Monthly Labor Review November 1998 59

Book Reviews

Household incomes Household incomes

in the Czech and

Slovak mark Slovak market

economies economies

International Report

Thesia I. Garner

and Katherine Terrell

Under the Soviet-based system,countries in Central and Eastern

Europe were among those with the most

equal distributions of income in the

world. A greater income inequality was

therefore an expected outcome of a transition to a market economy. After 5-7

years of observations on the transition,

two models of the process have emerged

within the former Soviet bloc: one in

Russia and other newly independent

states, and another in the Central and

East European countries. Russia and the

newly independent states have suffered

profound and continuous declines in

gross domestic product as the centrally

planned system disintegrated, government tax revenues plummeted, and weak

social safety nets were instituted. In contrast, the Central and East European

economies experienced only a brief period of economic decline, followed by

growth within a newly introduced market system. Moreover, some governments, including the Czech and Slovak

Republics, established relatively strong

social safety nets.1

Data from the Family Budget Surveys2

 of the Czech and Slovak Republics show that inequality, based on adult

equivalent household income,3 did not

change appreciably in the Slovak Republic from 1989, when the two republics operated as one country (before the

“Velvet Revolution”) to 1993, the first

In 1991, a single minimum wage was

established for the two republics. In October 1993, the Slovak government

raised its minimum wage to 47 percent

of the average economywide net wage,

a level higher than that in the Czech Republic. (See table 1.) The minimum

wage increase in the Slovak Republic

may have mitigated the increase of wage

inequality brought about by market

forces there, relative to the Czech Republic where the minimum wage was not

increased.

Social insurance

Social insurance is primarily composed

of unemployment compensation and

pensions. Both factors were likely to

have mitigated the widening of income

distribution in the two republics. Unemployment compensation did not exist in

1989 when there officially was no unemployment,6

 but it played a role in

1993 by replacing part of lost income

for 6 months. The eligibility criteria, entitlement, and replacement rates were

the same for the two countries in 1993.

However, the level of benefits rose for

some unemployed persons in the Slovak

Republic when the minimum wage was

raised. In addition, in both countries,

unemployment benefits were not taxed.

However, because the benefits were also

not indexed for inflation, their value

eroded over a spell of unemployment.

Unemployment compensation is likely

to have played a bigger role in income

inequality in the Slovak Republic than

in the Czech Republic.

Unlike unemployment compensation,

government-designed pensions did exist in 1989. In both 1989 and 1993, men

could retire with full pensions at age 60.

For women, the retirement age was between 53 and 57, depending on the number of children they raised. In 1989, individuals could draw a pension and work

for pay simultaneously and could easily

retire early with a full pension. These

options were no longer available for

Czechs beginning in 1993, when a comThesia I. Garner is an economist in the Office of

Prices and Living Conditions, Bureau of Labor

Statistics. Katherine Terrell is associate professor of international business and business economics, University of Michigan Business School

and the William Davison Institute, Ann Arbor,

Michigan.

year the country separated into two Republics (the year of the “Velvet Divorce”), 4 years into the transition to a

market economy. Also, income inequality in the Czech Republic did not rise to

any great extent after the transition. Income inequality in the Czech and Slovak Republics continues to be among

the lowest in the world. These countries

have created market economies with

relatively little increase in income inequality, primarily due to institutional

changes in the countries. Jiri Vecernik,

using 1988 and 1992 Microcensus survey data, reports a similar trend in income inequality for the two republics.4

This report briefly reviews the income policies which may have influenced the distribution of income in the

Czech and Slovak Republics during the

early years of the transition, and presents some results from a recent study.

The focus here is on wage policies, social insurance, the social assistance system, and income taxes. Other factors

likely to have affected income distributions include changes in macroeconomic conditions (briefly discussed

here), and asset redistribution (not considered here, but discussed in the full

article).5

Wage policies age policies

In both republics, wage controls were

first put into effect in 1991, and then

were used intermittently in the ensuing

years, with several changes in design.

In 1993, the coverage and scope

changed: wage controls limited an

enterprise’s wage bill growth to equal

that of the product of the firm’s total

number of employees at the beginning

of the year and the economywide average wage. The effects of wage controls

were not clear because fines were not

imposed until the enterprise exceeded

the wage bill growth norm by 5 percent.

