In the following article LFMI’s Vice-president Ruta Vainiene speaks about corporate investments exempted from the profit tax – a tax rule that was revoked some time ago in Lithuania, and how this rule is being revived in other forms in the life of people in Lithuania, and which of the two forms is fair and which is not.
Business community still remembers the time when, according to the law, investments, or the purchase of long-term material assets, were not taxed. This taxpayer-friendly rule of exempting investments from profit tax did not please bureaucrats and politicians. They believed it was too generous for the taxpayers, as they could invest without paying taxes. There were complaints that this rule was being abused, and cars and household goods bought by companies called suspicion. Of course, a clever bureaucrat should understand that whatever is good for a taxpayer should be good for the state. For instance, the boom of tax-exempt investments has undoubtedly contributed significantly to the current growth of gross domestic product that is beneficial for the most to the entire state. But a wide mindset is not an asset of everyone; that’s why this taxpayer-friendly rule was like a thorn in the side, bothering those state officials who counted budget revenues. Because every litas which goes into the taxpayer’s pocket is a litas that the budget did not receive today, and the staff counting the budget don’t tend to think about tomorrow, because they are implementing a plan that is an annual plan. Indeed, why would one go through that extra trouble of defending this non-traditional taxation from the bureaucrats of the European Union who also dream about bringing their competitors down? Drawing on the European integration rhetoric, the European practice and other political instruments, the rule of tax-exempted investments has been abolished.
But good ideas do not die. Forbidden, erased, abolished, they put their head up and strive for life. When they are not allowed to exist in their usual and convenient form, they look for new forms and a new body. Currently, the Lithuanian Law on Personal Income Tax is going to become a new shelter of tax-exempted investments. This Law allows not to tax, up to a certain amount, two types of personal investments – costs for education and interest rates on housing loans. The deduction of life insurance premiums and pension contributions laid down in the Law is not an exemption of these expenses from taxation: it is postponing these taxes until the time in the future when the benefits are paid out. The deduction of expenses from personal income is not typical of this tax in Lithuania. Personal income, after deducting the non-taxable minimum and insurance contributions, were taxed in full, without any other deductions. Why? It is more convenient because unlike businesses, people do no accounting, have no bureaucratic obligations to declare income and expenses, collect no receipts and so on. It used to be so, but it’s not going to remain so anymore. Personal income tax is getting similar to the corporate profit tax. But not in terms of the rate what is most saddening,* but in terms of the bureaucracy imposed that an individual willing to relieve his income tax burden will have to overcome.
The first step has been made and, eventually, there will certainly be more deductions from personal income. For instance, at the end of the very first year that the Law on Personal Income Tax is in force, it has been already proposed to exempt from the personal income tax the expenses of one computer, including the software and (or) internet access, purchased by an individual user per year. This proposal is linked with the latest economic fashion – the creation of the information society. Lithuania is said to be lagging behind by the number of computers, so tax-exempted purchases of computers would facilitate the purchase of computers and increase the consumption of electronic services. There is no doubt – it would really facilitate the purchase of computers. As for the consumption – it would hardly do so, because the tax-exempted computers would probably be bought (to replace the old ones) by those who already use them, and not those who intend to become users. But let’s admit that everything not taxed prospers and grows, so we should only appreciate it. However…
However, “the second best” solution is only the second best. It is worse than the former tax-exempted corporate investments, and here is why. First, because based on entirely undefined criteria, people’s expenses are divided into income tax-deductible and non-deductible. Some expenses incurred by people become nice and easy, while some other ones, for a certain reason, are doomed to carry the stone-weight of the income tax. Perhaps this is how the state carries out its policies of social support, i. e. that only the poor will not have to pay the personal income tax? Oh no, all the privileged expenses are typical of the people with medium or high income. Will people appreciate such tax relieves? Of course, they will, but not all of them. Not all the people have such expenses because they have more significant needs, and their expenses are taxed. Of course, there will be some people whose decision to purchase a tax-free product will be encouraged by a tax relief. Such a decision will be highly appreciated by the suppliers of such goods or services.
So what would we get in exchange to what? The rule of tax-exempted investments was applied to companies – the ones that are used to deducting expenses, doing accounting, preparing declarations, investing; to companies that are scrupulously inspected, so that all the violations could be easily prevented. The rule of deducting investments was the same for everyone and was applied to any long-term material property. So it was appropriate and the least discriminating. It was not a rule without any faults, of course, but it could have been revised. Sadly, it was abolished, providing a somewhat compensation to the companies instead – a reduced tariff of the corporate profit tax. Are companies happy about the abolished privilege and the lower profit tax rate? Usually not, because it is the Ministry of Finance that is happy with the rate and the increased budget revenues from the corporate profit tax.
What would the new order give to the people? Well, of course, they have been expecting a reduction of the personal income tax rate which is more than twice higher than the corporate profit tax, not to mention the state social insurance fund. In the neighbouring Latvia and Estonia, the personal income tax rates are markedly lower: 25 % in Latvia and 26 % in Estonia. Having abolished the corporate profit tax, Estonia did not stop. Presently, it is carrying out an income tax reform and is planning to reduce the income tax by two percentage points per year, so that the personal income tax was 20 percent by 2006. Everybody agrees on this issue in Estonia, but the neighbouring Swedes call Estonia a small predatory state. The state who applies probably the highest taxes accuses the state who is constantly reducing taxes a predatory one. These are very strange measuring criteria, to say the least. In Lithuania, the reaction to the Estonian tax reform is painful as well, attempts are made to downplay its success, to highlight minor failures or difficulties that nobody can avoid when walking the roads of a new reform.
In Lithuania, the tax rate was reduced for companies, but not for individuals. People really did not want to get entangled with the tiresome income declaration, household bookkeeping, knocking the doors of the Tax Inspectorate and other kinds of bureaucracy. But they will have to if they want to reduce the tax burden and take advantage of the deductions. Yet, not everybody will be able to play on this privilege because the tax relieves are not applied to all the personal expenses or investments. They cannot be applied to all the expenses because that would mean that only the personal savings are taxed, and this would not be logical. The root of the problem is that the very deduction of expenses has been misplaced. People are not enterprises, and not all of them are engaged in commercial activities. A great number of them receive income of just one or two kinds and they want to live without any duties imposed by the government. In other words, a significantly reduced income tax rate would be an optimal solution for both the people and the government. At least the Tax Inspectorate would not need to build a new building in Druskininkai** for storing paper income declarations of the residents.
It is very likely that the parliament will make passage for deducting the expenses of purchasing of computers by passing a draft law on personal income tax. And this is welcome, as people in Lithuania will certainly have to get computerised because home bookkeeping is going to become a rather complicated and time-consuming obligation. Just for the sake of the perfection of this proposal, it should be also lawful to deduct the expenses for paper, ink and transport or postage tat will be incurred by people who will have to deliver paper declarations about computers purchased to the Tax Inspectorate because declarations submitted electronically are not yet accepted as documents equal to the paper ones. That’s right; people will be carrying physically their paper declarations, although they will have all the untaxed possibilities to submit them electronically. This is because today it is the state authorities, not the people, who are badly lacking electronic literacy and informational progress.
[*] The main personal income tax rate is 33%, while the corporate profit tax rate is 15%.
[**] A small town, plaqued by a high level of unemployment, in which a special center for storing paper declarations of Lithuanian residents was built in order to create jobs.
