Oliver Röhn
OECD
OECD Economic Surveys: Czechia 2025
Abstract
The economy returned to growth and the outlook is improving, although risks are elevated. The restrictiveness of monetary policy has been gradually eased as inflation has fallen close to the target but underlying inflationary pressures persist. Fiscal consolidation has appropriately started and should continue in the medium term in line with the national and EU fiscal rules to rebuild fiscal buffers and prepare for long-term spending pressures. Increasing spending efficiency, including by building capacity to regularly conduct spending reviews and by strengthening incentives for overly small municipalities to cooperate or merge, implementing recent pension reforms, and revising family benefits to reduce disincentives for mothers with young children to return to the workplace, can help to improve fiscal sustainability.
The economy resumed moderate growth and inflation fell back close to target
After stagnating in 2023, the economy moderately recovered in 2024. Economic output surpassed the pre-pandemic level in mid-2022, but the economy was hit hard by the repercussions of Russia’s war of aggression against Ukraine. GDP was flat in 2023 as global demand cooled and private consumption contracted on the back of surging prices and tight financial conditions. Moderate GDP growth resumed in late 2023 and continued in 2024 driven mainly by increased household consumption supported by positive real wage growth. At the same time, investment and foreign demand remain subdued, slowing the recovery of Czechia’s export-oriented economy.
High frequency indicators suggest continued growth in early 2025 mainly driven by private consumption (Figure 1.1). GDP expanded by 0.5% in the fourth quarter of 2024 compared to the previous quarter, driven by domestic demand. Retail sales point to a continuation of the recovery in household consumption. Czech exports are dependent on developments in Europe and in the vehicle and other machinery and equipment manufacturing sectors (Figure 1.2). Hence, the slow recovery of external demand, especially from Germany, is weighing on industrial production and exports. The weakness is more pronounced in sectors outside vehicle manufacturing, while the automotive sector has shown resilience (Box 1.1). While supply chain disruptions continue to ease, export-oriented industrial firms perceive insufficient demand as the main factor limiting production. Decreasing policy interest rates (see below) have led to falling interest rates on new loans, and loan growth to the private sector has picked up.
Headline inflation has fallen back close to the 2% inflation target in 2024, but underlying inflationary pressures remain elevated (Figure 1.3). Headline inflation slowed markedly in the course of 2023, on the back of abating food, energy and industrial producer prices, easing supply chain disruptions, and tight monetary policy (see below). Inflation hit the 2% target in the first quarter of 2024. Inflation edged up in the second half of 2024 and stood at 2.8% in January 2025, largely due to volatile food prices and temporary base effects. Service price inflation has declined more slowly and remains elevated (Figure 1.3, Panel C), partly due to strong wage growth. The koruna depreciated mildly against the euro in 2024, exerting limited inflationary pressure.
Despite some cooling, the labour market remains tight (Figure 1.4). Amid weak economic activity the unemployment rate edged up in 2023 and 2024. However, the unemployment rate remains among the lowest in the OECD. Job vacancies have fallen, but labour shortages persist. Shortages are reported in most sectors but are particularly prevalent in construction. Refugees from Ukraine have mitigated labour shortages to some extent, especially in lower-skilled occupations. Czechia received a large inflow of Ukrainians, with about 380.000 refugees (3.5% of the population) under temporary protection at the end of 2024, around a quarter of whom are under the age of 18. In October 2024, almost 150.000 (about 2.8% of total employment) Ukrainian refugees were in employment in the Czech labour market. While a relatively high share of working-age Ukrainians is in employment, they often work in jobs below their qualifications. As a result of the tight labour market and past high inflation, nominal wage growth remains buoyant. Real wage growth turned positive at the beginning of 2024, after two years of decline. At the same time, unit labour cost growth has eased (Figure 1.4, Panel B) and cost competitiveness has improved in recent quarters (Figure 1.1, Panel F).
Note: Panel F: the scale is inverted for relative unit labour costs, so that an increase implies an improvement of cost competitiveness.
Source: OECD Economic Outlook database; Czech Statistical Office.
Exports of goods, % of total, 2023
Source: IMF, DOTS Database; UN Comtrade Database.
Source: OECD Consumer Prices Indices database; Eurostat.
Source: Ministry of Labour and Social Affairs (Job vacancies); Czech Statistical Office (Unemployed persons, Unemployment rate, Employment rate, Real and nominal wages); OECD Economic Outlook database (Unit labour cost).
The automotive sector is a key industry for the Czech economy and has recovered strongly from recent crises. Motor vehicle manufacturing accounts directly for around 4% of total value added and employment (Figure 1.5, Panel A). These shares roughly double if supplying industries are included. Moreover, exports of road vehicles account for about a fifth of total goods exports (Figure 1.2). Despite headwinds from increasing input costs, in particular energy, and shortages of labour and materials in the past two years, the motor vehicle sector has performed better than most other manufacturing sectors, steadily increasing production (Figure 1.5, Panel B).
The Czech automotive sector is closely integrated into global supply and demand chains, with Germany playing a particularly important role. Around half of the value added of Czech vehicle manufacturing exports originates domestically. Inputs from Germany, China and Poland for account for significant share of the value added of Czech exports (Figure 1.5, Panel C), highlighting these countries’ role in the Czech automotive manufacturing supply chain. German demand also plays a key role for Czech production in the vehicle manufacturing sector, with German final demand accounting for 20% of value-added (Panel D). Other important destination countries are France, Poland and China.
The green transition poses challenges to the automotive sector. Czech automotive production is still largely focused on internal combustion engines, even though exports of cars with alternative engines (hybrid or fully electric) have increased rapidly since 2020 and accounted for over a third of all passenger car exports in 2023. The decline in the production of cars with internal combustion engines will imply a phasing out of the production of certain parts and accessories (e.g. gear boxes, exhaust pipes). These specific components accounted for around 20% of all motor vehicle parts and accessories exports in 2023 (MoF, 2024[1]). Simulations suggest that if the production of these specific components were to cease without replacement, the production of the motor vehicle sector would fall by 6%, total gross value added by 0.9% and total employment by 0.3% (MoF, 2024[1]).
Source: OECD National Accounts database; Czech Statistical Office; OECD, Trade in Value Added (TiVA) 2023 edition.
