Since 1992 the Lithuanian Free Market Institute has been conducting surveys among Lithuanian opinion leaders who influence social and economic policy formation in Lithuania. The surveyed groups include high-ranking state officials and government executives, leading entrepreneurs, journalists, and academics. Polls have been headed and research findings generalised by LFMI’s research fellow Kęstutis Masiulis, PhD.
The summary of the results of the surveys conducted to date first appeared in Issues 8-9, 1996, of “The Free Market”. This issue presents Lithuanian opinion leaders’ attitudes to and evaluations of the Lithuanian tax system, foreign investment, shadow economy, and corruption.
Taxes should be reduced
The surveys show that Lithuanian opinion leaders see a pressing need for tax reform. The high level of taxes is regarded as one of the biggest roadblocks to business development, and taxes are ranked among those components of economic policy which require sweeping changes. Although opinion leaders are pressing for tax reform, it should be noted that a good many of them perceive it merely as tax cuts, rather than a fundamental redesign.
In late 1995 four fifth of those polled supported the idea of easing the overall tax burden. This measure was opposed by a mere 15.2%, while 4.4% had no opinion on the issue altogether. Over the years, however, the enthusiasm for tax cuts had faded. The number of opinion leaders in favour of tax cuts shrank from a total of 85.3% in 1994 to 83.6% in the spring of 1995 and 80.4% in late 1995. This period saw a diminishing support for tax cuts on the part of politicians (from 97.1% to 59.5%) and an ever-increasing approval from journalists. Supporters of different political parties did not change their attitudes. As a rule, the proponents of the Liberals (90%) and Centrists (92.5%) were the most encouraging. The most radical shift in opinion occurred among the advocates of the Democratic Labour Party (the DLP) since the percentage of opponents of tax cuts doubled from 18% to 36.5%.
In line with tightening up on control
The opinion that tax rates should be reduced in line with tightening up on control is gaining an increasing support on the part of opinion leaders. As compared to 55.5% in September-October 1994, in November-December 1995 their number reached 66.6%. Most of those questioned believe that tax cuts coupled with a more stringent administration would multiply budget revenues, rather than diminish them! According to the surveys, a total of 51.8% of opinion leaders think that tax cuts would expand the tax base, for part of the economy would quit the shadow sector in favour of legal business activity.
Taxes: progressive or proportional?
Opinion leaders appear to be resistant to fundamental changes in the tax system. Most of them say that natural persons should be subject to a progressive income tax (a tax that is charged at an increasing rate as the taxable income increases). A total of 56.3% of those polled-primarily supporters of the DLP (75.8%) and Social Democrats (74.2%)-approve of a progressive tax regime.
A proportional tax system-that is, a system when a single tax rate is imposed on all taxable income-is supported by 33.4% of opinion leaders and is the most popular among business people (52%) and those in favour of right-wing parties, in particular the Liberals (52.6%). The surveys unveiled a rather unusual divergence of views among proponents of the like-minded Christian Democratic and Conservative Parties as well as contradictions between these views and the parties’ official positions. The supporters of the Christian Democrats appeared to advocate more a proportional tax system (52%), although according to the party’s “socially oriented” programme, they were expected to support a progressive regime extolled by the party during the pre-election campaign. A total of 57.1% of the supporters of the Conservatives, in turn, appeared to favour a progressive tax system (37.1%), which is at variance with the party’s official statements. The surveys showed that only 37.1% of the conservative-minded respondents approved of proportional taxes which are also supported by 39.8% of opinion leaders without political preferences.
The surveys indicate that Lithuanian opinion leaders find a regressive tax system-a system when a tax is charged at a reducing rate as the taxable amount increases-the least appealing of all. It is favoured by a mere 7.4% of those polled, mostly by the supporters of the Centre Union (18.8%) and Liberals (10.5%).
It may be anticipated that the decisive battle in adopting new tax laws will take place between the advocates of progressive and proportional tax systems.
Business income – through tax relief and tax breaks
Opinion leaders’ predisposition towards tax cuts is reassuring. It should be noted, however, that their views are fairly inconsistent. A total of 69.8% of those polled believe that it is crucial to grant tax breaks for certain types of business. It is distressing-or maybe natural-that entrepreneurs are the staunchest propagators of tax breaks, with a mere 11.8% being against. The business community must have grasped the logic of the ongoing processes and therefore does not insist on freedom, tax cuts, and elimination of bureaucracy and red tape. Failing to realize that it is feasible to institute fundamental and generally beneficial changes, they go after tax benefits and tax breaks.
It is common knowledge that tax breaks do not simply shift the tax burden onto those who are ineligible for them, but also distort economic motivations and decisions. To become entitled to tax relief, people convert to other areas of business activity or alter its legal status. Many businesses attempt to benefit from legal ways of avoiding taxes simply by adjusting to eligibility criteria. It is evident that such thinking does not hold out much hope for having the overall tax burden eased.
Acceptable tax breaks
According to the surveys, opinion leaders approve of tax breaks for:
· enterprises employing the disabled (95.2%);
· pension funds (82.1%);
· small and medium-size business (70.7%);
· reinvested capital (69.1%);
· agricultural and food processing companies (67%);
· non-profit organisations (62%);
· 46.7% of those polled would grant tax benefits to promote “priority sector” enterprises.
