Ðåôåðàò: Transitional Success: USSR to EU
Ðåôåðàò: Transitional Success: USSR to EU
The Czech
Republic
Transitional
Success:
USSR
to EU
Public finance
policy issues during the political
economic
transition from centrally planned socialist
economics to
free market democratic capitalism.
V550 Dr.
Mikesell
November 20,
1996
Rick Ferguson
rfergus@indiana.edu
Eric Martin
emartin@indiana.edu
Dmitri
Maslitchenko dmitri@mailroom.com
Table of Contents
I. Introduction
II. Political Summary:
Restructuring for Transition
III. Transition to Market
Economy: 1990 - 1991
IV. Problems of Transitional
Monetary Policy and the Financial Sector: An Overview
V. Macro Economic Stability: 1993 -
present
VI. Monetary Policy: 1993
VII. Intergovernmental Financial
Relations
VIII. Budgetary Overview: 1993 -
present
IX. Tax Reform
X. Current Political Economic
Considerations: 1996
XI. The EU and NATO
XII. Conclusions
XIII. References
Introduction
In 1989, after
nearly 40 years of Soviet control, Czechoslovakia once again became an independent
nation, the Czech and Slovak Federalist Republic. This transition from Soviet
socialism to democracy culminated throughout Central and Eastern Europe with
the literal collapse of the Berlin Wall in East Germany, the heroic Gdansk
Shipyard Strikes in Poland. The student and worker protests in Prague and
Budapest were no less important.
The
Czechoslovakian revolution took place peacefully and over a much longer period
of time than events in other former Soviet Union or Warsaw Pact nations. Hints
of major reform in Czechoslovakia began as early as 1968. Czechoslovakian
officials, under Soviet power, moved incrementally to begin the long road
towards decentralization and independent Czechoslovakian rule. Their
increasingly effective efforts became known as the Prague Spring, a time of
growth, change and development.
Success was, of
course, neither immediate nor easy to achieve. The Cold War reached a pinnacle
in the Eighties and the winds of change began to blow in Central and Eastern
Europe. The CEE nations endured many hardships. Soviet oppression, though
waning by this time, became largely unbearable. Change in Czechoslovakia came
from the ground up; dissidents quietly began to return to popular power. The
revolution gained momentum by 1989. ‘Revolutionists’ began to demand sweeping
economic and political reform. They were backed by well organized and very
timely strikes and protests. After a two hour general strike on November 27,
1989, proving the immediate and widespread power and cohesion of the revolution,
the Soviet controlled authorities finally agreed to negotiate.
Through the
negotiation process and threat of further massive general strikes, former
dissidents assumed officially sanctioned ‘concessional’ positions. Within
months, they gained near complete (and very real) control of the Federal
Assembly. On December 29, 1989, Mr. Havel, a very famous and popular Czech
dissident, became President of Czechoslovakia (renamed the Czech and Slovak
Federalist Republic).
This initial
political victory represents only half of the nation’s success. Within the
first three years of self rule, harsh economic (and subsequent political)
realities forced the nation to divide once again. The nation as a whole was
unable to accommodate the vast discrepancies between the western Czech and
eastern Slovak regions. Massive economic reforms brought this to the popular
agenda as Slovakia suffered greatly while their Czech counterparts seemed to
benefit from reform.
The government
in Prague wished to move swiftly to further reform efforts. Slovakia hindered
Czech success and in turn suffered greatly by this Czech-led reform. Slovakia
simply could not move as rapidly toward a market economy due to the economic
configuration left to them by years of Soviet planned economics.
Political Overview: Restructuring for Transition
In 1992,
Vladimir Meciar, a very strong nationalist was elected prime minister of the
Slovak Republic, while Vaclav Klaus, a moderate federalist, was elected in the
Czech Republic. Unfortunately, these two leaders were unable to agree on common
economic and political strategies to govern the CSFR. Klaus’s reform plans, now
legendary, were simply inappropriate for the fledgling Slovak regions.
Slovakians felt alienated from the government reform in Prague. Within a short
time it was very clear that the Czech regions could not completely support
their Slovak countrymen through the transition. The two leaders agreed to
divide the Czech and Slovak Federalist Republic (CSFR) into the Czech and
Slovak Republics on January 1, 1993.
