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# 52013SC0353

**COMMISSION STAFF WORKING DOCUMENT Assessment of the 2013 national reform programme and convergence programme for THE CZECH REPUBLIC Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on the Czech Republic’s 2013 national reform programme and delivering a Council Opinion on the Czech Republic’s convergence programme for 2012-2016 /\* SWD/2013/0353 final \*/**

  

Contents

Executive summary. 3

1........... Introduction. 5

2........... Economic developments
and challenges. 6

2.1........ Recent economic
developments and outlook. 6

2.2........ Challenges. 7

3........... Assessment of policy
agenda. 9

3.1........ Fiscal policy and
taxation. 9

3.2........ Financial sector 20

3.3........ Labour market, education
and social policies. 21

3.4........ Structural measures
promoting growth and competitiveness. 25

3.5........ Modernisation of public
administration. 29

4........... Overview table. 32

5........... Annex. 36

Executive
summary

Economic Outlook

The Czech
economy contracted by 1.3% in 2012, and is expected to shrink again, by 0.4%,
in 2013, with real GDP growth turning positive (1.6%) in 2014 on the back of
growing household income. The unemployment rate,
which was 7% in 2012, is projected to rise to 7.5% in 2013 and to edge lower in
2014. Industrial production is showing signs of stabilisation compared to the
weak 2012 outcome and consumer confidence has already started to improve, although
from a very low level. Inflation is expected to remain subdued, falling from
3.5% in 2012 to 1.9% in 2013 and 1.2% in 2014.

The headline budget
deficit increased to 4.4% of GDP in 2012, significantly worse than forecast in
the 2012 convergence programme, and the Commission projects it will fall to
2.9% of GDP in 2013. However, the Czech authorities
do not envisage further consolidation measures in 2014 and beyond, and the
Commission forecasts that the deficit will increase marginally to 3% of GDP in 2014.
The 2013 convergence programme
confirms the medium-term objective (MTO) of a
structural deficit of 1% of GDP, but it does not specify a deadline for its
achievement. The structural deficit is projected to increase in 2014-2016;
therefore no adjustment towards the medium-term objective is foreseen. Government
debt is expected to reach nearly 52% of GDP in 2016 (from around 46% of GDP in
2012), but to remain below the 60% of GDP reference value.

Key Issues

Progress has
been made on fiscal and structural policies during the last year and the Czech Republic has reduced its budget deficit in 2012, excluding the one-off
deficit-increasing impact of the adoption of the law on financial compensations,
despite the deteriorating economic situation. In
the last twelve months, the Czech authorities implemented a sizeable
consolidation package, including increases in indirect taxes, reformed the
public procurement system, and took steps to strengthen the EU funds management
and control system. However, reform efforts in other areas, including the
long-term sustainability of public finances, the quality of fiscal adjustment,
childcare services and education have been limited.

In the short
term, the main challenge is to kick-start economic recovery by pursuing growth
friendly fiscal consolidation, ensuring the correct use of EU funds, better
exploiting the potential in the labour market and improving
public administration, education and research. While the case for moving
ahead with structural reforms remains strong, weak growth and rising
unemployment make it crucial to target policies that can also deliver results
in the short term.

·
Public finances:
Prioritising spending on employment, research and innovation, education,
childcare and transport and environment projects - such as projects co-financed
by EU funds – could bolster growth, while broadening tax bases,  including by
further evening out differences between employees and the self-employed, could
help to raise revenues in a non-distortive manner. Despite the relatively low
general government debt-to-GDP ratio (45.8% in 2012), rising expenditure on
pensions and healthcare could, in the medium and long term, limit the room for
spending on other policies and generate substantial public deficits.

·
Labour market: While
the labour-market situation in the Czech Republic has proved to be relatively
robust, the challenge remains to bring more women and disadvantaged groups –
particularly young and older people, low-skilled workers, long-term unemployed
and Roma – into the workforce. The employment rate of women was only 62.5% in
2012 (compared to 80.2% of men) and is exacerbated by the continued shortage of
childcare facilities, while the gender pay gap was 21% in 2011, one of the
highest in the EU (16.2 %). There is also a need to ensure that education and
training reflects labour market needs, as the number of third-level graduates
almost doubled between 2006 and 2012 (from 13.1% to 25.6%).

·
Innovation: A
major concern is the relatively low level of R&D investment by domestic
firms (0.72 % of GDP in 2011, below EU average) and the international relevance
of research done by public research institutions.

·
Public administration: Low accountability and stability in the public administration is a
risk for tackling the challenges the Czech Republic is facing. Public
administration is hindered by unclear career progression and vulnerability to
political influence. Corruption and low operational efficiency in the public
administration are perceived as major issues, and the Czech Republic remains at the 21st place among the EU countries in the Transparency International corruption
perception ranking. Furthermore, there is scope to improve tax compliance.

1.
Introduction

In May 2012, the
Commission proposed a set of country-specific recommendations (CSRs) for
economic and structural reform policies for the Czech Republic. On the basis of these recommendations, the Council of the European
Union adopted six CSRs in the form of a Council Recommendation in July 2012. These CSRs concerned public
finances, the tax system, the pension system, the labour market, the
performance of public administration and education. This Staff Working Document
(SWD) assesses the state of implementation of these recommendations in the Czech Republic.

The SWD assesses
policy measures in light of the findings of the Commission’s Annual Growth
Survey 2013 (AGS)[1] and the second annual Alert Mechanism Report (AMR),[2] which were published in November 2012. The AGS
sets out the Commission’s proposals for building the necessary common
understanding about the priorities for action at national and EU level in 2013.
It identifies five priorities to guide Member States to renewed growth:
pursuing differentiated, growth-friendly fiscal consolidation; restoring normal
lending to the economy; promoting growth and competitiveness for today and
tomorrow; tackling unemployment and the social consequences of the crisis; and
modernising the public administration. The AMR serves as an initial screening
device to determine whether macroeconomic imbalances exist or risk emerging in
Member States. The AMR found positive signs that macroeconomic imbalances in Europe are being corrected. To ensure that a complete and durable rebalancing is achieved,
14 Member States were selected for a review of developments in the accumulation
and unwinding of imbalances.[3]

Against the
background of the 2012 Council Recommendation, the AGS and the AMR, the Czech Republic presented updates of its national reform
programme (NRP) and of its convergence programme in April 2013. These
programmes provide detailed information on progress made since July 2012 and on
the future plans of the government. The information contained in these
programmes provides the basis for the assessment made in this Staff Working
Document.

The programmes
submitted went through an open consultation process. The preparation of the
national reform programme involved representatives of the Czech parliament,
social partners, regional authorities and other stakeholders. Before adoption
by the government the convergence programme was submitted to and discussed in
the Czech parliament.

Overall
assessment

The analysis in
this SWD leads to the conclusion that the Czech Republic has made some progress on measures taken to address the CSRs issued by the
Council on fiscal consolidation, taxation, the public
employment service and reforms of the public administration. In the last twelve
months, a sizeable consolidation package, including increases in indirect taxes,
has been adopted, and a reform of public procurement and an action plan to strengthen
the EU funds control system have been implemented.

Only limited progress has been made so far in implementing the 2012
recommendations on increasing the availability of
childcare facilities, improving the quality of fiscal adjustment and evaluating
education and research outcomes. No progress has been made on improving the
long-term sustainability of public finances.

Challenges
identified in July 2012 and reiterated in the AGS remain valid. In the short term, the main challenge is to kick-start economic
recovery by substantially improving the quality of fiscal adjustment, prioritising
and ensuring correct use of EU funds, making better use of the potential in the
labour market and enhancing and stabilising the public administration and
public procurement. Higher quality and efficiency in the education and research
system would help buttress innovation and human capital, improving medium- and
long-term growth prospects.

The policy plans
submitted by the Czech Republic address the challenges identified in last year’s
Staff Working Document, and broad coherence between the two programmes has been
ensured. The national reform programme confirms the Czech Republic’s commitment
to address shortcomings in the areas of education and the business environment.
The convergence programme demonstrates the Czech Republic’s commitment to
comply with the recommendations of the Excessive Deficit Procedure in line with
the Stability and Growth Pact.

2.
Economic developments and challenges
2.1.
Recent economic developments and outlook

Recent economic developments

The Czech
economy posted negative GDP growth of -1.3 % in 2012, as it shrank for
four consecutive quarters. A strong deterioration
in consumer confidence, with repercussions on household consumption, a drop in
public investment and a weaker external environment were the main drags on
growth in 2012. Household consumption was particularly hard hit in view of the
hikes in energy and food prices and the ongoing fiscal consolidation, including
tax increases (mainly value added tax). The unemployment rate has risen only
moderately so far, but the comparatively robust labour market performance masks
a persistent shift of labour from regular employment to bogus self-employment as
well as cuts in hours worked. Households are therefore under pressure not only
due to weak income growth but also because of lower job security, all of which
have a clear impact on confidence.

Economic outlook

Economic
activity should bottom out in the middle of the year along with a gradual
recovery in consumer confidence. However, real GDP
growth is still expected to edge down in 2013, largely due to a weaker outlook
for investment. While industrial production is showing signs of stabilisation
compared to the last quarter of 2012, falling domestic and foreign orders do
not augur well for a swift improvement. On the other hand, consumer confidence
has already started to improve, although from a very low level. Weak wage
growth and somewhat higher unemployment should still weigh on private
consumption in 2013 but the recovery is expected to gain traction in 2014. The
economy should pick up in 2014, supported by growth in real household income
and a slower pace of fiscal consolidation. Given the absence of near-term cost
and demand pressures, inflation should remain subdued over the forecast
horizon.