Czechia is diversifying its energy sources to enhance energy security. The country’s energy import dependency is relatively low in international comparison (around 40%) due to the still high share of nationally produced coal in the energy mix. However, before the war in Ukraine, Czechia imported almost all of its natural gas, oil and nuclear fuel from Russia. The share of imported natural gas from Russia has fallen to around 8% in 2023 thanks to diversification, with increased gas imports from Norway and through liquefied natural gas (LNG) terminals. By 2025, the country is also set to become independent from Russian oil and nuclear fuel imports.
The planned phase-out of coal by 2033 needs to be carefully planned to ensure energy security. New nuclear capacity will only come online in the mid-2030s and will partly replace older nuclear generators. This leaves an expansion of renewables and to a lesser extent natural gas as the main instruments to offset declining coal capacity and to satisfy increasing electricity demand in the transition period. As discussed in detail in Chapter 3, Czechia’s transmission grid is well connected with neighbouring countries, with a significant capacity to transport electricity across borders, helping to ensure security of supply in the coal phase-out period. However, expanding renewable energy capacity will require further investments in the electricity grid capacity and system flexibility (see Chapter 3).
Growth is set to strengthen but risks are elevated
GDP growth is set to pick up in 2025 and 2026 (Table 1.1). The recovery in household’s real disposable incomes and a normalisation of the saving rate from an elevated level will support stronger consumer demand. Trade policy uncertainty will weigh on investment, which will nevertheless pick up thanks to easing financial conditions and the stronger use of EU structural and recovery and resilience funds. Exports growth will accelerate as demand of Czechia’s trading partners strengthens. However, import growth will also pick up on the back of increasing domestic demand, resulting in a declining contribution of net exports to growth. Headline inflation is projected to fall back to the 2% target by 2026. Core inflation is gradually easing, helped by a pick-up in productivity growth that mitigates labour cost growth.
Annual percentage change, volume (2020 prices)
1. Contribution to changes in real GDP.
2. Percentage of potential GDP.
3. Consumer price index excluding food and energy.
Source: OECD Economic Outlook database.
Risks to the projections are skewed to the downside. An increase in tariffs or other trade barriers would hurt the export-oriented economy. An escalation of geopolitical tensions would weigh on foreign demand and could lead to increased global energy prices and renewed supply chain disruptions. A more persistent slowdown among trade partners, especially in Germany, would particularly slow growth. Disruptions in Germany’s automotive sector may also have repercussions on Czech car manufacturing (Box 1.1). Strong wage increases could hamper the competitiveness of the business sector and increase inflationary pressures. A strong depreciation of the koruna would lead to higher inflation and may force the central bank to pause monetary easing.
Monetary policy should continue to ease restrictiveness contingent on underlying inflation pressures durably subsiding
Inflation expectations have declined but remain above the 2% target. In January 2025, expectations of financial market analysts were close to the target, at 2.3% on the 1-year and 2.1% on the 3-year ahead horizon. However, non-financial corporations still expected inflation of 3% on the 1-year and 3.4% on the 3-year ahead horizons in December 2024. Household inflation expectations have traditionally been significantly above the target (in the range of 7-10% in the period 2017-2019, with actual inflation around 2-3% over the same period) and stood at 12.6% in December 2024 on the 1-year ahead horizon. Inflation expectation above the target may exert upward pressure on inflation via price and wage-setting dynamics.
Monetary policy is easing but remains restrictive. With inflation slowing, the Czech National Bank (CNB) gradually reduced the main policy rate (the two-week repo rate) from 7% to 3.75% between December 2023 and February 2025. The CNB estimates that the (real) natural rate of interest is around 1% in Czechia (CNB, 2024[2]). With real rates above that level, the monetary policy stance remains restrictive. The CNB signalled that given inflationary pressures in the economy, it would approach future monetary policy easing with great caution and may pause the interest rate reduction process. The central bank views a declining nominal short-term interest rate to around 3% by mid-2025 and broadly stable rates thereafter consistent with its projection of inflation remaining close to the 2% target in 2025 and 2026 (CNB, 2025[3]). In October 2024, the CNB announced an increase in the minimum reserve requirement from 2% to 4% as of January 2025 to lower the cost of conducting monetary policy. This follows the CNB’s decision to end the remuneration of minimum reserves in October 2023.
The narrowing interest rate differential vis-à-vis the euro area led to depreciation pressures on the koruna. The CNB started tightening its policy rate much earlier (in June 2021) and more strongly than the ECB. As a result, the short-term interest rate differential widened, peaking at about 700 basis points in mid-2022. Since then, the interest rate differential has continuously narrowed. This has put depreciation pressure on the koruna and in turn upward pressure on prices of imported goods and services and tradable inflation. The CNB intervened in the foreign exchange market to stem the koruna depreciation from May to October 2022, selling a total of EUR 25.56 billion of its foreign exchange reserves. In August 2023 the CNB officially ended its foreign exchange market operations. Since then, the CNB resumed sales of part of the income on international reserves under its managed float regime, and only maintains an option to use foreign exchange interventions in case of exceptional circumstances (especially to prevent excessive fluctuations of the exchange rate). As stated in the previous Economic Survey (OECD, 2023[4]), the key policy rate should remain the main monetary policy tool. Foreign exchange interventions are not a sustainable tool to stave off persistent depreciation pressures, especially in an environment of narrowing interest rate differentials with the rest of the world.
Monetary policy should continue to gradually ease restrictiveness contingent on underlying inflationary pressures durably subsiding. The tight labour market with brisk wage growth together with sticky services prices call for a continued prudent approach. Hence, any further easing of monetary policy should be cautious, informed by data and forward-looking.
The banking sector is resilient, but vulnerabilities should be monitored
The financial sector appears resilient overall. Banks dominate the financial sector, holding over three-quarters of financial sector assets, with foreign-owned banks accounting for around 85% of total assets of banks. Banking sector profits remained solid in 2023 and first half of 2024 despite some slowing of interest income as interest rates started to come down in late 2023. Capital and liquidity ratios well exceed their regulatory requirements, and non-performing loan ratios are low. Stress tests show that banks are able to withstand a significant adverse macroeconomic shock, although banks would have to use up their countercyclical capital buffers (CNB, 2024[5]).