Federal assets
and liabilities were split between the two nations in a two to one ratio. The
Czech Republic received the larger portions reflecting both size and
population. Again, the split was achieved peacefully, without massive debate.
The two countries agreed to form a customs union. They implemented identical
foreign policies with respect to third countries, and forbid tariffs or ‘bans’
between themselves. They also formed a temporary monetary union, which
collapsed within months as both countries unexpectedly experienced a massive
drain on foreign reserves during this time. To more fully understand the
current developments in the Czech Republic, one must examine the historical
economic decisions made before the break-up in 1993 as outlined below.
Transition to Market Economy Overview: 1990-1991
CSFR economic
reformers went to work immediately following the collapse of Soviet rule. The
reform package included near complete liberalization of prices, a complete
reversal of former exchange and trade systems and an impressive preparation for
massive and rapid privatization. These efforts were supported by financial
policies including a “pegged” exchange rate, currency devaluations, and
restrictive fiscal, monetary and wage policies.
Monetary Policy
Although
monetary policy is discussed in a separate section, it needs to be briefly
addressed here to understand the conditions in which the transition occurred.
Monetary policy in the initial stages of transition ensured that inflation remained
in control throughout currency devaluations and price liberalizations. The CSFR
devalued its currency by 20 percent in 1991 after several smaller devaluations
before hand. Taken as a whole, these devaluations reduced the value of the
currency by half within six months. Generally, monetary policy remained tight
throughout the entire period.
Fiscal Policy
Undoubtably, the
goals of the CSFR economic reformers were to drastically reduce government
spending. The former centrally-planned, output-driven economic policies were no
longer effective for the new capitalist democracy. Restructuring government
expenditures was a key component of reform. The main changes, aside from
massive privatization discussed below, forced reduced subsidies wherever possible.
Every sector of society, with the exception of health, welfare and education,
saw an abrupt end to government subsidies. In 1991 alone, for example,
officials reduced government spending by 12 percent to reach 47 percent of GDP.
This trend continued throughout the transition. Massive government spending, a
hallmark of socialism, ended virtually overnight.
Areas where
government spending remained high would remain so throughout the reform
process. Health and welfare for poor, elderly, unemployed and children is a
very difficult situation in any government, especially one in transition.
Reformers focused primarily on industry and energy in the initial stages,
leaving the areas of greater uncertainty to be dealt with in a more stable
political environment.
Price
Liberalization
As an almost
immediate measure, subsidies to foodstuffs and energy were reduced by nearly 50
percent. Retail prices for most household items increased by nearly 25 percent
literally overnight. By the end of 1991, the Czech government controlled only
6 percent of prices in the country as compared with 85 percent in early 1990.
Only basic necessities, oil, and agricultural products remained under state
control. To offset some of these shocks, wages increased, though only slightly
and not nearly enough to meet the increased cost of living. Politically
powerful trade unions prevented the passage of even more drastic reform
measures. Plans in 1991 to increase the price of electricity, heating oil and
coal by nearly 400 percent and rent by 300 percent were delayed until 1992 and
1993.
Foreign Trade
and Investment
After an initial
currency devaluation of nearly 50 percent, the government adopted an adjusted
exchange rate connected to a “basket” of convertible hard currencies. Internal
convertibility of hard currencies was established in 1991. These two measures
combined to foster trade and investment. Initially, the CSFR set a 20 percent
surcharge on imports coupled with a 5 percent tariff. These obstacles soon
ended as major provisions were passed to more actively encourage trade and
investment. Initial steps toward private property rights and the dissemination
of publicly owned lands further enhanced the investment environment.
Privatization
Privatization is
by far the most critical and complicated development the CSFR had to address.
Speed was critical. The ‘default mechanism’ ensured that current managers and
persons of powers would assume control and create their own joint venture
agreements with foreign entities.
State firms that
were nearly completely vertically integrated needed to be desegregated by form
and function. And the process had to be done well, for flailing industries
would simply increase state expenditures. Failures did not decrease
expenditures in compliance with the transitional reform strategy. The CSFR
privatization plan was threefold. Small-scale privatization was the easiest.
