In Discussion Paper No. 1151, Christopher Heady and Stephen Smith study the progress of reform in the systems of personal taxation and social security benefits of the Czech and Slovak Republics, modelling the reforms with household micro-data and a tax simulation model. The 1992 reform in the former Czechoslovakia created a tax system closely modelled on West European practice: the existing turnover tax was replaced with a value-added tax (VAT), and major changes were made to the taxation of corporate and personal incomes. Priorities were given to making a transition from arbitrary and negotiable tax structures to a more uniform and rules-based system, and to design taxation in such a way as to minimize administrative and discretionary requirements. Both objectives are reported to be generally achieved, although questions remain about the application of the new rules in practice, and, for the case of VAT, greater use could have been made of more administratively straightforward taxes. A microsimulation model is used to show that adverse distributional consequences of VAT-simplifications can be eliminated by altering other taxes and benefits, but only at the cost of increasing the overall marginal tax rate.

The same model is applied to simulate reforms of the social security system. Here, the former three-tier arrangement, based upon a social insurance scheme, social assistance, and remaining universal benefits, was transformed to a comprehensive system of state support in January 1995. The simulation shows that the reforms have a progressive distributional impact, favouring low income groups on average while disfavouring higher income receivers. The main drawback, again, is the distorting increase of marginal tax rates.

Tax and Benefit Reform in the Czech and Slovak Republics
Christopher Heady and Stephen Smith

Discussion Paper No. 1151, March 1995 (IM)