After a moderate price correction, property markets have stabilised. Residential property prices doubled in the period from 2016 to 2022 and grew much faster than income. House prices dropped by around 4% between Q3 2022 and Q2 2023 but have since stabilised and started to moderately increase again in 2024. The CNB assessed apartment prices still to be overvalued in the first half of 2024. However, the probability of a significant price correction (drop of more than 10% over the next two years) has declined from close to 30% in mid-2022 to around 1% in mid-2024, according to CNB estimates (CNB, 2024[6]). The price correction for commercial property was more pronounced, with prices declining by around 16% between Q2 2022 and Q3 2023. Prices have stabilised since then, but the CNB assesses commercial property prices to be still overvalued in mid-2024 (CNB, 2024[6]).
Macroprudential measures have been eased. The CNB lowered the countercyclical capital buffer in several steps between July 2023 and July 2024 from 2.5% to 1.25% as it assessed cyclical systemic risks to have receded. Moreover, the CNB decided to deactivate the upper limit on the debt-service-to-income (DSTI) ratio and the debt-to-income (DTI) ratio on new mortgage loans from July 2023 and January 2024, respectively. The DSTI had been set at 45% of the net monthly income (50% for under 36-year-olds) and the DTI at 8.5 times net annual income (9.5 for under 36-year-olds) in April 2022. The CNB continues to recommend that mortgage lenders should exercise high prudence when assessing applications for loans with DSTI ratios over 40% and DTI ratios over 8, test loan applicants’ ability to inter alia withstand rising lending rates and adverse income shocks, and not provide loans with maturities above 30 years. The loan-to-value ratio limit has been kept at 80% (90% for under 36-year-olds) since April 2022. Moreover, the Capital Requirement Directive (CRD) IV introduced a new systemic risk buffer into the EU regulatory toolkit. The CNB decided to activate the systemic risk buffer from January 2025 and set it at 0.5%, due to systemic risks including Czechia’s high trade openness, concentration of the economy in manufacturing and high costs associated with the green transition (CNB, 2024[5]).
Risks are related to the substantial exposure of the banking sector to the property market. Loans to the real estate sector account for 63% of total bank loans, with household mortgages accounting for 48% and corporate loans to the real estate and construction sector for 15% (Figure 1.6, Panel A). With the recent property price correction and falling interest rates, risks have declined. However, property prices still appear overvalued, and interest rates remain elevated compared to the pre-pandemic period. Moreover, the share of riskier loans in the loan portfolio has increased, partly in response to the deactivation of the DSTI and DTI limits. For example, the share of new mortgage loans with a DSTI in the range 50-60% increased from below 10% in 2023 to around 22% on average in July/August 2024. With mortgage loan growth expected to pick up, the authorities should continue to closely monitor risks in this market sector and consider reactivating the DSTI and DTI limits.
Structural and tax reforms can help alleviate imbalances in the property market. As discussed in previous Surveys, the process for obtaining construction permits has been one of the slowest and most cumbersome in the OECD, hampering a supply response to demand pressures. A new building act came into force in 2024 that aims to streamline and digitise the building permitting process but will take time to exert its full effect. Moreover, increasing recurrent taxes on immovable property and basing them on regularly updated market values would strengthen incentives to use the dwelling stock efficiently and reduce property price fluctuations (see tax section below).
Vulnerabilities related to the increasing share of foreign currency loans to corporates should continue to be closely monitored. The share of foreign currency (predominantly euro) loans to non-financial corporations has been growing quickly to slightly over 50% in early 2024 (Figure 1.6, Panel B). As the majority of non-financial corporations with FX loans is hedged, either through their foreign currency income or through FX derivatives, the CNB does not consider FX loans a systemic risk. Nevertheless, the exposure makes the banking sector more vulnerable to exchange rate volatility and external demand developments, and should therefore be closely monitored. Moreover, the high share of FX loans may weaken monetary policy transmission channels.
Source: Czech National Bank.
Consolidation should continue to rebuild fiscal buffers
The authorities have appropriately started to consolidate public finances in 2024. The fiscal position deteriorated markedly between 2019 and 2023 due to fiscal support to cushion the effects of the pandemic and the energy crisis as well as permanent measures, most notably the reduction of personal income taxes effective from 2021. As a result, public debt rose by over 12 percentage points to slightly above 42% of GDP in 2023 (Figure 1.7). The budget for 2024 foresees a moderate consolidation, with the budget deficit expected to fall below 3% in 2024 (Table 1.1). The fiscal improvement reflects the phasing-out of almost all energy support measures at the end of 2023 as well as a consolidation package in force since 2024. The consolidation package is largely focused on revenue measures worth around 1.2% of GDP, including increases in social security contributions, corporate income tax rates and real estate taxes (see detailed discussion below). On the expenditure side the package focuses on reduced compensation of public sector employees (0.2% of GDP) (MoF, 2023[7]). At the same time, expenditure increased in particular for defence to fulfil NATO commitments and for pensions due to their indexation to past high inflation. Reparations after the heavy floods in September 2024 also add temporary expenditure needs.
Consolidation should continue in the medium term to comply with the national and EU fiscal rules, rebuild fiscal buffers, and prepare for long-term spending pressures and support the disinflationary process. The budget for 2025 targets a further reduction of the budget deficit from 2.8% to 2.3% of GDP, largely thanks to cyclical effects as economic growth is projected to pick up. The Convergence Programme (MoF, 2024[8]) and medium-term fiscal-structural plan set a path to reach a structural budget deficit of 1% of GDP by 2028, which is the target level according to the national fiscal rules. The Czech Fiscal Responsibility Act defines the fiscal rules consisting of a debt rule (with a debt-to-GDP limit of 55%, after deducting cash reserves) and a structural deficit rule. The latter was loosened during 2020-2022. The 1% structural deficit is to be reached at the latest by 2028, as approved in 2023 as part of the consolidation package. According to the new EU fiscal governance framework for countries that meet both the EU debt (60% of GDP) and the deficit (3% of GDP) criteria, the European Commission (EC) can provide “technical information” at the request of a Member State. Czechia has received such technical information from the EC to achieve a primary structural surplus of 0.4% of GDP by 2028. The EU primary structural surplus target is consistent with the national structural deficit target. The authorities should specify consolidation measures in the amount of around 0.5%-1% of GDP that are needed to reach the structural deficit target.
Note: Panel A shaded area depicts forecasts.
Source: OECD Economic Outlook 116 database.
