15.04.2021 Taxes

[Czech Republic] Czech progressive tax in practice


Progressive taxation is one of the tools by which the state tries to achieve greater justice in the redistribution of wealth or uses it as a countercyclical tool, as proposed by J. M. Keynes in the 1930s. But it always depends on the point of view. Left-wing voters will push for progressive taxation to achieve greater justice, while those who are right-leaning will reject it for the same reason. But how does progressive taxation actually work in Czech conditions?

From 1st January 2021, the so-called progressive taxation of personal income tax (PIT) was formally returned to the Czech tax system. Formal progressive taxation in the Czech Republic last applied on 31st December 2007, i.e. 13 years ago. However, I deliberately use the term “formally” because even before 2021, de facto, under the Income Tax Act, there was progressive taxation (for PIT), except for slight differences, with almost the same “rate of progression” as today.

There are now two tax rates: 15% and 23%. Annual income up to 48 times the average wage is taxed at a rate of 15%. Income above this limit is already taxed at a rate of 23%. As indicated above, right-wing voters will argue that this is unfair, as there is not a single reason why we should punish the greater effort and success of the high-income population. Whether we agree or not, we need to think about if these people really give up most of their income to the state.

Health and social insurance, which are also paid from gross income, meet some tax features and some do not. The basic principles of the tax are: obligation, non-return, non-equivalence and non-purpose. The obligation means that its payment is given by law and is enforceable by the government. Non-refundability means that the taxpayer cannot claim it back. Inequality means that the taxpayer cannot expect consideration of a similar value, and non-purposefulness tells us that the taxpayer cannot influence what the tax will be used for. Health and social insurance meet the principles of obligation and non-refundability. Partly they also meet principle of inequivalence, but they no longer meet the principle of non-purpose.

If we consider social and health insurance as taxes for simplification, we must look at progressive taxation in the context of these two other levies. We will not take into account the payment of health and social insurance by the employer. At the same time, we take into account only those taxpayers who achieve at least the minimum wage for full-time work.

Health insurance is paid in the amount of 4.5% of gross income. There is no ceiling and formally no second rate. However, the situation is different with social insurance. The institute of the maximum assessment base for social insurance has existed since 2008. Social insurance amounting to 6.5% of gross income ceases to be paid as soon as a cumulative income of 48 times the average wage is achieved during the year.

Why does this institute of the maximum assessment base even exist? The answer to this question can be provided for example by Judgment of the Constitutional Court No. 135/2010 Coll., according to which the amount of the old-age pension should at least partially correspond to the amount of the premium paid during the economically active life. In other words, if there was no maximum assessment base for social insurance and people with extremely high incomes would thus pay above-standard amounts to the social insurance system throughout their lives, the state should adequately calculate and then pay them a retirement pension. However, the government will never be able to provide such high pensions (up to hundreds of thousands). For this reason, a ceiling has been created, from which high-income individuals no longer pay social insurance.

Although the maximum assessment base (for employees) was not introduced in the Czech Republic until 2008, this institute is much older and is related to the establishment of social insurance at the beginning of the 20th century. At that time, rather low-income employees / workers who were unable to prepare financially for their old age could enter the social insurance system. High-income individuals were completely excluded from the system. Later, however, the system was modified and everyone began to join the social insurance system, but for the above reasons, a ceiling was created, from which some no longer participate in the system.

But let’s go back to the Czech 48 times the average wage. This limit is exactly the same for the maximum assessment base for social insurance and for the tax progression of PIT. Let’s notice that while people start paying 8 percentage points higher tax for income tax above this limit (solidarity tax by 2020 was 7%), for social insurance the same person pays 6.5 percentage points lower social insurance. In fact, for the most part, there is a settlement and high-income people are deducted from gross income by a maximum of 1.5 percentage points more, as the chart below shows.

Up to the limit of 48 times (or 4 times, if we are talking about the monthly income) of the average wage, the percentage is still the same. From a given limit, the percentage begins to increase, which is caused by the difference of one and a half percentage points. The higher our income is, the lower the percentage increase is, and even with a salary of CZK 1 million per month, the contribution will not reach 27.3%. This represents a difference of only 1.3 percentage points compared to most people with average incomes, and can thus be considered negligible.

Thus, although there is progressive taxation in the Czech Republic, approximately the same percentage is deducted from gross income for all people. Taxation could thus be considered linear in this respect. If we had a flat-rate tax under otherwise unchanged conditions (and taxation was thus formally linear), we would in fact experience a tax degression in which the percentage of levies decreases with increasing income.

The purpose of this article is not to defend either side of the economic-political spectrum. After all, even a right-wing voters can refute the simplification I have used that says “social (and health) insurance is a tax” and argue that the existence of a maximum assessment base has its justification, which was, after all, explained in this article. The article is only intended to provide a deeper insight into the issue of progressive taxation in the Czech conditions in a wider context.

Author:

Martin Svoboda
Payroll Development Specialist
Contract Administration

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