MNI INTERVIEW: Czech Tax Cuts Risk Public Finances - Jansky

Unfunded Czech government plans to raise spending while cutting taxes will push the public purse further into the red, likely raising inflation while doing little to improve the country’s long-term growth prospects, a leading expert told MNI.

A planned reduction in the retirement age from 67 to 65 and other proposed pension system changes will lead to higher deficits for both the pension system and the government budget in the coming decades in the absence of countervailing income-raising measures, said Petr Jansky, Professor of Economics and head of the Centre for Public Finance at Prague’s Charles University.

“If the government combines tax cuts with spending pushes, then unless there are credible offsets you get bigger deficits. This would likely also lead to higher domestic demand in the short run, which can lift growth—but also risks re-igniting inflation,” he said.

While a strategy document published by Prime Minister Andrej Babis’s ANO party before October’s elections hinted at policy reforms which look good in principle as well as increases in spending on education and innovation, it is not yet clear which of these will be enacted given a tight fiscal situation, Jansky said, describing his expectations as “relatively low”.

“The incoming government has many plans to increase spending, but does not want to increase taxes or deficits. This obviously does not add up and the incoming government will need to prioritise and make difficult choices sooner or later,” he said.  (See MNI INTERVIEW: Czech Fiscal Gap To Hit 3% GDP-Council Chair)

Political pressure to run a more expansionary fiscal policy than the previous government is likely to increase over the coming months, though Jansky noted that while ANO are less concerned with running low deficits, their coalition partner party Motoriste has stressed their importance.

The Czech economy is currently in relatively good shape, growing and with only moderate inflation, he said. But while the picture seems stable overall, it is not necessarily set to flourish from the long-term perspective. 

CORPORATE TAX

Infrastructure spending is a key challenge, while questions remain over the new government’s commitment to spending a minimum of 2% of GDP on defence, let alone meeting NATO plans to commit the equivalent of 3.5% of total output.

Babis’s government should resist any temptation to reverse 2024’s corporate tax hike from 19% to 21%, and only lower it if it increases write-offs for depreciation - an idea which has been discussed by the new leadership, Jansky said.

“We have been patiently explaining that it is not necessarily wisest to reverse the Fiala-era CIT hike. Instead, we propose to accelerate depreciation for selected investments. The accelerated depreciation should increase investment and decrease tax revenues. For the tax revenues to remain constant, the government could consider increasing the tax rate."

Fiscal policy will interact with monetary policy in the coming months, as the government boosts spending and deficit financing, but an increase in Czech National Bank interest rates is not very likely in the coming months, Jansky said.

“I do not foresee open conflicts in the short term, partly because of the personal histories; the current governor of the Czech National Bank used to be an advisor to the incoming prime minister.” (See MNI EM CNB WATCH: Czech National Bank To End Year At 3.5%)