With the recent discussion of austerity packages and the approaching elections of next year, measures aimed at tackling the deficit and recession are at the forefront of economic discussions. Martin Jareš, Head of Tax and Customs at the Ministry of Finance, explains the motivation behind the Ministry’s proposals, and offers his opinions on the nation’s options for policy and growth.
11/24/09
Opening Remarks:
As you know, I am the head of the Tax and Customs Policy division. So of course my main field of interest is taxes – tax revenues, customs revenues, how much we will collect for years to come. This is my area of professional review that was affected by the crisis because there were some discretionary measures undertaken by the government in the first half of this year to help companies overcome the crisis. In the second half we concentrated more on the consolidation package so as not to have too large a deficit. We always have to calculate the budgetary and customs impact for the coming years.
Could you discuss how the tax policy changed when it was clear the crisis was to manifest in the Czech Republic?
When the crisis was fully present in our country (and in other countries around) the government said, well we should do something to start to react in some way. Then the National Economic Council of the government (NERV) was established, and they proposed several measures. The first one from the spring was concerned with what to do to help companies overcome the crisis. In the field of taxation, the main ideas were first to ease the management of cash flow, so to move some payments which under normal circumstances we would collect this year, and postpone them to some later date, either by just a few dates or to next year. One example of this was the income tax for which you have to pay quarterly prepayments and then settlement next year. And so we said OK, small companies with up to five employees are exempt from these prepayments. But if you have any taxes for 2009, you will pay all the taxes in 2010. We don’t require you to pay prepayments and then only settlement. You calculate the tax, compare it to the prepayments, and you either pay on top of that or you get refunded the money overpaid last year.
And then also the individual financial offices were instructed (the law provides individual agreements between financial office and company) to decrease this level of prepayments depending on the situation of the company. So they were instructed to treat favorably those companies which exempt more employees which were not guaranteed in bulk. This was a governmental decision; so they were instructed to treat them favorably and postpone these prepayments. This was one area.
There were other areas; one main measure concerned the VAT (value added tax) which you submit monthly or quarterly and end up paying taxes or refunding input VAT. There is a period of 30 days after which all the refunds should be returned by the financial office back to tax payers. [The new measure said that if] the taxpayer submits taxes electronically, they should be refunded within 15 days. So again, bring money faster to the companies so that they don’t have cash flow problems.
The last measure, if I remember well, increased the speed of depreciation periods. Normally we have five groups of assets; the first group is depreciated for three or four years, then the next group in six years. Those two groups consist of are cars, computers, basic machinery, the last group of real estate, and the remaining two groups of heavy machinery (10, 12 years) It was said for the first two groups (which are consumption goods and goods which can be changed quite easily for years 2009 and first half of 2010) that if you acquire these assets, then you are granted faster depreciation periods. You can depreciate it in just one year (changed from three or four years), or from five or six years to two years. The point is that those rates were changed to help companies buy assets in these troubled years so that they can deduct them from tax payments more quickly. What they would normally over three years they do now in one year. They don’t pay that many taxes now, but they can pay more in the time to come.
Do you have data from these measures to assess their effectiveness in promoting cash flow?
We have some data, though not about this depreciation because we will find out only when companies file tax returns in about June of next year. With regards to VAT payments, there will be some data concerning the amount of tax returns that were filed electronically and so what amount was returned faster. There was also another incentive in passing this measure, for the Minister of Finance hoped to promote electronic filing. Although it has been allowed for five or seven years, only 1% of companies use it. I don’t know if these measures really helped promote it or not.
With regards to the abolishment of the decrease of prepayments, I saw some data somewhere in the first half of the year, and there was quite an extensive impact. The amount of money was more than 10% of the total tax revenues. So if normally from corporate tax we collect 150 billion Czech crowns (Kc), the revenues were more than 20 billion Kc, so more than 10% of revenues were decreased because of that in the first half. If things go in the same direction, there could be the same numbers in the second half. This was definitely one thing that helped companies.