The
macroeconomic outlook underlying the CP and NRP is broadly plausible. According to the convergence programme, real GDP growth is
expected to reach 0.0 % and 1.2 % in 2013 and 2014 respectively,
compared to -0.4 % and 1.6 % in 2013 and 2014 respectively in the
Commission 2013 spring forecast. The macroeconomic scenario of the CP/NRP does
not include estimates of the macroeconomic impact of structural reforms.

2.2.
Challenges

The Czech Republic continues to face significant challenges in terms of strengthening the
domestic drivers of growth and the institutional fundamentals of the economy. Overall, the Czech economy is affected by the quality of consolidation
measures, insufficient effectiveness in the public administration,
underutilised potential in the labour market, in particular for women with
children, and a slow transition to knowledge-based growth. While the case for
moving ahead with structural reforms remains strong, the deteriorating cyclical
situation and the rising unemployment rate have accentuated the importance of
policy responses that can deliver results also in the short term.

The
overarching current challenge therefore is to promote a sustainable job-rich
recovery. Given that the room for manoeuvre for
fiscal policy is limited by the need to commit to fiscal stability, it is
essential to pursue fiscal consolidation in a manner that mitigates the
negative short-term impact on growth. On the revenue side, this entails making
the tax system more efficient and fairer by broadening tax bases, as, for
instance, large differences remain in taxes imposed on employees and
self-employed. This contributes to eroding tax revenues and gives rise to ‘shadow
employment’. Furthermore, there is scope to improve tax compliance and shift
the structure of taxation from labour towards taxes that are less harmful to
job creation and stimulate sustainable resource-efficient growth, such as
recurrent taxes on housing and vehicle circulation taxes.

A faster and sustainable
recovery is hindered by repeated cuts in public investment expenditure. Prioritising growth-enhancing expenditures with a high
multiplicative effect, such as projects co-financed by EU funds, would not only
help buttress recovery but could also contribute to tackling the long-term
challenges identified in the 2012 staff working document. Substantial growth
effects could follow from expenditure on employment-activating policies,
research and innovation, education, childcare facilities and projects improving
the quality of the transport network and the environment. In view of the high
energy intensity of the economy, investments in energy efficiency would
strengthen the foundation for sustainable development. At the same time,
ensuring correctness and efficiency of such spending is key.

Modernising pensions
and healthcare systems would help ensure their sustainability and adequacy. Long-term projections show that the Czech pension and healthcare
systems are facing substantial expenditure increases in the long run. Despite
the relatively low general government debt-to-GDP ratio, rising expenditure on
pensions and healthcare could, in the medium and long term, limit the room for
discretionary spending on other policies and generate substantial public deficits.

Human capital
is an essential ingredient for strengthening knowledge-based growth. As the number of graduates from Czech higher education institutions
has been rising in recent years, the challenge is to ensure that the education
and training students receive is of adequate quality and reflects labour-market
needs in both the national and the regional context. Regarding the research and
innovation system, a major concern is the relatively low international
relevance of research produced by domestic firms and public research
institutions. The potential for a strong high-tech orientation of the economy
offered by the sizeable manufacturing sector remains still underexploited.

While the labour-market
situation in the Czech Republic has proved to be relatively robust, challenges
remain in specific segments. The principal one is
the untapped potential in participation of women with young children, who are
disadvantaged by the scarce provision of affordable and quality childcare. This
prevents them from returning to jobs after parental leave fast enough to retain
the skills and human capital built up in education and previous occupations.
The employability and labour market participation of disadvantaged people also
remains to be improved, in particular as measures implemented by the public
employment services do not effectively address the challenge.

Low
accountability and stability in the public administration is a risk for
tackling the challenges the Czech Republic is facing. Performance of the public administration is hindered by unclear
career progression and vulnerability to political influences. Due to these
factors, corruption and low operational efficiency in the public administration
are perceived as major issues.

3.
Assessment of policy agenda
3.1.
Fiscal policy and taxation

Budgetary developments and debt
dynamics

The objective of the budgetary strategy of the Czech Republic is to bring the government deficit below the 3 % of GDP reference value by
2013 and keep
the deficit below the 3 % of GDP reference value in 2014-16. The programme confirms the medium-term
budgetary objective (MTO), which was fixed at a structural deficit of 1 %
of GDP in the previous 2012 programme. The MTO reflects the objectives of the
Stability and Growth Pact. However, the date for the achievement of the MTO is
postponed until after 2016 without further specification. In addition, the
programme foresees an increase in the structural deficit in 2014-16.

The headline
general government deficit increased to 4.4 % of GDP in 2012,
significantly worse than the objective envisaged in the 2012 programme. The worsening reflects mainly the impact of two one-off
deficit-increasing operations: the adoption of the law on financial
compensation to churches (1.5 percentage points, or pps, of GDP) and
corrections resulting from irregularities in the management of EU funds (0.3 pps
of GDP). Without these operations, the headline deficit would have shown a
stronger improvement than targeted in the previous programme (a deficit of 2.9 %
of GDP). The final budgetary outcome was also influenced by revenue and
expenditure measures (see Box 1) and a continued reduction in public
investment. Overall, the 2012 budget was implemented in line with the 2012
recommendation even though public investment was reduced significantly.

The programme
envisages a reduction in the headline general government deficit to 2.8 %
of GDP in 2013. Expenditure growth should be
contained somewhat by the expenditure measures adopted (further
across-the-board cuts in government consumption, a continued freeze on public sector wages at the central
level, and lower indexation of pensions) but, excluding
the effect of the two 2012 one-offs, the total expenditure ratio is projected
to increase by 0.6 pps to 43.3 % of GDP in 2013. Revenues are forecast to
increase by 0.4 pps to 40.4 % of GDP in 2013 on account of temporary and
permanent revenue-side measures adopted in 2012, which include an increase in both value added tax (VAT)
rates, in excise duties and in the property transaction tax along with changes
in personal income tax and social contributions (see Box 1). The Commission services 2013 spring forecast projects a slightly
higher government deficit at 2.9 % of GDP in 2013, based on a more
conservative underlying macroeconomic scenario in 2013. Despite the net
positive effect of discretionary measures, the recalculated structural balance[4] will improve
by only 0.1 pp to 1.6 % of GDP in 2013. The risk of a worse-than-expected
budgetary outcome in 2013 mainly stems from additional corrections in EU funds
reimbursements. On the other hand, one-off revenues linked to the planned
auction of new telecom frequency bands could result in a better-than-expected
budgetary outcome compared to both the convergence programme and the Commission
services 2013 spring forecast.

Box 1. Main measures

|| Main budgetary measures ||

|| Revenue || Expenditure ||

|| 2012 ||

|| · Increase in the lower VAT rate from 10 % to 14 % (+0.5 % of GDP) · Introduction of a lottery tax (+0.2 % of GDP) · Increase in excise duties on tobacco (+0.1 % of GDP) · Higher tax allowance for families with children (-0.1 % of GDP) || · Adoption of the law on financial compensations to churches (+1.5 % of GDP) · Cuts in operational expenditure of and public subsidy to construction savings scheme (-0.6 % of GDP) · Financial corrections to non-recognised expenditures co-financed from the EU (+0.3 % of GDP) ||

|| 2013 ||

|| · Increase in the both VAT rates and in excise duties (+0.4 % of GDP) · Changes in personal income tax and health insurance contributions (+0.2 % of GDP) · Introduction of a private pension pillar (-0.2 % of GDP) · Increase in the property transfer tax and other revenue (+0.1 % of GDP) || · Cuts in operational expenditure of the central government (-0.3 % of GDP) · Lower indexation of pensions (-0.2 % of GDP) · Reduction in subsidies for renewable energy (-0.1 % of GDP) ||

|| 2014 ||

|| · Further changes in excise duties adopted as part of 2012 revenue package (+0.1 % of GDP) · Expiry of special tax on photovoltaic power plants (-0.2 % of GDP) · Frontloading of some measures in personal income tax (+0.1 % of GDP) || · Changes in sickness benefit payment system (+0.1 % of GDP) · Savings resulting from the simplification of public administration (-0.3 % of GDP) ||

|| 2015 ||

|| · Changes related to direct tax and payments reform (-0.4 % of GDP) · Tax deduction on dividends for corporations (-0.2 % of GDP) · Lowering of mandatory VAT registration limit (+0.1 % of GDP) · Tax deduction on dividends (-0.1 % of GDP) || · Savings in government consumption linked to introduction of the single collection point (-0.3 % of GDP) ||

|| 2016 ||

|| · Changes in social contributions (+0.3 % of GDP) · Expiry of some changes adopted in 2012 in personal income tax and social contributions (-0.2 % of GDP) · Unification of VAT rates (-0.4 % of GDP) || n.a. ||

|| Note: The budgetary impact in the table is the impact reported in the programme, i.e. by the national authorities. A positive sign implies that revenue / expenditure increases as a consequence of this measure. The degree of detail reflects the information made available in the convergence programme and, where available, of a multiannual budget. ||

·

The programme
does not envisage further consolidation measures in 2014 and beyond and the
budgetary plans are moreover not sufficiently supported by concrete measures. The programme abandons previous consolidation plans for 2014-16,
in favour of a new course aimed at keeping the headline deficit just below 3 % of GDP in
2014-16, in order not to ‘deepen the procyclical effects of fiscal policy’. According to the programme, the government deficit will edge up by
0.1 pp to 2.9 % in 2014, which seems due to rounding effects, as the
revenue and expenditure ratios change in broadly the same order of magnitude.
The planned savings in the public administration in 2014 are not sufficiently
specified and seem to rely heavily on the sale of state property rather than durable
cost savings. Also, as the government plans to increase public investment only
moderately over the programme horizon from the historical low reached in 2012,
it is possible that expenditure may be higher in order to cover the investment
gap created in past years. A number of factors impinge on the deficit in the
outer years of the programme: the expiry of temporary revenue measures in 2015,
the impact of planned changes related to direct tax and payments reform in the
same year and VAT unification in 2016. No measures are planned to offset these
factors. The projected significant reduction of expenditure by 0.7 pps and 0.6
pps of GDP in 2015 and 2016 respectively is not supported by adequately
specified measures. Savings from introduction of the single collection point
are likely to be more spread over time.

