It is good that the government prepared and implemented the consolidation package. Thanks to him, public finances will be in a significantly better state than they would be without him. And whatever critical I think about him, I would like to keep it in this context: Yes, thanks, government, for the consolidation package. That the government has embarked on the consolidation of public finances is not only commendable, but also surprising, as some of the current government parties promised before the 2021 elections a budgetary version of squaring the circle: increasing spending, reducing taxes and reducing deficits. In contrast, the consolidation package, with its spending cuts and tax increases, represents a more realistic approach to deficit reduction and sound public finances.
But the package alone is not enough for healing
The overall scope of the consolidation appeared to be relatively well set when announced in May (98 billion in 2024 and 151 billion in 2025, a slightly larger half on the expenditure side rather than the income side, but, as we already know today, short-term “subsidies” in the energy sector introduced by the government after the increase in energy prices from the previous year) and the Czech government was aiming for a relatively significant reduction in the structural deficit. Back in May, NERV believed that the consolidation package could help reduce the structural deficit by roughly one percentage point compared to 2022.
Half a year later, we now know a little more. In September, the government presented the draft budget for 2024, and it has a deficit of 252 instead of the 210 billion planned in May. Based on it, the National Budget Council estimates a reduction in the structural deficit of just 0.1% of GDP from 2.3% of GDP in 2023 to 2.2% of GDP in 2024. This is the best description of the expected reality we have, and I think it’s a good one don’t pretend it’s different. Despite the consolidation package, the structural deficit will remain relatively high in 2024, too high. It would have been even worse without the consolidation package. At least this is how the level of the structural deficit does not increase, when it will only decrease at a snail’s pace between 2023 and 2024.
How is it possible that the structural deficit will not decrease much in 2024 despite the consolidation package? In addition to raising taxes and reducing expenses in the consolidation package, the government also reduces some taxes and mainly increases some expenses.
Apart from the consolidation package, the government is not generating new tax revenues to fulfill its new spending priorities, for example in the area of defence. Thus, in the end, the consolidation package will bite off only 0.1% of GDP from the structural deficit at least in 2024, and the rest of the package actually goes to increased spending in other areas, whether they are determined by an active decision of the government, new laws or the existing set of laws, or for example inflation . And the outlook from 2025 onwards, when the impact of the consolidation package should be higher than in 2024, remains even more uncertain precisely because it is not certain whether there will be further increases in spending or tax cuts by then, and if so how much.
Notes for future consolidators
The specific form of the package is a done deal. So there is no need to analyze the details and what could have been done better. But whether this government chooses to consolidate beyond the package, even though it now publicly rules it out except for taxing certain vices, or any future government wants the country to borrow less, I offer notes that might be helpful to them.
In the consolidation package, the government packed roughly dozens of measures, mainly spending cuts and tax increases. Hopefully no one is happy about it. Neither families with children, nor self-employed persons, nor companies. Neither students nor pensioners. This shows both the broad scope of the measures in the consolidation package, which will affect almost everyone at least a little, but also the fact that these are really unpopular spending cuts and tax increases – with which the government will restore public finances, but the immediate effects on the affected people are naturally almost always negative.
Some measures are more successful, such as property tax increases, others I would rather not see in the package, such as across-the-board spending cuts or budget-losing changes in value added tax. When the government decided to consolidate, it hit the nail on the head with some measures. For example, taxes on vices such as tobacco, alcohol or gambling should have been increased – and the introduction of an excise tax on still wine will hopefully soon follow. I would like to commend the government for increasing the real estate tax, which, even after its increase, remains one of the lowest in Europe and more or less the only wealth tax in the Czech Republic.
She also hit on some other measures, but didn’t quite make it. State support for building savings remains, even if only at half the level. The tax discount for a non-working spouse is now only for those with children under the age of three. Tax-exempt non-cash employee benefits are ultimately not abolished, but limited. Some tax credits, such as those for students or school fees, have been abolished, but it is not clear why others, such as those for mortgages, have not. I support curbing the abuse of work performance agreements, but it remains to be seen how bureaucratically demanding the new solution will be and how it will work in practice.
