Facts and Analysis

Facts and Analysis. Why Redistribution Seems Lower in Lithuania

Redistribution may be defined as the transfer of tax revenue to finance the state apparatus and maintain the government. One of the ways to calculate the size of redistribution of an economy is to calculate the ratio between tax revenue and the gross domestic product (GDP). This indicator is used by the Eurostat and various international organizations, such as OECD, the World Bank, etc. Some economists even use this as a proxy indicator for tax burden. Many agree that high values of tax revenue-to-GDP signal high level of redistribution. New Member States are often berated for having relatively low levels of redistribution and these statistics are presented as alleged successes or presumed failures of supposed liberal economic policies by the new Member States.

Regardless of the efficacy of tax revenue-to-GDP indicator, it seems that statistics are biased against new Member States. Our research proposes that the tax revenue-to-GDP indicator is biased against countries which do not tax transfer payments, have higher shadow economies, and lower sovereign debt. If adjusted to reflect these differences, the tax revenue-to-GDP indicator does not show significant differences between old and new Member States. This challenges the claim that new Member States redistribute to little or that they should redistribute more.

The calculations of the adjusted indicator show that if different factors (taxation of social security contributions, size of official non-observed economy during the year) were assessed, the maximum rate of redistribution in Lithuania could reach 34.2 percent of GDP (4.8 percent higher compared to Eurostat estimated size of 29.4 percent of GDP in 2015). The average size of redistribution in the EU would be 40.8 percent of GDP (0.8 percent higher than the current rate of 40 percent of GDP).

 

Redistribution-1

Factors that influence the indicator of redistribution

– Taxation of social security contributions

In many countries social security contributions are taxed. If revenue from taxing social security contributions are treated as tax revenue and if social benefits primarily come from public sources, there is a possibility that redistribution statistics are skewed. More precisely, countries that tax social security contributions might seem to have more tax revenue than those which do not tax social security contributions or transfer payments.

According to OECD data, countries that tax security contributions collect a part of their revenue through those taxes. In different countries the part of tax revenue derived from taxes on social security contributions ranges from 0.3 to 5.5 percent of GDP. Almost all EU countries impose taxes on social security contributions. As a result, those countries seem to redistribute more. The adjusted sizes of redistribution (with regard to taxation of social security contributions) based on the below formula are provided in Figure 3.

Redistribution-formulaRedistribution-5

 

 

 

 

 

 

 

 

 

 

 

 

– The size of the shadow economy (tax non-collection)

Calculations of the indicator of redistribution (the ratio between tax revenue and GDP) should assess the shadow (non-observed) economy. Differences in values of non-observed economy (NOE) in the GDP calculation may significantly distort the tax revenue-to-GDP statistics.

The estimate of non-observed economy (NOE) is included in GDP calculations, but the data on tax revenue only reflects the actual tax revenue. The higher the estimate for NOE is used in GDP calculations, the larger the denominator, the lower the indicator of redistribution.

The impact of non-observed economy on redistribution is assessed based on the formula below. Results are presented in Figure 4.

Redistribution-6Redistribution-7To account for non-observed economy, we have to adjust Lithuania’s redistribution indicator by 4.8 percent (up to 32.2 percent of GDP). If Member States include the shadow economy in their official GDP statistics, the average size of redistribution in the EU would account for 40.8 percent of GDP as compared to the current Eurostat estimate of 40 percent.

The full analysis (in Lithuanian) is available at http://www.llri.lt/naujienos/ekonomine-politika/25539/lrinka

LFMI’s previous analysis and a paper on redistribution of intra-budgetary funds across Lithuanian municipalities (in English) is available at http://en.llri.lt/news/economic-policy/redistribution-of-intra-budgetary-funds-across-municipalities/lrinka

Facts and Analysis. Municipalities, Investment and Communities

Investment is a key element behind economic growth. Research shows that municipalities where investment is higher have lower unemployment and higher average wages.

2013 and 2014 data show that two thirds of municipalities recorded a growth of foreign direct investment and material investment per capita. Overall economic activity judging by the ratio of active agents to people having a business licence increased in almost all of Lithuania’s 60 municipalities. Yet, more than half of municipalities reported a decline in the number of construction permits.

The situation regarding investment across the country’s municipalities is improving, but the progress could take up an even faster pace.

