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OO RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHPG #0973/01 2361421
ZNR UUUUU ZZH
O 241421Z AUG 07
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC IMMEDIATE 9524
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY

UNCLAS SECTION 01 OF 02 PRAGUE 000973 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: PGOV PREL EZ ECON EFIN
SUBJECT:  CZECH GOVERNMENT WINS FIRST LEGISLATIVE TEST IN PASSING 
REFORM PACKAGE 
 
Ref: A. Prague 939 
      ¶B. Prague 698 
      ¶C. Prague 359 
 
¶1. (SBU) Summary: On August 21, the Czech lower chamber approved the 
government's public finance reforms, securing the first serious 
legislative victory for the Topolanek government.  Despite 
protracted behind-the-scenes lobbying among coalition partners, one 
coalition MP defected and voted against the controversial bill. 
Starting next year, the legislation will gradually reduce corporate 
and personal income taxes, cut social spending and introduce fees 
for health care.  The bill still requires Senate approval and 
President Vaclav Klaus's signature, but no resistance is expected 
from either.  However, debate over economic reform will continue 
with the 2008 budget bill and additional reform legislation next 
year.  End Summary. 
 
¶2. (U) Of the 200 deputies, 101 backed the reform package (99 of the 
100 coalition MPs and former Social Democrats Milos Melcak and 
Michal Pohanka, now unaffiliated). Ludvik Hovorka (Christian 
Democrat) was the only coalition deputy to vote against the 
proposal; Hovorka, who is one of the most left-leaning of the 
Christian Democrats, found the reforms too harsh. All 98 opposition 
Social Democrat (CSSD) and Communist deputies voted against. The 
opposition refused to back the proposal, saying the reforms would 
not curb the deficit as the government claims, and they would harm 
most people economically. CSSD leader Jiri Paroubek said his party 
would revise the economic reforms once it returns to power. 
 
¶3. (SBU) The tight vote in the lower chamber was preceded by two 
weeks of exhausting coalition negotiations. Although the draft 
reform bill passed in the first reading with the votes of all 
coalition MPs, several of them threatened later that they would not 
support the bill in the final reading unless their changes were 
incorporated during the second reading.  The most vociferous voices 
were Hovorka and former Finance Minister Vlastimil Tlusty (ODS). 
Unlike Hovorka and the opposition, Tlusty and a few other ODS MPs 
criticized the government reform bill for not going far enough in 
reducing tax rates.  Tlusty and the other ODS MPs voted for the 
reform after they won agreement to lower tax rates below the 
original government proposal. But after the bill passed its second 
reading in mid-August, Tlusty and his supporters discovered further 
concerns in terms of tax deductions they did not like; they secured 
a promise from PM Topolanek that the government would propose 
revisions to remedy these next year. On the other hand, Hovorka did 
not accept any compromise solutions offered to him by coalition 
negotiators and eventually voted against the reform bill.  While the 
tensions with Tlusty and Hovorka did not prevent passage of the bill 
that Topolanek had at one point said he would stake the fate of the 
government on, the difficulty in winning passage, and particularly 
the failure to bring Hovorka on board, suggests the government could 
face further problems in parliament.  On the other hand, the two 
CSSD "renegades" proved their reliability on this vote. 
 
----------------------- 
REFORM PACKAGE CONTENTS 
----------------------- 
 
¶4. (U) Despite the fact that the fiscal problems preventing early 
Czech Republic Euro adoption (target date postponed from 2009 until 
2012) are based on the expenditures side (general social benefits), 
most of the public debate over the reform bill has been focused on 
the income side (tax cuts, which have long been an ODS priority). 
Personal income tax rates will be cut to a flat rate of 15% for all 
income levels in 2008 and to 12.5% in 2009, corporate tax will be 
cut to 21% in 2008 and to 19% in 2009 from the current 24%, and the 
lower of the two VAT brackets for "basic goods" will be increased 
from 5% to 9% while the second VAT rate for "luxury goods" will 
remain at 19%. 
 
¶5. (U) There is strong consensus among economists that something 
must be done about public finances and that while this reform 
package is better than nothing, it can hardly be considered 
"radical" reforms.  Instead of using increased revenues from changes 
to the VAT rate to finance the deficit, the government will use it 
to offset the income and corporate tax cuts.  Private sector 
economists predict the reform package will yield a general 
government deficit of 4.5%/GDP. (Note: Maastrich convergence 
criteria = 3%/GDP. End Note)  While economists lament the continued 
lack of fiscal discipline, the business sector is thrilled by the 
corporate tax cuts that will put the Czech Republic on par with 
neighboring Slovakia's corporate tax regime. 
 
¶6. (U) On the expenditures side, effective 2008, there will be a cap 
on social taxes at USD 4,000/month, the retirement age will increase 
to 65, birth allowances will be reduced, maternity allowances will 
decrease after two years, the parental allowance will be limited to 
lower income brackets, benefits for parents with children entering 
the first grade will be abolished, and for the first time, people 
will pay a nominal fee for doctor's visits.  Effective 2009, the 
first three days of sick leave will not be paid at all and sickness 
 
PRAGUE 00000973  002 OF 002 
 
 
benefits will increase after the 30th day to help individuals with 
long-term care issues.  This is to address the fact that he Czech 
Republic currently has one of the highest number of sick leave days 
taken among EU countries. 
 
¶7. (SBU) Comment: Debate over public finance reform will continue as 
the 2008 budget is expected to be presented to Parliament in 
September, and looming down the road are a pension reform bill by 
the end of 2007 and a health care reform bill in 2008.  In addition, 
to appease ODS Deputy Chair Vlastimil Tlusty, who has been a 
relentless thorn at PM Topolanek's side, the government agreed to 
amend the reform package within six months.  However, current 
Christian Democrat Finance Minister Kalousek, even after voting in 
favor of the reform package that cuts personal income tax to a flat 
rate of 12.5% in 2009, has said publicly that he does not believe 
the income tax rate should be lower than 15% due to budgetary 
implications.  Given this kind of internal battles within the ruling 
coalition, we can expect further drama in Parliament in the near 
future. 
GRABER