Because policy changed often and enforcement was weak, it is unlikely that

wage controls had a significant effect on

wage growth or wage dispersion.
60 Monthly Labor Review November 1998

Table 1. Average monthly net wage and social transfers in the Slovak and Czech

Republics, 1993

Gross wage

(economywide)1 ................... 5,264 — 5,264 — 5,459 —

Net wage

(economywide)2 ................... 4,669 100.0 4,669 100.0 4,788 100.0

Social transfers

Minimum wage ...................... 2,200 47.1 2,450 52.5 2,200 46.0

Unemployment benefits:

Average3 ............................ 1,360 29.1 1,360 29.1 1,585 33.1

Maximum4 .......................... 3,300 70.7 3,675 78.7 3,300 68.9

Minimum living

standards for:

One-member household .... 1,700 36.4 1,980 42.4 1,960 40.9

Two-member household5 ... 2,900 62.1 3,510 75.2 3,500 73.1

Four-member household6 .. 5,100 109.2 6,180 132.4 6,170 128.9

Average monthly pension:7

Old-age .............................. 2,367 50.7 2,367 50.7 2,799 58.5

Disability ............................ 2,247 48.1 2,247 48.1 2,639 55.1

Widow ................................ 1,255 26.9 1,255 26.9 1,192 24.9

1Excludes small firms with fewer than 25 employees.

2Based on calculations (using data from the 1993 Family Budget Survey) of the ratio of average household after-tax income to before-tax income (0.886 in the Slovak Republic and 0.877 in the Czech Republic). 3 Calculated as: (total amount of benefits paid out in the year/12) /(average number of persons unemployed and receiving benefits in a month). 4 Maximum for the unemployed who were not taking a retraining course.

5 Household consisting of two adults.

6 Household consisting of two adults and two children aged 6 to 9 years and 10 to 15 years.

7

Average monthly level of pensions for the year.

prehensive law on pensions was passed.

The law introduced a “work or retire”

system and limited early retirement to a

maximum of 3 years before the legal retirement age. The Slovak Republic did

not have such a law in 1993. Because

pensions were indexed for inflation in

both republics, the average pension

maintained its value over the 1989–93

period. Disability pensions were somewhat lower than old-age pensions in each

republic, and widows’ pensions were

only about one-quarter of the average net

wage. The changes in the pension system were likely to be countervailing: indexation would likely reduce inequality,

but an increase in the number of persons

becoming pensioners would likely increase inequality.

Social assistance system

Unlike unemployment compensation, a

social assistance system did exist in

1989. Several legal changes were made

in the system during the 1991–93 period,

resulting in a complex web of legal

norms and a variety of benefits. One important thrust of the changes was an increase in the number of means-tested

benefits in 1993. Generally, transfers in

1993 were considered means-tested social assistance and nonmeans-tested social aid available primarily to families

with children (family benefits).

In 1991, the right was established for

everyone to receive “assistance essential

for ensuring the basic living conditions.”

Minimum living standards were set for

various types of households and served

as a basis for means testing. The minimum living standard for each household

was the sum of a personal minimum

(based on whether one was an adult or a

child) and a household minimum (a function of the number of individuals living

in a household). Households could receive a cash benefit equal to the difference in their income and the minimum

living standards. Prior to October 1993,

the two republics had the same minimum

living standards; afterward, the standard

in the Slovak Republic rose, a result of

the increase in the minimum wage.

The levels of social safety nets can

be assessed by comparing the average

levels of social assistance, pension, and

unemployment benefits with the minimum wage and the average economywide net wage in 1993.7

 (See table 1.)

Until October of 1993, the relative levels of the safety net were marginally

lower in the Slovak Republic than in the

Czech Republic. In the first half of 1993,

the average person living alone could receive 36 percent of the average net wage

as social assistance in the Slovak Republic, versus 41 percent in the Czech Republic. Unemployment benefits were 29

percent of the average net wage in the

Slovak Republic and 33 in the Czech

Republic.8 The level of social assistance

for large families was higher: an average family of four in the Slovak Republic could receive benefits equal to 109-

132 percent of the average net wage; a

comparable family in the Czech Republic could receive 129 percent of the average net wage. For low-wage workers

in either country, this could be a substantial benefit.

Before 1994, households with children in the Slovak Republic could receive a package of family benefits, regardless of their level of income; a similar package was available before 1996

in the Czech Republic. Social support

benefits were not taxable, but there was

implicit taxation in that these benefits

were included as part of total income of

Slovak Republic Czech Republic

January to September October to December January to December

Characteristic

Monthly

average

(Slovak

crowns)

Percent of

net wage

Monthly

average

(Slovak

crowns)

Percent of

net wage

Monthly

average

(Czech

crowns)

Percent of

net wage

International Report
Monthly Labor Review November 1998 61

a household when applying for social

assistance. The most important of these

benefits are described below.