The Lithuanian Free Market Institute has analysed the situation with investment development in Lithuania’s municipalities and has conducted a survey of more than 250 local community leaders. The survey was aimed to elicit information about local communities’ attitudes towards business investment and involvement in the development of investment projects, relationships and communication with investors, and the scope and peculiarities of their engagement in the public policy process relating to investment development.

The survey findings show that:

  • Communities welcome investment sand recognize the benefits they bring;
  • Communities have insufficient knowledge of the legal and public policy processes relating to their involvement in the development of investment projects;
  • Communities are not inclined to conflict with investors and such conflicts are quite rare;
  • The risk of conflict can be further diminished through education of local communities and timely communication.

Full analysis (in Lithuanian) Municipalities, Investment and Communities is available here.

Facts and Analysis. Is There Budgetary Revenue in Increasing Taxes?

The Lithuanian Free Market Institute has examined the future social model-related draft Labour Code and draft amendments to the Law on State Social Insurance Pensions as well as the Law on State Social Insurance and submitted its comments and proposals to relative legislative bodies.

Download full research paper and position notes (in Lithuanian):

 

 

Facts and Analysis. How Do Minimum Wage Increases Affect Companies?

In the years 2012 through 2014, the monthly minimum wage in Lithuania was increased three times, from 231.70 EUR (800 LTL) in 2012 to 299.76 EUR (1,035 LTL) in 2014 and there are new plans for another increase in 2015. However, there has been a lack of research on the consequences of increasing the minimum wage for Lithuania’s companies.

The Lithuanian Free Market Institute (LFMI) conducted a corporate survey and four case studies of Lithuanian enterprises to analyse the impact and implications of increases in the minimum wage on the business sector. A total of 181 small and medium-sized enterprises were surveyed in order to find out how they were affected by the recent increases in the minimum wage and what implications a future increase might involve.

The results of the survey show that not all companies are in a position to increase the minimum wage and that the increases in 2012 and 2013 negatively affected every third surveyed company. Reportedly, a planned increase in the minimum wage by 58 EUR (200 LTL) will negatively affect 48% of enterprises and in order to balance wage costs, companies would be forced to undertake a number of undesirable measures: 29% of companies would cut jobs, 30% would reduce working hours and 19% would lower wages for those who earn more than the minimum wage.

LFMI also carried out four case studies of the surveyed companies in order to show the effects of an increase in the minimum wage on specific enterprises. Case studies show that increases in the minimum wage lead to job cuts, boost consumer prices and dissolve the wage differences between qualified and low-skilled workers. Also, they have a negative impact on enterprises regardless of their financial position and force companies with many minimum-wage earners to cease business activities.

Download the company survey (in English) Facts and Analysis. How do minimum wage increases affect companies? and (in Lithuanian)  Faktai ir analizė. Kaip MMA didinimas paveikia įmones? (I)

Download the case studies (in Lithuanian) Faktai ir analizė. Kaip MMA didinimas paveikia įmones? (II)

Facts and Analysis. How do Minimum Wage Increases Affect Companies?

2014, October 23rd, Vilnius – A survey conducted by the Lithuanian Free Market Institute shows that a rise in the minimum wage negatively affects Lithuania’s businesses and hurts workers. Of the 181 companies questioned, every third said that the 2012 and 2013 increases in the minimum wage had a negative impact on their businesses. If the minimum wage were to increase by 200 litas (€ 57,92) in 2015, it would impair 46 percent of the surveyed companies.

“It is a shame that in Lithuania increases in the minimum wage are based on political, not economic, logic. On paper, it may look like it makes people richer, but in reality it puts workers at a disadvantage. As a consequence of increasing the minimum wage, some companies will have to reduce salaries or even fire employees,” says LFMI President Žilvinas Šilėnas.

According to the survey, the rise in the minimum wage in 2012 and 2013 led about a third of the surveyed enterprises (35 percent) to abandon their business development plans. If the minimum wage were to increase by another 200 litas (€ 57,92) in 2015, almost half (48 percent) of the surveyed companies would scrap or delay their plans for future development.

“Increasing the minimum wage deprives companies of the option to decide where to best spend the organization‘s money,” LFMI Senior Policy Analyst Vytautas Žukauskas says.

The surveyed companies lowered their payroll as a direct consequence of the increased minimum monthly wage in 2012 and 2013. Some companies dismissed employees (17 percent) or reduced working hours to part-time (15 percent).

If the minimum wage were to increase by 200 litas (€ 57,92 ) in 2015, a total of 29 percent of the surveyed companies would cut jobs and another 30 percent would reduce working hours. In addition, every fifth company would lower salaries of the employees who earn more than the minimum wage.

