Facts and analysis. An investment-friendly corporate tax model will help to recover from the crisis

Claude, „The Embarkation of Saint Paula“, 1639, Museo del Prado

Claude, „The Embarkation of Saint Paula“, 1639, Museo del Prado.

The transition to the taxation of distributed profits would increase investments and help the economy to recover from the crisis as quickly as possible, according to the Lithuanian Free Market Institute (LFMI). Simultaneously, it would create new jobs, increase economic efficiency and people‘s income.

“By presenting the analytic material, we invited the business community and the authorities to a discussion about the tax exemption on reinvested profits. Such discussion was planned in the government program, and due to the crisis, it cannot be postponed any longer, – said the president of the LFMI Elena Leontjeva, – Investments by various companies would help the economy to recover as soon as possible after the crisis”.

As stated in the LFMI analytical material presented today, investment stagnation in the years 2009–2012 shows that after an economic downturn it may take a while for the investment activity to reach a level, which would increase people’s income. It is the number of investments in the country that determines the productivity of companies and other variables that are attributed to prosperity: the level of revenues and prices, employment, and budget revenues. Lithuania is still far behind the European Union average in terms of capital per employee, which is the main reason for the income and wage gap between Lithuania and Western Europe.

“Companies’ own resource investments would increase after abolishing the taxation of the reinvested profits. It is pretty much the only source of investments while recovering from the pandemic, especially when companies lack access to loans,” – stated Leontjeva.

As of today, earned profits in Lithuania are taxed twice: on the company level and by dividends. This means that effective profit tax is as high as 27.75%. Since the abolition of the zero rates on the reinvested earnings in 2002, a chronic development of income tax breaks has been observed. According to Leontjeva, ongoing initiatives to supplement income tax with new benefits confirm the need to abolish investment taxation. Income tax places an indirect, yet particularly heavy burden on smaller and medium companies. The costs of income tax calculation and control are regressive: the smaller the company, the higher the ratio between the costs and the turnover.

“While the capital and jobs are being relocated from Asia to Europe, it is very important for us to catch the train and catch up with our neighboring countries Estonia, Latvia, and even Poland, where the model that is being discussed is already applied”, – encourages Leontjeva.

Under this model, the tax is applied only on paid dividends, whereas funds dedicated to investments and business development are tax-free. This not only frees up funds for investments but also eliminates the need for tax profit accounting. Simultaneously, with all similar burdens and the tensions between the taxpayers and administrators, incentives for shadow activities are decreasing. The experience of the neighboring countries also displays that shortly after applying the model profits and other tax revenues start growing.