Pension reforms have improved fiscal sustainability, but longer-term spending pressures due to ageing and the green transformation remain significant. The public investment needs to reach climate mitigation and adaptation targets are substantial (see Chapter 3), although they are partly covered by EU funds. Moreover, both the European Commission and the national fiscal council assess Czechia’s long-term sustainability situation as medium-risk. This is mainly due to Czechia’s ageing population. In 2023 and 2024, pension reforms were enacted to limit pension expenditure, including by reducing pension benefit growth, tightening early retirement options and increasing the statutory pension age (see below). According to the latest EU Ageing Report (EC, 2024[9]), which only takes into account the pension reforms enacted in 2023, ageing-related costs, notably on pensions, health care and long-term care, would increase between 2024 and 2050 by 3.9 percentage points of GDP (peaking in 2060 at around 5 percentage points). This is larger than the EU average of 1.2 percentage points. Without further measures to contain ageing-related costs, debt would rise to close to 100% of GDP by 2050 (Figure 1.8, current policies scenario). Preliminary estimates suggests that if the pension reforms enacted in late 2024, which include an increase in the statutory retirement age, were fully implemented, debt would increase less steeply, to around 70% of GDP in 2050. Moreover, consolidation to reach a structural deficit of 1% of GDP and maintain it from 2028, in line with the national fiscal rule, would stabilise debt at the current level (Figure 1.8, fiscal rules scenario). Combining fiscal consolidation with structural reforms would bring debt on a downward trajectory (Figure 1.8, fiscal rules and structural reforms scenario).
A combination of tax and spending reforms can help ensure fiscal sustainability without harming growth. On the revenue side, a further shift away from social security contributions towards property and indirect taxes, including environmental taxes, could make the tax system more growth friendly. On the spending side, fully implementing the recent pension reforms would go a long way in mitigating ageing-related spending pressures, although further reforms are still needed to ensure debt sustainability. Moreover, there is scope to realise efficiency gains for example by strengthening spending reviews and performance budgeting, reforming the highly fragmented local government system and rebalancing family benefits. Significant inflows of EU funds will support investment, help the green transition and mitigate the social impact of climate policies. Investment spending from the EU Recovery and Resilience facility (EUR 9.2 billion or around 3% of GDP) is expected to peak in 2025 and 2026. Investments related to the new 2021-27 programming period of the EU cohesion funds (EUR 21.1billion, around 7% of GDP) will gradually increase. Moreover, Czechia is expected to receive around EUR 2 billion from the newly established EU Social Climate Fund and EUR 20 billion from the EU Modernisation Fund to mitigate the social impact of the green transition.
General government debt, as a percentage of GDP
1. The "Current policies” scenario is based on the OECD Economic Outlook 116 database until 2026 and the OECD Long-Term Economic Model thereafter. Increases in ageing related costs are not offset and based on the EU Ageing Report 2024. The scenario does not include pension reforms enacted in December 2024.
2. The “Fiscal rules scenario” assumes that a structural budget deficit of 1% is reached until 2028 and maintained thereafter.
3. The “Fiscal Rules and structural reforms scenario” assumes in addition to the fiscal rules scenario higher real GDP growth of about 0.5 p.p. on average over projection period compared to the baseline scenario, based on the reforms scenario outlined in Box 1.1.
Source: OECD Long-term Economic Model; EU Ageing Report 2024
Making the tax system more growth friendly
The tax burden is comparable to the OECD average, but the revenue structure is biased towards social security contributions. Tax revenues as a share of GDP stood at 33.7% of GDP in 2023, close to the OECD average (33.9% of GDP). However, Czechia relies significantly more on social security contributions and less on personal income taxes (PIT) and property taxes than other OECD countries (Figure 1.9). As pointed out in previous OECD Surveys, a lower reliance on social security contributions and higher revenues from property taxes and indirect taxes, including environmental taxes, would make the tax system more growth-friendly and reduce the exposure of government revenue to ageing.
Tax policy changes in 2024 as part of the consolidation package (see above and Table 1.5) are expected to increase revenues but are unlikely to lead to a significant change in the tax structure. As discussed further below, changes included an increase of the employee sickness insurance contributions, a hike in immovable property tax rates, a reduction in the number of VAT rates from three to two as well as some hikes in excise tax rates (e.g. on tobacco and alcohol). Moreover, the progressivity of the personal income tax (PIT) system was increased by lowering the threshold for the top marginal tax rate, while the tax base was broadened by reducing some tax exemptions. These changes are broadly in line with recommendations in the previous Survey (Table 1.6). Finally, the corporate income tax rate was hiked from 19% to 21%. With this change, the statutory income tax rate, which is higher than in most other central and eastern European countries, is moving closer to the OECD average rate (23.9%).
The tax and benefit system puts a high burden on low-income earners and does not encourage second earners to work. Due to high social security contributions, the average tax wedge – the gap between the net take-home pay of workers and their costs to employers – for low-income earners and people without children is high in international comparison (Figure 1.10, Panel A). A lower tax wedge could help ease labour market tightness by attracting workers at the margins of the labour market. The high tax wedge may also incentivise workers to shift to self-employment, the incidence of which is relatively high in Czechia and is often quasi-dependent employment (OECD, 2020[10]). The recent reintroduction of the employee sickness insurance contribution has further increased the tax wedge. A significant number of tax credits and allowances reduces the tax burden for families, with the fiscal preference for families with children among the highest among OECD countries (OECD, 2024[11]). At the same time, the tax wedge for second earners in families with children is among the highest in the OECD (Figure 1.10, Panel B), which reduces the incentives for second earners to take up work. The high tax wedge is due to the loss of some cash and tax benefits when the second spouse takes up work, as well as the high social security contributions. The recent limitation of the dependent spouse tax credit to spouses who take care of a child up to the age of three will lower the tax wedge for second earners.
Further shifting the tax mix towards revenues from recurrent taxes on immovable property could make the tax system more growth-friendly. In 2023, revenue from recurrent taxes on immovable property accounted for 0.18% of GDP, compared to an OECD average of 1% of GDP (
Figure 1.11). In 2024, the centrally set base tax rates on immovable property were raised on average by around 80%, albeit from a very low level. At the same time, the range of local coefficients that municipalities can apply to the tax rate has been widened (from 1.1-5 to 0.5-5), which has led a few municipalities to reduce the real estate tax by setting a lower local coefficient. In addition, the tax per square metre of the property was indexed to consumer price developments. The reform will lead to higher property tax revenues overall, which is welcome. However, even after these changes, revenues from property taxation will remain very low. Further increasing revenues from recurrent taxes on immovable property would create some room to lower more distortive taxes. Moreover, indexing the property tax to consumer price developments will prevent the erosion of real tax revenues but does not appropriately account for housing price cycles and regionally different developments of property valuations.
