Two Approaches to Cyclical Adjustment of Fiscal Balances: The Case of Czechia

This paper focuses on estimation of cyclically adjusted balance in Czechia with emphasis on period from 2010 onwards. The estimation is performed using two common approaches: Standard approach, known as OECD approach, uses the business cycle (output gap) as the relevant indicator of the cyclical position for each tax category. Alternative approach, known as ESCB approach, uses various macroeconomic variables and their respective cycles as relevant indicator for the cyclical adjustment. Therefore, each tax category is linked to the cycle of its own macroeconomic variable. In Czechia, the two approaches lead to different results which indicate the relevance of what the output gap is driven by and how the business cycle is reflected in wages, household consumption and profits. Given the tax system of Czechia, the cycle of wages and consumption is of particular importance. If the business cycle is driven by ups and downs of firms\\\' profits, the standard approach overestimates its impact on fiscal revenues. Conversely, if the economic growth or downturn is driven by wages and consumption, the standard approach underestimates its impact on fiscal revenues. In many years the cyclically adjusted balance estimated by alternative approach varies from standard approach between 0.2% to 0.5% GDP.