For how long were these measures in place?
Those decrease of prepayments and faster return of VAT refunds were introduced someone in February or March. The faster depreciation rates required a change of legislation. The legislation was changed September or October, but everyone prepared for these changes and knew they would be valid in the end of 2009 and first half of 2010. Of course some companies need to do some preliminary calculations, but it’s important when they file the tax return. So lets say in June, most of the companies filed in June. It’s important when they calculate how much they have to pay.
Are you still focusing on anti-crisis measures or looking more towards the deficit?
So as I said, in the first half we introduced mainly those measures. There were other measures which were shifts of money from one period to another, so basically not paying now but paying later. There were also some permanent tax decreases; one of them was the VAT on passenger cars. Normally if a business buys anything and uses it when they conduct business, they can deduct the VAT input from their VAT output. So they can deduct the VAT owed to the government. This was valid for all-purpose engine cars created since 1993. […] Now we said, OK, lets change this measure and allow also deductions of VAT for all passenger cars in the full amount. […] The main point is that passenger cars now can be bought without VAT. This measure also required legislation; again there was a decrease of taxes.
[…] There were some other measures in the area of the Ministry of Labor, which had some complicated design. There were some credits, or deductions from social security contributes that were regressive. (The lower the salary the higher the deductions.) So we started at a certain level, and then it went down … so they introduced this measure in June or July. Later on when we started to discuss the consolidation package, there was an agreement made between the government and trade unions and some unions of employers abolishing this particular measure. It will be formally enforced this year and next year and valid only up until December.
It’s not a very consistent policy, but that’s how it goes. In the first year everybody wanted to help companies. Then they find out, oh come on the deficit will be too high and so they have to do something, lets also look at those measures. Companies say, this measure is too complicated, so if you scrap it we don’t care, and so the government decided to scrap it. But I don’t know much about it because this concerns the Ministry of Labor (upon the advice of the Economic Council).
When we started to think about consolidation and some measures which could decrease the deficit, we didn’t want to go back to, lets say, reintroduce the impossibility to deduct VAT on passenger cars. We wanted to come up with something else, and that’s why, you maybe know from newspapers, we came up with several tax increasing measures. They were not targeted at some special companies in trouble like the previous measures, but rather were the most general measures. We decreased VAT rates by 1%, and we increased the rates of excise on beer, spirits, mineral oils, and cigarettes. And we also doubled real property tax rates which go to the municipality, so basically they will have twice as much money. (Estimated 80% increase of their revenue.)
These other measures – VAT and excise – they go partly to the state budget, partly to regional government budgets, partly to community municipalities. These are the main measures on the tax side. There were also some measures on the expenditure side, but I don’t know that much about them.
Do you think that the Ministry was preemptive in implementing these tax increasing measures?
Just last week I was at the OECD and there was a tax policy and analysis working group gathered. This included all the OECD countries. We discussed some of these measures; last year in May and in November, the discussion was mainly on the reaction, response of tax policy to the main financial crisis, and everybody started to describe their measures. My understanding was that the development in all countries in 2008 and early 2009, everyone concentrated on helping companies and promoting consumption. They discussed this scrap car program – you get some money when you buy a new car and get rid of your old car. (In the US there was money put into those programs.)
Now the focus has switched to consolidation. My understanding is that this is a development in all countries. First the government was eager to do something to help companies, and now everyone has noticed that the deficit will be too high, especially in the European Union (EU) where there are very tight rules. Excessive deficit procedure was also initiated from the sight of the European Commission (EC), so we had to do something. And there were a few countries that said they think the crisis, or lets say recession, will still be here. So they still need to do the opposite, which means helping companies and decreasing taxes. One of these countries was Germany; they were saying, we don’t think that the crisis or recession is over, we don’t think that it’s time to increase taxes again, we still have some other packages for the next year. But most of the countries of development had the same stance as the Czech Republic. Now everybody is designing or has recently designed some consolidation packages, or tax increasing measures, basically.