Table 1.3 presents estimates of the fiscal impact of selected recommendations. The results are indicative and do not allow for behavioural responses. Moreover, revenue gains from the recommended reform package via higher employment are not included.
Fiscal saving (+) and costs (-)
Table 1.4 quantifies the GDP impact of the main recommendations based on the OECD Economics Department long-term model.
Relative to baseline
Source: OECD Economics Department Long-Term Model
Share in total tax revenues, % of total taxation, 2022 or latest available year
Note: The OECD and OECD Europe aggregates are an unweighted average.
Source: OECD Revenue Statistics database; OECD Environmental Related Tax Revenue Database (ERTR).
Note: The principal earner in the two-earner married couple works at 100% of the average wage (AW).
Source: OECD Taxing Wages database; OECD (2024), Taxing Wages 2024: Tax and Gender through the Lens of the Second Earner, OECD Publishing, Paris, https://doi.org/10.1787/dbcbac85-en.
Revenue from recurrent taxes on immovable property, % of GDP, 2023 or latest available year
Source: OECD Revenue Statistics database.
Changing the tax base to regularly updated market values could make the tax more efficient and fairer. Czechia is one of very few OECD countries (together with Slovakia, Israel and Poland) that bases recurrent taxes on immovable property on the size (in square metres) of the property rather than its estimated market value. A system based on the property size is less accurate in accounting for taxpayers’ housing wealth, as it disregards other physical characteristics of the property which are determinants of its value, such as quality, number of rooms, age, or the presence of balcony. Additionally, in a size-based property tax system, tax revenues are not responsive to changes in the housing cycle. This limits the effectiveness of the tax as a stabiliser of fluctuations in the housing market. If the tax base was changed to property values, it would be important to regularly update the values. Taxing properties based on outdated values can make the tax regressive as houses that experience large increases in market values become relatively under-appraised and under-taxed. Moreover, homeowners have an incentive to remain in undervalued homes, thereby reducing residential and labour mobility (OECD, 2022[12]).
A property value-based recurrent tax on residential property can also encourage a more efficient use of the current housing stock. According to 2021 Census data, around 16% of dwellings are vacant in Czechia (Ministry of Regional Development, 2023[13]), which is a high share in international comparison (De Pace, 2024[14]). A significant share of unoccupied family houses are cottages, mainly in recreational areas of the country. Nevertheless, there are also significant vacancies in densely populated areas, for instance about 94 000 vacant dwellings in Prague, although, due to the statistical definition, this may include rented apartments of people who work in Prague but regularly commute to their family homes outside of Prague. Vacancies reduce the supply of dwellings available for purchase or rent, putting upward pressure on house prices, especially when located in highly demanded areas. Gradually transitioning to a higher recurrent tax on residential property based on regularly updated values would help address this issue, as it would increase the cost of keeping properties unused. Additionally, the authorities could consider introducing specific taxes on vacant dwellings (on top of regular property taxes), as in Australia, Canada and France. These taxes have proven to be successful in reducing vacant homes. However, they require thorough monitoring and compliance checks, which add to administrative costs (OECD, 2022[12]).
The tax design can make higher property taxes more politically acceptable and address issues for households that are rich in assets but have low income. Property tax reforms are unpopular, especially in countries like Czechia where owner-occupied housing is widespread, including among low-income households. Switching from size to market-based property valuations could imply a steep rise in the tax bill for many households. Country experiences for example from Denmark and Ireland suggest that a gradual phasing-in of the tax changes on residential property, accompanied by lower statutory tax rates, tax rebates or tax deferrals, for example paying the tax only when a house is sold or bequeathed, can increase acceptance and help avoid an abrupt hike in tax bills for homeowners. Additionally, allowing for paying the tax in instalments, as is done in Canada, Denmark, or the United States, may help households to overcome liquidity constraints and improve tax compliance. Furthermore, progressive taxation, by setting progressive tax rates or by granting exemptions or credits, can protect low-income households and thereby bolster fairness and acceptability of increased property taxation.
Regularly updating the value of residential properties can be administratively costly, but digitalisation can limit the burden on the administration. The most common method for property evaluation in OECD countries is based on sales comparisons, which use detailed data on recent sales for properties with similar characteristics. Digitalisation can reduce the costs of regular appraisals. Computer-assisted mass appraisals (CAMA), as done in the Netherlands, estimate values for a group of properties using mathematical modelling. Alternatively, data from digital platforms advertising properties for sale can be used. These methods reduce the costs associated with frequent property revaluations (OECD, 2022[12]). As these approaches require technical capacities, they may be best undertaken by higher levels of government, for example at the level of the central government or regions.
The VAT tax base could be further broadened. By unifying the reduced rates of 10% and 15%, the number of VAT rates was reduced from three to two in 2024 - the standard 21% rate and a reduced rate of 12%. Some selected goods and services were also shifted from the regular to the reduced rate (e.g. some food items). While the simplification is welcome, maintaining VAT exemptions or reduced rates is inefficient. Reduced VAT rates for equity reason is also a poorly targeted instrument as all households benefit from the reduced rates, including the affluent. Furthermore, differential VAT rates provide opportunities for tax evasion by re-classifying goods to benefit from lower rates. According to the VAT Revenue Ratio indicator (OECD, 2022[15]), Czechia lost about 41% of its potential VAT revenues in 2020 (or about 5% of GDP) due to VAT exemptions, reduced rates, weak enforcement or VAT non-compliance, a slightly lower share than the average OECD country (44%). In addition, in 2022, the VAT registration threshold was doubled to CZK 2 million (around USD 86 000). This is a relatively high threshold (OECD, 2022[15]). While this reduces the tax administration and compliance costs for SMEs, it can have a negative impact on revenues and introduces a competitive distortion. A number of OECD countries combine a low VAT registration and collection threshold with simplified procedures to calculate the VAT liability for SMEs.
