Analytics, Direct Speech, Interview, Taxation, The Baltic Course No. 27

This government decision on tax reduction was received with general public satisfaction as it applied to all citizens employed in Lithuania. However, as it often happens in Lithuania, when reducing one of the taxes, we often raise another tax. That was case, for example, when a new “temporary social tax” at the rate of 4% was introduced in 2006. In fact it represented an increase of the corporate income tax from 15% to 19% because the new tax was calculated on the same tax base as the corporate income tax, i.e. from a company’s profit. No doubt, the Lithuanian businesses reaction to introduction of this tax was negative because it increased the tax burden of corporate entities.

Starting from 2007, the “temporary social tax” was reduced to 3% but so far it is not clear whether the personal income tax rate will be lowered in future (in 2008).

VL: Personal income tax at the level of 27% effective in Lithuania is still among the highest taxes in the EU. We have fallen behind other Baltic states in respect of reducing this tax. What are the forecasts concerning reduction of this tax. When it is planned to cut the rate to 24%?

Gediminas Kirkilas: I would like to point out that one should not compare blindly the nominal income tax rate in different countries because taxation provisions differ a lot from country to country. Firstly, different countries apply different tax rate systems. If the country applies progressive tax, the top-level tax rate is 40% or even 50%. Therefore one has to take into account also other elements such as the minimum non-taxable income and a great number of other aspects. If we compare, let’s say, taxes for Lithuanian residents receiving adopted by the government minimum or average wages with the same category of population in neighboring countries (which are often named as our main competitors) then the tax burden in Lithuania will be somewhere in the EU-average.

I would like to underline once more that the reduction of the personal income tax rate is not a competitive race. These are in fact economic solutions that needed to be thought out very carefully and any speculations on the subject are irresponsible at the very least. For example, Latvia has several times announced rather ambitious plans on significant personal income tax reductions. However, at present it has become already clear that Latvia stands no chance of doing this in the coming years, unless it chooses the path of steeply raising other taxes, therefore the initial idea has been abandoned.

A decision has already been made about lowering the Lithuanian personal income tax to 24% at the beginning of 2008, and special provisions for this have already been included in the law. When this decision takes effect, the nominal tax rate in Lithuania will be smaller than in Latvia and only by a few percentage points higher than in Estonia. Such minor differences in the tax rates do not have any significant impact neither on the country’s competitive ability nor on the business environment.

VL: Won’t the process of personal income tax reduction entail any changes or increase in the tax base?

G. K.: No decisions providing for increase of other taxes have been made due to the intended reduction of the personal income tax rate to 24%. According to the government program, personal income tax can be cut to 20% and the minimum non-taxable income can be raised to 400 litas a month, if such opportunity arises in the country. The said financial opportunities include total budget expenditure as well as revision of certain elements of the tax system. A number of experts propose to make the system even more transparent, to discard various tax allowances, exemptions or reduced rates. There are various other suggestions and ideas too. The government intends to discuss all those suggestions during the third quarter of this year, when considering the possibility of further reducing the personal income tax rate.

VL: What are the long-term plans for reducing the personal income tax? Have any measures been planned for further reduction of the personal income tax, once it has been cut to 24%? If yes, how would it affect the revenues in the budget, will alternative sources of supplementing the budget be sought or is it planned to reduce budget expenditures?

G. K.: An answer to this question requires an additional insight into my previous comments that are based on the assumption that any tax cuts should be economically weighted. In the course of implementing the abovementioned government program, the government will have to take into account all those aspects.

Tax reduction is not an end in itself, such reduction is aimed at achievement of more serious goals than just “moving ahead” of the neighbors. In that case, for example, the Scandinavian countries with their high taxes would have never been able to take leading positions among most competitive world economies. Therefore, when discussing tax changes as an element of the competition policy, one has to bear in mind also other factors of the competitive environment. Moreover, taxes are the state’s main source of revenues, therefore they have to be collected at the amounts required for assignments for social needs and performance of public administration functions.

VL: More and more Lithuanian residents are registering as individual entrepreneurs and pay personal income taxes. What are the statistics for collection of personal income tax on this kind of individuals? Is it planned to amend the Law on the Personal Income Tax in this respect? If yes, what kind of changes would await people engaged in individual business operations?

G. K.: People have the right to choose whether to be as employed persons, to become employers themselves or to engage in individual business activity. It is important that the tax system should not artificially encourage choice of this or that option, i.e. taxation provisions have to be reasonably similar, considering the degree of risk and the required investments. It is no secret that for certain groups of people (for example, those whose activity is connected to registered patents) the personal income tax is rather different from the economic reality, at least in large cities, but any decisions in this respect will be made only after comprehensive evaluation of all circumstances.

VL: A number of Lithuanian residents make use of the allowances provided for under the Law on the Personal Income Tax. How much the budget is losing because of that? Are any changes planned in respect of applying those allowances?

G. K.: After filing their tax returns for 2006, Lithuanian residents could expect to receive back over 310 million litas in overpaid taxes. To date over 200 million litas have been already paid back.

The amounts to be refunded to individual taxpayers have been growing every year and have increased more than three times since the system was first put into operation (the 2003 taxation year). As it had been already mentioned before, most experts propose to tie any further reductions in personal income taxation with revision of the tax allowances system (and not only in respect of the personal income tax) and take an integrated approach to the whole issue. It is apparently inevitable because with the increase of the net income at hand after taxes are paid and adequate reduction of the personal income tax rates the importance of the tax allowances is greatly decreased. Moreover, reduction of the tax rate will also bring down the amount to be refunded to a given individual as overpaid taxes.

The Baltic Course 27, Autumn 2007