While the
deficit target for 2013 complies with the Council recommendation, the projected fiscal effort
does not comply with the Pact. The general government deficit target of 2.9 % of GDP in 2013 is
in line with the Council recommendation of 2 December 2009. The programme
confirms the previous MTO of a deficit of 1 % of GDP, which adequately
reflects the requirements of the Stability and Growth Pact. The (recalculated)
structural budget deficit is projected to increase by 0.3 %, 0.2 %
and 0.5 % of GDP in 2014, 2015 and 2016 respectively; therefore no
adjustment towards the MTO is envisaged in the programme, which is not in line
with the Stability and Growth Pact. According to the information provided in
the programme, the rate of growth of government expenditure, net of
discretionary revenue measures, complies with the expenditure benchmark of the
Stability and Growth Pact in 2014, but in 2015 and 2016 it is not expected to
contribute to an annual structural adjustment towards the MTO of 0.5 % of
GDP. This is because the growth rate of government expenditure exceeds, by 0.3 %
and 0.5 % of GDP respectively, the lower rate under the expenditure
benchmark of 0.45 % of GDP.

The public
debt ratio is projected to increase but remain below the reference rate. Since the debt-to-GDP ratio is below the reference rate, the debt
reduction benchmark is not applicable. The debt-to-GDP ratio is forecast to
continue to increase over the programme period, albeit at a slowing pace, and to
reach 51.9 % of GDP in 2016. The contributions of the primary balance and
interest expenditure are projected to remain stable. The interest risk and
currency risk seem broadly contained, given the relatively low share of
short-term and variable debt and of foreign-denominated debt.

Box 2. Excessive deficit procedure for the
Czech Republic

On 2 December 2009, the Council
decided that an excessive deficit existed in the Czech Republic. The most
recent Council Recommendation under Article 126(7) TFEU was adopted on the same
date. The Council recommended that the Czech Republic’s authorities should put
an end to the present excessive deficit situation by 2013. In particular, the
Czech Republic was recommended to implement the deficit-reducing measures in
2010 as planned in the draft budget law for 2010; to ensure an average annual
fiscal effort of 1 % of GDP over the period 2010-13; and to specify the
measures necessary to achieve the correction of the excessive deficit by 2013,
cyclical conditions permitting, and accelerate the reduction of the deficit if
economic or budgetary conditions turn out better than expected at the time. In
addition, in order to limit risks to the adjustment, the Czech Republic was recommended to rigorously enforce its medium-term budgetary framework
and to improve monitoring of budget execution throughout the year to avoid
expenditure overruns compared to budget and multiannual plans. Furthermore, the
Council invited the Czech authorities to implement reforms with a view to
raising potential GDP growth and reforms conducive to enhancing the quality of
public finances, in particular reforms improving the efficiency and
effectiveness of public spending. In addition, the Council invited the Czech
authorities to continue with the necessary pension and healthcare reforms.

An overview of the current state of excessive
deficit procedures is available on: http://ec.europa.eu/economy\_finance/economic\_governance/sgp/deficit/index\_en.htm
(please refer to country sections at the bottom of the page).

Fiscal framework

The fiscal
framework has remained largely unchanged since 2004, when the last
comprehensive reform was adopted. The main features
include an expenditure rule for central government and multiannual fiscal
planning within the medium-term budgetary framework, which is based on a
rolling three-yearly fiscal outlook. Apart from the nominal expenditure
ceilings, there are no additional numerical and binding fiscal rules targeting
the central government. The enforcement of the expenditure ceilings is weak, as
they have been revised upwards several times. Moreover, the local authorities
are not bound by these ceilings, and the link between their expenditure and the
state budget expenditure is not easily identifiable. The fiscal framework
further suffers from the limited transparency of budgetary procedures, the
limited coordination between different levels of government in the budgetary
cycle and the lack of systematic evaluation of public spending based on clear
performance criteria.

A new
constitutional act on fiscal responsibility, adopted by the government in 2012,
is currently under discussion in the parliament.
The main components of the constitutional act include (i) a debt ceiling of 60 %
of GDP for the general government with corrective measures in case a threshold
of 40 % of GDP (excluding cash reserves to finance government debt) is
breached, (ii) setting up of a national fiscal council, (iii) a debt rule for
regional and local governments and (iv) the obligation for all public entities
to prepare a three-yearly budgetary outlook. The commitment to introduce an
expenditure rule covering the whole general government sector is also included.

A draft act
on rules of fiscal responsibility, specifying the implementation of the
constitutional act on fiscal responsibility and additional rules, has been
presented, but is yet to be adopted by the government and the parliament. The draft act envisages a Committee for Budgetary Forecasts, which
would assess macroeconomic and general government revenue forecasts ex-ante twice
a year. At this stage, it remains unclear how the independence of this
Committee is to be guaranteed. The draft act further details the debt and
expenditure rules as well as the content of the medium-term budgetary
framework. A transition period for the debt rule may be considered, as the
current debt level is already above the envisaged threshold of 40 %. In
addition, the draft act specifies the composition, funding and responsibilities
of the Fiscal Council, which would include the monitoring of fiscal rules and
the assessment of fiscal policy. Accelerating the operational establishment of
the Fiscal Council, together with ensuring its independence and providing
adequate resources, would contribute to greater transparency in the management
of public funds and would be in line with good practice.

Long-term sustainability

The Czech Republic continues to face a large
sustainability gap. While the country does not appear to face a risk
of fiscal stress in the short term, the Czech Republic is, however, at medium
risk in the medium and long run, mainly due to the cost of ageing.[5] The government
debt ratio (45.8 % of GDP in 2012 and expected to rise to 50.1 % in
2014) is below the 60 % of GDP threshold. Medium-term
debt projections (Graph below Table V in annex) indicate that, with full
implementation of the programme, debt would be higher by 2020, although still
below the 60% of GDP reference value. Risks would be higher if the structural primary balance were to revert to
the lower values observed in the past, such as the average for the period
1998-2012. Containing growth in age-related expenditure, in particular in
pension expenditure and healthcare spending, would contribute to the
sustainability of public finances.

The main source of the unsustainable increase in pension expenditure
remains the slow rate at which the statutory retirement age is being raised.
While the retirement age for men is set to reach 65 by 2020 in most Member
States, in the Czech Republic it is expected to reach only 63 years and 8 months
in 2020 (the pace of the increase is only two months per year). For women, the
expected retirement age will also remain below 65 but this is mostly due to the
very low starting point.[6]
Ensuring that the retirement age reaches 65 by 2020 and linking it to life
expectancy thereafter would significantly strengthen the sustainability of the
system.[7]

Graph 1:
Statutory retirement age in 2020 (men)

Note:
The retirement age in FI, FR and SE is not specified at a comparable basis.

Source:
Commission.

Over the reporting
period, the government has not taken systemic steps to improve the long-term
sustainability of the first pension pillar. As part
of the consolidation strategy, it has limited increases in pensions between
2013 and 2015. This measure is set to expire in 2015; thereafter pensions will
be adjusted based on the current pension indexation formula (prices and a third
of the rise in real wages). A number of Member States have opted for an
indexation formula based on prices, which, when implemented over the long run,
generates substantial savings while, at the same time, preserving the
purchasing power of pensioners.

Two reforms of
the second and third pillar entered into force in January 2013: one improved the functioning of the voluntary private pension savings
scheme (the ‘third pillar’) and the other introduced a new fully funded
statutory pillar with a partial voluntary opt-out from the ‘first’ pillar. The
latter has so far attracted a low number of participants, partly because of the
risk that the scheme could be rolled back in the near future given the lack of
a wider social consensus on the reform. Participation in the fully funded
statutory pillar is also conditional on topping up the present level of
contributions with a further 2 % of salary, which is relatively difficult
in the current economic circumstances. Once the system settles, it may require
legislative adjustments to help ensure that savers choose appropriate
investment profiles over the life cycle of their savings and that the envisaged
pension-payment arrangements do not penalise those who opt for a lifetime
annuity. An appropriate level of participation in both the second and the third
pillar will be essential to ensure the adequacy of old-age pensions.