Retail stores, restaurants and small service or industrial workshops were sold
to the highest bidders in weekly public auctions. Where no CSFR buyers were
found, a second round of auctions allowed foreigners to bid.
Property
restitution was more difficult. The government needed to equitably redistribute
land that had been taken nearly 40 years earlier. This is a difficult and
involved issue. CSFR citizens are allowed to claim land taken from them, though
the burden of proof is on them. Where no proof exists, special arrangements can
be made for state assistance. In areas of conflict, the issue will be brought
to the courts. A large part of the country was not in private hands before
Soviet rule. Some of this land can be used as an offering to parties where
disputes over ownership exist. Also, lands that have been improved (shops,
developments, houses, etc.) are sold at specially determined rates to the
former property owners. Prices and possible alternative compensation for those
owners who do not wish to purchase these ‘improvements’ are again settled by a
special court arrangement.
Large-scale
privatization progressed swiftly. Some state-owned firms were sold outright to
private interests while others remained under indirect state control until
buyers were found, legal or economic concerns settled, or parliamentary debate
resolved.
Social Policy
The strong
tradition of labor unions and their political strength proved crucial to social
security reforms throughout CEE. The CSFR was no exception. Labor unions were
instrumental in keeping CSFR unemployment at very low levels and social safety
net benefits quite high. Essentially the state guaranteed incomes at a minimal
level to meet the ‘cost of living’ for the unemployed or the under-employed.
Pensioners and parents of children received benefits adequately covering bare
essentials. Further benefits for health care were distributed at the local
level as the health system still remained under state control.
Problems of Transitional Monetary Policy and the
Financial Sector
Since the
introduction of reforms, monetary policy played a key role in the economic
stability of the Czech Republic throughout the transition. Inflation remained
surprisingly low (though relatively high in 1989 and 1990), exchange rates were
relatively stable (after initial fluctuations), and external reserves stayed
strong throughout the period (spurred by unusual and unexpected outside
interest in the Czech Republic as the first reformer to prove its success).
What is perhaps
most impressive are the obstacles Czech officials overcame in developing an
effective monetary policy. First, the entire CMEA trading block was virtually
dismantled. Reform and transition would be difficult even with stable trading
partners. In the CMEA, all of the countries were experimenting with and
adjusting prices, exchange rates and policies. It was very difficult to set
monetary conditions correctly, in real or absolute terms.
Second, within
just a few short years, the CSFR itself broke apart for economic and political
reasons. This was largely unexpected and proved difficult in the policy making
arena. As the break-up drew near, officials had a difficult time determining
which policies should be enacted based upon which of many scenarios might occur
in the CSFR.
Third, after
finally establishing the terms of the CSFR split and negotiating a seemingly
effective customs and monetary union between the two new countries, the
monetary union failed miserably. Within a few months, the union caused
significant drains on much needed foreign reserves in both countries and had to
be abandoned.
Finally, the
Czech tax system had to be completely overhauled. Additionally, the banking
system needed massive reform. Large spreads in interest rates were common and
overall the banks were simply reluctant to lend on any long term basis, a major
impediment to domestic investment and growth.
All of these
massive changes occurred within just a few years. Throughout these
developments, monetary policy remained extremely tight. At the onset of the
reform period, it was at its tightest, with a minor break late in 1991, once
the political economic dust had settled. Otherwise, the next monetary reprieve
didn’t occur until the second half of 1993. By 1994, broad money grew at 30
percent compared with growth of 15 percent a year earlier. More important than
doubling growth figures is that the economy was able to withstand this growth
by 1994!
Interest rates
were high throughout the period, and continue to remain high by most western
standards (over 9 percent). Interest rates were not directly controlled but
were subject to central bank reserve requirements and discount rate
announcements. Liquidity was further controlled through regular auctions of
treasury bills.
Bank reform
focused primarily on establishing the legal framework for transactions between
the central bank and newly established commercial banks. Weaknesses still
remain in reporting and accounting and the reluctancy for banks to lend.
Several commercial banks have had to come back under government control to
prevent major economic problems.
