Recession-hit Estonia is seeking to boost defence funding by raising the value-added, income and corporate taxes by 2%. Meanwhile, Lithuanian businesspeople and economists say that the country has a chance to boost its competitive position vis-à-vis its longstanding regional rival if it manages to maintain stability in its tax system.
The experts don’t rule out the possibility to Lithuanian businesses in Estonia will decamp because of the deteriorating tax and economic environment. Time will tell whether they will return to Lithuania or seek more attractive markets.
Lithuanian Finance Minister Gintare Skaiste believes that Estonia’s tax changes will have a far greater impact on the country’s tax system than will the defence package which Lithuania adopted earlier this summer.
Estonia’s government decided on September 23 to introduce a three-part “defence tax.” If the plan is adopted in Parliament, VAT will rise by 2% to 24% in 2025. The personal income tax will climb to 22% next year and 24% in 2026. The corporate income tax will also rise by 2% to 24% from 2026 (22% next year). A 2% rate is also to be introduced on reinvested profits, which are not taxed in Estonia at this time.
Estonia does not have a progressive tax system, so all taxpayers pay the same rates.
The tax rises are meant to support major investments in defence and the national economy. Media reports suggest that the government is also planning to cut public spending by around one billion euros over the next three years.
Skaiste argues that tax hikes mean that Estonia will have broader sustainable sources of defence funding than Lithuania does do.
“The changes in Estonia are broader in scope and will mean more significant changes in its tax system,” Skaiste told BNS. “Our changes were more focused on excise policy and the corporate tax, while they have implemented more changes to systemic taxes.”
Lithuania has implemented a lesser tax increase for national defence needs. The finance minister said that the country needs less in additional funds for this. She also added that Estonia is increasing taxes not just to finance defence, but also to maintain sustainability in borrowing.
“Their projections show that if they do nothing, their debt levels would rise dramatically, as would their debt servicing costs,” said Skaiste. “If they want to spend the money on defence and not on debt servicing, that is their choice. We will see how this affects their economy.”
Vilius Tamkvaitis is a senior analyst at the Lithuanian Investors’ Forum, and he also believes that Estonia’s taxes are being changed to avoid an increase in public debt.
“It is practically impossible to balance the budget in any other way right now during a period of economic slowdown,” Tamkvaitis told BNS.
The president of the Lithuanian Business Confederation, Andrius Romanovskis, for his part, says that by raising three different taxes, Estonia is demonstrating that all of its citizens must contribute toward national defence.
“One can criticise the scale of the hikes, which are quite drastic, but they are opting for a horizontal hike, as opposed to progressive taxes,” Romanovskis told BNS. “In principle, the message is that defence is everybody’s business, whether they are high earners or low earners.”
Zygimantas Mauricas is chief economist at the Luminor Bank, and he believes that the tax hikes will have a negative impact on Estonia’s already weakening economy.
Both aforementioned institutions and the bank predict that Estonia’s economy will shrink this year while Lithuania’s will continue growing. Luminor forecasts a 1% contraction for Estonia this year as against a 2.4% growth rate in Lithuania.
“Estonia’s economy will stagnate while Lithuania’s will grow,” predicted Mauricas.
The economist also says that the VAT and corporate tax hikes, higher excise duties and a new car tax in the smallest Baltic state will also fuel inflation, and businesses are likely to pass rising costs on to consumers.
“More tax increases will make Estonia just about one of the most expensive countries in Europe,” Mauricas argued.
Romanovskis, for his part, argues that the tax changes are harming Estonia’s competitiveness.
Tamkvaitis also says that tax hikes in Estonia will make Lithuania’s tax environment more favourable, but Lithuania competes not just with Estonia, but also against other countries in Central and Eastern Europe.
“It’s a small benefit for Lithuania, but in the broader context, it should not mean any significant changes,” Tamkvaitis told BNS.
Finance Minister Skaiste, however, does not believe that it is proper to compare the Lithuanian and Estonian tax systems.
“It is not appropriate to compare Estonia directly to Lithuania, as they have a different non-taxable income rate in their individual tax system, and theirs is also a completely different corporate tax system,” the minister told BNS.
Source: BNS
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