“Of course, an increase in the minimum wage is no issue for companies which already pay higher salaries. However, the survey we conducted shows that a rise in the minimum wage negatively affects businesses, especially those which are in unstable financial shape and which employ many minimum wage earners. Some of the companies have had to fire employees or cut their working hours. We understand that for people in such organizations salaries do not increase and there is also a risk of losing jobs,” Vytautas Žukauskas says.

The minimum wage has been raised three times in recent years, from 800 to 850 litas in 2012, to 1000 litas in 2013 and to 1,035 litas (€ 299,76) in October 2014. “There are better ways to improve living standards for people who earn low salaries. Firstly, politicians seem to forget that they can increase non-taxable income instead of raising the minimum wage. This way people would earn more and company costs would not grow. Secondly, we would improve conditions for investment and see more businesses paying more than the minimum wage,” Žukauskas noted.

If the non-taxable income were raised to equal the minimum wage (1,035 litas/ € 299,76), the net earnings would approximately increase from 870 litas (€ 251,97) to 941 litas (€ 272,53). 

A total of 181 Lithuanian companies took part in the survey. Most of the companies (47 percent) are based in the Vilnius and Kaunas regions, while others are located in the Šiauliai, Panevėžys, Utena, Telšiai, Alytus, Klaipėda, Marijampolė and Tauragė regions. Of the surveyed companies, the largest group (66 percent) comprised organizations with up to 50 employees, and 65 percent employed minimum wage earners. The survey was conducted in the summer of 2014.

Download the corporate survey (in English) Facts and Analysis. How do minimum wage increases affect companies?

Facts and Analysis. Activity and Policy Changes of the Competition Council 2009–2013

Konkurencijos leidinysABSTRACT  of LFMI analysis “Facts and analysis. Activity and policy changes of the Competition Council 2009–2013“

The object of this analysis is the activity and policy changes of the Competition Council (2009-2013). Three main aspects of the council are under assessment: its activity, the changes in the Law of Competition, and how the Competition Council itself has assessed its accomplishments.

Trends and statistics

The amount of rulings made by the Competition Council is decreasing, but the penalties it issues are getting larger. This allows us to think that the Council is concentrating more on large-scale investigations that involve violations of the Law of Competition that disturb the market most.

Rulings on concentrations (rulings on mergers) still make up the largest share of all the Council’s rulings, despite having decreased during 2009-2013. The numbers of identified violations and concentration prohibitions remain very low.

The number of rulings for abuse of the dominant position has increased, but a part of the rulings are withdrawals of investigations or refusals to initiate investigations. Only a few penalties were issued for abuse of the dominant position; some of the penalties were extremely harsh.

The amount of violations by the bodies of public administration is not decreasing. The number of instances when public administration bodies fail to comply with the rulings of the Competition Council is increasing.

The amount of the rulings on prohibited mergers has increased; so have the penalties for the violation. During the past five years, the total amount in penalties was 17 times bigger than during the period of 2000-2008.

Changes in the Law of Competition that have affected the supervision of competition

The administrative requirements for economic entities in the field of concentration supervision were reduced. The powers of the Competition Council have been expanded; it has acquired more legal tools to be used during investigations.

The competition law regulation is being elaborated, which adds clarity to social relations.

The methodology of assessing the public benefits of the Competition Council activity

The assessment of the cartel duration is inaccurate because it fails to take into account that such agreements are short-lived by nature and do not necessarily constitute economic harm.

Due to the principles of the economy of scale, prices do not necessarily increase in the event of concentration. In Lithuania, merger control is too stringent, which does not guarantee greater security.

When assessing the benefits of given penalties, the harm done is not assessed. In addition, the underlying assumption that the state is able to use the acquired money more efficiently than the consumers or the penalized companies persists.

Download the analysis (available in Lithuanian only): “Facts and analysis. Activity and policy changes of the Competition Council 2009–2013“

Facts and Analysis. Small Loans Market and Regulation in Lithuania

The small loans market (quick credit, pay day loans) often gets a lot of criticism in the media. Its critic’s state that the market has too little supervision; that the industry does not properly access the ability of its customers to repay their loan; high interest rates etc. In October 2013, the Lithuanian Bank introduced a new amendment to consumer credit law underthe Ministry of Finance. Some of the amendmentsare very strict and their implementation will have a significant negative impact on the consumer credit market. However, the impact is felt not only buy credit grantors, but by their beneficiaries as well, as access to consumer credit becomes more difficult.

