As recession-hit Estonia seeks to boost defence funding with plans to raise value-added, income and corporate taxes, Lithuanian businesses and economists say Lithuania has a chance to increase its competitive position in the region, if it maintains the stability of its tax system.
Lithuanian Finance Minister Gintare Skaiste believes that Estonia’s tax changes will have a far greater impact on the country’s tax system than the defence package adopted by Lithuania over the summer.
The Estonian government decided on September 23 to introduce a three-component defence tax. And if the plan is approved by the country’s parliament, the VAT will rise by 2%, to 24% from 2025, and the personal income tax rate will also rise by 2%, to 24% from 2026.
In addition, corporate income tax would be increased by a further 2%, to 24% from 2026 (rising to 22% next year). A 2% rate will also be introduced in 2026 for reinvested profits, which are currently tax-free in Estonia.
There are no progressive taxes in Estonia, so all taxpayers will pay the same rates.
The country intends to raise taxes, as it plans major investments in defence and the economy. In addition, according to the media, the government plans to cut public spending by around 1 billion euros over the next three years.
Skaiste says that by increasing taxes, Estonia also offers broader sources of defence funding than Lithuania.
“The changes in Estonia are broader in scope alone and will make a more significant change in its tax system. Our changes were more focused on excise policy and corporate tax, while they have more changes in systemic taxes,” Skaiste told BNS.
Lithuania has had smaller tax increases for national defence needs, as the country needs less additional funds for this, the finance minister points out, adding that Estonia has decided to increase taxes both to finance defence and to maintain a sustainable level of borrowing.
“Their projections show that if they do nothing, their debt levels and debt servicing costs will rise dramatically. So, if they want to spend those funds on defence rather than on debt servicing costs, this is their choice. We will see how this affects their economy,” Skaiste said.
Vilius Tamkvaitis, a senior analyst at the Investors’ Forum, also believes that Estonia introduces tax changes to avoid increasing its public debt.
“It is practically impossible to balance the budget in any other way at the moment amid the economic slowdown,” he told BNS.
Andrius Romanovskis, president of the Lithuanian Business Confederation, says that by raising tax rates Estonia is showing that all citizens of the country should contribute to defence.
“One can criticise the scale of the hikes, as they are quite drastic, but they are opting for a horizontal hike rather than starting with progressive taxes. In principle, their message is that defence is everybody’s business, whether they are high earners or low earners,” Romanovskis told BNS.
Zygimantas Mauricas, the chief economist at Luminor Bank, believes that the tax increases will have a negative impact on Estonia’s already weakening economy.
Both institutions and banks predict that the Estonian economy will contract this year, while Lithuania’s economy will continue growing. Luminor, for example, forecasts a 1% contraction for Estonia this year and a 2.4% growth rate for Lithuania.
“Estonia’s economy will stagnate, while Lithuania’s will grow,” Mauricas predicts.
Moreover, the economist says, the VAT and corporate tax hikes, as well as higher excise duties and a new car tax in Estonia, will further fuel inflation, and businesses are likely to pass on rising costs to consumers.
“More tax increases will make Estonia just about one of the most expensive countries in Europe,” Mauricas pointed out.
Romanovskis argues that the tax changes are worsening Estonia’s competitive position.
According to Tamkvaitis, the tax raises in Estonia will make Lithuania’s tax environment more favourable. However, Lithuania is competing not only with Estonia but also with other Central and Eastern European countries.
“It’s a small benefit for Lithuania, but in the broader context it should not make any significant changes,” Tamkvaitis told BNS.
However, Lithuania’s Finance Minister Skaiste believes it is not correct to compare the Lithuanian and Estonian tax systems.
“It is not appropriate to compare Estonia directly with Lithuania as they have a different non-taxable income rate in their personal income tax system, and also they have a completely different corporate tax system,” she noted. (LRT)