The difference is that those decreasing measures were mainly targeted at some special groups and now the focus is on more general measures and consumption taxes such as VAT. (This is very broad. Everybody pays some part of an increased VAT.)
Whether it was too early or not – I’m not sure. This development has occurred in all countries, so I think if you compare us to Sweden, Belgium, and the Netherlands, they said something similar as we did. Same timing and similar thinking in governmental developments.
How can you account for the fact that projection for GDP growth is about 0 – 1 % growth, and that the recession is likely to continue? Do you think the Czech Republic is right in passing these austerity measures, or should we be leaning more in the direction of Germany?
It’s hard to say what will be more advisable. When we were discussing these measures in the first half of this year, I always advocated to not decrease some taxes on a permanent basis. We should only do those cash flow switches lets say, so to allow companies to pay later. I was already thinking that when tax revenues fall quickly because of the crisis, it’s not good to decrease taxes as we did because there will be harsh consequences for our deficit and we will have to do something later (which we now do). But there were other people, and especially in the government’s National Economic Council, who basically said, no, we propose these tax decreasing measures. So my understanding is that this was the correct way to try to decrease the deficit for next year. Whether the crisis will be here or not – of course the predictions for this at times are very inaccurate. In the fall and spring outlook publications of this year, every prediction was getting worse and worse. Now the predictions have stabilized, lets say half a year already it has been roughly the same. If it’s indeed true that next year we will have zero or around zero growth (which I don’t know I’m not myself engaged in these macro-forecasting exercises), then I think it’s not necessary to do any special measures to promote consumption. Even in the US now you can see that if you promote consumption of cars in one period, you basically steal the consumption from the future. Which means that once the governmental programs stop, no one will buy cars for half a year and the car industries will be in the same recession that they avoided before. So this is quite an easy critique of those programs.
So I think the governmental ideas or intentions to decrease the deficit are correct and right ones in place in today’s situation. The increases in taxes are not that big, 1% basically. No one will not recognize any change in prices. It will bring some money to the pockets of the government, so I think this is the correct way. Though as I said, I wouldn’t even introduce some of those measures before. I have maybe a different approach than was decided for the country.
With regards to your plans for 2010 and on, do you think that the tax revenues generated will be sufficient to reduce the deficit?
Probably not, we will have to think again of some new sources of extra money. Perhaps this means we have to increase some existing taxes or even introduce some new ones, but it’s always hard to do the latter.
As I said, the EC initiated the excessive deficit procedure, and we have to show them a trajectory towards basically zero deficit, or at least below 3% of GDP (which is the Maastricht criteria). Currently it’s about 6%. So we need to show some reliable path from this 6% over three years. There are still more plans to come. Our situation is also complicated by the fact that we don’t have an appointed political government right now because we have what’s called an expert government, so our Finance Minister climbed from the lowest rank up to deputy Minister just last year, and he is responsible for the budget now as minter. His main area of interest is the budget and low deficit. He doesn’t need to take care of what voters will say for a particular measure – he doesn’t want to be reelected and does not have any political alliances.
So we could propose some measures, but in June there will be elections, and so this government doesn’t have any power to actually change something or does not want to even engage in political discussions. Probably the ministry will only prepare some possibilities, proposing what the newly elected government can do this on the tax side and on the expenditure side. The next political government with a clear political majority in the Parliament will have to decide which path to take.
I think at least preparing some menu of possible changes is OK in the given situation.
What policies do you expect for the new government to be elected?
It depends if the right or left wing will be elected, so it’s hard to say. If the Social Democrats will win, then of course they will rely more on taxation; they will probably reintroduce progressive taxation on personal income tax. For two years already we have had a flat tax with just one rate like in other Eastern countries. They will maybe increase at least slightly the tax on corporations and businesses. If the right wing party wins, they will probably focus more on cutting expenditure, and if they increase taxes they will probably increase consumption taxes.