Macro Economic Stability 1992 - present
By 1992, the
CSFR began to show significant signs of success. Though they were in fact more
disadvantaged than many other countries in the CEE, they fared well. Their
export market consisted almost entirely of former members of the Council for
Mutual Economic Assistance (CMEA) who were in the same transitional position as
the CSFR, impeding efficient trade. Fortunately, inflation on the whole in the
CSFR remained remarkably low when compared to the rest of the CMEA, as did
external debt. Inflation did jump just before the CSFR breakup into the Czech
and Slovak Republics. Experts suggest this occurred in part due to the fear of
instability during the breakup and in part due to an anticipated VAT. As
expected, in 1993 (in the Czech Republic), inflation rose again after
introduction of the VAT.
In 1993, free
from its less advantaged Slovak counterpart, the Czech Republic better targeted
its economic recovery plan. The plan encompassed three main elements:
1) A balanced
state budget that encompassed sweeping tax reform;
2) A tight monetary
policy to reduce the inflation caused by VAT and other lesser effects (which also
improved its external position for trade and investment); and
3) Moderate
wage increases (adjusted to inflation) and a stable exchange rate.
This reform
policy was backed by an IMF “stand by” arrangement as a precautionary measure.
The IMF would assist if the Czech Republic needed financial assistance. This
happened once early in 1993 and Czech officials repaid the loan before it came
due (much to the delight of the IMF).
Unemployment
remained remarkably low in the Czech Republic at 3 percent in 1993, while
Poland’s figures (another major success story in CEE) still remain in
double digits. Low, virtually non-existent unemployment certainly contributes
to greater political and popular acceptance of the above fiscal and monetary
policies.
Many attribute a
major setback in the Polish “Shock Therapy” reform efforts to the political
demands of the labor unions. The Polish President, Lech Walesa, understood the
need to keep wages low to implement the reform. But he feared for his political
power and caved in to labor pressures by granting wage increases. By doing so
he nearly destroyed the entire economic reform process. He claimed that had he
not, the entire political reform process would have crumbled.
Czech officials
didn’t face this obstacle as unemployment throughout the transition remained
low. The political reform process was slightly segregated from the economic
reform process. The small Czech population (roughly 10 million) was easier to
organize than Poland’s 40 million. Regional differences were less and political
factions less pronounced. Regardless, by 1993, the Czech Republic had a very
cohesive popular political support base which facilitated the economic reforms.
By 1994, foreign
trade increased substantially, with much of the growth occurring between EU
member nations. Tourism in Prague, now a “must see” on any European vacation,
contributed to increased trade to maintain a strong balance of payments and a
surplus in the current account. Though FDI by 1994 had decreased (after very
high initial investments in 1992 and 1993), the
capital account
maintained high inputs due to the rise in borrowing of Czech firms (which
proved even better for Czech long term economic success).
GDP began to
rise slightly after a period of decline from 1991-1993 of nearly 20 percent.
Privatization entered its second round in 1994 for enterprises being privatized
through voucher programs. The first wave of privatization is considered a
remarkable success (a model to be used farther east). As this first wave ended
in 1993, the Prague stock exchange began trading and the banking system went
though increased and improved reforms. The Czech Republic was a leader in the
CEE in trade and investment. Economic reform efforts, coupled with the above
mentioned political support, put the Czechs at the forefront of CEE success.
Industry
Industrial
output by 1993 declined by nearly 21 percent compared with 1991 figures. This
can partially be explained by increases in the service sector, as investment
soared in service sectors and dropped dramatically in the industrial sector.
Also, the industrial sector was the most inefficient sector in the former
centrally planned economy and much of those inefficiencies were corrected with
the introduction of market reform. Most industries produced less as consumption
dropped. And they did so more efficiently as output based economic plans were
no longer used.
It is
significant to note that the Czech Republic does not have an industrial policy.
They feel the state does not have enough information or resources and thus it
is most efficient to allow the private sector complete control. Government
could assist with exemptions and subventions, but the market should determine
winners and losers.
However, the
Czech government continued, through 1994, to bail out state-owned enterprises,
mostly due to their economic (employment) and political leverage. In essence,
this hurts struggling smaller, private, firms that are unable to compete with
giants, let alone subsidized giants. These large industrial subsidies are all
but gone in most industries today, however they still exist for politically
sensitive or economically vital industries. In some cases the government reluctantly
returned to subsidies as not all of the initial privatization efforts proved
successful. Some large enterprises were not effectively dismantled and the
resulting giant enterprises were simply too large and inefficient for the new
market economy. It took several years, in some cases, to learn this lesson.
