Report on the Long-Term Sustainability of Public Finances (Summary)

Report on the Long-Term Sustainability of Public Finances (Summary)

The current Czech Fiscal Council Report on the Long-Term Sustainability of Public Finances shows what impact a short period of expansionary fiscal policy and changes to the fiscal rules can have on the long-term sustainability of public finances. Although the projection in the Report covers a 50-year timescale, the initial conditions set today are fundamental to determining the size of the burden that future generations will have to bear.

The second section of the Report indicates that Czech public finances are currently facing enormous pressure and the COVID-19 pandemic has fundamentally affected the health of public finances. This is due not only to a decline in GDP and related economic measures, but mainly to changes in the long-term settings of fiscal policy – changes often not related to the COVID-19 pandemic itself.

We show in Box 2.1 that the increase in Czech debt during the pandemic completely deviates from the expected path of public debt in the international context. While the Czech government balance was better than the European Union average in 2019 and 2020, the International Monetary Fund’s spring outlook identifies the Czech Republic as the country with the second-highest expected debt growth in the EU.

In the third section, we discuss two of the main assumptions on which we base our long-term projection of public finances. The first is real convergence of the Czech economy, characterised by growth in labour productivity and an increasing share of wages in the economy. The second key parameter is the CZSO demographic projection, which we adjust for the actual development of the population. In Box 3.1, we discuss how the COVID-19 pandemic has affected demographic trends. In the adjusted demographic projection, the observed higher mortality and better migration balance slightly improve sustainability in the short term. However, as can be seen from the fourth section, which provides estimates of the expenditure and revenue sides of public finances, the problem of population ageing persists in the long run. It undermines the sustainability of the pension system. Without a significant change in the configuration of the pension system, the share of old-age pension expenditure in GDP will increase from the current 7.7% to 12.3% over the next 40 years.

The demographic changes are reflected in other areas of public finances besides pension system expenditure, most notably in health care, education and the system of cash benefits. Box 4.2 describes why the reform of the pension system in the form of the proposal submitted to the government in May 2021 will not ensure the long-term sustainability of public finances. Furthermore, as a result of the adjustment of the tax mix, which we discuss in more detail in Box 4.4, the assessment of the long-term sustainability of Czech public finances has deteriorated significantly.

This is confirmed by the projection developed in the fifth section. Assuming that the current fiscal policy stance and other components of economic policy that affect public debt do not change, the projected government debt will increase to 334% of GDP at the end of the 50-year projection horizon. This is significantly more than the 202% of GDP in the previous projection. Therefore, if there is no change in the current policy, the debt brake threshold (55% of GDP) will be breached as early as 2024, i.e. 19 years earlier than we expected in last year’s Report. For the government debt to be no higher than the debt brake threshold in fifty years’ time, the government balance would have to improve by 7% of GDP in each year of the projection.

Under the weight of uncertainty associated with the baseline scenario, we have prepared several alternative scenarios in section 6. These show how the projection would look given different demographic variants, assuming that the retirement age is linked to life expectancy based on the “quarter of life retired” principle or given faster labour productivity growth due to technological progress. According to most of the demographic alternatives, the path of public debt is similar to that in the baseline scenario. Both the alternative of linking the retirement age to life expectancy and that of faster productivity growth provide lower debt trajectories, but neither of them in itself leads to long-term sustainability of public finances. In addition, an intergenerational accounts analysis shows that the greatest burden of the constant postponement of sustainable pension reform will be borne by generations born mainly in this millennium.

The current Czech Fiscal Council Report on the Long-Term Sustainability of Public Finances shows what impact a short period of expansionary fiscal policy and changes to the fiscal rules can have on the long-term sustainability of public finances. Although the projection in the Report covers a 50-year timescale, the initial conditions set today are fundamental to determining the size of the burden that future generations will have to bear.

The second section of the Report indicates that Czech public finances are currently facing enormous pressure and the COVID-19 pandemic has fundamentally affected the health of public finances. This is due not only to a decline in GDP and related economic measures, but mainly to changes in the long-term settings of fiscal policy – changes often not related to the COVID-19 pandemic itself.

We show in Box 2.1 that the increase in Czech debt during the pandemic completely deviates from the expected path of public debt in the international context. While the Czech government balance was better than the European Union average in 2019 and 2020, the International Monetary Fund’s spring outlook identifies the Czech Republic as the country with the second-highest expected debt growth in the EU.

In the third section, we discuss two of the main assumptions on which we base our long-term projection of public finances. The first is real convergence of the Czech economy, characterised by growth in labour productivity and an increasing share of wages in the economy. The second key parameter is the CZSO demographic projection, which we adjust for the actual development of the population. In Box 3.1, we discuss how the COVID-19 pandemic has affected demographic trends. In the adjusted demographic projection, the observed higher mortality and better migration balance slightly improve sustainability in the short term. However, as can be seen from the fourth section, which provides estimates of the expenditure and revenue sides of public finances, the problem of population ageing persists in the long run. It undermines the sustainability of the pension system. Without a significant change in the configuration of the pension system, the share of old-age pension expenditure in GDP will increase from the current 7.7% to 12.3% over the next 40 years.

The demographic changes are reflected in other areas of public finances besides pension system expenditure, most notably in health care, education and the system of cash benefits. Box 4.2 describes why the reform of the pension system in the form of the proposal submitted to the government in May 2021 will not ensure the long-term sustainability of public finances. Furthermore, as a result of the adjustment of the tax mix, which we discuss in more detail in Box 4.4, the assessment of the long-term sustainability of Czech public finances has deteriorated significantly.

This is confirmed by the projection developed in the fifth section. Assuming that the current fiscal policy stance and other components of economic policy that affect public debt do not change, the projected government debt will increase to 334% of GDP at the end of the 50-year projection horizon. This is significantly more than the 202% of GDP in the previous projection. Therefore, if there is no change in the current policy, the debt brake threshold (55% of GDP) will be breached as early as 2024, i.e. 19 years earlier than we expected in last year’s Report. For the government debt to be no higher than the debt brake threshold in fifty years’ time, the government balance would have to improve by 7% of GDP in each year of the projection.

Under the weight of uncertainty associated with the baseline scenario, we have prepared several alternative scenarios in section 6. These show how the projection would look given different demographic variants, assuming that the retirement age is linked to life expectancy based on the “quarter of life retired” principle or given faster labour productivity growth due to technological progress. According to most of the demographic alternatives, the path of public debt is similar to that in the baseline scenario. Both the alternative of linking the retirement age to life expectancy and that of faster productivity growth provide lower debt trajectories, but neither of them in itself leads to long-term sustainability of public finances. In addition, an intergenerational accounts analysis shows that the greatest burden of the constant postponement of sustainable pension reform will be borne by generations born mainly in this millennium.

Key findings in the baseline scenario are available here.