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Cablegate: Czech Government Wins First Legislative Test in Passing

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OO RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHPG #0973/01 2361421
ZNR UUUUU ZZH
O 241421Z AUG 07
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC IMMEDIATE 9524
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY

UNCLAS SECTION 01 OF 02 PRAGUE 000973

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: PGOV PREL EZ ECON EFIN
SUBJECT: CZECH GOVERNMENT WINS FIRST LEGISLATIVE TEST IN PASSING
REFORM PACKAGE

Ref: A. Prague 939
B. Prague 698
C. Prague 359

1. (SBU) Summary: On August 21, the Czech lower chamber approved the
government's public finance reforms, securing the first serious
legislative victory for the Topolanek government. Despite
protracted behind-the-scenes lobbying among coalition partners, one
coalition MP defected and voted against the controversial bill.
Starting next year, the legislation will gradually reduce corporate
and personal income taxes, cut social spending and introduce fees
for health care. The bill still requires Senate approval and
President Vaclav Klaus's signature, but no resistance is expected
from either. However, debate over economic reform will continue
with the 2008 budget bill and additional reform legislation next
year. End Summary.

2. (U) Of the 200 deputies, 101 backed the reform package (99 of the
100 coalition MPs and former Social Democrats Milos Melcak and
Michal Pohanka, now unaffiliated). Ludvik Hovorka (Christian
Democrat) was the only coalition deputy to vote against the
proposal; Hovorka, who is one of the most left-leaning of the
Christian Democrats, found the reforms too harsh. All 98 opposition
Social Democrat (CSSD) and Communist deputies voted against. The
opposition refused to back the proposal, saying the reforms would
not curb the deficit as the government claims, and they would harm
most people economically. CSSD leader Jiri Paroubek said his party
would revise the economic reforms once it returns to power.

3. (SBU) The tight vote in the lower chamber was preceded by two
weeks of exhausting coalition negotiations. Although the draft
reform bill passed in the first reading with the votes of all
coalition MPs, several of them threatened later that they would not
support the bill in the final reading unless their changes were
incorporated during the second reading. The most vociferous voices
were Hovorka and former Finance Minister Vlastimil Tlusty (ODS).
Unlike Hovorka and the opposition, Tlusty and a few other ODS MPs
criticized the government reform bill for not going far enough in
reducing tax rates. Tlusty and the other ODS MPs voted for the
reform after they won agreement to lower tax rates below the
original government proposal. But after the bill passed its second
reading in mid-August, Tlusty and his supporters discovered further
concerns in terms of tax deductions they did not like; they secured
a promise from PM Topolanek that the government would propose
revisions to remedy these next year. On the other hand, Hovorka did
not accept any compromise solutions offered to him by coalition
negotiators and eventually voted against the reform bill. While the
tensions with Tlusty and Hovorka did not prevent passage of the bill
that Topolanek had at one point said he would stake the fate of the
government on, the difficulty in winning passage, and particularly
the failure to bring Hovorka on board, suggests the government could
face further problems in parliament. On the other hand, the two
CSSD "renegades" proved their reliability on this vote.

-----------------------
REFORM PACKAGE CONTENTS
-----------------------

4. (U) Despite the fact that the fiscal problems preventing early
Czech Republic Euro adoption (target date postponed from 2009 until
2012) are based on the expenditures side (general social benefits),
most of the public debate over the reform bill has been focused on
the income side (tax cuts, which have long been an ODS priority).
Personal income tax rates will be cut to a flat rate of 15% for all
income levels in 2008 and to 12.5% in 2009, corporate tax will be
cut to 21% in 2008 and to 19% in 2009 from the current 24%, and the
lower of the two VAT brackets for "basic goods" will be increased
from 5% to 9% while the second VAT rate for "luxury goods" will
remain at 19%.

5. (U) There is strong consensus among economists that something
must be done about public finances and that while this reform
package is better than nothing, it can hardly be considered
"radical" reforms. Instead of using increased revenues from changes
to the VAT rate to finance the deficit, the government will use it
to offset the income and corporate tax cuts. Private sector
economists predict the reform package will yield a general
government deficit of 4.5%/GDP. (Note: Maastrich convergence
criteria = 3%/GDP. End Note) While economists lament the continued
lack of fiscal discipline, the business sector is thrilled by the
corporate tax cuts that will put the Czech Republic on par with
neighboring Slovakia's corporate tax regime.

6. (U) On the expenditures side, effective 2008, there will be a cap
on social taxes at USD 4,000/month, the retirement age will increase
to 65, birth allowances will be reduced, maternity allowances will
decrease after two years, the parental allowance will be limited to
lower income brackets, benefits for parents with children entering
the first grade will be abolished, and for the first time, people
will pay a nominal fee for doctor's visits. Effective 2009, the
first three days of sick leave will not be paid at all and sickness

PRAGUE 00000973 002 OF 002


benefits will increase after the 30th day to help individuals with
long-term care issues. This is to address the fact that he Czech
Republic currently has one of the highest number of sick leave days
taken among EU countries.

7. (SBU) Comment: Debate over public finance reform will continue as
the 2008 budget is expected to be presented to Parliament in
September, and looming down the road are a pension reform bill by
the end of 2007 and a health care reform bill in 2008. In addition,
to appease ODS Deputy Chair Vlastimil Tlusty, who has been a
relentless thorn at PM Topolanek's side, the government agreed to
amend the reform package within six months. However, current
Christian Democrat Finance Minister Kalousek, even after voting in
favor of the reform package that cuts personal income tax to a flat
rate of 12.5% in 2009, has said publicly that he does not believe
the income tax rate should be lower than 15% due to budgetary
implications. Given this kind of internal battles within the ruling
coalition, we can expect further drama in Parliament in the near
future.
GRABER

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