Before the introduction new regulations, it is necessary to pre-assess existing needs. There must be a clearly identified problem (without any distortion) and it must be solved in a way that does not essentially result in the collapse of market services (regulation may not be the actual service insurance). Adjustments must also be based on the proper use of problem assessment in the credit market.The techniques currently used, and the indicators evaluating the extent of the problems in the consumer credit market, are not compatible, and they distort the true state of the industry.  The regulator, in order to better assess the situation, should improve valuation methods and collected statistics in the industry.

Many of the problems in the consumer credit market stem from the adopted solutions of irresponsible credit borrowers. Therefore, regulations have to ensure that incentives for responsible decision making are not impaired,such as the transfer of responsibility fromthe credit buyer to the creditor. Regulation has to be directed to people with personal responsibility. Troubleshooting has to be focused on thecustomer’sfinancial knowledge and understanding of the risks involved. However, regulation cannot presume that all market participants are incapable of making the right decisions, and a consumer credit service in the market (in one form or another) is desirable.

Before imposing further regulations, it is necessary to assess whether the existing regulations are not sufficient. Lithuania has adopted many common laws in the governing the consumer credit market. Statistics show that these regulations have an impact on the market. Therefore, it is necessary to make sure the existing regulatory framework already addresses the problems.

Download the study (in Lithuanian) Facts and analysis. The small loans market and regulation in Lithuania

 

 

Facts and Analysis. Integrated EU Market for Card, Internet and Mobile Payments

front page_IF

Lithuanian Free Market Institute (LFMI) provides the analysis regarding European Commission’s (EC) proposal to regulate Interchange Fees (IF) across Europe. This is an executive summary of the analysis.

Interchange Fee (IF) is a fee paid by a merchant when a transaction is carried out between merchant’s bank and consumer’s bank for goods or services purchased by a consumer with the help of a card drawn by a consumer from his/her bank.

Download:

–          Briefing paper of the analysis (3 p.): http://files.lrinka.lt/AM/LFMI_IF_summary.pdf

–          The extensive analysis (13 p.): http://files.lrinka.lt/AM/LFMI_IF.pdf

The problem in brief

According to the European Commission:

  1. Current IFs are too high, vary across countries and are not transparent. This situation hampers development of a single market in EU, and thus requires regulation.
  2. This fee (IF) is the main obstacle for e-commerce growth, spread of electronic and new innovative payment methods and development of single market.
  3. Harmonizing IF rates across EU would promote competition, innovation and the growth of e-commerce.
  4. Additional regulations, such as co-badging, “easier market access” for new companies, standardization on various levels, changes in ownership structure of companies by separating card schemes from payment processing companies would also bring benefits.

According to LFMI:

  1. LFMI supports the EC’s aim to develop a single integrated European market, but measures suggested by the EC are not entirely suitable for the objective and instead could harm consumers and businesses and reduce EU’s global competitiveness if it were implemented.
  2. Regulation would be especially harmful to consumers and new merchants or startup businesses that rely on or are developing new innovative solution for the e-commerce market. It is highly likely that consumer would have much less to choose from and the prices for goods and services could be higher, whereas entrepreneurs could have less incentive to innovate, develop and invest.

