discusses the recent Czech experience with the medium term expenditure framework and some proposals for strengthening it. Stronger political will is the main precondition for its success, in the absence of which any new fiscal rule that targets the budget balance would not be effective. Further refinements in the expenditure rule to improve its flexibility, and transparent monitoring and assessment of its implementation could facilitate compliance with the framework.

4. Expenditure reform priorities need to be guided by the objective of enhancing efficiency and budget flexibility. Chapter III focuses on cross country analyses of spending efficiency and flexibility, and proposes areas for fiscal adjustment that reduce inefficiencies. The analysis, which uses a mapping of spending inputs to performance outcomes to develop an efficiency frontier, suggests scope for improvements in healthcare and education spending. Additional social benefit spending will yield marginal gains while improved targeting of existing benefits could perform better in terms of reducing poverty and inequality.

5. Expenditure restructuring is also needed to create room for growth–enhancing investment projects funded by the EU. Chapter IV examines the absorption capacity of EU–funded projects in the Czech Republic. After a slow start, the pace of implementing these projects has picked up recently, placing increasing demands on the budget in future.

6. Strong public financial management and transparency are also crucial to ensure successful implementation of fiscal reforms. Drawing on the Fund’s pilot project for implementing GFSM 2001, Chapter V focuses on fiscal accounting issues. It recommends expanding the coverage of institutions and transactions in the data and supplementing source data to enhance its consistency and comparability, which will contribute to stronger fiscal policy analysis and transparency.