• Child allowances were provided from

birth to the end of the child’s education.

In 1995, the amount of the benefit was a

function of the age of the child, ranging

from 6 percent (for a child younger than

age 6 ) to 9 percent of the 1993 average

gross wage (for a child older than age

15).

• Parental allowances provided payments to a parent personally caring fulltime for a child up to age 3 (or up to age

7, if the child was handicapped). This

benefit was only provided to a nonworking parent, except in cases when

the net income earned by the parent was

less than or equal to the personal minimum living standard. In 1994, the maximum benefit was approximately 26 percent of the average economywide wage.

• Maternity leave benefits provided

women 28 weeks of paid leave from

work. This benefit was a function of the

woman’s previous wage, with a maximum level. The replacement ratio was

reduced from 90 percent in 1991 to 69

percent in 1994, but the maximum level

rose from 1.03 to 1.8 times the minimum

wage.

• Maternity and Pregnancy Compensation Benefits were provided to women

who had to move to a lower paying job

due to pregnancy or child-care problems.

Taxes

Changes in the tax system were introduced throughout the 1989–93 period.

However, in 1993, a new comprehensive

tax law introduced two important

changes in income taxes for both countries. (Policies concerning taxes which

apply to goods and services also

changed during this period, but are not

discussed in this report.) The new tax

system included:

• A more progressive income tax, with

rates beginning at 15 percent (for yearly

taxable incomes up to 60,000 crowns in

both republics), rising to a maximum of

47 percent. Taxable income included

wages and salaries, self-employment income, rental income, interest income,

and dividends. A taxpayer allowance of

20,400 crowns per year could be deducted and there were exemptions for a

spouse and children. Social insurance

contributions also became deductible.

• A new payroll-based social insurance

tax paid partly by employees and partly

by employers. The employee-plus-employer combined rates were 27.2 for

pensions, 4.8 for sickness benefits, and

4.0 for unemployment insurance.

The new system explicitly separated

the tax for social benefits from the new

income tax (in 1989, the tax for social

benefits had been part of the wage tax).

In their 1995 study, “Tax and Benefit

Reform in the Czech and Slovak Republics,” C. Heady and S. Smith conclude,

“The new income tax plus the payroll

taxes paid by employees is more progressive than the old wage tax but [the

new income tax] provides smaller child

tax allowances. The increased progressivity is a rational response to an

expected increase in the degree of pretax income inequality, and the reduction

in child tax allowances represents a reduction in a level of state support for

children that had been very generous by

western standards.”9

Income inequality

How did income inequality in 1989,

when the two republics were one country and operated primarily as a command economy, compare to inequality

in 1993, when the two republics were

separated and had functioned for 4 years

under more market-oriented forces? In

answering this question, it is helpful to

review the macroeconomic condition in

relation to income policies. In 1993,

market forces may have contributed to

the divergence of inequality in the two

countries by creating more unemployment in the Slovak Republic and more

private sector employment in the Czech

Republic. The two governments’ wage

policies may have had an equalizing effect by not allowing wages to rise more

rapidly, and by creating a minimum

wage floor. The increase in the minimum

wage in the Slovak Republic in 1993

could have improved incomes there

relative to incomes in the Czech Republic. The higher minimum wage also implied a higher social safety net in the

Slovak Republic, as it raised the minimum living standard and social assistance associated with it. Changes in social insurance are likely to have dampened the rate of growth of inequality in

the two countries by protecting the income of pensioners and the unemployed, especially in the Slovak Republic where the incidence of unemployment was higher. Finally, revisions to the

tax law may have contributed more to

lowering after-tax income inequality in

1993, compared with the income inequality in 1989.

The Gini coefficient was used to measure after-tax income inequality in the

two republics. As noted earlier, adultequivalent household income with person-weighting was used for the analysis. The Family Budget Survey income

data are used to show that inequality

rose in the two countries by small

amounts over the 1989–93 period. In accounting for the small overall increases

in inequality over time, decomposition

analysis was used to identify two

countervailing effects which were likely

to have primarily contributed to this result. In particular, the creation of labor

markets and self-employment contributed considerably to increases in the

Gini coefficients over time. However,

government policies, specifically the tax

and transfer systems, reduced the income inequality generated by the introduction of the market system.

It is interesting to note that although

the overall change in inequality was

nearly identical in the two republics, the

magnitude of principal offsetting forces

was greater in the Czech Republic.