Brief analysis of proposed regulation

  1. Payment market differences across EU do not mean that market is not functioning. IFs across countries are determined by market conditions (economic, technological, regulatory and etc.) therefore are different between states. High IFs rates are observed in countries that lack the infrastructure necessary for development and spread of card, internet and mobile payments. While countries with low IFs usually enjoy high numbers of cards and card users, higher value transactions per card, a significant number of points of sale (POS) and people are in the habit of using electronic payment options, instead of cash or bank transfers. Suitable examples would be Estonia and Lithuania. Rates in Estonia are much lower than in Lithuania, because the spread of cards, their usage, transaction values and number of POS is greater than in Lithuania.
  1. Obligatory co-branding increases costs. A suggestion to force companies to use co-branding (several brands on a payment card) would create a number of issues and potential problems. Just to name a few: Which brand is liable in the case of fraud or theft? Different brands have different technologies and IT protocols, how to resolve it? How would few brands on a card affect time spent at the cash register and which brand is the main one? Can the consumer choose the default priority brand or make the choice every time when paying? Instead of benefiting the consumer and increasing usage if cards, co-badging may have an opposite effect. High likeliness of more expensive services to the consumers due to increased costs that are related to implementation of these proposals and less consumer choice.
  1. Artificial separation of companies does not increase efficiency, but increases costs and prices. EC claims that separating ownership between card schemes and payment processing companies would make market access for new or cheaper card schemes easier and thus such action would promote competition. However, separating payment card schemes from their payment processing subsidiaries could mean higher operating cost and this would result in higher fees for both consumers and merchants. This could happen because companies would no longer enjoy economy of scale and could not set standard procedures and, this would decrease efficiency. Companies have invested through the years to improve operations, to reduce costs and build reputation. It is highly unlikely that such separation would promote efficiency and innovation in the market and promote entrepreneurs to take risk.
  1. Pricing transparency of payment services does not require regulations. According to EC, consumers are not aware of particular costs of payment methods that they use. LFMI argues that regulating the price is not a solution to a problem of lack of information. There are a number of examples when markets are working perfectly, even if the consumer is not aware of the costs. From “iPhone” to cars or to electricity bills. Consumers care about the final price of goods and services.
  1. Forced standardization could reduce EU competitiveness.  European Commission suggests setting standards for cards and card operations, establishing a standardization body (regulatory agency) and setting standards for e- and m-payments. However, there are market standards and even ISO standards for cards which are in circulation today. E- and m-payment are new payment options and are still being developed, especially m- payments. This market is rapidly developing and the introduction of common standards might prevent or slow down the growth of it. In order for Europe to be in the lead in terms of e-commerce, it is necessary to allow such markets to develop on their own with the minimal level of intervention from regulatory authorities. We will never know how a new payment method would look tomorrow if we prevent entrepreneurs from developing it by setting standards that do no promote innovation.
  1. Excessive payment and data security regulation does not ensure greater security. EC emphasizes the fact that payment and data security is not sufficient and therefore requires improvement and the number of parties which have access to sensitive consumer data, have to be kept to a minimum. LFMI agrees that payment and data security is very important. However, a lot of investment has been done by companies to prevent fraud in traditional payment methods, which gave good results. But due to rapidly increasing use of internet technologies fraudulent activities are moving to the internet and mobile payments (e- and m-payments). However, there should be a careful consideration when creating rules for security and understanding the nature of fraudulent activities. We suggest that EC should restrain from setting up specific standards or rules for companies on how to prevent fraud and data loss. Companies have a self-interest to prevent fraud and data loss and they invest a lot into new technologies, conduct strict due diligence. More so, additional requirements by government require additional resources (investment, time and human), which in the end add up to the costs and increase the final price. More importantly, because a lot of operations are carried out globally, certain security regulations might prevent global interoperability.
  1. Consequences of IF regulation from other countries does not support the need for IF regulation in EU. Results of regulations, mainly of regulating IFs, can be seen in Spain or Australia. In both cases, consumers saw increased card fees, fees for overdrafts, reduced discounts and benefits. Banks were increasing such fees for consumers, because they saw reduced cash flows from IFs paid by merchants. More importantly, merchants in Spain and Australia internalized these savings and did not pass them to consumers in the form of lower prices. This was clearly opposite of what, the governments of both countries had expected. In the end, there was less incentive to invest and innovate and to develop new payment methods and for entrepreneurs to enter the market. Competition was dealt a serious blow and consumers paid the price for reckless intervention into the market.

In 2011 there were 727 million payment cards in circulation, 1.44 per capita and it is a 4.6% increase of non-cash payment instrument usage from the previous year.  There were 90.6 billion transactions carried out with a card, with an average value of such transaction at around 52 EUR with the total value being 1.9 trillion EUR. According to Ecommerce Europe, the e-commerce market grew by 19% in 2012. Europe is the biggest e-commerce market in the world (surpassing USA and Canada) in business to consumer (B2C) segment with a 35.1% share while USA and Canada has a 33.1% share and Asia-Pacific with 25.6% share. It its estimated, that by the end of 2016 the European B2C market should reach a volume of 625 billion EUR or more than double the current volume. Additionally, it has been estimated, that m-payments (mobile payments), the newest payment platform that has the most potential of all payment methods, should reach 1 trillion USD volume by 2014 of which 350 billion USD should come from Europe. To add, around 47% of Europeans have a smartphone. That empowers entrepreneurs to develop m-payments and expand the e-commerce in Europe.