What obstacles do you face when trying to press forward tax measures within the Ministry and within Parliament?
In my experience with the implementation of the last consolidation package, or the ‘Janota package’ as it has been nicknamed, there was the idea that we should do something for next year. In the beginning of October, there should have been elections, but the constitutional courts objected to this. Janota and his Ministry thought they would be in office only until September or end of October and so they didn’t want to pass any measures for 2010. When they found out they would be in office for more than half of 2010, he understood that we must take some action and propose this package.
Our work within the Ministry was OK because we all decided on the measures. My colleagues and I proposed something on the tax side – an increase of all consumption taxes by some small amount, proposed this and that, etc. The proposal changed a bit once we engaged in political discussions. Janota is more inclined towards the right wing and listens to them more, so he removed from the package some points that those members of Parliament would have difficulties supporting, and so on. But of course the Social Democrats have their say as well. Then it was proposed in the government, I don’t know what discussions they had, but in the end the government approved it and in the Parliament there was not much opposition against it.
There were some lobbyists, from the tobacco industry, for example (it was one shining example). We introduced or proposed some measure to increase taxes on cigarettes, so of course they guarded their interests; any increased tax means lower profits for them. They lobbied extensively to both parties, so several members of Parliament started to say ‘I think these taxes are too much, I have some proposal’…they succeeded because the lobbyists were very effective. The increase in taxes was not as high as we had proposed, but it was not such a big deal. We will have to increase the tax because of EU regulations for 2014 anyway.
I don’t want to say that it was smooth, but there were no major obstacles in the way of negotiating and approving this package, at least from what I know. Of course I was only involved in the beginning when the measures were proposed and calculated and described. Farther steps I maybe watched in Parliament, but was mostly not involved.
Furthermore, I think in the media it was treated quite positively; even all of the journalists who are mainly young, liberal (libertarian) – right wing orientated with small state, low taxes view – were quite in favor of this package. When some members of Parliament wanted to change some aspects of the package, even they wrote something to support this package – I was quite surprised. Maybe it was because of the crisis for in the past 10 years it hadn’t been the case that if the Ministry were to increase taxes, it was always commented on negatively by the media. So even public opinion was quite favorable. They even showed some cases of a mother and father who are both unemployed and who were quoted saying, yes, we understand and see that this is correct, to increase VAT. […]
Overall, I think there were no major programs to get this approved, aside from these small lobby changes and discussions.
With regards to plans for the future, it’s hard to tell because of the elections; no one will say during the elections, I will increase taxes. Our Minister maybe will want to present something before the elections so they can comment on it. As it usually goes, the coalition government will always have some excuse once elected; in the elections we said this, but under this new view and circumstances, we need to treat it a little differently. Maybe during the election campaign they will say it’s impossible to increase taxes, but then even the right wing party, after the elections will increase taxes because they will see that the deficit will be really too high.
How will the Ministry and the government being able to combat the rising unemployment?
First thing, the Minister of Finance is not responsible for combating unemployment. This mainly pertains to the Ministry of Labor and Social Affairs. It’s true that we are thinking about what we can do in taxes. In taxes you can increase the willingness of people to become employed. There are some ways like income tax credit which they first introduced in the UK, which basically means you have some tax reductions for everybody, but it goes gradually down so that it doesn’t take that much money out of the tax revenues; it’s only targeted to low income people. We can again introduce some progressive taxation. We have today a 15% rate…. we could propose a lower rate for low income, higher for high income, which would increase net salary. So this measure is targeted at people who live from some unemployment subsidies, transfers from the government for whom these social subsidies are so high that they don’t want to become employed. This is what we could do in the tax system, but with the economic crisis in our world economy, it’s not the case that there is a lot of growth and some people just don’t want to work because they rely on social benefits. Today there are no free jobs so even if the people would like to work they cannot. It is hard to start their own business even though there are some subsidies for that, and so on.
