The Czech economy was severely affected by the global downturn, owing to its high degree of openness and integration in global production chains. The fiscal position was also hit hard, prompting a rapid shift in policy from stimulus to consolidation. The medium-term challenges facing the country are principally concerned with creating conditions for rapid convergence with advanced OECD economies by restoring the sustainability of public finances and improving the business environment.

After several years of growth averaging close to 6% per annum, the economy slowed markedly in 2008, entering a sharp recession in the fourth quarter. Real GDP is projected to have fallen by 4.3% in 2009. This reflected the collapse of world trade that followed the onset of the global financial crisis. The economy’s integration in international supply chains, particularly its specialisation in the export of consumer durables and capital goods, made it vulnerable to such a global trade shock. The trade collapse quickly triggered a contraction in domestic demand, especially fixed investment. Private consumption growth turned negative in the third quarter of 2009, as households responded to rising unemployment and a sharp slowdown in wage growth. On the production side, most major sectors contracted, with tradables suffering the most. Manufacturing alone accounted for around half the total drop in gross value added, and service sectors linked to the cycle in manufacturing, like trade and transport, were also hit hard.

This chapter describes how the global crisis hit the economy and the channels through which the external shock made itself felt. It then examines the policy response to the crisis before proceeding to consider the major medium- and longterm challenges confronting the authorities during the recovery. The most important of these concern the state of public finances. First, there is an urgent need for a clear and credible strategy for medium-term fiscal consolidation that would bring the general government deficit down from its current unsustainable level. Secondly, the authorities should move ahead with the reforms needed to address the fiscal consequences of rapid population ageing. Previous Surveys have identified this as a major long-term challenge facing the country, but structural reforms in healthcare and pensions, the two areas of greatest concern, have largely stalled. The current crisis has in some respects made it harder to advance reforms in those areas, but it has done nothing to diminish the need for them.

In 2008, the government implemented a major overhaul of the personal income tax (PIT), replacing the previous progressive rate schedule with a single 15% rate levied on an enlarged base. This was accompanied by significant changes to the corporate income tax (CIT) and an increase in the concessionary rate of value added tax (VAT) applied to many goods and services. The reform made the tax system more transparent and was broadly consistent with OECD recommendations concerning pro-growth tax reform. These tax changes followed the adoption of significant changes to the benefit system, particularly housing and social assistance benefits, in 2006-07. This chapter describes the main elements of these tax and benefit reforms and provides an initial assessment of their impact, with particular emphasis on changes in the effective tax rates of workers and firms. It begins with an overview of the systems and a summary of recent changes. This is followed by an evaluation of those reforms. A final section explores the scope for further reforms in future.

This chapter assesses recent regulatory reforms and considers the scope for future initiatives in this area. It begins with a look at the substance of product- and labourmarket regulation before turning to the questions of regulatory policy per se, particularly simplification and impact analysis. Both substance and process are important, since recent OECD and academic research suggests that less burdensome product- and labour-market regulation and better regulatory management systems are both associated with better performance in terms of output, employment and productivity. A final section looks at the contribution that e-government is making to these efforts and at the areas where the authorities could do more to use egovernment methods to enhance the business environment.