REPORT ON THE LONG-TERM SUSTAINABILITY OF PUBLIC FINANCES

REPORT ON THE LONG-TERM SUSTAINABILITY OF PUBLIC FINANCES

The 2022 Report on the Long-Term Sustainability of Public Finances (the “Report”) was prepared at a time when the economy had recovered from the immediate consequences of the COVID-19 pan- demic. However, the pandemic significantly affected public finances on both the revenue and expenditure side. Scarcely had the situation started to calm down after the pandemic when Russian federation invaded Ukraine. This triggered a large migration wave and generated a negative supply shock stemming from growth in prices, especially of energy and food. The events of 2020–2022 show what impact an accumu- lation of one-off shocks and a short period of expan- sionary fiscal policy can have on the long-term sus- tainability of public finances.

Section 2 of the Report indicates that public finances faced great pressure in 2021 in spite of a partial re- newal of economic growth. The general government sector recorded a deficit of 5.9% of GDP for 2021, the largest since 2003. The medium-term outlook is also negatively affected by the previous relaxation of the Act and by the fact that many of the measures adopted during the COVID-19 pandemic are of a more lasting nature than the pandemic itself, and some were often not even directly related to it.

In a box on the Potential implications of EU climate policy for Czech public finances in section 2, we out- line the challenges arising from the European Green Deal, which sets the goal to reduce greenhouse gas emissions. As the Czech Republic is one of the larg- est greenhouse gas emitters per capita in the EU and also has one of the lowest environmental tax reve- nue-to-GDP ratios in the EU, these impacts could be substantial.

In section 3, as usual we describe the macroeco- nomic assumptions of the long-term public finance projection. First, we assume real convergence of the Czech economy, growth in labour productivity and a rising ratio of wages to gross value added. The second key parameter is the demographic projection of the Czech Statistical Office (CZSO), which we ad- just for actual population growth. This adjustment re- flects a higher gross birth rate, higher net migration and above all a substantially higher gross mortality rate linked with the indirect impacts of the COVID-19 pandemic. Almost 44 thousand more people died during 2020 and 2021 than the CZSO’s 2018 demo- graphic projection had predicted. We analyse the im- pacts of this change in detail in a box on changes in the demographic projection, where we also discuss the effect of a methodological change connected with the 2021 Census leading to a reduction in the total population by almost 207 thousand. This demographic change implies an improvement in the long-term public finance sustainability parameters (a decrease in the dependency ratio from 2.95 in 2020 to 2.82 in 2021). However, a strong population ageing trend persists in the long run.

Population ageing is reflected primarily in the sus- tainability of the pension system (section 4.1). If the parameters of the pension system are left un- changed, the share of old-age pension expenditure in GDP will increase from the current 7.5% to 11.5% over the next 40 years. The most recent changes to the parameters of the pension system have generally tended to increase its expenditures. In a box on the new replacement rate estimation method, we illus- trate, for example, the increase in the initial replace- ment rate for 2022 (from 40.7% in 2021 to 43.1%) stemming primarily from how pensions have been valorised in response to the sharp growth in prices and the effect of the introduction of a “child-rearing bonus” in 2023. The demographic changes are re- flected in other areas of public finances besides pen- sion system expenditure, most notably health care (section 4.2), education (section 4.4) and the system of cash benefits (section 4.3).

The revenue and expenditure projections are re- flected in the projected debt path, which is described in section 5. Assuming that the current fiscal policy stance does not change, the projected government debt will increase to 296% of GDP at the end of the 50-year projection horizon. Therefore, if there is no change in the current policy, the debt brake threshold (55% of GDP) will be breached as early as 2028. For the government debt to be no higher than the debt brake threshold in fifty years’ time, the primary struc- tural general government balance would have to im- prove by 6.04% of GDP in each year of the projec- tion.

Given the uncertainty associated with the baseline scenario, we have prepared several alternative sce- narios in section 6. These show how the projection would look assuming that the retirement age is linked to life expectancy based on the “quarter of life re- tired” principle or given faster labour productivity growth due to technological progress. Both the alter- native of linking the retirement age to life expectancy and that of faster productivity growth provide lower debt paths, but neither of them in itself leads to long- term public finance sustainability. In our discussion of different demographic variants, we present an al- ternative examining the impacts of the reception and integration of refugees from Ukraine. Section 6 also contains an generational accounts analysis, which reveals that younger generations born mainly in this millennium will bear the brunt of the constant post- ponement of sustainable pension reform.

The whole report is available here and charts here.