So we could do something to improve the design of tax systems, but it probably will not help that much.
I think the main problem of the crisis (and what would help) is access to credit and money from companies. Banks are very cautious now, they have stopped borrowing, so companies are having trouble getting credit. When this improves, things may gradually improve on the unemployment side.
Will the tax measures you’ve proposed be effective in promoting business in the Czech Republic?
With regards to taxation and growth, there was one OECD study published one or two years ago called Tax and Growth, and they tried to identify those taxes, which are the least problematic and which are the greatest obstacles. (If you concentrate on the fact that taxes take money from the private sector, all taxes are obstacles, despite the fact that the public sector does finance something with these revenues.)
They identified that the least growth distorting taxes are real estate taxes paid by households (not by companies). […] Then there are consumption taxes, especially broad consumption taxes, like VAT which has the same rate for all goods and services. Then you have the personal income tax and corporate income tax. Corporate income tax has the greatest negative effect on growth. That’s why in the consolidation package we concentrated on increasing real estate taxes and consumption taxes. This will probably be the way for the future; we will probably have to introduce just one VAT rate for 2010. It’s also possible that we will introduce direct taxes on income and corporations and increase them. Most likely, or at least my advice will be, to increase those taxes only by a small amount, and concentrate more on increasing real estate and consumption taxes. This should be the strategy which, in times when you need to increase taxes (which always affects growth in some way) does so in the most growth enabling way. We are aware of this problem, but we will try to tackle it as best as possible.
Is there some way you can influence foreign investment through your policies?
Somewhere around 2000, we put into place some measures mainly designed to attract Foreign Direct Investment (FDIs). There were some investment incentives comprised of several spending programs and tax holidays for five years, under some circumstances for ten years. We were quite successful (but it was quite easy during times of growth); especially after the EU accession, we attracted a lot of foreign investment; also domestic companies benefited from that. (Germany took the most advantage of these subsidies, then French and American companies.) This resulted in quite a large growth, over 6% of real GDP growth. We have a lot of new (mainly) car factories. We became quite a big car producer when you calculate car production per capita. I think we were second place only to Slovakia (which has only 5 million, and we are 10 million, so two factories here means twice as much income per capita there) Now in times of crisis, it’s apparent that we are maybe over reliant on foreign investments, and especially in the manufacturing industry. I don’t know the last statistics, but probably we will have now quite a high share of industry, of manufacturing, in our GDP. In Western countries, perhaps Western Europe, they concentrate more on services; services represent maybe more than half of their GDP. So I would say, in my personal view that it’s already enough with attracting foreign direct investment, especially in the fields of manufacturing and so on. In ten years or more, when there will be economic growth and the work force will be more educated in Eastern countries like Russia, the Ukraine, or somewhere in Asia, they will still have lower salaries. It’s only natural that when our factories become obsolete in ten or twenty years, they will build a new factory not in our country but in another; our solution was only a temporary one. It worked well for ten years, but in the next ten years, who knows. For the coming years, we should focus mainly on services and innovation, things of that nature. Putting cars together from parts – it’s not a solution for the future. It was OK for the last ten years, maybe the next ten years it will still be OK, but not in the long run.
How can you attract higher value added investment such as research and development?
Frankly speaking I don’t know. In 2005 we introduced some tax credits for research and development (R&D). R&D is normally a cost for companies, so with this measure they deduct it. We have introduced some extra allowance in the amount of 100%, so basically deducted twice from our costs. We have some ground agency which promotes something. Whether this is sufficient or not, I don’t know. I’m not an expert in this field. Again at the OECD meeting there was some new innovation strategy, a new study they are preparing. Maybe we can draw some ideas from somewhere else. It also requires a change in thinking from members of Parliament, which I’m not sure they fully understand.
Do you feel that the Czech Republic has been effective in distinguishing itself among other CEE Economies?
