VZCZCXRO5244
RR RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHPG #0698/01 1651321
ZNR UUUUU ZZH
R 141321Z JUN 07
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC 9220
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 PRAGUE 000698 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EUR/NCE, EUR/ERA, EB/IFD/OMA, E STAFF 
TREASURY FOR OASIA ANNE ALIKONIS 
STATE PLEASE PASS USTR WENDY MOORE 
COMMERCE FOR ITA/MCA/EUR MIKE ROGERS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV PGOV EZ
SUBJECT: CZECH REPUBLIC: ECONOMIC REFORM PACKAGE PASSES 
FIRST READING BUT FACES UPHILL BATTLE IN PARLIAMENT 
 
REF: PRAGUE 359 
 
¶1. (SBU) SUMMARY AND COMMENT:  The Topolanek government's 
economic reform package passed its first reading June 8 and 
now faces the most difficult phase of debate and amendments 
before it goes to the second reading in August.  The economic 
reform bill is the flagship of the Civic Democrat (ODS) 
coalition government and contains much of what the party has 
preached during its eight years in opposition.  The reform 
package is a source of great controversy even within the 
coalition, as evidenced by high turnout for the first 
reading.  While individual components of the bill (e.g. flat 
tax, healthcare co-payments) are causing some rift, it is the 
politics of compromise rather than the economic merits of the 
bill that poses the greatest challenge to the bill winning 
final Parliamentary approval. This will be a test of 
Topolanek's leadership and management skills as he does some 
soul-searching about the trade-off between meaningful 
economic reforms that risk failure in Parliament vs. a 
"better than nothing but not by much" reform bill that will 
survive Parliamentary approval.  The outcome of this bill has 
the potential to bring down this government since Topolanek 
has linked it to a Parliamentary vote of confidence on his 
government.  Debate and compromise in the run-up to the 
second reading in August will reveal more about the likely 
fate of the Topolanek coalition.  END SUMMARY AND COMMENT. 
 
--------------------------------------------- ----- 
PUBLIC FINANCE REFORM VIA TAX CUTS, SOCIAL WELFARE 
RESTRUCTURING, HEALTHCARE REFORM 
--------------------------------------------- ----- 
 
¶2. (U) The Topolanek government's controversial economic 
reform bill -- flat and lower income & corporate tax (with 
numerous exemptions), higher rate for the lower VAT bracket, 
cap on social security tax, increase in the retirement age, 
reduction in some social welfare benefits, restructuring sick 
pay, introduction of healthcare co-payment (reftel para 7) -- 
passed the first of three readings in the lower house of 
Parliament June 8.  The first reading is a simple yea/nay 
vote to consider the bill, and it is during the period before 
the second reading that most of the haggling over the content 
of the reform package will take place.  The second reading is 
not expected before August 7, after Parliament returns from 
its summer recess.  ODS' focus is the "misused social state" 
based on the principal that it should be more advantageous to 
work than to be on social welfare.  The current system, 
according to ODS, disincentivizes some income groups from 
seeking employment. The opposition Social Democrats are 
strongly opposed to the flat tax, preferring instead a 
progressive tax system.  They also oppose payments for 
prescription and medical consultations. 
 
¶3. (U) Economists generally agree that something must be done 
about public finances and concur that this reform package is 
better than nothing, even though these can hardly be 
described as "radical" reforms.  Instead of using increased 
revenues from changes to the VAT rate (currently "basic 
goods" are charged 5% and "luxury goods" are charged 19% but 
the new system will raise the lower rate to 9%) to finance 
the deficit, the Topolanek government will use it to offset 
the lower income and corporate tax rates.  So while the 
proposed changes to the tax regime sound the most radical on 
paper, in terms of budgetary impact, the changes are 
budget-neutral at best.  The majority of the impact on public 
finances will come from changes to the social welfare 
benefits (sick leave pay, maternity pay, child benefits pay). 
 Economists agree that the primary problem with the budget 
deficit is on the expendituers side (i.e., social welfare) 
than on the revenue side (i.e., tax policy). 
 