Contrary to
the country-specific recommendation, the government introduced a new early
retirement scheme in 2013, which offers the
possibility of drawing pensions up to five years before reaching the statutory
retirement age. The early-retirement pensions are going to be paid from the
(third) pension savings pillar. However, the pillar enjoys a substantial state
subsidy through direct co-payments and tax deductibility of contributions. In
addition, the beneficiaries of these pensions will not be penalised for
retiring earlier in terms of the level of their old-age pensions, as is
customarily the case with early-retirement schemes.[8] Irrespective
of whether the eligibility criteria for access to the scheme will effectively be
met by only a limited number of persons, as the government expects, the measure
allows beneficiaries to use the previously accrued public subsidy for a purpose
that goes against policies to extend working lives.

The expected
increase in health and long-term care spending also makes a substantial
contribution to the cost of ageing. Reforms aimed
at improving the efficiency of the health system via cost containment and more
market-oriented solutions have been implemented in recent years in the Czech Republic. For example, user fees for doctor consultations, prescriptions and hospital
stays that were introduced in 2008 have been generally successful in reducing
overconsumption of health services.[9]
Monitoring of reforms increasing private payments would reduce the risk of creating
unequal access to care. Despite the steps taken so far, problems still exist.
Compared to other Member States, the Czech healthcare system tends to be
excessively centred on hospital care, which gives rise to inefficiencies. Both
the share of public hospital expenditure in total public current health expenditure
and the number of acute hospital beds per 1 000 persons are among the
highest in the EU. Also, patients tend to stay too long in hospital care and
the share of one-day surgical interventions among total hospital admissions is
the lowest in the EU.[10]
There is scope to improve provision of care in the most clinically appropriate
and cost-effective way, for example by moving to day-of-surgery admission and
reducing inappropriate lengths of stay in acute care hospitals. Continuing to develop
alternatives to institutional care would also contribute to reducing long-term
hospital stays in favour of independent living solutions. Measures presented in
2013 NRP aimed at optimizing the network of health and social services and
increasing efficiency of health insurance system are steps in the right
direction.

Tax system

Overall, the Czech Republic made some progress on the 2012 recommendation on taxation. The country-specific recommendation called for exploiting the
available space for increases in taxes least detrimental to growth, shifting
the high level of taxation on labour to housing and environmental taxation and
reducing the discrepancies in the tax treatment of employees and the
self-employed. The tax-to-GDP ratio in the Czech Republic remains relatively
low in comparison with the rest of the EU. In 2011, it stood at 34.4 %,
against the EU average of 38.8 %. However, the Czech Republic has a high
implicit tax rate on labour (the sixth highest in the EU). Taxation on labour
is the main source of revenue (51.9 %, slightly above the EU-27 average of
50.8 %), followed by consumption (32.6 %) and capital (15.5 %).

To exploit
the available room for increases in taxes least detrimental to growth, some measures
were adopted in 2012. Effective from 2013, both
value added tax rates were increased by 1 pp (until 2015), some exemptions from
excise duties related to diesel used in agriculture were gradually abolished,
and tobacco and cigarettes excise duty rates were also increased. In 2014,
exemptions from excise duties related to diesel used in agriculture will be
fully abolished and cigarettes excise duties will be further increased. Full
unification of both value added tax rates that would simplify the system and
reduce compliance costs was postponed to 2016.

Limited
progress was made in 2012 on increasing taxation of housing and environmental
taxation. While the real estate transfer tax was
increased by 1 pp (to 4 %), no steps were taken to raise the very low
level of recurrent property taxes (the fourth lowest in the EU). Plans to
introduce a CO2 tax and abolish exemptions from excise duties on
natural gas for heating have been dropped. While the revenue from environmental
taxes on energy in 2010 was the sixth highest in the EU, due to the relatively
high energy intensity of the Czech economy the implicit tax rate on energy was
below the EU average. Moreover, non-fuel environmental taxes in the area of
transport remain very low (the third lowest in the EU).

While
temporary measures adopted in 2012 increased the progressivity of the labour
taxation system and the tax burden on labour, the
existing legislation includes a reduction of the total labour burden in 2015.
The measures adopted in 2012 include the introduction of a 7 pps additional tax
surcharge above the social contributions cap for high-income earners, the
abolition of ceilings on health insurance contributions, and the abolition of
the basic tax allowance for working pensioners. These measures will all expire
in 2015. The existing legislation includes the tax reform adopted in 2011 and
effective from 2015 which would lower the total tax burden on labour. From
2015, the personal income tax rate will rise by 4 pps to 19 %, albeit with
a narrower tax base. The social security contributions are set to increase slightly,
as the current total rate of 34 % for employers’ contributions will be
replaced by a payroll tax of 32.4 %, but employees’ health insurance
contributions should increase by 2 pps.

Structural
challenges remain in taxation of labour. The tax
wedge on low-income earners, while not excessively high by EU standards,[11] could be one
of the factors behind the relatively high unemployment rate among low-skilled
workers. Currently, the minimum tax base for health insurance contributions
leads to a relatively high tax wedge for part-time workers earning less than
the minimum wage, which could be one of the factors behind the very low
utilisation of part-time work. Measures to address this might therefore
encourage the labour participation of second-income earners.

Limited
progress has been made on reducing the discrepancies in the tax treatment of
employees and the self-employed in 2012. In 2012, a
cap on selected categories of flat-rate expenses deductions available to
self-employed was introduced,[12]
with an impact on a limited number of high-income self-employed only, and some
limitations were introduced on the use of allowances for the spouse and
children of the self-employed. The current system of taxation of the
self-employed combines a low tax base (50 % of their income tax base) with
large flat-rate deductions for expenses (as a percentage of total income)
thereby creating perverse incentives for employers to hire de facto dependent
employees as self-employed. Furthermore, it severely reduces the tax revenue obtained
from a large and growing group of taxpayers,[13]
putting more pressure on the authorities to cover the revenue gap with
increased taxation of other activities, all other things being equal. In spite
of the rising number of self-employed, the tax revenue from the self-employed
has decreased substantially, particularly since 2008, when the last major
changes to the tax system were enacted. It accounted for only 2.2 % of the
total personal income tax revenue in cash terms in 2011 compared to around 12 %
in 2008.

Graph 2:
Self-employed

Note:
PIT from self-employment is proxied by PIT reported in tax declarations. All
self-employed, unlike most employees, are obliged to submit a tax declaration.

Source:
Czech Financial Administration, AMECO.

The Czech Republic has room to improve the efficiency of its tax administration. The administrative cost per net revenue collected is one of the
highest in the EU.[14]
The tax collection system creates one of the highest tax compliance burdens for
small and medium-sized enterprises (SMEs) in the EU, which is one of the key
bottlenecks that prevent more dynamic development of the business environment
in the Czech Republic.[15]

In response
to the 2012 recommendation to take action to improve tax collection, reduce tax
evasion and improve tax compliance, the government adopted several measures to
lower VAT avoidance. These include a new concept of
‘unreliable taxpayer’, a requirement to use verified bank accounts for all
business transactions, and a duty for newly registered VAT payers to submit tax
returns on a monthly basis, the two latter requirements being implemented as
from 2013. The first measure is intended to avoid taxpayers declaring
bankruptcy before meeting their tax obligations. In particular, the business
partners of companies that have seriously breached the VAT law in the past will
be liable for the unpaid VAT due on their transactions. The 2013 national
reform programme also states that VAT returns will be filed exclusively in
electronic form from 2014. All these measures are likely to narrow the scope
for VAT fraud but also increase the compliance burden on businesses and reduce
the ease of doing business.

Reports
suggest that the largest compliance costs in terms of the time it takes to pay
taxes are due to personal and company income taxes (including health and social
contributions)[16]. For these taxes, the government is planning to establish a single
collection point in 2015, which is expected to centralise the procedural
aspects, such as payments, audits and appeals.[17]
This measure could effectively streamline the tax administration and help
reduce the complexity of the current system for taxpayers. However, a major
drawback of the reform is that the tax bases for personal income tax, health
and social contributions will not be harmonised, thereby leaving a large part
of the potential benefits of the reform unexploited. Taxpayers will still have
to conform to several legal acts, rulings and practices in order to determine
the level of taxes. Although the date of entry into force of the single
collection point is laid down in a law, it still faces substantial
implementation risks given the delays it has already encountered.

3.2.
Financial sector

The banking
sector is mostly foreign-owned and the Czech banks as a whole remain net
creditors to their parent banks. Despite the
deterioration in the real economy, the Czech financial sector enjoyed stable
conditions, as confirmed by key macro-prudential indicators, and remained
resilient to external risks. The banking sector generates sound profits and is
well capitalised, with a loan-to-deposit ratio well below 100 %. In spite
of a recent increase, the proportion of non-performing loans remains well below
the EU average. With relatively low government debt and falling interest rates on
Czech government debt in 2012, the sovereign rating has remained stable and
benefits from a stable outlook.

The SME
Access to Finance Index for the Czech Republic in 2011 shows a weak performance
compared to the EU average, in particular due to
very poor access to venture capital, while access to banks loans is perceived
by SMEs as still relatively good. The deterioration in SME access to bank
lending from 2009 to 2011 was comparatively small. With an underdeveloped stock
exchange and venture capital market, equity financing remains very limited and
the real economy effectively depends on financing provided by banks or own
resources. There was some progress in 2012 given that the government started
setting up a new State Seed/Venture Capital Fund designed to assist in funding
newly emerging innovative businesses. Also, commercial banks launched a new
guarantee facility for innovative start-ups in the Czech Republic.

