Economists are frequently regarded as oracles of numbers and mathematics. However, economics is the study of human action measured in monetary terms. For an economist, understanding people’s motivations and grasping how economic futures are shaped by a multitude of asynchronous and uncoordinated decisions is more essential than mere numerical fluency.
LFMI President Elena Leontjeva.
The stated objective of the tax reform that is proposed by the Lithuanian government is to finance national defence – a necessity no one disputes. What differs is the vision of how this objective can be achieved without compromising the economy that sustains the tax base. Defence requirements can also be financed through internal state reserves. By this, I do not mean cash or gold holdings, nor the reserve accumulated by the State Social Insurance Fund (Sodra). The state possesses property and land that are redundant for its functioning, and a particularly untouched reserve – excessive bureaucracy – trimming which would not only conserve resources but also accelerate the generation of GDP and budget revenues.
Should the economy grow to €100 billion in GDP by 2030, as is the ambition of both business and government, then an additional €5 billion in GDP and €1.5 billion in revenues for defence would be generated on an annual basis. Borrowing remains another option, as does plugging various tax loopholes. Collectively, these sources could even yield more than the 5–6% of GDP annually targeted for defence. Crucially, this would be achieved without shooting ourselves in the foot.
Progressive Does Not Mean Progress
The proposed package pledges progressive taxation for Lithuania, a concept that should not be equated with advancement or progress, as it may, in fact, impede both. The gradual increase in rates is intended for all types of income as well as real estate. Only dividends are spared from progressive rates – but this is no concession, as dividends are already subject to corporate tax, bringing their effective rate close to 30%.
Should the coalition’s proposals materialise, all other activities – including self-employment – with earnings above 60 average wages (AW) annually (€126,532 in 2025) would face a tax rate of 32%. Some even more radical proposals advocate a 40% rate for income above 120 AW (€253,065 annually). The message to the public is clear: generating greater value and prosperity in Lithuania means being punished with higher taxes. The question is who wants to be punished. Thus, it should not be surprising if people start taking steps to stay below the 60 AW threshold.
Thus far, the 32% rate has only applied to wages, with one special feature: upon reaching 60 AW, an individual ceases contributing to the State Social Insurance Fund, keeping their overall tax burden the same as everyone else. Now, with the proposal to apply higher rates to income not normally subject to the State Social Insurance Fund contributions, we face progressive taxation that undermines the principle of taxpayer equality. Unfortunately, there is one problem – non-labour income is far more mobile than earned income.
Capital and People Flee Faster Than Laws Can Catch Up
Income is generally like water, flowing where taxes are lowest. This reform is likely to encourage Lithuanians either to operate below the lowest tax thresholds or to move their activities and tax payments abroad. France has already tried this route. Once they realised how much “water had leaked out”, the authorities rushed to rescind the taxes, only too late as the revenue never returned. Estonia has also recently admitted that the latest tax increases were a mistake leading to economic stagnation. Today, Estonia is reversing plans to raise personal income tax and abolishing its 2% corporate tax. VAT, rising to 24% in July, will remain the main pillar of defence financing. These changes are justified by the need to revitalise a stagnating economy and rekindle people’s motivation to act.
Our tax policymakers, meanwhile, still rely on the mechanical assumption that higher rates equate to higher revenue. If behavioural effects were factored into the calculations, the forecasts would be quite the opposite – sending people so many negative signals could lead to lower budget revenue. At that point, we might find ourselves crying out in French to businesses and investors who have fled abroad – cherchez de l’argent (look for money)!
Rates, Percentages, and Public Messages
It is understandable that progressive tax rates were promised to voters, and honouring promises is noble. However, the circumstances are becoming too serious due to shifting priorities manifesting in global trade wars that may rock the economic boat, the looming threat of war, stagnating foreign investment, and Lithuanian capital increasingly flowing abroad. Is it fair to keep such electoral promises that contradict national priorities and may ultimately harm the very voters who may lose jobs, steady income, and increased pensions?
Thus, what should be done to grow budget revenue? First, public messages signalling that creating greater prosperity in Lithuania will be punished by higher taxation need to be switched off. When the state punishes, people and businesses defend themselves by using less taxed business models or relocating to more favourable jurisdictions with fewer burdens and more incentives. Proportional taxation disincentivises people from the temptation to engage in dishonourable games against the state by hiding under lower tax thresholds. After all, high earners still pay more, which is what everyone wants.
On the other hand, progressive taxation threatens not only the better-off but may also encourage lower earners to avoid becoming victims of “progress” by dodging higher brackets. The proposed tax scale entices nearly everyone into strategising for tax optimisation rather than channelling energy into wealth creation.
If we want more – not fewer – taxpayers in Lithuania, we should examine the countries to which our citizens move to live and work. Such countries are our direct competitors, and it would be far better if the financial “water” flowed from there to us rather than the other way round.
Capital Votes With Its Feet
Politicians claim that ordinary people should not be burdened, and that the strongest should foot the bill. Thus, a recently increased corporate tax is set to rise again by two percentage points, to 18%. The reform architects estimate a €200 million gain for the budget. Yet they calculate the tax differently from those who pay. Business accountants will quickly calculate the hit to returns on investment, whereas investors will respond with “data-driven” decisions or, as the saying goes, capital will vote with its feet. Since corporate tax directly affects investment attractiveness, it should be assessed not only as a revenue boost, but as a potential loss.
If corporate tax is to rise again, it should be moderate. At the very least, it is prudent to spare reinvested profits – those returned to the economy – from further taxation. Such practice would help Lithuanian firms upgrade technologies, develop competitive products, and create well-paid jobs, thereby enriching the budget. Politicians have every interest to support it if they wish to keep promises with access to funds to fulfil them.
Ultimately, it is not the rate, but the shift in motivation that determines budget revenue. Taxing the most capable ends up hurting those politicians aim to protect.
What Will Actually “Fall”
Just as water flows to deeper ground, income moves to lower-tax environments. Such old wisdom should be inscribed in tax legislation and hung above every tax policy maker’s office. When raising tax rates, we must not merely multiply income by percentages, but also assess human response, motivations, behavioural changes, and consequences. “Understand people” should be a worthy line in the explanatory memorandum to any government tax package.
