Fiscal systems in transition: The case of the Czech income tax

Abstract

TAX REFORM has been a major priority of microeconomic policy during the process of economic transition in Central and Eastern Europe. In the Czech Republic, a fundamental restructuring of the tax system took place from the start of 1993, introducing a tax system broadly in conformity with taxation practice in Western Europe. The new system includes personal and corporate income taxes, a value added tax of the type operated by EU member states, and excise duties on a limited number of commodities, including motor fuels, alcohol and tobacco.' This article considers the reasons for tax reform and the consequences of the particular measures adopted, focusing on the case of one component of the Czech reform, the personal income tax. Compared with personal income taxes in Western Europe, this now raises relatively little revenue; indeed, the new income tax actually raises a smaller proportion of fiscal revenue than the old system of income taxes which it replaced. The article attempts to evaluate the reasons for changing from the earlier system, and to show the role played by the new income tax within the overall Czech fiscal system2 We concentrate on an analysis of the old and new personal income taxes because this raises interesting questions about the relative incentive, distributional and revenue-raising properties of the two systems. While we have something to say about indirect taxation, the sheer complexity of the old turnover tax system makes a similar comparative analysis, based on formal modelling and microsimulation, uneconomic, if not unfeasible. For example, in 1989 there were 1506 turnover tax rates, varying from -291% to + 88%: a system one Czech economist described as 'chaotic'.3 The article is in four main parts. The first discusses the priority which has been given to tax reform in the process of economic transition, and the objectives and constraints which have dictated the pattern of tax reforms which have been undertaken. We then provide a quantitative assessment, based on household microdata from the Czechoslovak household budget survey, of the structure of income taxation and the impact of income tax reform in the Czech case. First we describe the pattern of household income tax payments under the highly differentiated pre-1993 CSFR tax system, and show that much of the complexity of the pre-1993 system, including the different allowances and marginal rates of tax for different groups of taxpayersaccording to age, marital status, gender, disability and dependants-achieved little