Government would Like to Scoop Out from an Empty Bucket

It’s a mistake to link the tax reform only to the introduction of euro
This interview appeared in the midst of heated economic debates over the tax reform in Lithuania.

The ruling coalition’s and economists’ positions on the tax reform in Lithuania are different as black and white.
When debating the tax reform, politicians from the left-wing majority claim that Lithuania needs to generate additional revenues to reduce the budget deficit, if it wants to introduce the euro from the beginning of 2007.
Economists, in their turn, call for not focusing only on the launch of the euro as the country is being plagued by significantly graver problems.
Emigration of the workforce, a lack of qualified labour, a shortage of investments – these are but a few problems which, if unsolved, would leave Lithuania at the tail end of the poorest EU member states.
Back in the autumn of 2004, the Lithuanian Free Market Institute (LFMI) made an analysis of tax reforms implemented in other EU countries. However, the left-wing Government of Algirdas Brazauskas showed little attention to it.
The daily Lietuvos Rytas interviews LFMI’s President Ugnius Trumpa about the planned tax reform.
– The ruling majority at first declared that they have agreed upon the tax reform, but afterwards each of the four parties in coalition started criticizing this agreement. Is the tax reform so important indeed? What flaws has the current tax system then?
– People in Lithuania pay an income tax which is unquestionably too high. Countries that pursue reforms apply personal income taxes at the rate between 13 and 19 percent.
Lithuania with it’s a hefty 33-percent rate and a fairly big social security contribution paid by employers,[1] is not competitive any more among both EU’s newcomers and old-timers. Politicians in Lithuania have already managed to realize that and understand they must do something about that.
The other reason why the country’s tax system must be changed is the need to finance the delayed reforms in education, social security and health care. These areas have been so neglected that they may collapse at any time.
– It means that the goal of the Brazauskas Government is to collect more money into the budget?
– A relentless itch to collect more budget revenues is the primary reason why the government is seeking to impose new taxes.
But how can they get this money? Well, this question leads to the most complicated puzzle which has been causing real havoc in politicians’ heads.
As labour in Lithuania is taxed extremely heavily, it would be fairly insensible to raise the personal income tax; consequently, new taxes are seen as the first way out. So the government puts forth a draft law on the real estate tax for residents, initiated when the Conservative party was in power.
But this is absolutely clear that this tax won’t put an end to all financial problems.
If only expensive real estate is taxed, the government is likely to fail to raise the planned revenues, and this might serve as a temptation to tax all owners of real estate in the end.
However, if cheaper residential property is taxed just as well, the burden will strike hardest the middle class which is the most dynamic part of society. This layer will sustain a serious blow. More than that, the administration of this tax may be unbelievably costly, and the receipts from the tax will be relatively negligible.
It seems that the Prime Minister has already evaluated the ratio of political risk to economic benefit: that’s why he started changing his opinion about the real estate tax.[2]
The majority of people in Lithuania feel their load of taxes is too heavy, so any talks about levying news taxes are politically condemned to fall.
– Politicians’ views regarding the planned tax amendments change almost overnight. How would you explain this fact – different interests of parties’ supporters?
– Some problems lie in the ideology. The left parties find it especially difficult to cut taxes. Although at present taxes are being reduced not only by the right but also by the left politicians a number of countries worldwide. The economy is forcing to act in this way.
A lack of experience in carrying out tax reforms is one more roadblock for the coalition.
Having no experience and economic background, our politicians take no interest in the tax reforms that have been conducted in other countries.
For instance, our institute has made an analysis of tax reforms in other countries and submitted it to the government, however, nobody from there took a deeper look at it.
On the other hand, parties fail to find consensus promptly because Lithuania has never had such a mixed coalition.
– Let’s say, parties will agree, and changes in tax rates will be instituted already from the next year, perhaps some new taxes will appear. But if budget revenues shrink after that, one party of the coalition will start blaming the others for proposing an improper version of the tax reform. This can break up the coalition, can’t it?
– Such a scenario is quite possible. That’s why tax issues are being debated so vehemently at present.
But the central issue today is not the coalition’s crisis but the fact that Lithuania has come to the crossroads: will our economy grow as fast as it did or will the growth slump?
If taxation of labour is not reduced radically, the country’s resources of economic growth will be exhausted in five or ten years. It’s enough that Lithuania is lagging behind its neighbours in attracting investments, not mentioning the fact that it is leading in taxing its labour force.
If such situation remains, investments will continue bypassing Lithuania. And then not only the labour force will emigrate. Then the capital of local investors, sustaining economic growth today, will flee to more attractive markets as well.
– But politicians don’t talk about attracting investments; they don’t seem to be concerned about the emigration of the labour force. The Prime Minister is only repeating the fact that new taxes are necessary for the introduction of the euro. Is the government wrong here?
– Linking the tax reform to the launch of the euro is a politically risky decision. It’s a mistake that has to be amended instantly.
If after the introduction of the euro people see that the economy is not growing, while prices are rising, they will pin the blame for all of their tribulation on this government and the euro. You can’t think of a better scenario to disqualify membership of the EU and the EMU!
Of course, the problem with the budget deficit must be tackled but the government shouldn’t present everything so as if Lithuania will perish if it doesn’t launch euro in 2007. It is equally absurd to say that if the country doesn’t impose a real estate tax for residents, it won’t be able to bring in the euro.
– But we need money to make reforms anyway. Where to get it?
The basic source for that is better administration of budgetary expenditure. It’s no secret that this is Lithuania’s weakest ability as far as administration is concerned. The European Commission stated that as well before the country entered into the EU.
However, even today we don’t see any attempts from the government at least at trying to grapple with this problem. Not a single ministry is analysing the effectiveness of their work. The Ministry of Finance feels no responsibility for that. The National Audit Office of Lithuania is supposed to do so according to its bylaws, however, it doesn’t.
For this reason plentiful resources are either wasted or don’t hit the targets they were meant for.
The second source is tax privileges and exemptions. All tax favours have emerged as a result of protecting some interest groups at the expense of others.
But if the government sets to eradicate tax privileges without cutting the personal income tax today, this would be a political mistake. How can government officials tell the people who have enjoyed good tax conditions that now these conditions will be eliminated without giving anything in compensation?
So it’s indispensable to lower the income tax significantly and to remove tax exemptions at the same time.
– But income tax decuctions from education fees show the government’s position to encourage people to seek higher education.
Decuctions from contributions to fully-funded pension insurance motivate people to save for the old age.
By repealing these tax favours the government will cease encouraging people to learn and save.
How to dovetail these aims?
– The best form of expenditure administration is when people themselves decide where they will spend their money.
If we talk about a clumsy administrative system, which by way of tax relieves aims at directing peoples’ activity and influencing their choice, then we talk about a totalitarian, not a free society.
Once Lithuania has made the decision to renounce government as the means of regulation when we chose the course of a free state and a free society.
So we should expel from our mind those magically attractive forms of administration when decision makers imagine that they have the lever to sway the members of society by trying to pin-point how they should live.
Besides, tax exemptions create preconditions for conflicts among various interests. If government loves some groups more than others, those others feel harmed and unappreciated. Such a system encourages others to seek for government favours as well, and this paves the way for corruption.
Interviewed by Mantas Dubauskas, coorespondent of ‘Lietuvos rytas’
[1] Employers pay a 29-percent social security contribution, employees – four percent (LFMI’s note).
[2] After a strong reaction from the business community, economists and academics, the Prime Minister announced he didn‘t want the real estate tax anymore, although after some time later he said that the tax would probably be introduced but only to the real estate used for commerce (LFMI’s note).