A key task of the Czech Fiscal Council (CFC) under Act No. 23/2017 Coll., on the Rules of Budgetary Responsibility, as amended (the “Act”) 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.
The Act last year underwent two amendments that led to a substantial relaxation of the rules of budgetary responsibility. The first raised the cap on the structural deficit from 1% to 4% of GDP, with public finances to be consolidated at a rate of 0.5 pp a year in subsequent years.
The second amendment to the Act, passed in December 2020, set no limit on the structural deficit rule as a basis for determining budget expenditure and left the year-on-year rate of growth of consolidation unchanged. The second amendment therefore leads to a 1% structural deficit not being reached again until 2031. This is substantially worse than in the first amendment, as the latter envisaged a return to this key rule of the Act four years earlier.
The changes to the Act fundamentally worsened the starting position of the long-term public finance projection. Public debt rose by almost 8 pp to 38.1% of GDP in 2020 and thus topped 38% of GDP for the first time since 2014. The structural deficit increased to 2.7% of GDP in 2020 and will probably climb to 6.5% this year on the back of the new measures.
The coronavirus pandemic has put public finances objectively under huge pressure, yet fiscal policy during the crisis has also contained measures not linked to the pandemic. Public finances are thus being affected by a combination of temporary economic measures targeted against the impacts of the COVID-19 pandemic and measures worsening the sector’s structural position, in particular a significant reduction in personal income taxation, the abolition of real estate acquisition tax and an increase in pensions in excess of the statutory indexation scheme.
The COVID-19 pandemic will recede, but the long-term challenges for public finances will remain relevant. Given that there is no recovery and consolidation strategy for the post-pandemic period, however, public finances will carry a legacy of rising debt for a long time to come.
The basis for assessing public finance sustainability is the long-run future path of general government debt, which has been worsening significantly from year to year ever since the CFC was established in 2018. If current fiscal policy is maintained, the debt brake will be breached as early as 2024, i.e. 19 years earlier than we expected in last year’s Report, while the projected general government debt at the end of the 50-year projection horizon will rise above 300% of GDP. The overall impact on public finance sustainability over the COVID-19 pandemic period is thus much worse than we expected in the previous Report.
As in past Reports, however, population ageing is still the main common denominator of future public finance problems. Pension reform-related activities ground almost to a halt during the pandemic, so the Ministry of Labour and Social Affairs did not submitted a pension system reform bill to the government until May this year. However, as we describe in more detail in the text of the Report, the implementation of the proposed pension reform in this form would further exacerbate the problem of long-term public finance sustainability.
Alternative scenarios, moreover, indicate that neither the incorporation of extremely positive impacts of digitalisation and robotisation, nor more favourable demographic trends, will solve the problem of long-term Czech public finance unsustainability either. The linking of the retirement age to life expectancy under the current legislation would considerably improve the long-term sustainability of Czech public finances but would not solve the problem completely.
This Report shows clearly that just one year of relaxed fiscal policy could negatively affect public finance sustainability in the medium and long term. The sharp increase in projected debt in the period covered suggests that the Czech public finance system is in a state of long-term imbalance. A recovery plan and sustainable pension reform will be needed to correct this imbalance, but time is getting very short to prepare and implement them.
As the CFC has repeatedly pointed out, the later changes are made to the public finance system, the more painful and costly they will be. With regard to both current and future generations, it is therefore essential for measures of sufficient quality to be taken as soon as possible