¶4. (U) The specific contents of the reform package are 
significant on their own merits but even more so when 
considered in their entirety as a drain on public finances 
that derailed Czech aspirations to join the eurozone in 2009. 
 Despite the robust GDP growth of over 6% for the past two 
years, the Czech general government budget deficit ballooned 
from 2% in 2005 to 2.9% (estimated) in 2006.  The budget 
deficit forecast is estimated at 3.9% in 2007 and 3.6% in 
¶2008.  The main culprits are the tax cuts and the significant 
increase in mandatory social spending in the run-up to the 
June 2006 general elections.  The new public finance reform 
package seeks to reinstate fiscal discipline and push the 
 
PRAGUE 00000698  002 OF 003 
 
 
deficit down to 2.6% by 2009, as reflected in the latest 
update to the Czech-EU convergence program completed in 
March.  On June 13, the European Commission publicly 
criticized the Czech Republic for failing to do enough to 
rein in its public deficit.  This was widely reported in the 
local press, but it is not clear whether the Topolanek 
government will try to use this to garner support for the 
reform package. 
 
------------------------------------------- 
POLITICS OF THE REFORM BILL: LACK OF BUY-IN 
------------------------------------------- 
 
¶5. (SBU) The June 8 vote was very well attended, with 198 of 
the 200 Members of Parliament (MPs) present, a clear 
indication of the importance of the issue.  Of the two MPs 
who were absent, one was from the ruling coalition and the 
other from opposition, thereby balancing each other out in an 
evenly-split Parliament.  98 MPs supported and 97 MPs opposed 
the reform package. Three MPs abstained: former Finance 
Minister under the first un-confirmed Topolanek government 
Vlastimil Tlusty (ODS), ODS Parliamentary whip Peter Tluchor, 
and KSCM's Ludvik Hovorka.  Had only two of those three 
opposed, the reform package would have failed.  Tlusty, 
Hovorka, and several other coalition MPs had indicated a 
willingness to allow the measure past the first reading in 
order to open up debate on amendments which will precede the 
second reading. 
 
¶6. (SBU) This reform package is not just about economic 
reforms and euro compliance.  It is the traditionally 
business-friendly Civic Democrats' opportunity to implement 
changes they talked about for eight years in opposition. As a 
result, when he publicly introduced the bill on April 3, PM 
Topolanek had said he would link the bill to a Parliamentary 
vote of confidence on his coalition government. However, he 
has since backed off from that stance and instead considered 
"fast tracking" the bill through parliamentary votes to limit 
debate.  However, after about 10 coalition MPs said they 
would not support the package unless they were given the 
chance to discuss amendments, Topolanek dropped the idea. 
Topolanek will be under significant pressure to compromise on 
several of the frequently stated ODS goals if he wants to 
assure passage of the measure. 
 
¶7. (SBU) One of the most vocal opponents of the reform 
package from within the coalition is former Finance Minister 
Vlastimil Tlusty.  He prefers a flat income and corporate tax 
of 12% (vice the proposed 23% for income tax and 19% for 
corporate tax), simplication of the tax system (fewer 
exemptions), and VAT rates of 17% and 9% (vice the proposed 
19% and 9% VAT suggested by the government).  Having said 
that, our interlocutors believe his opposition to the 
government plans are more politically motivated than due to 
ideological differences on the merits of the reform package. 
Even though he proclaims that the current reform would 
unevenly burden the middle class, he is more peeved that 
Topolanek gave up the Finance Ministry, which Tlusty headed 
under the first Topolanek government that failed to win 
Parliamentary vote of confidence, to the Christian Democrats. 
 Tlusty wants to win back his lost prestige; that is his 
motivation. 
 
---------------------------------- 
PROSPECTS FOR SUCCESS: RATHER SLIM 
---------------------------------- 
 
¶8. (SBU)  If the reform package were to fail in the second or 
third reading, it could lead to the end of the Topolanek 
government.  There has not been a formal decision to de-link 
the reform bill from a vote of no confidence; Topolanek has 
simply stopped talking about it and changed his rhetoric to 
better reflect the political reality -- a lack of buy-in -- 
even within his own coalition.  The coalition government's 
written manifesto still says it will relinquish power if it 
can not pass its reform package.  With the second reading 
expected to begin after Parliament returns from its summer 
recess August 7, and given that the third reading must take 
place within 48 hours after the second reading, theoretically 
the bill can pass within the same plenary session in August. 
The most interesting and significant debate will happen 
between now and when Parliament reconvenes in August.  Post 
believes the chances for this reform bill winning 
 
PRAGUE 00000698  003 OF 003 
 
 
Parliamentary approval in its current form are 51%.  However, 
numerous proposed amendments are anticipated before the 
second reading and given the unpredictable lusty factor, it 
is unclear whether and what kind of a reform package will 
ultimately win Parliamentary approval. 
GRABER