3.3.
Labour market, education and social policies

After proving
resilient in previous years, the Czech Republic’s labour market started to show
signs of deterioration. The unemployment rate
started to increase in 2012, but at 7.0 % it remains well below the EU
average 10.6 %. At the same time, the employment rate increased to 71.5 %
in 2012 on account of rising employment of older workers. However, recent
projections[18]
reveal an expected shortfall of 1.9 pps in meeting the 2020 employment target
if no countervailing measures are adopted. A persistent challenge remains the
situation of women with young children and other disadvantaged people, notably
young and older people, low-skilled workers, long-term unemployed and Roma. The
gender employment gap[19]
and the gender pay gap[20]
were among the highest in the EU. While youth unemployment (15-24) has doubled
since 2008 and continued to increase in 2012, it still remains below the EU
average. Moreover, the proportion of youth not in employment, education or
training stabilised and also compares favourably with the EU average. This
said, the worsening situation in the labour market heightens the importance of effective
public employment services and education policy reforms in order to tackle the
weak trend growth of labour productivity.

Labour market

The Czech Republic made limited progress on the 2012 recommendation to increase the
availability of affordable and good quality early childhood education and care. Despite a continued shortage of childcare facilities, in
particular for under three year olds,[21]
there are no plans to increase budgetary support to public pre-school
childcare, to the detriment of the female employment rate. Recent (2012) OECD
projections show that full convergence of the female employment rate with that
of males would stop the projected decline of the total labour force and
increase GDP per capita by as much as 16.5 % by 2030.[22] In addition,
parental leave remains among the longest and most expensive in the EU,
according to the OECD Family database. A draft act on pre-school facilities, to
be discussed by the government in 2013, includes plans to introduce private
‘child groups’ led by professional nannies accompanied by tax subsidies for
care providers and participating families. The measure is a step in the right
direction but falls short of the objective to allow most workers to return to jobs
after parental leave. In particular low income families are not likely to
benefit much from the planned tax credit, unless they work for large companies,
which are the most likely to set up a private kindergarten. No steps were taken
to ensure quality of care at private facilities. The risk is that the new
private facilities will fail to provide adequate human capital development for
the children. A European Social Fund (ESF) pilot project supporting the
setting-up of company-based childcare is being implemented from 2013 and will
likely improve the situation only to a small extent.

Graph 3: Children below the age of 3 enrolled in formal childcare
(%)

Source:
Eurostat (EU SILC).

Progress has
been made on improving the performance of the public employment service, as
recommended in 2012. Implementation of the reform
of the public employment service adopted in 2011 continued in 2012, with
positive effects expected to materialise in the medium term. However, in 2012
the workload of the labour offices increased, to the likely detriment of the
quality of employment services provided and job search assistance against the
background of rising long-term unemployment. In this context, plans in the 2013
NRP to increase staff at labour offices in 2013 by 750 new positions are a step
in the right direction. Also, ESF projects are to be implemented in 2013 with
the aim of improving skills and capabilities of labour office staff but no
measures have been announced to reduce the high administrative workload at the
labour offices and to increase the availability of services. A system of
outsourcing of employment services to private providers was adopted in 2012 but
not implemented because of weaknesses concerning the fee structure,
arrangements for evaluating agencies’ performance and a targeted selection
policy. A draft amendment that would revise the outsourcing system is to be
discussed by the government in 2013. While the budget for active labour market
policies in 2013 was increased, as also mentioned in the 2013 NRP, and the role
of training was strengthened, the overall expenditure on active labour market
policies remains relatively low, as does the share of participating jobseekers.
To address persistent weaknesses in the monitoring and evaluation of activation
programmes the active labour market policies are being strengthened through
co-financed support from the European Social Fund. Two new activation
programmes were introduced in 2012, aimed at improving access to employment and
supporting existing positions in companies affected by the economic slowdown.[23]

Education

The Czech
higher-education system has recorded an unprecedented increase in the number of
students, which is likely to facilitate meeting the national Europe 2020
tertiary education target.[24]
The main challenge now remains to ensure that students are equipped with skills
needed to succeed in the labour market and to further promote quality of
education at all levels in order to capitalise on the rising number of
students.

Two main
measures were put forward in response to the
2012 recommendation to establish a transparent system for quality evaluation of
higher-education and research institutions with a clear link to their funding.
First, the share of the performance-based funding available to higher education
institutions (HEIs) has been raised from 20 % of the total institutional
funding in 2012 to 22.5 % as of 2013. The national reform programme does
not envisage any further changes in the share or the relevance of the quality
indicators in the near term. Secondly, the government is preparing a revision
of the Higher Education Act, planned to be adopted in 2013. The revision is
expected to enhance the accreditation system (from 2015) and to differentiate
funding (from 2016) according to the profile of study programmes (professional,
academic and research) offered by each HEI. Regarding accreditation, the plan
is notably to move away from ex-ante checks on ‘input’ criteria (such as the
quality of academic staff) towards surveillance based on internal quality-evaluation
mechanisms. The envisaged change in funding should promote stability over the
medium term, as contracts would be multiannual, and support the development of
more professionally oriented bachelor degrees, which could help reduce the
record-high proportion of students continuing for master’s degrees and
contribute to a lower drop-out rate. These are relevant and ambitious
proposals, although their actual impact will depend on the final design and timetable
of the reform and on the ownership of key stakeholders. The 2013 national
reform programme also announced measures concerning strengthened cooperation
between education and employers, which could help improve labour-market
relevance in particular of vocational education and training.

At the level
of compulsory education, Czech pupils attain broadly average results in
international comparisons of education outcomes such as PISA (2009). The system is relatively cost-efficient in the sense that average
results are achieved at below-average costs. In all areas tested, however, the
education outcomes have worsened over time and show a high degree of dispersion
across students also within the same school.[25]
Against this background, the Council recommended establishing an
improvement-oriented evaluation framework that would help identify and develop
weak elements of the system.

Besides
ongoing curricular reforms, the authorities responded to this recommendation
with two main sets of measures. The first one entails
establishing minimum education standards along with the development of nationwide
testing of pupils. The tests are currently in the pilot phase and should be
fully operational from school year 2013-14. Despite known risks, the tests
could help identify, and provide useful feedback to, schools, teachers and
pupils in need of additional support.[26]
Such support will need to be provided systematically if this measure is to become
a relevant response to the country-specific recommendation. A second set of
measures aims to improve the quality and attractiveness of teaching. The
government raised the entry salary for teachers in 2012 and is developing a new
career system, which is expected to enter in force in 2014. The system should
enhance in-service training and tighten the link between wages and performance.
The effectiveness of this measure will also depend on whether it will include
incentives to attract high-quality headmasters and teachers to schools with low
social and economic status.

Social policies

The share of
population at risk of poverty or social exclusion remained among the lowest in
the EU at 15.3 % in 2011. Poverty is mostly
concentrated in disadvantaged groups, such as the unemployed
(at risk of poverty of 46.4 %), single parent families (at risk of poverty
of 35.6 %) and the Roma,
who face significant barriers to better integration, in particular in the
education system and the labour market. Recent UNDP/WB/EC surveys (2011) estimated
the risk of poverty among Roma in some territories at above 80 %, their
unemployment rate at above 50 % and their experience of discrimination
when looking for work at above 60 %.[27]
Equal access to quality and inclusive education for Roma children remains
impaired, as only 24 % of Roma children attend pre-school facilities, and
the education system fosters segregation through the widespread practice of
putting Roma children into sub-standard schools designed to cater for the
mentally challenged. According to Czech School Inspection data, 26.4 % of
children educated in such sub-standard institutions in 2012 were Roma, but on
the positive side, their number has decreased by 8.6 pps over the previous two
years and a reassessment and correction of diagnostic tools is planned from
January 2014.[28]
Ensuring quality and inclusive care for all children is crucial for supporting
children’s development. The Agency for Social Inclusion has developed several
initiatives to improve the situation in several excluded localities, but its
capacity and resources remain limited. The government policies to fight social
exclusion are described in two strategic documents[29] but the
responsibilities for coordination channels are not fully clear, which creates
substantial implementation risks. The strategies lack an integrated approach,
more concrete measures, quantifiable indicators, a clear timeline and a robust
monitoring mechanism. No new concrete measures are proposed in the 2013 NRP.

3.4.
Structural measures
promoting growth and competitiveness

Potential
output growth in the current decade is expected to slow to less than half of
the level achieved in the previous decade. This is
mostly due to the downward trend in productivity growth. Low expected
productivity growth is consistent with the overall ranking of the Czech Republic as ‘a moderate innovator with below average performance’ in the 2012
Innovation Union Scoreboard. The relative strengths of the Czech economy are
the quality of human resources and the solid dynamism of businesses in terms of
introducing marketing or organisational innovations and entering new markets.
However, some of the key drivers of innovation performance both outside and
inside firms are clearly underperforming compared to other Member States. This
concerns especially the level of openness, excellence and attractiveness of the
research system and the country’s performance in patent applications and
Community trademarks and designs. There is also ample room for improvement
regarding the business environment, resource efficiency and the quality of
transport infrastructure.