The approximation of social insurance conditions for self-employed persons to those for employees is also welcome. Unfortunately, the expenditure flat rates remain untouched, excessive and unrealistically high. Thus, the social insurance of self-employed persons undergoes only moderate changes (the assessment basis increased from only 50 to 55% of profit) and not in the best way (the minimum assessment basis will increase from 25 to 40% of the average wage, but it will affect relatively a lot low-income earners and few will affect the black and high-income).
Failed tax changes
A good goal would be to increase progression, even in accordance with the OECD report from March, but reducing the application of the higher rate from four times to three times the average wage does not make good sense to me. This creates a new income between three times and four times with the highest marginal taxation, while income above four times is taxed relatively less due to the persistent social insurance caps at four times the average wage.
There are some measures I would rather not see in the package. These include the re-introduction of sickness insurance payment by all employees at the rate of 0.6%, and therefore an increase in labor taxation even for those with the lowest wages. I would replace the extensive reduction of the state’s operating expenses and the volume of salaries of civil servants with analyzes based on selective cuts.
And rather than such a revision of VAT rates as is included in the package, none at all. These changes lead to a reduction in the collection of this tax and contain many not entirely meaningful transfers. I would like to ask, not only rhetorically, but also seriously, why the repair of shoes, leather products and bicycles or household cleaning work was added to the basic 21% VAT rate, but on the contrary, occasional mass bus transport is being moved from the basic 21% to the reduced 12% VAT rate persons or delivery of single-use medical and diagnostic devices?
We would have better answers to these questions if the government had and published quality analytical documents corresponding to the importance of the consolidation package. Unfortunately, I lack an analysis of the fundamental impacts of the measures in the package on the economy and individual population groups. Such analyzes would also help us see how the government grappled with the difficult questions associated with any such adjustments, such as balancing the interests of different generations or how much the changes should affect the poor and how much the rich.
The government’s role in this is partially supplemented or replaced by think tanks such as IDEA or PAQ Research. They show in one study that when you take the consolidation package together with the $120 billion in 2020 personal income tax cuts, people with higher incomes are better off today, while those with lower incomes are worse off.
In addition to a detailed impact assessment and justification of changes, many year-old proposals from our NERV group for public finance are also missing. The advantage is that an increase in some omitted taxes or a reduction in the running costs of municipalities, the police and other security forces can thus become the basis of some future package.
Without healthy public finances, the economy will not grow in the long term
Given the moribund performance of the economy in recent months and years, it is natural that consolidation is discussed at least as much as possible pro-growth measures. This is also why we at NERV are now working on their proposals following a request from the government. But these proposals will be largely consistent with the consolidation of public finances in the sense that their budgetary costs will be low and they will be reform or structural improvements in areas such as the labor market and education.
At the same time, if the situation were to change sometime in the future and the government would need to support growth more strongly in the short term in the event of a major slowdown in the economy, it would be possible to temporarily increase some spending and reduce some taxes to avert a larger crisis. We are probably not in such a situation yet, but it is important to monitor the development of the economy. At the same time, long-term healthy public finances enable the government to respond to a significant economic slowdown by supporting it through budgetary measures.
Good consolidation package
If I were to mark the government’s consolidation package as in school, it would get an “okay”. In order for the government’s consolidation effort to be at least commendable, if not excellent, it should approach it even better at the level of the entire public finances and individual measures. I would have to have significantly fewer notes on the eulogy, as I described above.
And ideally, consolidation would have to be more reflected in the government’s overall budget policy. Here, there are fundamental positive steps, for example in the pension system (thanks to the pension changes, which are even more important for the long-term sustainability of public finances than the consolidation package), but also less positive ones in next year’s budget. It would also be important to improve consolidation preparations, from analytical documents and impact assessments, which would most likely affect the content as well. Overall, let’s not forget that good is good – and significantly better than adequate and inadequate. Therefore, government, thanks for the consolidation package!
Given the long-standing imbalance between budget expenditures and revenues, we can expect – and welcome from the point of view of the health of public finances – further consolidation efforts in the coming years and election periods. If governments do not continue their consolidation and reform efforts, not only will we become unsustainably indebted and spend more and more on debt service in the coming years, but the performance of our economy will continue to remain below its potential.