Financial Accounting and Analysis balancesheet.pdf
Towards a rational tax policy in the czech republic
1. Toward a Rational Tax Policy in the Czech Republic
Colin Shea
The intelligence of any tax policy can be assessed according to three goals: efficiency, equity, and
administrability. Generally speaking, the Czech tax system meets none of these tests well. Work and
consumption are actively discouraged, dragging down the economy. The adminstrative burden of
taxation is relatively onerous and fraud rates are high. Most damning of all is the extraordinarily
regressive nature of the tax system which has led to the highest concentration of wealth in the European
Union.
I propose a simple change: to shift a portion of taxation from income and consumption to property
instead. I do not address the question if the level of taxation is appropriate or efficient in this paper,
merely the nature and method of its collection. In my analysis I assume state revenues are kept neutral.
Irrespective of the taxation level as such, the proposed solution will have several positive impacts. First,
it will stimulate employment and consumption, increasing GDP. Second, the potential scope and
motivation for tax evasion will be reduced. Third, property prices will go down and supply will increase,
improving affordability of housing. Lastly, the regressive nature of the Czech tax system will be reduced,
leading to greater economic equality and social cohesion.
The structure of Czech tax revenues is abnormal and regressive
Czech tax collections differ wildly from average patterns seen around the OECD, characterized by high
consumption taxes, virtually nonexistent property taxes, and high social payments.
i
While consumption taxes are not out of line compared to the rest of the OECD at 11% of GDP, it should
be noted that certain countries manage to maintain much lower levels. The United States for instance
maintains sales tax at 4% of GDP, Switzerland at 6% and Japan at 5%ii
. VAT taxes are extraordinarily
regressive, obviously hitting hardest the people with the lowest disposable income and savings rates.
2. One distinguishing characteristic is the high rate of social and health contributions, which are far in
excess of OECD standards. This has an obviously detrimental impact on hiring full time employees as the
‘all in’ cost of employees far exceeds that of temporary staff. This leads to increased incidence of tax
avoidance through utilization of non-employment structures (Švarc system) and has a pronounced effect
on economic growth. The below graph shows the overall relationship between the tax wedge on
employment wages and nominal GDP growth across the OECD between 2000 and 2015. There is a clear
and statistically significant correlation between the two (Pearson coefficient = .21).
Czech Republic collected 19b Kč in property taxes in 2015, circa 1.3% of the tax base compared to the
OECD rate of 6%. This astonishingly low rate favors landholders, property owners and those maintaining
passive incomes from such assets. Additionally, it reduces substantially the opportunity cost of holding
inactive assets and, correspondingly, the overall velocity of the real estate market. This effectively
reduced supply leads to higher prices than would otherwise be the case, reducing the affordability of
property in general. This cycle is self-reinforcing as well. Artificially constricted supply raises prices,
convincing owners their assets are appreciating and reducing motivation to sell, further constricting
supply, and so on.
The tax system is burdensome and leaky
While the overall administrative burden of the Czech tax system has reduced, according to
comprehensive World Bank assessments it is still far above many comparable countries in the EU. Only
Italy and Germany have similar administration levels. France – hardly a paragon of administrative
efficiency – has a 40% lower administrative burden than Czech Republic. Spain, Belgium and Austria have
similarly low levels, while Finnish taxes are less than half as burdensome as Czech.
3. In addition to this, the relatively high tax rates leave an obvious incentive to evasion. This seems
particularly concentrated in VAT in Czech Republic. The European Commission identified the tax gap in
VAT collections in Czech Republic at 16% vs 10.4% median across the EUiii
. In 2015 one single case of VAT
avoidance worth 5.1b Kč was discovered. Overall tax evasion and fraud in Czech is estimated to be over
10% of total receipts (150b Kč annually)iv
.
The overall result is an extraordinary concentration of wealth
The Czech Republic seems relatively egalitarian in terms of income. The Gini coefficient for Czech
Republic is .262; the only countries in the EU with less income inequality are the Nordicsv
.
This figure is deceptive, however and hides an enormous discrepancy in wealth. Wealth inequality,
combined with a highly regressive income tax system, leads to an especially pernicious self-reinforcing
cycle. Individuals and families with assets generate passive income taxed at low levels and are more able
to find mechanisms to avoid or reduce tax, accumulating further wealth; those without such assets and
unable to save their way out of the cycle of high employment taxes and high consumption taxes have no
hope of significant asset accumulation. Social mobility is permanently reduced and the principle of
meritocracy fatally compromised.
4. The Czech Republic has managed the extraordinary feat of within 30 years moving from a Communist
system to the most concentrated level of national wealth in Europe. 39% of the nation’s wealth is owned
by the top 1% of individuals. This is even higher concentration than the United States – not the poster
child for redistributive policies - where the corresponding figure is 37.3%vi
.