Research and innovation

The Czech
innovation system is dominated by foreign affiliates of large multinational
firms. In 2011, business research and development (R&D)
expenditure reached 1.11 % of GDP, a value which is approaching the EU
average but is still not in line with the strong innovation potential of the
country’s manufacturing sector. The low proportion of business R&D
expenditure by domestic firms is reflected in particular in the weak output
performance of the country in terms of patent applications under the Patent
Cooperation Treaty and licence and patent revenues from abroad.[30]

There is
scope for improving the quality and relevance of public research, which seem relatively
low by international comparison. In particular, the
number of high-impact scientific publications and the degree of collaboration
between public research institutions and the business sector is very low.[31] In terms of
inputs, public expenditure on R&D rose in 2011 to 0.72 % of GDP, the
ninth best performance in the EU. The main challenge for the Czech innovation
system therefore remains to improve the effectiveness of its science base in
reaching a higher level of excellence and supporting the development of
innovative activities through enhanced collaboration with domestic firms. Public
research activities are currently split between academic institutes (with a
limited teaching curriculum) and universities. This entails a risk of diluting
skills and competencies to the detriment of critical mass and excellence needed
for sustainable partnerships with industry.

To ensure
that public R&D funding is allocated on the basis of excellence, the Council recommended that the government improve the system for
evaluating the quality of research institutions and ensure that funding is
linked to the outcome of the quality assessment. The current system for funding
public research institutions does not sufficiently reflect the specificities of
each scientific field and the needs of the business sector. Moreover, the outcomes
of the evaluation methodology are not binding for the allocation of
institutional funding, as only about 20 % of the institutional funding of
public research institutions is allocated on the basis of the evaluation of
their performance. In response to this, the government intends to adopt for the
period 2014-16 a revised methodology based upon new evaluation criteria and
peer review to better take into account the quality and relevance of the
research performed. In parallel, work is expected to start, with the support of
EU funds, on the development of a new evaluation and funding system aimed at promoting
excellence and maximising the economic impact of research. The governance of
the national research and innovation system remains, however, split between
several bodies[32]
and this may cause delays in implementing the planned reforms.

Some steps to
increase involvement of the private sector have been taken. New programmes, including the Technology Agency’s ‘Alpha’ Programme,
have been launched to stimulate cooperation between public research
institutions and businesses in sectors such as transport, energy and the
environment. Furthermore, the Income Tax Act has been amended to allow from
January 2015 private firms to deduct the cost of R&D activities contracted
out from their taxable income.

Business environment

Improving the
business environment remains an issue in the Czech Republic, in particular with
respect to starting a business.[33] In fact, the
Czech Republic is lagging behind on fulfilling the objectives of conclusions of
the May 2011 Competitiveness Council on the need to set up a fully functional
one-stop shop for businesses and reduce the time and cost to start up a
business. However, a new Act on Business Corporations, adopted in 2011 and
effective from 2014, is expected to provide some improvement to the business
environment for selected groups of companies, mainly for limited liability
companies. Regarding other indicators of the quality of the business
environment, the average time to enforce contracts and resolve insolvency
remains above the EU average but some progress has been made on shortening the
delays in payments.[34]
Moreover, the Czech Republic performs relatively well with respect to the time
and cost it takes to obtain licences.[35]
The use of e-government services has also improved, likely due to the
establishment of basic public administration registers. E-government services
were used by 92 % of businesses (2012) and 42 % of citizens (2011),
which is expected to support progress in meeting the 2015 target in this area. The
2013 NRP includes information on the on-going eco-audit project aimed at
reducing administrative burden of companies related to environmental
regulation.

The Czech Republic is amongst the Member State with the highest number of regulated professions
according to the database on regulated professions.[36] A public
consultation on the review of the regulatory framework for professions was conducted
in 2012 and the results are to be presented in 2013. This is an important step
in order to reduce or eliminate barriers to those professions for which regulation
is not proven necessary or is considered excessive (including the length of
mandatory traineeships) and for which easier access could unlock further
employment creation and growth.

Energy, climate and resource
efficiency

Despite
improvement in the last few years, the Czech Republic has still one of the
highest energy and carbon intensities in the EU.[37]
The potential for energy savings is substantial,
especially in the buildings and industry sectors.[38] Current plans
to improve energy efficiency show only limited ambition as they target to
achieve only about a third of the potential energy savings attainable through
higher energy efficiency.[39]
Lack of an integrated energy efficiency strategy and of strong coordination
capacity is a major limitation for further improvement. Such a strategy would
bring a long-term vision and the sectoral prioritisation required to
effectively allocate available resources and identify adequate tools.[40] The Czech Republic has not set an indicative
national energy efficiency target as required under the Energy Efficiency
Directive,[41]
and has not indicated how it will reach an acceptable 2020 level of primary
consumption and final energy consumption. Regarding the efficiency of the
housing sector, funding for the second building-efficiency programme (planned
for another seven-year period) is not fully ensured as it relies on income from
auctioning of ETS allowances, which are difficult to predict. High energy intensity is also reflected in the relatively low
quality of air in the Czech Republic. The Czech Republic has repeatedly
exceeded EU standards for PM10[42]
over the past few years in numerous regions. Following the adoption of the
Clean Air Act in 2012, the Czech Republic must prepare a new national emission
reduction programme in 2013.

Regarding
renewable energy, the Czech Republic achieved its 2011/12 interim target
already in 2009 but progress has slowed significantly since, mainly due to a moratorium put in place in 2010 for connecting new
renewable energy sources to the electricity grid. The main source of renewable
energy remains biomass used for heating. In electricity generation, renewables
amount only to 7 % (the EU average is 17 %), of which most stems from
hydropower and biomass co-firing.[43]
The National Renewable Energy Action Plan outlines some measures to develop
renewable energy sources but these are not considered to be strong in all
sectors, particularly in transport and grid reinforcements. The 2013 NRP
mentions plans to revise and stabilise the legislation concerning RES in 2013.

The Czech Republic has a large implementation gap concerning the national waste management
policy as it still relies heavily on landfilling of municipal waste.[44]
Despite encouraging progress on recycling and
composting, municipal waste generation increased in 2008-10, contrary to the
general tendency in the EU-27. A pending amendment to the national Waste Act
entails a gradual increase in fees for landfilling, which would be one of the
relevant steps towards putting the ‘waste hierarchy’ in place, even though
income from landfilling fees is already relatively high. Embedding this in the
updates of the National Waste Plan and in the Waste Prevention Programme
planned for 2013 would strengthen the credibility of the authorities’ effort.

Transport

The capacity
limitations of the transport infrastructure are one of the bottlenecks to
growth. The lack of effective interconnections
between railways and other modes of transport also adversely affects transport
performance. The railway network is extensive but under-maintained. Several
regional railway connections have been discontinued recently due to
unprofitability.

The 2011 and
2012 NRPs outlined an ambitious list of rail and highway projects, with further
plans to develop transport infrastructure in the 2013 NRP. The progress achieved is, however, limited and future prospects are
uncertain due to cuts in transport infrastructure investment.[45] In addition,
infrastructure projects are often not very effective and efficient, due to non-compliance
with public procurement rules, increasing costs of ongoing projects, and the lack
of economic analysis and a systematic approach in the planning. In the first
half of 2013, the government is planning to adopt the second phase of the
Transport Sector Strategy and a new transport policy for 2014-20, both of which
are relevant steps towards better strategic planning. The new transport
strategy is expected to include measures to improve interoperability in urban,
public passenger and rail transport through better use of intelligent transport
systems and innovative technologies. On the positive side, for certain
connections the opening of the railway market to private operators has
contributed to more competition, lower prices and better services to
passengers. Overall, though, competition is still limited and further opening
of the railway sector, together with full separation of transport and
infrastructure operations, is necessary.

3.5.
Modernisation of public administration

Efficiency and
quality of public administration remains a challenge in the Czech Republic. Key problems highlighted in business surveys include excessive red
tape, corruption, low enforceability of law, frequent changes in the legal
framework, instability and inefficient public spending. The Transparency
International Corruption perception index for the Czech Republic improved
slightly in 2012, moving up to 54th place in 2012 from 57th place in 2011;
however, the country’s position in the EU ranking has remained the same, at
21st place, for the last three years.

Limited
progress has been made on the need to step up the fight against corruption, as
stressed in the 2012 country-specific
recommendation on public administration. Most of
the non-legislative measures have been taken but progress in adopting the
priority legal acts in the anti-corruption strategy for 2011-12 is very slow
(e.g. on independence of the state prosecution, conflicts of interest, freedom
of information, creation of specialised courts, regulation of lobbying, the
Public Servants Act, financing of political parties); in some cases the
adoption process has been stopped in the Czech parliament (extension of powers
of the Supreme Audit Office, protection of whistleblowers).[46] A new anti-corruption strategy for 2013-14, adopted by the government
in January 2013, and the 2013 NRP retain the intention to adopt the priority
acts.

The Public Servants Act, called for in the 2012 recommendations, has not
been adopted. A draft version of the act, prepared
after the inter-ministerial consultation process in April 2013 and to be
discussed by the government in 2013, retains significant weaknesses, despite
some improvements compared to previously presented draft versions. The new
draft does not seem to adequately assuring the objective of separating political
appointees from non-political staff, guaranteeing independence and stability of
state officials and creating a well-functioning career system. In this regard,
the Public Servants Act falls short of the Act on Public Service which was
adopted in 2002 but has not entered into force due to several postponements and
is to be replaced by the new Public Servants Act. The quality of the public
administration is one of the ex-ante conditionalities for the use of the EU funds
in the new programming period 2014-20. The 2013 NRP retains the intention to
prepare a new public servants act.