These principal forces affected prima-
62 Monthly Labor Review November 1998

rily taxes and transfers, and earnings.

The relative impact of taxes and transfers differed in the two republics. By

1993, in the Czech Republic, changes

in the transfer component contributed

more to the reduction in the growth of

inequality than changes in the tax component. The reverse was true in the Slovak Republic, where changes in the tax

component were more important. The

protection of pensioners’ incomes was

particularly effective, especially in the

Czech Republic. However, the introduction of a “minimum living standard” also

seems to have mitigated any increase in

inequality by augmenting the incomes of

the poor. Earnings, in contrast to taxes

and transfers, contributed to increases in

inequality. Earnings contributed the

most to increasing after-tax income inequality in the Czech Republic, relative

to the Slovak Republic, over the 1989–

93 period. 

Footnotes Footnotes

1

 This report is based on highlights from Thesia

I. Garner and Katherine Terrell, “A Gini Decomposition Analysis of Inequality in the Czech and

Slovak Republics During the Transition,” Economics of Transition, Vol. 6(1), pp. 23–46. 2 The 1989 and 1993 Family Budget Survey

data were collected monthly using diaries. The

Family Budget Survey sample design did not account for all households in the countries. A quota

design was used with the following social groups

sampled, as defined by the work status of the head

of the household: workers, employees, the selfemployed (in 1993, but not 1989), persons working in agriculture, and pensioner-headed households in which there are no economically active

members. A household in which the head was

employed at the time of sample selection, but then

became unemployed for more than 6 months in a

calendar year, resulted in the household being

dropped from the sample. Not included at the time

of the initial sample selection (as defined in June

or so of the preceding year) were the following:

households in which the head was a pensioner

but in which there were other economically active members, and households headed by unemployed persons. The latter group also included

households headed by students and other nonworking persons not receiving a pension or wage.

In addition to social group, other selection criteria include the net income per capita for household members, the number of dependent children

in economically active households, and the number of members in the pensioner households.

Using weights based on data from the 1988

Microcensus and 1989 Family Budget Survey,

households in the Family Budget Survey represented about 95 percent of all households in the

Czech Republic and 94 percent in the Slovak

Republic in 1989 weights (the weights were created by T. I. Garner and M. Fratantoni, in “Creating Weights for the Czech and Slovak Family

Budget Surveys Using Microcensus Data,” unpublished data, Washington, D.C., Bureau of Labor Statistics, 1997). Using the 1992 Microcensus

data, about 95 percent of Czech households were

represented by the 1993 Family Budget Survey

sample, compared with only 87 percent of Slovak households. Weights were created using region, social group, and household size. If there

were shifts in the population from 1992 to 1993

as defined by these variables, the inequality results could differ. However, based on results from

other studies, inequality was increasing in the

Czech Republic more than in Slovakia during this

period, but the increase was only marginal in

both.

3 Adult-equivalent household income is computed as total household income divided by the

number of equivalent adults in the household. We

used the scale adjustment factors proposed by the

Organization for Economic Cooperation and Development (OECD) to determine the number of

equivalent adults in each household. (See The

OECD List of Social Indicators, Paris, OECD, 1982).

The OECD scale factors assign a weight of 1 for

the first adult, 0.7 for each additional adult, and

0.5 for each child. Because the focus of the research is the economic well-being of individuals,

adult-equivalent income values were allocated to

each person in the household. This weighting resulted in the individual distribution, rather than

the household distribution, of incomes.

4

 Jiri Vecernik, Markets and People: The Czech

Reform Experience in a Comparative Perspective (Aldershot, England, Avebury, Ashgate Publishing, Inc., 1996).

5 See Garner and Terrell “A Gini Decomposition Analysis of Inequality.”

6

 For more on the low unemployment rate in

the Czech Republic, see Robert J. Gitter and

Markus Scheuer, “Low unemployment in the

Czech Republic: “miracle” or “mirage,” Monthly

Labor Review, August 1998, pp. 31–37.

7 Because the minimum living standard and

unemployment benefits did not exist in 1989, we

could not carry out this comparison for 1989.

8

 In practice, the person would receive his or

her unemployment benefit (from the district labor office) and then receive the difference between the minimum living standard and the unemployment benefit as a social assistance benefit

(from the social assistance office).

9 C. Heady and S. Smith, “Tax and Benefit Reform in the Czech and Slovak Republics,” Centre

for Economic Policy Research Discussion Paper

Series No. 1151, March 1995.

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