Enhancing spending efficiency
Increasing the efficiency of the public administration can help to improve fiscal sustainability and raise the quality of services provided to citizens. The size of the public sector in the Czech Republic in terms of general government expenditures (43% of GDP in 2022) is close to the OECD average but significantly below the OECD-EU average (50% of GDP in 2022). In terms of employment (17.3% of total employment in 2021), it is also somewhat smaller than the OECD average (18.6%). Nevertheless, given medium- to long-term spending pressures the authorities should strive to identify potential areas for spending efficiency gains based on evidence.
Czechia has recently piloted spending reviews. Spending reviews are widely used in OECD countries. If well designed they have the potential to systematically analyse the government’s existing expenditure, to prioritise and reallocate expenditures, and to improve the effectiveness within programmes and policies. In 2023, Czechia established a small unit within the Ministry of Finance dedicated to spending reviews. So far, the unit has completed two pilot spending reviews (on ICT spending in the public sector and subsidies in the culture sector). A review of all public subsidies is ongoing. As discussed in this Survey, future spending reviews could be particularly useful in the areas of family (see below) and innovation policy (see Chapter 2), in particular the system of direct (e.g. grant) R&D support. The pilot reviews revealed some challenges especially related to obtaining relevant performance data and regarding cooperation with line ministries (EC, 2024[16]).
The government should continue efforts to institutionalise spending reviews. The OECD Best Practices for Spending Reviews (Tryggvadottir, 2022[17]) stress that political leadership is crucial to ensure the viability and sustainability of spending reviews, and ensure the cooperation of all ministries. Political commitment is likely to be greater if the relevant line ministries can retain a proportion of the efficiencies identified to fund new priorities within their ministries (Tryggvadottir, 2022[17]). Once sufficient capacity has been built-up, spending reviews should be systematically integrated into the budget and medium-term frameworks. For example, in Denmark the decision on which reviews to conduct is taken at the beginning of the year with the aim of having the findings available to inform the budget negotiations in June. Moreover, it is essential that the Ministry of Finance monitors the implementation of spending review decisions and holds line ministries accountable for delivering to the agreed conclusions. In the United Kingdom for example, the Treasury is responsible for overseeing the implementation and monitoring potential risks through regular engagement by the Treasury’s spending teams with line Ministries.
Increasing analytical capacities and data sharing across the administration is essential to strengthen evidence-based policymaking, including high-quality spending reviews. Strengthening evidence-based policy making has been identified as one of the key priorities for the Czech government in the recent OECD Public Governance Review (OECD, 2023[18]). The recent creation of the Government Analytical Unit (VAU) in the Office of the Government is an important step to develop analytical capacity and support more evidence-based policymaking. Several ministries and agencies have also started to build-up analytical capacity. One significant challenge relates to data interoperability, including merging or linking administrative datasets. Moreover, accessing micro-level information from the Czech Statistical Office is difficult (OECD, 2023[18]). Overcoming difficulties related to cumbersome administrative procedures to access data and addressing privacy concerns are essential to foster a more open and transparent data culture across the Czech administration. Stronger collaboration with research institutions can also help foster more evidence-based policy making. This may require creating formalised agreements with research institutions covering matters of data access and use. In Denmark, for instance, there are agreements between all research institutions and Statistics Denmark, which, among other things, clarify roles and responsibilities.
Czechia’s local administrative organisation is highly fragmented, hampering the efficient provision of high-quality public services and investment. In 2022, the average municipal size was 1 710 inhabitants, the smallest among OECD countries (Figure 1.12). The median size of Czech municipalities was 442 inhabitants and 95.7% of municipalities had fewer than 5 000 inhabitants. The strong fragmentation has historical reasons, as the increase in the number of municipalities and municipal self-government after the Velvet Revolution was, to a certain extent, a response to the previous centralised system. However, as discussed in detail in a previous Survey (OECD, 2020[10]) and the OECD Public Governance Review (OECD, 2023[18]), most Czech municipalities are too small to ensure cost-effective and good-quality public services. The small size of municipalities also brings challenges due to low staff and administrative capacity.
Despite important political challenges, merging municipalities should remain on the political agenda. Several OECD countries have opted for municipal mergers. In the Netherlands and Switzerland, municipal mergers have been a gradual process. Nordic countries have implemented successive waves of mergers. Several OECD countries have used incentives to encourage municipal mergers, such as providing financial subsidies, guidance and technical assistance (e.g. Norway, Switzerland). Some countries encouraged mergers by keeping the former municipal administration with a sub-municipal status, as in Ireland, Korea, New Zealand, Portugal, the United Kingdom or in France, with the delegate mayors. Incentives need to be accompanied by appropriate consultations, negotiations and communication efforts to gain support from local stakeholders and civil society and ensure buy-in.
The tax sharing formula should be tweaked to strengthen incentives for municipalities to get larger. Total tax revenue is shared among different levels of governments according to a complex tax sharing formula. The tax sharing formula mainly takes into account population size (88%), but also the number of children in nursery and primary schools, and the cadastral area. As analysed in a past Economic Survey (OECD, 2020[10]), the tax sharing formula implicitly benefits municipalities with very few inhabitants, which is largely due to the inclusion of the cadastral area component in the formula. As a result, the average tax revenue per inhabitant follows a U-shaped curve, with the smallest municipalities having higher revenues per inhabitant than medium-sized municipalities. It is important to compensate small municipalities for the higher per capita costs of delivering basic services. However, given the strong administrative fragmentation, the tax-sharing formula could be made more neutral for small municipalities, to reduce incentives to remain small.
Voluntary intermunicipal cooperation is common but lacks stability and is often focused on a single purpose. Voluntary associations of municipalities (VAMs) are a common form of inter-municipal cooperation. VAMs generally include only a limited number of municipalities and the majority are single-purpose and may focus on a one-time investment project or the ongoing provision of services (e.g. waste management). VAMs often importantly rely on external, temporary sources of financing such as EU funds.
In 2024 an amendment to the Law on Municipalities introduced a new form of VAM, so-called communities of municipalities. To form a community of municipalities, at least 15 municipalities (or three-fifths) from the same municipality with extended powers (i.e. municipalities that fulfil several administrative functions delegated by the central government on behalf of smaller surrounding municipalities) need to participate. The aim is to strengthen cooperation at a larger scale, for instance to ensure coordination and joint delivery of certain public services, and incentivise multi-purpose and more stable cooperations for territorial development. The municipalities within a community can hire shared staff as employees of the community. However, membership remains voluntary.
