* Czechs see lower budget revenue despite repeated hikes* Economy in recession, eroding benefit of low borrowing costs* Consumers on defensive, some seek lower prices abroad* Cautionary tale for austerity-minded governmentsBy Jan LopatkaPRAGUE, July 27 There is a Czech saying that goes "if brute force doesn't work, try even more brute force". And it is this path that the country's government has taken to slash its budget deficit, even as evidence shows that it is not working. The Czechs' strategy, at a time of general economic weakness, of piling up new tax hikes has helped to put thrifty consumers on the defensive, contributing to the country's slide back into recession and halting deficit shrinkage. It did not have to be this way. With debt of only around 40 percent of annual output, the Czechs are seen more like Germany than Greece or Spain. They embraced austerity on their own volition rather than under market pressure. The Czech example provides food for thought in the debate raging around the world over whether austerity or stimulus holds the key to future prosperity in the present economic climate. The tone of that debate is shifting from a previous emphasis on slashing deficits to greater recognition of the need to promote growth, after austerity campaigns from economies as diverse as Greece and Britain have choked growth and prevented recovery from taking hold. Prime Minister Petr Necas's centre-right cabinet has won plaudits from investors for his determination to cut the Czech deficit, which is now just over the European Union's prescribed ceiling of 3 percent of gross domestic product. His reputation as a cost cutter has pushed bond yields to all-time lows. With yields of just 2.319 percent on 10-year bonds - far below the Czechs' regional peers or many euro zone states - it has saved billions of crowns on debt servicing. But it has also prompted Czechs to put off big purchases and seek lower prices abroad, cutting tax revenue. The government had factored that in. But now its hope that low borrowing costs can outweigh lost revenue due to weaker growth are fading."The tax burden is beyond the bearable boundary, and every further tax increase lowers state revenue," Tomas Prouza, an economist at consultancy Partners who was a deputy finance minister in a leftist government from 2004 to 2006, wrote in an article this week.
"At a time ... when we are dangerously dependent on the German economy and when it is being shown clearly that blunt cuts and savings at all costs are a path to hell, the steps of the Necas cabinet are becoming a danger for the long-term health of the Czech economy."The economy shrank 0.8 percent in the first quarter, the second quarter of decline, as a 2.3 percent fall in household spending combined with falling demand in the euro zone - the main market for the Czechs' dominant export sector. PUSHING ON WITH AUSTERITY There is a consensus that Czech public finances, which like those of most EU states are hobbled by the health and pension costs of an ageing population, need a fix. Necas and Finance Minister Miroslav Kalousek have focused largely on value-added tax (VAT), a less volatile option than income taxes on profits, and revenue that is relatively easy to collect. For this year, the government hiked the lower VAT rate to 14 percent from 10, keeping the top rate at 20 percent. The assumption was that the hike and higher growth would raise VAT revenue by 15.5 percent to 221.6 billion crowns.
But the reality has been strikingly different. State budget data for January to June showed that VAT collection actually dropped 2.6 percent to 92.14 billion crowns, just 41.6 percent of the full-year target. Aiming to cut the deficit to below the EU's ceiling of 3 percent of gross domestic product in 2013, the lower house of parliament approved a bill to hike the VAT rates again next year to 15 and 21 percent. That was followed by other planned hikes for 2013, including a hefty income tax increase for workers making over 4,000 euros a month. The moves have drawn fire from backbenchers in Necas's Civic Democrat party, which has watched the moves hit its popularity."We are going against the interest of our voters. On top of that, tax hikes do not work - they only raise inflation, strangle growth and in the end lower the tax intake," said MP Petr Tluchor, when the law was before parliament. CUTTING BACK
Retail experts say Czechs have begun to economise by shopping abroad, including for items such as food that are taxed less in neighbouring states like Poland."Some retailers say they have 60 or even more percent of customers from the Czech Republic," said Jaromir Beranek, of Mag Consulting, an advisory firm focused on shopping tourism, referring to some firms across the border in Germany and Poland. It would not be the first time tax hikes have backfired. In 2010, a much-criticised petrol tax rise led truck drivers to buy fuel abroad, hurting both tax revenues and the fuel business. Finance Minister Kalousek - who has repeatedly warned in recent years that the Czech Republic could go the way of Greece if it didn't tackle its debt and deficits - argues otherwise. He says households have cut consumption, but mostly by shifting purchases to the lower-tax food category from higher-taxed durables and services, such as eating out. He said technical changes to tax collection made this year's first half look weak, and the second half would improve. Other data shows consumers are heavily on the defensive. The consumer confidence index dropped to 14-year lows in the first half of 2012, hitting bottom in May. Retail sales fell from March to May, indicating further contraction in the second quarter. Vojtech Benda, senior economist at ING Commercial Banking in Prague, said it is not only the tax hikes, but the overall economic weakness that is causing a consumer lockdown. He said the government could miss out on some 35 billion crowns in VAT collection this year, or 16 percent of the total goal."Households have reacted not only to the rise in prices but to the overall perception of the economy. The motif of caution has been very strong," Benda said. The government has stuck to its plans on the tax hikes, but has shown signs that it is concerned it may be choking growth. Last week, it announced cuts to its three-year GDP forecasts and said it would ease off on austerity, allowing deficits in 2014 and 2015 to go above previous targets."There is a big risk that tightening the fiscal consolidation would be counterproductive," Kalousek said.