Foreigners should not count on tax breaks
A total of 74.3% of opinion leaders disapprove of tax breaks for foreign companies. A similar percentage of the respondents insist that foreign and domestic companies should operate under equal conditions, an opinion that was clearly articulated during parliamentary debates on the amendments to the Law on Foreign Investment. Yet, the proposal to treat domestic and foreign investors equally was endorsed with an element of doubt. It was decided to sustain the existing tax benefits and to refrain from further expanding their scope.
Centralised tax collection is welcome
Although opinion leaders lack a clear vision of how to redesign tax collection, a total of 41% agree that the task of technical collection (according to the rates established by law) of all taxes (social security contributions, income taxes, VAT, custom duties, etc.) should be delegated to one institution, making others responsible for only distributing collected resources. Presently, functions of the existing institutions frequently overlap, and exchange of information is highly ineffective, thus enabling economic entities to profit by it. Safeguarding their own interests, both small and big fish can squeeze through the “cracks” of taxation institutions.
Speculations about the scope of shadow economy
The surveys show that the shadow sector accounts for 42.5% of the country’s economy. Entrepreneurs maintain that as much as 44.1% of the country’s economic activity goes unreported, while journalists indicate an even bigger figure, 50.7%.
According to the respondents, shadow economic activity has proliferated most of all in trade: 55.7% in real estate, 50.5% in retail trade, and 49.9% in wholesale trade. As compared to other sectors, in agriculture shadow activity is estimated at a mere 27.4%.
Even if these evaluations are exaggerated, they provide evidence that a large part of economic activity in Lithuania remains outside the law.
“Shadow” activity – the last chance to hold out
Goods and services supplied by the shadow sector are quite cheap, which gives them a big advantage over the production afflicted with a cumbersome tax burden. In many cases the ability to evade taxes is the only way to hold out in business.
Shadow economy becomes natural and acceptable as laws devoid of common sense render a legal business activity virtually impossible. In other words, the degree of shadow economy reflects the degree of disadvantage the economic and political conditions impose on private business initiatives.
The fight against bribery fuels. . . bribery
The surveys show that a good many officials fail to comprehend the way the shadow sector emerged. Instead of improving the overall business climate, they take concerted efforts in creating new, “effective” means to pressure and extract every tax possible from the suffocated private business. Evidence shows, however, that prohibitions, control and prosecution have the opposite effect. Shadow economy keeps growing, providing an open invitation for bribery and corruption. With such a system in effect, both entrepreneurs and officials can successfully exercise their ability to split private and public life, a practice developed in the Soviet times.
Corruption – like bread and butter
In the process of the surveys the press kept reporting on increasingly astonishing cases of corruption exposure. Over time however, they ceased to flabbergast the public, for one gets used to things. Bribery became a natural phenomenon of the post-soviet life. Yet, how do opinion leaders suggest fighting the hydra of corruption? Here the responses unfolded a clear divergence of views.
Supporters of the Conservatives and Social Democrats would tighten up on penalties for accepting bribes. The DLP would also impose heavy penalties for bribing. The advocates of the Liberals, Centrists and Christian Democrats give preference to economic liberalisation measures. They suggest reducing customs duties, licenses and other restrictions on commercial activity, and only then contemplating the introduction of really stiff penalties.
Business people and journalists propose:
· reduction in licenses and customs duties, that is, economic liberalization (entrepreneurs-7.4 points, journalists-7.3);
· heavy penalties for accepting bribes (6.7 and 7.4 respectively); and
· reduction in the administrative apparatus (6.3 and 7.0).
Academics underline only the first two measures, while officials would supplement them with severe penalties for those who bribe (6.3 points) and adequate salaries for officials (6.1). Most of the questioned politicians indicated stiff penalties for accepting bribes (6.7), changes in public thinking, and adequate salaries for officials (5.8).
Corruption and morality
The surveys show that opinion leaders are still being influenced by the stereotype thinking that bribery exists not because of the deficiencies of the economic order but because of society’s moral downfall. Most of the politicians and journalists approved of the measures designed to alter public thinking. The same journalists and even more entrepreneurs maintained that corruption stems first of all from the powers of officialdom, that is, restrictions and constraints putting in motion the bureaucratic machine of licenses, permits, prohibitions, customs duties, certificates, and accounts. Those charged with the task of fighting corruption should in the first place see to it that this source of “regulation” stops gushing a fountain of dishonesty. And only then can one hope for a positive shift in public morality.
Tax policy: the principle of “roll” and “stick”
Opinion leaders suggested many different ways of improving tax collection. The supporters of the DLP tend to rely on the “stick” principle, that is tightening up on tax administration and imposing penalties for illegal business activity. Those in favour of the Social Democrats seem to be fond of the “stick”, too. In addition, however, they propose a smaller tax burden “roll”. Conservative-minded respondents would lash with the penalty “stick” and promote by the tax reduction and business freedom “rolls”. The supporters of the Christian Democrats, Centrists and Liberals have a preference for the “roll” by advocating freedom and tax cuts. Besides, liberals would also allow legalising undeclared property. It should be noted that supporters of the aforesaid parties would not reject the “whip”. They would simply assign to it a secondary role.