Prices
Consumer price
inflation by 1993, after the initial shocks of the VAT, stabilized at 18
percent. Experts estimate the VAT added 7 percent to inflation during 1993 and
an additional 2 percent can be attributed to government administered price
regulations. Price regulations remained mostly in the utilities sector.
Adjustments from 1994-1995 increased prices in several key areas including gas,
oil, transportation, medicine and telecommunication tariffs.
Wages
Wage restraints
through a “tax based income policy” was an important feature of the CSFR. Wage
restraints ended in 1993, but had to be brought back by the end of the year by
the Czech government. The rational behind bringing the restraints back was that
market forces were not yet adequate to control wage increases. Wage increases
had to remain close to increases in consumer prices to avoid inflationary
difficulties. Therefore, as late as 1995, up to 100 percent tax rates were
applied to wage increases over allowable limits, effectively keeping wages at
desired rates.
Monetary Policy:
1993
By 1993, Czech
monetary policy began to stabilize in conjunction with political and economic
indications of success. The basic aims of monetary policy at this point were
simply to maintain internal and external currency stability. Officials kept the
Czech crown pegged to stable European currencies and prevented inflation from
rising above 10 percent. In a somewhat disguised blessing, foreign capital flowed
into the Czech Republic at high rates in 1994 causing officials to raise
reserve requirements from 9 to 12 percent to insure inflationary stability. The
banking system, though still flawed, was able to withstand the pressures. The
economy certainly welcomed the increased capital.
By 1993 and even
more so by 1994, monetary policy was less of a political tool in the reform
process. Stability in many respects had been achieved. The nature of further
reform and continued stability relied almost entirely upon fiscal
decision-making. To fully understand and appreciate the political economics of
reform from 1993 onward, both fiscal and monetary, an examination of the Czech
budget is helpful. Defining the role of the state in the new market oriented
economy is critical. Two main issues must be examined, the resources and
informational capabilities of the state. Both are limited and both are not
independently effective. The budget and the political issues surrounding its
passage are important in understanding the Czech approach to stability now that
much of the transition has been rather successfully completed.
Intergovernmental
Financial Relations
Before the
budget analysis, a brief overview of intergovernmental financial relations may
be helpful. The Department of Finance makes budgetary estimates for the
Ministry of Economy. They regulate spending and essentially decide which
organizations and institutions receive the much sought after government
subsidies. They are also responsible for government accounting, financial
management and regulation of wages. The Department of Finance is classified
under the Ministry’s “Administration and Finance” section.
The Foreign
Economic Relations Department, the European Affairs Department and the Economic
and Social Policy Department are all included under the Ministry’s “Economic
Policy.” They all report to the Ministry and are essentially charged with the
difficult task of improving and encouraging economic development both home and
abroad. The Ministry also supports a wide variety of business development
departments; Small Business, Business Promotions, Tourism, etc. Though their
interactions, cooperation and communication are limited, they all follow
somewhat coordinated general policy initiatives of the Ministry.
The 1993 Budget
The following
budget summary is based on the 1993 budget because that was the first budget
elaborated as the independent Czech Republic. Before the transition, Czech had
one of the more state dominated economies in the CEE. The state controlled
almost all economic activity with government expenditures reaching as high as
65 percent of GDP in 1989.
The 1993 budget
focused on a more developed private sector. The budget is fundamentally
influenced by tax reform which will be discussed in the following chapter.
Revenues
The 1993 budget
is based on three main revenues: the value added and excise taxes (36.9
percent), income tax from legal entities (25 percent) and social insurance
(28.5 percent). The new tax system (and total restructuring of public finance
to benefit local budgets) reshaped the revenue system and forced budget
developers to complete more in-depth estimates of revenue flows. They were
forced to make more accurate revenue predictions.
Total revenues
in 1993 reached 419 billion crowns (26 Kc per $1USD), of which 343 billion went
to the state, 41 billion to local districts and 35 billion to health insurance.