Incentives for longer-term municipal cooperation should be strengthened. Forming voluntary associations of municipalities involves transaction and coordination costs, for example to search for a suitable partner municipality to form an association with. Coordination costs also tend to increase with the number of participants in a VAM. Together with political costs, these costs can hinder the establishment of otherwise beneficial cooperations. Many OECD countries have recently introduced financial incentives to encourage inter-municipal co-operation. For instance, France offers special grants and a special tax regime in some cases. Other countries, like Estonia and Norway, provide additional funds for joint public investments. Slovenia introduced a financial incentive in 2005 to encourage inter-municipal co-operation by reimbursing 50% of staff costs of joint management bodies – which led to a notable rise in the number of such entities (OECD, 2023[18]). In Czechia, the central government could for example offer financial support to hire shared staff of communities of municipalities, as is currently being discussed. In addition, mandating inter-municipal co-operation over a legally defined set of public services, delegated or independent competences can be an effective way of improving the quality and efficiency of service delivery and supporting wider use of inter-municipal co-operation schemes. Developing data on functional areas, i.e. territorial areas of economic activity rather than administrative units, would help municipalities establish the most beneficial cooperations.
Average number of inhabitants per municipality, thousand, 2022
Source: OECD Subnational government structure and finance database.
There is a need to build administrative capacity and skills at the local level. The small size of municipalities also brings problems of low capacity. The lack of adequately educated and skilled staff and expertise in small municipal offices is an acute challenge when dealing with investment projects, procurement and financial management (OECD, 2023[18]). Evidence shows that investment per capita in small municipalities in Czechia is significantly lower than in mid-sized or larger municipalities (OECD, 2020[10]), partly reflecting different needs. A backlog of investment projects due to insufficient capacity may also partly explain why local authorities have been running substantial surpluses for several years. Support to build capacity should be tailored to groups of municipalities that face similar challenges and designed and provided in a systemic and sustainable way, rather than offering technical assistance on a case-by-case basis (OECD, 2023[18]). Support could also target VAMs for example by encouraging peer exchanges and knowledge sharing across VAMs. The National Development Bank plans to open so-called investment hubs in regions to facilitate project preparation. In addition, Czechia is piloting regional competency centres for public procurement purposes. These competency centres, if proving successful, could potentially be expanded to areas beyond public procurement.
Recent reforms have improved the overall sustainability of the pension system
Population ageing is putting pressure on the sustainability of the public pension system. The ratio of elderly people (65 and over) to the working-age population (20-64 years) is projected to rise from 34.9% in 2024 to 55.7% in 2060 before falling slightly (EC, 2024[9]) (Figure 1.13). These demographic developments are the main driver of rising public pension expenditure in the future. According to the latest EU Ageing Report, public pension expenditure will increase rapidly from 2030 onwards, from 8% to 11% of GDP in 2060, and the balance of the pension system will reach a deficit of 3.3% of GDP in 2060 (EC, 2024[9]). Pension expenditure is expected to decline slightly after 2060 to 10.4% in 2070 mainly due to cohort effects as smaller cohorts enter retirement age.
Note: The baseline projection in Panel B does not account for the pension reforms enacted in December 2024.
Source: European Union, 2024 Ageing Report, Economic and budgetary projections for the EU Member States (2022-2070); Ministry of Finance of the Czech Republic.
Recent reforms will significantly improve the sustainability of the pension system if fully implemented. In early 2023, pension benefits for parents were increased, raising pension expenditures. However later in 2023, the first phase of a comprehensive pension reform was enacted, including a reduction of the indexation of pensions and a tightening of early retirement options. In particular, since January 2024 pensions will be indexed to a pensioner cost of living index plus a third of the growth in real average wages (instead of one half of the real wage growth previously). Moreover, from October 2023, early retirement can only be taken 3 years before the statutory retirement age (instead of 5 years) with at least 40 years of contributions (35 years previously). In addition, the penalties for early retirement were increased (1.5% for every 90 days). The second part of the pension reform was approved by parliament in December 2024. The original plan of the reform would have established an automatic link between the statutory retirement age and gains in life expectancy from 2030 onwards when the current cap of the statutory retirement age of 65 is reached. This would have reduced pension expenditures by about 1 percentage point from 2050 (Figure 1.13, Panel B). The enacted reform limits the increase of the statutory retirement age to one month per year and caps the retirement age at 67. In addition, the second part of the pension reform foresees a reduction of the accrual rates.
Reforms to delay retirement should be accompanied by policies that foster employability of older workers. Research suggests that increasing the statutory retirement age and tightening early retirement options will significantly increase the average age of labour market exit (e.g. (Turner and Morgavi, 2020[19]) (Morgavi, 2024[20])). However, the effect will depend on labour market settings and accompanying policies. To ensure that older workers remain in employment it is important to strengthen incentives for them to participate in adult learning (see Chapter 4) and facilitate access to part-time work and flexible work arrangements. In Finland, for example, the working time act allows older workers to work fewer than the regular working hours in order to retire on partial early old-age pension or partial disability pension. In Norway, employees were given a statutory right to reduced working hours from the age of 62 in 2008. Moreover, job rotation programmes help older workers, particularly those with health-related issues or those in arduous occupations, to identify and transition into roles that better align with their skills and aspirations (OECD, 2024[21]).
Financing some of the redistributive parts of the pension system through general taxes would allow to lower mandatory contributions or increase accrual rates for higher earners, as recommended in the OECD Pension Review (OECD, 2020[22]) and previous Economic Surveys (OECD, 2023[4]). The Czech pension system is strongly redistributive. The old-age pension consists of a flat-rate component (basic pension) and an earnings-based component with caps on pensions of higher-income earners, weakening the link between pension contributions and future benefits. Old-age poverty rates are low. While the net replacement rate of the average wage earner is around the OECD average, the difference between high and low earners is large in international comparison. At 41.5%, the replacement rate of high-income earners (at twice the average wage) is well below the rate of low-income earners (at half of the average wage), at 89.7%, a large gap by international comparison (OECD average: 52.8% for high-income versus 73.2% for low-income earners) (OECD, 2023[23]). Redistribution takes place exclusively within the pension system as all pension revenues come from contributions, although deficits of the pension system are covered by general government revenues. In contrast, many countries finance part of pension spending through taxes. Financing some redistributive parts of the system (e.g., part of basic pensions or credits for non-employment periods) through taxes could create room to strengthen the link between paid contributions and benefits. Alternatively, it could help reduce high mandatory social security contributions and thereby lower the high tax wedge (see above).
