The state of the Czech Republic 2004

Commensurate with the current government’s political vision, 2004 saw an increase in taxes and the state’s role in the economy for the sixth year in a row. Over the preceding twelve months, the share of government expenditure as a proportion of GDP soared – from 45% in 1997, the last year with a right-wing government – to more than 50% this year. Similarly, the unemployment rate reached 9% in 2004, up from 5% in 1997.

Despite a high rate of taxation and growing regulation, the Czech economy has continued to be a lure for foreign investors. During the first half of 2004 alone, it recorded $2.5 billion of foreign direct investment – more than any other country in Central Europe.This is not only due to the political stability that accession is perceived to guarantee but also thanks to lower wages and taxes compared to Western Europe. Undoubtedly, this influx of capital has benefited the Czech economy – GDP growth was above 3% throughout 2004 and is predicted to rise to 4.1% in 2005.

REFORM, OF A SORT

Throughout their six year term, the government has become more and more indebted.The annual deficit in 2004 exceeded 8% of GDP, whereas in 1997 it was 2%. Since the end of the last centreright period of power, the public debt has increased from 10% of GDP in 1997 to more than 30% in 2004.With EU membership, the pressure on the state budget grew even stronger. Since May 1st the government has had to pay 1% of GDP to Brussels, with billions more Czech Korunas lost in the form of custom duties, an additional source of revenue for the EU budget.Thousands of civil servants, required to comply with newly imposed EU regulations, have also been added to the public sector payroll.

Due to the combination of the impending fiscal realities of EU membership and the necessity of raising extra revenue to combat a rising budget deficit, the government passed a series of measures under the auspices of ‘reform’.The goal of the proposed changes was to force the budget deficit below the 3% threshold of GDP within five years – in anticipation of joining the Euro and in accordance with the EU Growth and Stability Pact’s rules. In reality, they were little more than tax-hikes and entailed no alteration of underlying public sector structures.The rate of VAT on many goods and services, such as food in restaurants, accommodation, language courses, construction works, and hairdressing services was increased from 5% to 19%, even though the minimum required by EU legislation is only 15%.

As part of its fiscal ‘reform’, taxes were increased for self-employed individuals, who in the Czech system pay lower socialsecurity contributions and who, prior to the reform, did not have to pay any income tax if their businesses were generating no profit. Ironically, this additional levy does not provide the state with any extra income, since the number of self-employed people has fallen as a result of the tax increase.The government did, however, decrease the rate of corporate tax from 31% to 28%, though during the same period, neighbouring Slovakia reduced its corporate rate to 19%.

The opposition Civic Democratic Party (ODS) have argued that the government’s steps are non-systemic.They have long been advocating the introduction of a 15% flat tax, which would apply to VAT, corporate taxes and income tax.The ODS plans to decrease mandatory contributions to the state pensions system and allow people to save money for their old age on a voluntary basis; proposes a healthcare reform, which would increase the personal responsibility of patients; and calls for tuition fees at state universities.

The ODS has been out of power since 1997, when former Prime Minister (and current Czech President) Vaclav Klaus’ government collapsed after a currency crisis – which saw the end of the fixed exchange rate after seven years – and a scandal concerning party financing.The political turbulence these events caused led to the Social Democrats winning in the 1998 elections.

However, the last six years of CSSD rule have seen its popularity slide.They only won the June 2002 elections by a legislative (coalitional) majority of two seats in the 200 seat Chamber of Deputies (Lower House). Indeed, the growing burden of taxation has raised so much public ire that, to compensate for the resulting price increases, the government handed out an extraordinary payment of CZK1000 (€30) to each pensioner, shortly before the European parliamentary elections in June.

Despite this, the growing public debt, high unemployment and tax increases led to a sharp fall in the ruling Social Democrats’ support in the polls.The party obtained a mere 12% of the vote, and thus carried only 2 seats in the European parliament out of the total 24 reserved for the Czech Republic.The opposition Civic Democrats (ODS) got 31%, and consequently 9 seats.

On the left, the CSSD lagged behind the unreformed Communist party (KSCM), who gained 20% and are now the dominant leftwing political force in the country. The failure in the European elections led to a change of leadership in the Social Democratic party.The unpopular Vladimír ˇSpidla was replaced as both Party Leader and Prime Minister by the former Interior Minister Stanislav Gross.To get rid of ˇSpidla, the party promoted him to the post of European Commissioner for the Czech Republic. He was subsequently awarded the portfolio for Employment, Social Affairs and Equal Opportunities – ironically, the mismanagement of his country has made him one of the best-paid Czechs.

The change of leader did not, however, help to boost the CSSD’s withering popularity. In the November by-elections, during which a third of the Senate seat were up for grabs, the opposition ODS gained 19 out of the 27 available seats. Based on a system of the proportional allocation of the national vote, the Christian Democrats obtained 3 seats, the KSCM gained 1 seat, and most tellingly, CSSD acquired no seats at all. However, elections to the Czech Parliament’s Lower House, which is the body with legislative prerogative, are not due to be held until 2006, so the Czech Republic still has to wait for real reforms.

It is not yet clear whether accession to the EU will, in the long term, facilitate or encourage a reformist agenda. EU membership meant that the Czech Republic gave up sovereignty in the areas of trade policy, agricultural policy, and a substantial part of tax policy. However, in return, the country obtained almost-free access to the EU market, the right to apply for European subsidies, and a voting right in European institutions.

Accession has undoubtedly had an effect upon the fabric of Czech society.While it has brought in substantial FDI, Czech citizens are increasingly concerned about EU interference in their domestic affairs. In October, Prime Minister Gross went to Rome to sign the draft European Constitution. However, both President Klaus and the opposition ODS have been strongly opposed to the document, most notably its provisions to transfer further powers to Brussels, extend qualified-majority voting into new areas of policy, and reduce the weight of the Czech vote in the EU Council of Ministers. Moreover, Czech right-wing parties fear that the adoption of the Constitution could seriously undermine the introduction of necessary free market reforms, facilitating instead the spreading of harmful regulation policies through EU legislation.

Thanks to the gains from the national Senate elections, the ODS may now be able to block the ratification of the Constitution in the Czech Parliament.This move may soon be recognised as the first sign of the return of the ODS and a reformist agenda to the forefront of Czech politics.

This text was published as a part of „The state of the Union“ published by the Stockholm Network 2005

Petr Mach is the Executive Director of the Centre for Economics and Politics in Prague