A modest proposal
A significant overhaul of the tax system would confer a number of obvious economic and social benefits.
My specific proposal is to increase the property tax burden by a factor 5x, which would merely bring
Czech Republic in line with the OECD average. This would generate total property tax receipts of 100b Kč,
an incremental 80b to what is taken today.
This 80b would be offset by corresponding reductions in social/ health taxes and VAT at the level of 40b
each. VAT would be reduced by 13%, leading to a reduction in consumer prices of 2.3%. Assuming a 20%
elasticity of demand, this would increase overall consumption by a long term and sustainable .46%.
Social and health contributions would be reduced by 6% (circa one third accruing to consumers and two
thirds to employers). Again we may expect an elasticity of consumer demand as well as employment
capacity.
Various land and property taxes could be assessed which would not be overly difficult from an
adminsitrative point of view. Total housing stock in the Czech Republic for instance is estimated at 4.3
trillion Kčvii
; a 1% property levee would generate 43b per annum in tax receipts. A rough calculation of
hectares of arable land in Czech Republic at current prices yields a value of 424b Kč; again a 1% levee
would generate 4.2b Kč annually. A fair and transparent distribution of the 100b target among
residential and commercial property and land would not be difficult to construct.
The corresponding elasticity of demand will be far lower in this segment. The more assets one possesses,
the lower proportion of one’s income is spent on consumption. Therefore there will be a net gain in
economic activity. A slight inflationary impact could be expected from increasing asset prices as the tax is
passed through. On the other hand, this tax will stimulate sale of stranded or unused assets as their
5. owners are presented with tangible cash outflows. This increased supply of assets for sale will reduce the
inflationary aspect of the tax and possibly eliminate it entirely.
Tax evasion will be reduced. Employment status can be fudged, income can be hidden, assets can be
offshored, VAT can be avoided; land and property are impossible to hide. Assuming 80% of the existing
tax loss rate could be avoided by shifting towrd property taxes, an incremental 7b Kč of tax receipts
would be generated annually.
A few arguments and exemptions are typically presented against this approach. First, poor farmers are
typically trotted out to show how the traditional way of life is being eroded as they are forced off the
land. To solve this, smallholdings can be taxed at a lower rate if desired. The fact should not obscure that
just over 4.000 landholdings constitute 90% of arable land in the Czech Republicviii
.
Second, pensioners will be presented who cannot pay the tax on apartments they inhabit their whole
lives. Again, a sliding scale of tax rates can be prepared with (for instance) lowest rates for housing units
<50 SQM living area and higher rates for those over 200 SQM. People may be thought to have a certain
right to a residence, but this does not mean they necessarily have a right to live in palatial apartments in
prime locations while young families struggle to find money for down payments on their first flats.
A particular point is whether the state itself and religious entities should be subject to such taxes. The
answer is absolutely. Part of the argument behind the land and property tax is it encourages efficient use
of assets by imposing an opportunity cost on not using them. There is no reason state entities should not
be subject to the same pressure citizens are in this regard. If the state cannot use an asset efficiently it
should sell it to a private citizen or company that can. Regarding the church, it may seem
counterintuitive to tax lands they have recently received in restitution after they were expropriated by
the communist regime. But how did the church originally acquire these assets? Not through private
enterprise, or producing goods and services people bought of their free will. Church assets were
acquired by forced tithes, indistinguishable from taxes, and tax burdens should be imposed on them at
least as great as any individual or private company.
A simpler, fairer, and more equal tax system
There is nothing to lose from making this shift and much to be gained. Fraud will be reduced, economic
activity increased, and the general equitability of the Czech economy and distribution of wealth will
improve.
Of course numerous and powerful vested interests will fight against such a change, using a populist,
Trumpian version of political jiu jitsu that tries to dress up the coddling of oligarchs in a costume of
defense of the common man. These arguments must be exposed for the farce that they are before they
gain traction. This is a simple, practical realizable change that any reasonable and just politician must
support.
i
OECD. https://www.oecd.org/tax/revenue-statistics-czech-republic.pdf
ii
OECD. http://www.oecd.org/tax/tax-policy/tax-database.htm
iii
https://ec.europa.eu/taxation_customs/sites/taxation/files/2016-09_vat-gap-report_final.pdf
iv
http://www.czech.cz/en/Aktuality/Current-Affairs/Prime-minister-unveils-plans-to-fight-tax-fraud
v
OECD. https://www.oecd.org/eco/surveys/Czech-Republic-2016-overview.pdf
vi
Credit Suisse, Global Wealth Databook 2015, p. 147