Revenue growth was 13.4 percent and local budgets rose 35.2 percent in 1993
Expenditures
A large part of
the expenditures for the Republic encompassed transfers to the people. The
largest programs are pensions, family allowances and sickness insurance. Social
transfers were increased in 1993 to create reserves for expected increases in
unemployment. Expenditures on branches of government like health care, for
example, increased by 50 percent in 1993, simply responding to demand. A move
to create the National Health Fund was instituted out of a revamped payroll tax
and transfers from the central budget to care for the non-working public. The
health fund reduced local spending on health care thereby reducing local
transfers. Expenditures on education and culture also increased by a third over
1992 levels. These additional expenditures were partially offset by a new wage
tax targeting employers and a combination of the following:
1) Savings in
compensatory income support and sickness benefits by a new means tested model;
2) A freeze on
subsidies to agriculture, transportation and mining; and
3) Large
cutbacks in real 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 Ministry’s 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 Czech’s 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 all tariffs with EU countries by 1997 (excluding “sensitive products”).
These changes are helpful to the Czech economy but slightly premature. Experts
claim they are done solely to impress the EU application reviewers.
The EU and NATO
EU membership is
inextricably tied to NATO membership. It is important to understand the
similarities and differences between these two organizations, especially as
they concern the Czech Republic and the continuation or completion of the
transition. The transition is both economic and political and therefore should
be examined in terms of both EU and NATO powers. The EU and NATO are arguably
the most advance powers economically and politically in the world. NATO
includes the US, while the EU, of course does not. It is interesting, then,
that many claim EU membership is virtually predicated on NATO membership. This
creates an interesting foreign policy situation for the Czechs. It is not
contradictory, but perhaps a bit dispersed in terms of goals and objectives.
Originally, NATO
was created as a response to the communist threat. Recent discussions between
NATO and Russia suggest this threat no longer exists. So what is NATO’s
role today? For the time being, NATO has a very powerful, though perhaps
indirect role in the continuation of EU expansion. EU membership would bring
long term economic and political stability to the CEE (a NATO objective as
well). NATO must continue to work in association with the EU to bring stability
throughout the region to insure that the “communist threat” is indeed diffused
indefinitely. It is not out of the question that massive economic and political
upheaval in the FSU could result in some nationalist power rising up and posing
a serious threat to European interests. It is in this sense that NATO and EU
have a very common, and perhaps final goal.
Recently while
in Detroit campaigning, President Clinton set a date for NATO expansion. He did
not specifically mention which countries he was referring to, however, he did
say that ‘their’ inclusion into NATO is expected by 1999 (by ‘their’ most experts
assume, Poland, Czech and Hungary). If the Czech Republic becomes a NATO member
by the year 2000, EU membership could come as early as 2003 or 2004.
Therefore,
politically, the Czech Republic needs to satisfy the goals of both EU and NATO.
Economically, they need to address the EU a bit more thoroughly then the US as
the EU will be their main trading partner, but the US will remain a powerful
ally, investor and trade partner. Although membership in either of these
prestigious world powers would be remarkable for a country just a decade after
socialist rule, the Czechs need to proceed carefully.
In joining the
EU, the Czech Republic will face a somewhat unpleasant reality. After years of
being the political and economic leader of the transitional Warsaw Pact
countries, they would be immediately subverted to the lowest status in EU
member countries, lower than Portugal. Though this would enable them to receive
EU assistance, both technical and financial, it would also require them to
adapt possibly painful domestic policies involving increased environmental
standards, increased costs and drastically high competition in terms of quality
and markets. It would also find them having to compete with Hungary and perhaps
the most important country from the EU perspective, Poland. If Czech is forced
to split benefits and favors with Poland and its huge 40 million person
markets, they will indeed have their work cut out for them. Another major
problem are the EU legal requirements for issues like consumer protection.
The benefits to
EU membership, of course are many. The Czech Republic currently meets four of
the five requirements for EU membership under the recent Maastricht Treaty. The
Czechs reached EU membership levels for currency stability, interest rates, debt
as a percentage of GDP and public expenditures as a GDP percentage. They still
fall short on the inflation determinant. 1996 inflation is still at 9.1
percent. This would have to be lowered to 3.8 percent to conform to EU
standards, a daunting task. The country will continue to reduce taxes wherever
possible to stimulate the economy, but this is increasingly difficult as the
Czechs are now in a relatively comfortable position where increased reductions
in taxes would seriously hurt social benefits.
