Under Act No. 23/2017 Coll., on the Rules of Budgetary Responsibility, as amended (the “Act”), a key task of the Czech Fiscal Council (CFC) every year is to prepare a Report on the Long-Term Sustainability of Public Finances (the “Report”) and submit it to the Chamber of Deputies of the Parliament of the Czech Republic.
As in previous Reports, in this current one the CFC assesses the Czech public finance situation from both the medium and long-term perspectives. The key indicator in the first case is the current structural balance, while that in the second is the projected path of public debt over the next 50 years, which indicates the size of the long-term imbalance. We demonstrate the degree of urgency of the need to address the two imbalances by estimating the year in which the economy risks breaching the “debt brake” if revenue and expenditure policies remain unchanged.
Czech public finances are currently significantly imbalanced. This situation arose through a combination of a medium-term imbalance and a chronic failure to address the future impacts of population ageing.
However, the current problems are predominantly a result of an extreme relaxation of fiscal policy over the last two years. This easing was justified by the atypical nature of the COVID-19 crisis and the need for a firm fiscal response to it. While it is clear that the crisis required fiscal policy action, the extent of the response was excessive. Moreover, actions were taken with reference to the crisis which had nothing in common with it and which significantly worsened the structural public budget balance. Unfortunately, some of the measures proved problematic or even damaging from the fiscal and macroeconomic perspective. Perhaps the most prominent example is the sharp cut in personal income tax approved at the end of 2020, which, given the macroeconomic situation, not only failed to boost economic growth significantly, but also fuelled the inflationary pressures currently facing the Czech economy.
Public finances entered 2022 in a large structural imbalance. Government papers published to date unfortunately indicate no major reduction in the imbalance in the coming years. Fiscal consolidation efforts are of course being complicated by the new crisis driven by Russia’s attack on Ukraine. New expenditure requirements are therefore being placed on public budgets. The revenue growth being generated by the high inflation is not sufficient to cover them.
The current public finance situation is also a result of problematic treatment of the fiscal rules. The successful functioning of these rules is fundamentally conditional on long-term legislative stability. Regrettably, the double amendment of the Act in 2020 greatly undermined the entire credibility of the system. In particular, poor-quality interventions in the construction of the structural balance rule made it
much vaguer and harder to implement the rule.
As previously mentioned, in this Report the CFC presents the public budget situation from the medium and long-term perspectives. Unfortunately, we have to say that there has been only a minor improvement by comparison with the results presented in the previous Report, and the key conclusions are unchanged. If the imbalance is not eliminated in the near future, the debt ratio could reach the debt brake threshold (55% of GDP) by 2028. Our long-term analysis meanwhile indicates that the current tax and spending policies would lead to a sharp increase in the debt – especially from the 2030s onwards – that would not be financeable in the long term.
It is therefore clear that significant changes will have to be made on both the revenue and expenditure sides of public budgets. Even though these changes will not be popular, they need to be commenced as soon as possible, because our calculations show that the later they are made, the more costly they will be. However, delaying reforms also has redistributive impacts, as the financial burden shifts from the
current economically active generations to future generations.