The self-employed contribute significantly less to the pension system than dependent workers. Until recently, the assessment base for social security contributions of the self-employed was set at 50% of profits, with a minimum contribution base of 25% of the average wage. This set-up effectively lowers the overall contributions of self-employed workers compared to employees with a comparable income. While the lower pension contributions of the self-employed lead to lower pension benefits, the high solidarity within the pension system redistributes strongly in their favour. A reform in 2023 gradually increases the general assessment base from 50% to 55% of profits and minimum assessment base from 25% to 40% of the average wage. While this change will ensure higher pension contributions and benefits, it mainly affects self-employed persons with low profits while self-employed persons with high profits continue to enjoy a strongly favourable treatment (Prokop, Pertold and Ostrý, 2023[24]). To further improve the system, the assessment base for social security contributions of the self-employed should be further increased. Analyses by the OECD (OECD, 2020[22]), the Fair Pension Committee in 2020 and the National Economic Council to the government (NERV) suggest that an increase of the assessment base to 70-75% of profits would ensure better harmonisation of contributions between self-employed workers and employees with similar earnings.
Rebalancing family benefits to raise employment of women with young children
The employment rate of mothers with young children is very low in Czechia (Figure 1.14). While female employment is high overall, it drops significantly in the years after childbirth. Long leave periods for women reduce chances of re-entering the labour market and lead to negative consequences for career progression as well as earnings mobility over the life course (e.g. (Thévenon and Solaz, 2013[25])). This contributes to the gender pay gap, which is above the OECD average, as well as lower pension income, leading to a higher risk of poverty in old age for women. Increasing employment rates of mothers with young children would help mitigate labour shortages and the impact of a shrinking work force as well as likely lead to additional tax revenues. Family benefits need to be reviewed, in particular the balance between cash benefits (e.g. parental leave allowances) and in-kind benefits (e.g. early childhood education and care), with a view to reducing disincentives for mothers with young children to work outside the home.
Employment rates for women (15-64 year-olds) with children aged 0-2, by maternity leave status, %, 2021 or latest available year
Source: OECD Family database, https://www.oecd.org/els/family/database.htm.
Very long parental leave and relatively generous associated cash benefits discourage women from returning to work, as discussed in detail in previous Surveys (OECD, 2023[4]). In 2024, the maximum length of time the parental allowance can be drawn was reduced. For children born after 1 January 2024, the benefit can be drawn until the child reaches the age of three, down from four previously. On average across OECD countries, parental leave is around 33 weeks. At the same time, the benefit amount was increased. While parental leave is not gender specific, in 2023/24 more than 98% of parental allowance beneficiaries were mothers. Over the years, more flexibility has been introduced to give parents a choice over the length of parental leave. Each recipient of the parental allowance is entitled to a fixed budget (currently CZK 350 000 for one child, CZK 525 000 for twins) and chooses their monthly instalments, which in turn determines the length of the parental leave. On average beneficiaries were drawing the benefits for 31 months. The design of the benefit induces lower income beneficiaries to draw the benefit for a longer period. This is because the maximum monthly instalment is a fraction of the beneficiary’s income, leading to lower monthly instalments for lower-income beneficiaries and hence longer drawing periods to exhaust the total allowance. The authorities plan to increase the minimum amount that can be drawn, allowing for faster drawing of the benefit by low-income households, which is welcome. While it is possible to draw the parental allowance and work, data on how many recipients work are currently not available. Research shows that an increase in the parental allowance by 36% in 2020 led to a decline of labour market participation of mothers on average by 4.8 percentage points (Grossmann, Pertold and Šoltés, 2024[26]).
Public expenditure on family benefits by type of expenditure, % of GDP, 2019
Source: OECD Family database, http://www.oecd.org/social/family/database.htm.
The effective duration of paid parental leave should be gradually reduced, and part of the parental leave should be made conditional on both parents taking some of the parental leave in households with two parents. The amount of commensurate cash benefits should be reduced accordingly. The savings should be redirected to expand affordable childhood education and care facilities. Different ways exist to reduce the effective duration of parental leave. The maximum duration of parental leave could be further shortened. Moreover, some OECD countries with relatively long paid parental leave entitlements reduce the generosity of the benefits over time (e.g. Hungary and Finland). In addition, some countries offer a childcare allowance or a subsidy of childcare fees available to working parents as an alternative to parental allowances. For instance, in France, income-related childcare allowances are provided to parents who use nurseries.
Further expanding affordable, high-quality childhood education and care (ECEC) should remain a key priority. Enrolment of children under the age of three in ECEC is among the lowest in the OECD. As discussed in detail in Chapter 4, there is a lack of affordable childcare places in Czechia. This is an important constraint hindering mothers’ return to work. The introduction of children’s groups (under the Ministry of Labour and Social Affairs) in addition to kindergartens (under the Ministry of Education) has helped increase capacity. However, there is a risk that the quality of provided services differs. Kindergartens must follow a framework education programme prepared by the Ministry of Education, while children’s groups do not follow any centralised education programme. As discussed in detail in Chapter 4, rebalancing public spending from parental leave towards expanding ECEC capacity and supporting low-income families to cover ECEC fees, ensuring children benefit from minimum standards of learning and development opportunities across ECEC providers, and attracting a qualified workforce can help mothers return to work and ensure equality of opportunity for children.
Increasing the flexibility of working arrangements can help mothers (re-) enter the labour market. Part-time work is used more rarely compared to other OECD economies, despite an increase in recent years, especially for women. Increasing the use of part-time work and incentivising employers to provide flexible work options suitable for mothers with pre-school children is one of the priorities set out in the government’s Gender Equality Strategy for 2021-30 (Office of the Government of the Czech Republic, 2021[27]). In 2020, job sharing was legislated with the aim of encouraging a higher uptake of part-time work by mothers. Higher flexibility of jobs, better enforcement of rights for part-time work and flexible teleworking arrangements can support the re-entry of women into the market. In Sweden, for instance, mothers can split the parental leave period of 18 months into a number of shorter spells and use them to shorten working hours until their children reach the age of eight. They also have the right to shorten working hours up to 25% of the normal hours even if the parental leave days are used up in this period.
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