The Czech Republic has made substantial progress in implementing the Public Procurement Act, as
recommended in 2012. The amendment to the Act has
been in force since April 2012 and additional implementation rules for the act
were adopted in 2012. Recent monthly data suggest that the number and value of
new public tenders is closer to the average for the last two years, indicating
that initial difficulties with implementation have been overcome. However, only
limited efforts have been made to address difficulties in implementing the Act
reported by local authorities, in particular the lack of administrative
capacity and of guidance that would speed up and smooth the process.

Some progress
has been made on improving the implementation of EU funds, in line with the
2012 recommendation. Due to irregularities in projects
financed from EU funds, financial corrections were applied in 2012. An action
plan to strengthen the management and control system of the implementation
structure for the European Regional Development Fund (ERDF) and the Cohesion
Fund (CF) was agreed with the Commission and most of the measures included in
it were implemented by the end of 2012. However, fulfilment of the action plan
will need to be continuously monitored. In March 2013, in addition to the three
programmes with payments from ERDF/CF stopped fully or partially at the end of
2012, payments were stopped fully or partially for another six Operational
Programmes, with further possible financial corrections under discussion. The
vast majority of deficiencies in the implementation of EU funds stem from a
weak public administration, inadequate legislation dealing with conflicts of
interest, lack of transparency in the ownership structure of participating
companies, and bypassing of public procurement legislation.

Substantial progress has been made on the issue of anonymous paper shares,[47]
highlighted in the 2012 recommendations. The lack
of transparency regarding the ownership of firms with anonymous shares
encourages corruption, money laundering and tax evasion. In December 2012, 53.5 %
of joint stock companies in the Czech Republic had only paper bearer shares and
41.7 % had only registered paper shares according to the Czech Capital
Information Agency. An act that regulates anonymous paper shares was approved
by the parliament in May 2013. According to the proposed
act, unless firms enter the paper bearer shares in a central depository or
deposit them in a bank, they would be converted into registered paper shares.
The regulation enables selected public authorities to request information on
ownership of the paper bearer shares deposited in banks and the central
depository. While the act is a step in the right direction, extending the right
to request information to other public authorities, in particular the
competition authority, would further improve the situation. Also, requiring
third party registration for all types of shares, including registered paper shares,
would help increase transparency. Importantly, the new citizen’s code effective
from 2014 introduces a new form of property ownership, the so-called ''svěřenecký fond' trust with limited transparency on the user of and beneficiary of
proceeds from property, including shares. This step seems to go against the
direction of the proposed changes in anonymous shareholding.

4.
 Overview
table

2012 commitments || Summary assessment

Country-specific recommendations (CSRs) ||

CSR 1: Ensure planned progress towards the timely correction of the excessive deficit. To this end, fully implement the 2012 budget and specify measures of a durable nature necessary for the year 2013 so as to achieve the annual average structural adjustment specified in the Council recommendation under the excessive deficit procedure. Thereafter, ensure an adequate structural adjustment effort to make sufficient progress towards the MTO, including meeting the expenditure benchmark. In this context, avoid across-the-board cuts, safeguard growth-enhancing expenditure and step up efforts to improve the efficiency of public spending. Exploit the available space for increases in taxes least detrimental to growth. Shift the high level of taxation on labour to housing and environmental taxation. Reduce the discrepancies in the tax treatment of employees and the self-employed. Take measures to improve tax collection, reduce tax evasion and improve tax compliance, including by implementing the Single Collection Point for all taxes. || Some progress The general government deficit target of 2.9 % of GDP in 2013 is in line with the deadline for correcting the excessive deficit set out in the Council recommendations. The 2013 spring forecast projects a headline deficit of 2.9% of GDP in 2013. The average annual fiscal effort of 1.4% of GDP over the period 2010-2013, based on the (recalculated) structural budget balance, is above the effort of 1 % of GDP recommended by the Council. Some progress was made on decreasing the size of across-the-board cuts and of cuts in growth-enhancing expenditure. In 2013, the government adopted plans to streamline the state administration in 2014-15 and expenditure on R&D is set to increase. Some progress on taxation. A package of tax measures adopted in December 2012 increased indirect taxes (VAT and excise duties) and property taxation (real estate transactions) and reduced limits on deductible expenses for the self-employed. The package also included temporary measures increasing labour taxation and also the progressivity of the system. No measures on environmental taxation and recurrent real estate taxes were adopted and current plans are likely to be delayed. Limited progress on tax collection and compliance. Measures were adopted to limit VAT fraud and the introduction of a single collection point for income taxes is envisaged for 2015. This does not, however, exploit the room to reduce the administrative burden from paying taxes and its effective implementation is subject to risks.  ||

CSR 2: Introduce further changes to the public pension scheme to ensure its long-term sustainability. Reconsider plans to allow an earlier exit from the labour market. Promote effective participation of younger workers in the envisaged funded scheme to improve adequacy of pensions. || No progress No progress made on pension system sustainability. As part of the consolidation package, indexation of pensions was lowered. The Czech Republic introduced an early retirement scheme, which goes against policies to extend working lives. Participation in the newly launched fully funded pillar is below expectations. The pillar has still to prove its viability.  ||

CSR 3: Take additional measures to significantly increase the availability of affordable and quality pre-school childcare. || Limited progress The draft law on pre-school childcare is to be adopted by the government in 2013. The law facilitates the provision of private childcare and introduces tax incentives for companies and families. Broader provision, affordability and adequate quality of the new facilities may not be ensured. No additional capacities in public childcare were provided. ||

CSR 4: Strengthen PES by increasing the quality and effectiveness of training, job search assistance and individualised services, including of outsourced services. || Some progress The reform of the public employment service was adopted in 2011 and implemented throughout 2012, the effects of which should materialise in the medium term. Additional support is also being granted from various European Social Fund projects aimed at improving provision of assistance, quality and accessibility of services, etc. Two new activation programmes for safeguarding jobs and training were put in place in 2012. Plans to increase employment service staff and improve evaluation were announced. The outsourcing of employment services should be revised in 2014. ||

CSR 5: Adopt and implement as a matter of urgency the Public Servants Act to promote stability and effectiveness of the public administration in avoiding irregularities. Ensure adequate implementation of the new Public Procurement Act. Address the issue of anonymous share holding. Ensure correct implementation of EU Funds and step up the fight against corruption. || Some progress Limited progress fighting corruption. Key measures from the 2011-12 anti-corruption strategy not adopted. Plans retained with delay in implementation in the 2013-14 strategy. Limited progress on the Public Servants Act: a new proposal from April 2013 retains important weaknesses. Substantial progress in implementation of the Public Procurement Act with scope for providing further support for administrative capacity at local and regional level. Substantial progress in addressing anonymous shares issue: An act regulating anonymous shares from 2014 was approved by parliament in May 2013. According to the act, unless firms enter the paper bearer shares in a central depository or deposit them in a bank, they would be converted into registered paper shares. Information on ownership of unregistered bearer shares will be made available to selected public authorities. Scope for greater transparency by requiring third party registration for all types of paper shares. Some progress on EU funds implementation. Implementation of an action plan on EU funds control system agreed with the Commission. Problems in reimbursement of EU funds occurred again in March 2013 and measures adopted in 2012 on the level of irregularities in EU projects have yet to show a positive impact. ||

CSR 6: Adopt the necessary legislation to establish a transparent and clearly defined system for quality evaluation of higher education and research institutions. Ensure that the funding is sustainable and linked to the outcome of the quality assessment. Establish an improvement-oriented evaluation framework in compulsory education. || Limited progress The system for evaluating the quality of higher education institutions has changed only marginally over the reporting period. Further progress is expected from the implementation of the higher education reform, which is planned to be adopted in 2013. The link between quality and funding was strengthened somewhat in 2013 but no further steps are envisaged in the near future. A framework that would define and integrate the responsibilities and capacities of the state, funding bodies, headmasters and teachers in improving quality in compulsory education has not been put forward. Measures to strengthen the evaluation of educational outcomes and quality of teaching in compulsory education are under preparation (nationwide testing from 2014 and new career system for teaching staff announced), but systemic support to underperforming pupils and teachers is yet to be organised. ||

Europe 2020 (national targets and progress) ||

Employment rate target set in the 2011 NRP: 75 % || Employment rate: - 2011: 70.9 % - 2012: 71.5 % Given the relatively high employment rate, the target/sub-targets are within reach; however: - there is a lack of substantial progress in key areas such as childcare provision, activating parents with small children, or strengthening the public employment service; - the increase in the effective taxation of working pensioners and the elimination of the current lower statutory minimum wage levels applicable to those aged 18 to 21 and to the disabled as of January 2013 are measures that may cause small job losses.