The EU is
currently in the process of implementing their monetary union. Though this is a
fantastic goal for the Czech Republic, they are not yet in a position to
completely abandon their own monetary policy and rely entirely on fiscal
policy. Even though they could not be permitted to join the EMU upon their EU
membership (it has much stricter requirements than general membership), it
would be strange for the Czech Republic to enter the EU knowing that they are a
far cry from EMU membership. This is not to say it is inadvisable. The Czechs
must join the EU at almost any cost. It is simply a concern worthy of mention.
As the EU expands, the core states will be able to continue a favored status or
elite power center, revolving around EMU involvement and not simply EU
membership. This could be an important strategic leveraging issue for the core
states (and a major point of contention for the Czech Republic as a new
member).
There are many
concerns and areas for excitement both politically and economically for the
Czech Republic. They are in a very good position to come out far ahead of
anyone’s expectations. Perhaps even their own. EU and NATO membership will both
be achieved within the next 5-10 years, no matter what difficulties are faced
along the way.
Conclusions
In just seven
years, the Czech Republic transformed itself from a socialist,
Soviet-controlled industrial-based economy to an increasingly service oriented
OECD member and number one contender for the next wave of EU and NATO expansion
in the region.
The Czech
Republic’s success can be largely attributed to its small size and population
and its relative ethnic and religious homogeneity. More important, however, is
the Czech determination and persistence in meeting the challenges of transition.
The transition that began in 1989 entailed a great many hardships. Not all of
the CEE countries made it through the transition so successfully. The Czechs
succeeded because they were able to stick to their plan when most other
countries were forced to abandon for political reasons and popular discontent.
When the reform
package became difficult, the Czechs didn’t revolt, they didn’t strike and they
didn’t complain. They showed remarkable foresight in taking early steps to
revamp their tax system and banks, keep inflation and unemployment and wage
increases low, and keep their currency at stable levels. These were not all
easily accomplished. They survived the difficult times and came out on top of
the CEE as the only country to make it through the transition virtually
unscathed. This smooth transition earned their revolt the nickname, “the Velvet
Revolution.”
The Czech
Republic is now poised to embark upon a greater challenge, that of becoming one
of the world’s power core with EU and NATO membership. It will entail further
difficulties, but compared with the accomplishments of the past and their
ability to overcome Soviet oppression and transition from central planning,
there is little doubt that the Czech Republic will succeed in their final step
toward complete transition from the USSR to the EU.
References
Economist.
Country Profile: Czech Republic. The Economist, London. 1996.
Economist.
Saving Graces. The Economist November 9, 1996.
Freiden
Jeffrey. International Political Economy 3rd Edition. St. Martins Press,
NY. 1995, Section IV.
Heady,
Christopher. Tax Reform and Economic Transition in the Czech Republic.
Fiscal Studies, Feb. 1994.
Heady,
Christopher. Tax and Benefit Reform in the Czech and Slovak Republics.
Center for Economics and Policy Research, Discussion Paper Series No. 1151.
March 1995.
Klaus,
Vaclav. The Ten Commandments of Systemic Reform. Occasional Paper 43,
Group of Thirty, Washington, DC, 1993.
Munk,
Eva. Trouble Brews Over Tax Break. The Prague Post, January 18, 1995.
Munk,
Eva. 25 Year Old Sports Car Picking Up Speed. The Prague Post, January
18, 1995.
OECD
Economic Surveys. Czech Republic. OECD, Paris, 1996.
State
Budgets and the 1993 Fiscal Policy. CTK Business News. May 4, 1993.
Svejnar,
Jan. The Czech Republic and Economic Transition in Eastern Europe.
CERGE-EI, Prague, Academic Press, NY, 1995.
Untitled.
CTK National News Wire. December 11, 1992.
Web
Sites: http://www.cerg.cuni.cz
http://www.aifs.org/czoo.htm
http://alta
vista.digital.com - simple query cz repub, transitional economies
http://www.lbs.lon.ac.uk/school/wpaps
http://www.ssc.upenn.edu/east/spring95/janusz
http://www.hiid.harvard.edu/pub