Transitional Success: USSR to EU

A personal income tax was also introduced to replace the previous network (maze?) of taxes on wages of large enterprises,

Transitional Success: USSR to EU



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investment, including a public housing plan begun in 1992.


Transfers from federal accounts to the Czech government totaled 90 billion crowns, one fifth connected with expiring credits granted abroad and debts owed by the former Czechoslovakian and CSFR government. Debt service is a major component of the 1993 budget. The debt reached 115 billion crowns by 1993. 40 billion crowns were transferred liabilities of the Czechoslovakian Commercial Bank from operations of the so-called central foreign currency resources. Total expenditures on debt service reached 23 billion crowns in 1993. Due to its size and proportion of the entire budget, some of those payments were deferred. Eight billion crowns, the total Czech share of the 1992 debt, was financed through state bonds and money from the national property fund. Old debt principals were deferred for a year until 1994.






Tax Reform



The main elements of the systems prior to 1993 included taxes on enterprise surpluses, payroll and turnover. Wage or income taxes existed but were largely insignificant. The main function of the taxes were to transfer enterprise surpluses to the state budget and to sustain the administratively determined price structures. Tax incentives played no role in the economic system.


Sweeping tax reforms dominated the budget for the 1993 year. They included new indirect, direct and property taxes and modification to the payroll tax including a shift in the tax burden from corporate incomes to wage incomes. From 1992 to 1994, relative to GDP, the share of wage based taxes rose while the share of corporate income tax fell and indirect taxes remained unchanged.


These new direct taxes eliminated earlier distinctions for taxation of businesses based on forms of ownership and employment status. The new system of VAT and excise taxes expanded the coverage of indirect taxes to services. It also mitigated the falling implicit rate in the earlier turnover tax and condensed the range of standard tax rates.

The reforms promoted investment by lowering the cost of capital to businesses. This reform featured a significant reduction in the statutory rate of taxation, standardization and acceleration of allowed depreciation and a 10 percent credit on investment in selected equipment which reduced the dispersion in effective taxes on investment activities. This is how the cost of capital was lowered. The tax allowed the rate of taxation on enterprise profits to drop from 55 to 45 percent.


A personal income tax was also introduced to replace the previous network (maze?) of taxes on wages of large enterprises, the incomes of artists and authors, and the various forms of income derived from the emerging private sector. The new tax had all wage and self employed income taxes on a progressive scale with marginal rates from 15 to 47 percent, standard deductions and additional deductions allowed for social insurance contributions, children, transportation to work, etc. Interest, dividends and capital gains were subjected to 15 to 25 percent, encouraging investment only slightly. Social security and health taxes on wages of 36 percent from the employer and 13.5 percent employee replaced the old payroll tax of differential rates. Net taxes on gifts, inheritance and motor vehicles were implemented and the import surcharge was eliminated. Although the system went through amazing changes as outlined above, much of these changes were to no avail.


Tax evasion and avoidance


The problem with this system is that these any tax structures are still relatively easy to get around if one is willing to operate in the shadows. In the first quarter of 1994, the (23% rate) VAT yield was 30 percent below initial expectations. The corporate and VAT combined barely yield 80 percent of original estimations (one suspects that estimate is high...). Overall, Czech shadow economic activity, though low, is still significant. Estimate suggest anywhere between 15 and 25 percent of the economy works in the shadows.


Police claim it is almost impossible to investigate and prosecute tax violations. The criminal codes do not allow for them to effectively investigate such activities, and no other effective mechanisms yet exist. Change in codes and regulations are too complex and far too frequent. The Ministry of Finance claims that between 1993 and 1994 there was a change in the tax codes at least every 4 days. An example is the modification in 1994 of the corporate income tax from 45 percent to 42 percent, a reduction in the highest marginal personal income tax rates from 47 to 44, and an increase in allowable expenses. These simple changes required major modification in software and procedure for the Ministrys clerks to keep up with the changes. The Ministry coordinates 12,000 employees in hundreds of local offices that constantly need to register and update databases with the latest tax changes.


Due to all the confusion, police estimate they can only catch roughly 10 percent of tax related crimes. A 1994 law adds to the difficulties by allowing businesses to keep their records secret. Employees can be sworn to secrecy regarding certain administrative procedures in firms, like tax issues. The criminal code states that banks can only be forced to reveal tax information after initial evidence from a formal investigation. With no information to go on, investigations rarely reach formal status. Additionally, a great deal of business transactions are still conducted on cash basis due to the ease and tradition. This opens very easy avenues for tax evasion and avoidance as cash is barely trackable.


Many of these tax reforms will become obsolete as the Czech Republic bids for EU membership. Czech will have to compete with EU tax codes, one example entails small breweries. Parliament passed a law on EU guidelines that allows a larger consumption tax on alcoholic beverages to be granted only to small, independent breweries. Breweries producing less than 200,000 hectoliters per year will be eligible for consumer tax cuts of up to 50 percent. The law sets a progressive rate up to the minimum margin limit.


Though it may seem straight forward, experts are unsure whether this brings the tax code closer to EU standards or drives them farther away. Are they protecting small business, providing tax shelters to favored companies, or preparing for entrance into the EU? Currently no one knows. The tax reform process is slow. Though much has been accomplished on the books, no one is really sure what the final outcomes will be. One suspects, as with many recent development in the Czech Republic, change will gravitate toward EU standards wherever possible. As the potential for EU membership draws near, one can expect many of these seemingly confusing tax issues to be clarified immediately as the Czech Republic attempts to do business with one of the most developed and powerful economic forces in the world.






Current Political Economic Considerations: 1996



Perhaps the most exciting chapter of the Czech political and economic transition is still to come. In November 1995, the Czech Republic signed a membership agreement with the Organization for Economic Cooperation and Development. The Czech Republic is the first CEE country to enter the rich boys club. The Czechs furthered their status by recently declaring that they were now considering themselves a developed economy. Though perhaps a bit premature and self-serving, OECD membership certainly entitles them to make such a claim. Many more economic issues still need to be addressed however, before transition can truly be considered complete.


The Czech Republic should reach growth levels of 7 percent this year. That growth needs to be achieved for the next ten years to simply double their income, and even then they will remain far behind their western neighbors. Current GDP in the Czech Republic is only about $3500, which according to the World Bank, ranks them near Malaysia. Fortunately, unemployment is practically non-existent at about 3.2 percent, the lowest rate in all of Europe. And the Czech trade deficit runs about 5-7 percent of GDP. Some experts suggest that rapid appreciation of the crown in recent times is to blame.


Furthermore, wages are a problem. Though they remain low, they are rising very quickly even with governmental controls. To stay competitive Czech business must increase productivity. This tends to be very difficult without cheaper capital. Though tax designs are in place to cheapen capital, it is not immediate nor as effective as necessary. Finally, average savings rates throughout the CEE are about 18 percent, which is just half of the very successful East Asian Tigers (and two to three times that of developed economies). Czech needs to decide how fast and how much more they will grow in the near future. Regardless of some of these more negative indicators, Czech has made a significant transition. The numbers above simply indicate that their journey is not yet complete.



OECD membership is just a small step toward the Czechs ultimate goal of EU membership. The Czech Republic is revamping their policies in order to comply wherever possible to EU regulations, guidelines and policies in order to facilitate their membership bid. Some of these changes include a decrease in the number of income tax brackets, decreases in the VAT from 22 percent to below 20, and the end to al

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