One may conclude that the fight against shadow business activity will be based on a combination of the “stick” and “roll” principles. The best results would be achieved by liberalising economy and reducing tax rates in line with
(a) increasing the transparency of the legislative framework;
(b) rejecting complex and irrational regulation;
(c) eliminating the conditions for abuse of official power; and
(d) enforcing fundamental legal rules.
Control in line with reduction
A total of 66.6% of opinion leaders hold that tax compliance control should be tightened up in line with tax cuts. As many as 94.9% of those polled would approve of easing the tax burden, since, the argument goes, it would not harm even the state budget. Of these, 60.2% were confident that budget revenues would increase, and 22.5% said they would remain at the same level.
The economic and political climate should encourage legal business initiatives, instead of pushing entrepreneurs to hide their activities. If legal business did not require high costs and sacrifices, people would realize that the “black market” game is not worth the candle because of too many pitfalls involved. Unfortunately, the present business conditions, according to the respondents, are different. One can hardly find a firm which does not keep its incomes off the books or pays every penny of compulsory social security contributions.
It has become a bad tradition that it pays more for business people to focus on circumventing the tax laws and scheming to get tax breaks, rather than on increasing productivity and encouraging technological and managerial innovations. Entrepreneurs who are intent on holding out have already got used to the type of expenses called “bribes and other costs of shadow existence”. It stands to reason that with the existing tax rates and the degree of abuse of official power, the costs of surviving in legal business would be much higher. For many firms they would be too high.
The effect of adverse factors
The following presents entrepreneurs’ opinion about the biggest roadblocks to business development in Lithuania and its comparison with the average assessment (on a ten-point evaluation scale):
· high level of taxes (the business community-7.5, the average-6.0);
· high costs of credits (7.6-6.6);
· lack of investments (7.1-6.8);
· frequent law changes (6.9-6.1);
· corruption (6.2-6.3);
· bureaucracy (6.0-5.7);
· customs duties and licenses (6.0-5.2); and
· organized crime (5.3-6.0).
Journalists’ concern about organized crime
Although it is business people who are supposed to suffer from organized crime more than any other segment of society, they indicate it as a less binding constraint to business activity, as compared to the average assessment. Of all the surveyed groups, journalists appear to be most concerned about organized crime’s menace to society. It is the press that brought to light the truth about the activities of the alternative structures-the so-called “families” and “security units”. These institutions-known worldwide as mafia-took advantage of the trials and tribulations of the transition period, imposing by force their own rules on Lithuania’s economic life. Each with its own sphere of influence, “families” collect taxes and protect a large part of the business community from the control, and sometimes even abuse of power, of law institutions. They administer “justice”, thus generating enormous profits.
Protectionism is a typical tenet of the thinking of opinion leaders. 68.6% of those polled hold that benefits are crucial for certain types of business, and a mere 11.2% dispute their expediency.
Let us have a closer look at Lithuanian laws. It appears that they are teeming with all sorts of “care” for various branches of national economy, branches which because of this very “care” have eventually lost incentive to increase efficiency and compete with foreign producers. The major concern of the protected industry is to sustain the capacity to influence top officials and thus continue to vegetate at the expense of impoverished Lithuanian consumers.
Lack of investment is another source of concern. It is generally recognized that the unfavourable investment climate was created by the ruling elite itself by means of (a) frequent economic law changes, and (b) bureaucratic barriers which originated widespread corruption and official abuse of power.
Protectionist laws adopted in recent years deprived foreign banks of the possibility to enter the Lithuanian market. With such policies in effect, the costs of credit resources became so high that Lithuanian producers began to call for government intervention by guaranteeing “cheap soft credits” and protecting Lithuanian producers in their competition with foreigners. Protectionism gives rise to further protectionism. Here the process comes full circle.
The benefit of foreign banks
Is it worth opening the market to foreign banks? The 1994 November-December survey shows that
· a total of 90% of opinion leaders hold that foreign banks should be encouraged;
· 63.9% argue that they would multiply credit resources, reduce interest rates, and invigorate the country’s economy; and
· 42.6% of the respondents said that foreign banks would contribute to the abolition of the monopoly position of local banks, diversify financial services, and bring along modern technology.
The end of the protectionism era
Although theoretically opinion leaders had been conscious of the pernicious effects of protectionism, it was the banking crisis of December 1995 that finally opened politicians’ eyes. Six months later (on June 4, 1996) Article 6 of the Law on Commercial Banks which prohibited foreign banks from establishing branches and representative offices in Lithuania was amended. Yet another six months passed before the Lithuanian financial market saw the first sign of a new era: the Bank of Lithuania gave a middle-sized Polish bank, “Kredyt Bank SA”, permission to establish a branch in Lithuania. On this occasion Chairman of the board of Kredyt Bank SA Stanislav Pacuk said that they would “try to reduce interest rates on loans and the prices of banking services” (daily Respublika, 11 13 1996). The competition flywheel stirred.