It is difficult to say. Of course from my point of view we are different from Hungary; their public finance and economic development is quite different from our. But whether it’s possible someone else from the United States or perhaps over the ocean to distinguish among some small countries, I don’t think ordinary people could tell. Maybe some experts would know.
What is perhaps now more distinct – people can tell there are different developments in different parts – is say between European countries and some Baltic states. The Baltic States were given as the example as Eastern European Tigers. Now we see that their economic development was not built on such a strong base as in Central Europe. So maybe those two regions will now be differentiated. But the four most similar countries – Poland, Czech Republic, Slovakia, and Hungary – I don’t know. I think no, normal people would not be able to say what is different from one country to the next.
Could potential investors in R&D make this distinction?
Maybe they see bad developments now in Hungary. Whether this can really help distinguish among the countries, I’m not sure. I know, for example, speaking about R&D, that in Hungary they also introduced some measures, not in R&D but in some other field, maybe film production.
I don’t know whether our 100% tax allowances are really such a strong incentive. The main reason why we wanted to do it was to promote R&D development here. So for our national producer Skoda, for example, we wanted some R&D of new engines. We wanted the new engine lab to be situated in our country; I don’t know whether they succeeded. This particular tax credit was one way to attract them. They are currently moving car production to the Ukraine, and even to India and China. We would like for our country to have R&D, at least for example we will succeed in having Skoda’s research in our country for in the case of Skoda, there are some historical ties, and maybe Volkswagen understands that, but for other companies, I don’t know. We should try, because this is the only way for the future.
What are your thoughts on NERV’s recommendations to follow the example of Finland’s economy?
I was two weeks ago in Parliament for a meeting of some committee on business affairs and environment. There were two members of NERV presenting their final report called ‘From Helsinki with Love’, and they were explaining why they went to Finland, what they learned there; (I was also discussing this at the OECD meeting with a Finnish delegate, so it was quite interesting;) they tried to persuade members of Parliament that what we really need is a professional approach to economics – they said how it works in Finland, and they have some similar national economic council comprised of some government, trade union. In our country we have something similar to that, but also some experts. And they paid recently for some study by Michael Porter, a top economist employed in these affairs. They produce work of this sort and discuss it in a very official manner. These NERV representatives urged members of Parliament to become more professionals like in Finland. Whether this can really be the case, I’m afraid it’s not that easy. It takes maybe one generation before things will change in way that can be comparable to Finland. At least the ideas, and some directions that we should follow are present. Whoever is interested can read what should be done – what is one possible way for the country to improve. I hope things will gradually improve, but as I said, it requires some changes in thinking for top members of society.
What do you think are the most troublesome long-term problems the country can face?
In my professional view of public finance, it’s mainly the deficit because we are unable to cut the expenditures. I think the expenditures are too high – there is not enough control. All the ministries are always able to advocate why they need extra money for certain spending programs. We need some treasury, because we don’t have a treasury as such. This problem is also connected with corruption, because if you don’t have control over expenditures, you can easily put some money into someone’s pocket who actually shouldn’t get it. For example in Parliament the NERV members said that in Finland all of the spending programs have some evaluation of costs and benefits. They calculate some spending ratios, and when they have to cut something, they start with the lowest ratio – so only those with the most profitable spending potential are realized. Something like that should be implemented in our country. (By the way, when I said corruption, I did not mean bribing; in our country corruption is more present in the scope of friendships. Sometimes it helps, if you have some problems and are unable to solve them in a normal way, to use these corruption friendships. There’s not actually that much bribing, but because in the past we were always ruled by some ‘evil state’ and would try to find ways around the rules imposed, this tradition continues. The people – when they find conditions to be unfavorable to them, they try to find a way out – friends, or friends of friends who could change the rules a little bit, etc.) So this is all interconnected – the poor control over spending programs, which means lower than best possible functioning of public services, and thus soft corruption. I think this is one of the greatest problems in our country, and especially because it is quite widespread and people view it as an OK practice.