R&D target set in the 2011 NRP: 1 % || ||

Greenhouse gas (GHG) emissions target: limit the increase to +9 % (compared to 2005 emissions, Emissions Trading Scheme emissions are not covered by this national target). || Change in greenhouse gas emissions not covered by the Emissions Trading Scheme between 2005 and 2011: -6 % According to the latest national projections submitted to the Commission and taking into account existing measures, the target is expected to be reached: -6 % in 2020 compared to 2005 (with a projected margin of 15 percentage points). ||

Renewable energy target: 13 % Share of renewable energy in all modes of transport: 10 % || The share of renewable energy sources in gross final energy consumption was 9.4% in 2011 and 0.6 % in the transport sector. (Source: Eurostat. April 2013. For 2011, only formally reported biofuels compliant with Art. 17 and 18 of Directive 2009/28/EC are included). ||

National indicative energy efficiency target for 2020: not notified || The Czech Republic has failed to notify its energy efficiency target as required by Articles 3 and 24 of the Energy Efficiency Directive. ||

R&D target (public funding of R&D): 1 % || Strong increase from 0.63 % in 2010 to 0.70 % in 2011. ||

Early school leaving target: 5.5 % || Early school leaving rate: 5.5 % in 2012. ||

Tertiary education target: 32 % || Tertiary attainment: 25.6 % in 2012. The country, having very high enrolment rates in tertiary education, is assigning higher priority to improving quality than to further increasing the number of students. ||

5.
Annex

Table I. Macroeconomic indicators

Table II. Comparison
of macroeconomic developments and forecasts

Table III. Composition of the budgetary adjustment

Table IV. Debt dynamics

Table V. Sustainability indicators

Table VI. Taxation indicators

Table VII. Financial market indicators

Table VIII. Labour market and social
indicators

Table IX. Product market performance and
policy indicators

Table X. Green Growth

[1] COM(2012) 750 final.

[2] COM(2012) 751 final.

[3] 13 in-depth reviews were published on 10 April 2013. While selected
for an in-depth review in the AMR, Cyprus was ultimately not reviewed under the
Macroeconomic Imbalance Procedure in view of the advanced preparations for a
financial assistance programme.

[4] Cyclically adjusted balance net of one-off and temporary measures,
recalculated by the Commission on the basis of the information provided in the programme,
using the commonly agreed methodology.

[5] The Czech Republic has a sustainability gap of 5.0 % of GDP,
which is above the EU average (3.0 %). Compared to the 2012 Fiscal
Sustainability Report, the gap has narrowed by 0.5 pps.

[6] The statutory retirement age for women with two children is set to
reach 61 and 8 months in 2020. According to current legislation, the gap in
statutory retirement ages between men and women, including the differentiation
according to the number of children, is set to close fully in 2041.

[7] The statutory retirement age in the Czech pension system is set to
increase by two months (and more) per cohort of birth without any predefined
limit. However, the absence of any clear and direct link to life expectancy
exposes the system to the risk of under- or over-reaction to future changes.

[8] The established early-retirement scheme currently allows workers to
retire up to three years before reaching the statutory retirement age. The
period is set to increase to five years once the statutory retirement age
reaches 63 (subject to a lower limit of 60 years of age).

[9] See Joint EC(ECFIN)-EPC Report on Health Systems (2010).

[10] See Joint EC(ECFIN)-EPC Report on Health Systems (2010). The number
of acute hospital beds per 100 inhabitants is 4.9 in the Czech Republic, compared to the EU average of 3.7; the average length of stay is 7 days (versus 5.9
in the EU) and the share of day-case surgery is 5 % versus 23 % in
the EU.

[11] At 39.3%, the tax wedge
on low-income earners (singles at 67% of the average wage) was the tenth
highest in the EU in 2012.

[12] Flat-rate expenses deductions were limited to CZK 800 000 per
year for activities in the category eligible for 40 % flat-rate expenses
deductions and to CZK 600 000 per year for activities in the category
eligible for 30 % flat-rate expenses deductions.

[13] The share of self-employed in total employment has been increasing since 1995 and stood at 17% in 2011 (sixth highest in the EU).

[14] OECD (2011): Tax Administration in OECD and Selected Non-OECD
Countries.

[15] See the 2011 OECD Forum on Tax Administration Report for evidence
of the size and cost of administration per net revenue and the
PricewaterhouseCoopers 2013 Paying Taxes Report for estimates of the compliance
burden on businesses.

[16] PwC 2013 Paying Taxes report

[17] This measure follows an internal reform of the tax administration,
which started in 2011 with its headquarters being split off from the Ministry
of Finance into a separate entity. In 2012 a specialised unit was created for
large taxpayers and in 2013 some of the principal tasks (including planning of
tax inspections) were shifted from local to regional level. This substantial
reform, once settled, is expected to harmonise the practical and methodological
aspects of the work of tax offices.

[18] EPC Aging Working Group: 2012 Ageing Report.

[19] In 2012 the employment rate (20-64) was 62.5 % for women and 80.2 %
for men, with the high gender employment gap standing at 17.7 pps (EU: 12.2 pps).
The gender employment gap is high among young employees (e.g. among 30-34
year-olds it reaches 34.3 pps; EU: 13.7 pps) but the figures are also very high
with respect to older employees (55-64) where the gap stands at 21.3 pps (EU: 14.6
pps).

[20] The gender pay gap was 21 % in 2011, one of the highest in the
EU (16.2 %).

[21] In 2011, only 5 % of children under three years of age are
cared for in formal childcare, below the EU average of 29 %.

[22] Closing the Gender Gap. Act Now, OCED 2012. OECD Publishing.

[23] The projects ‘Traineeships in companies — education through practice’
and ‘Get trained for stability’ are being carried out under the ESF in 2012-14.

[24] The share of tertiary graduates among young people aged 30-34
increased by more than 95 % between 2006 (13.1 %) and 2012 (25.6 %).

[25] See the 2009 results of the OECD PISA
Report. However, latest data
from 'Trends in International
Mathematics and Science Study'
(TIMMS) and 'Progress in
International Reading Literacy Study' (PIRLS) suggest that the downward trend
could have been reversed recently.

[26] Computer tests are likely to be biased in favour of a narrow range
of competences. There is also a risk that teaching will become excessively
focused on the topics tested. See SWD 2012 for further details.

[27] FRA Roma Pilot Survey 2011; UNDP/World Bank/EC Regional Roma survey
2011.

[28] See Czech School Inspection Report (2012) ‘Postup transformace
bývalých zvláštních škol ve školním roce 2011/2012’. According to the 2011
UNDP/WB/EC survey, early school leaving among young Roma (18-24) in the Czech Republic is above 90 %.

[29] The National Roma Integration Strategy for
2010-2013, and the Strategy on the Fight Against Social Exclusion 2011-2015.

[30] In terms of patent applications under the Treaty, the Czech Republic ranks 18th in the EU with a normalised value (per GDP) of 22 % of the
EU average. Regarding licence and patent revenues from abroad, it ranks 20th in
the EU with a normalised value (per GDP) of 9 % of the EU average.

[31] The Czech Republic ranks 21st in the EU with only 5.5 % of all
Czech scientific papers published in the 10 % most cited scientific
publications worldwide (‘high impact scientific publications’), compared to the
EU average of 10.9 %. Only 1 % of the R&D carried out by
universities is funded by the business sector (and only 3.4 % in the case
of R&D carried out by other public research institutions).

[32] The Intergovernmental Steering Committee coordinates the
implementation of the International Competitiveness Strategy, while the Council
for R&D and Innovation advises the Prime Minister on related matters.

[33] World Bank Doing Business 2013 ranks the Czech Republic in 140th place (out of 160 countries) in terms of the ease of starting a business.

[34] World Bank, Doing Business 2013.

[35] European Commission study ‘Business Dynamics: Start-ups, business
transfers and bankruptcy’ 2011.

[36] See Commission website: http://ec.europa.eu/internal\_market/qualifications/regprof.

[37] Energy intensity in the Czech Republic stood at 383 kgoe/k€ in
2005-10, more than twice the EU-27 average (153 kgoe/€). Accordingly, with
a 1.2 t CO2 equivalent/1000 €, the carbon intensity
of the Czech economy is more than twice the EU average (source: Eurostat).

[38] All key sectors of the economy, including industry, transport, and
housing, display significantly lower performance in terms of energy and carbon
efficiency than the EU average (with an energy intensity of 263 toe/k€ against an
EU average of 150 toe/k€, 627 toe/k€ against an EU average of 512 toe/k€ and
112 toe/k€ respectively). Nevertheless, the planned energy savings announced in
the second National Energy-Efficiency Action Plan (NEEAP) are particularly low
for the buildings and industry sectors compared to their potential (source:
Commission’s Energy Efficiency Database).

[39] The Czech Republic reported only small planned energy savings for
2016 in its second NEEAP. For a comparison with potential savings, see the Commission
Energy Efficiency Database.

[40] See STE Research Report (2011) by Forschungszentrum Jülich.

[41] Article 3 of the Energy Efficiency Directive requires Member States
to report their national energy consumption targets before 1 May 2013.

[42] PM 10 (particulate matter) values became mandatory in 2005 in
accordance with the Air Quality Directive.

[43] Member States’ energy dependence: an indicator-based assessment, 13
December 2012 (country factsheets).

[44] See DG Environment website on ‘Support to implementation — municipal
waste’.

[45] Total investment expenditure in transport infrastructure stood at CZK
83 billion in 2008 and CZK 44.4 billion in 2011 (Transport Yearbook Czech
Republic 2011).

[46] Implementation report on the 2011-12 strategy from 2012.

[47] Czech legislation allows the existence of specific types of shares:
paper bearer shares (listinné akcie na majitele/doručitele), ownership
of which is determined by the physical holding of the paper share and which are
not registered anywhere, and registered paper shares (listinné akcie na
jméno), ownership of which is determined by the list of shareholders
held by the company. Both registered shares and bearer shares can also exist in
a book-entry form registered in the central depository.

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