Analytics, Banks, Financial Services, Lithuania, Taxation

International Internet Magazine. Baltic States news & analytics Thursday, 16.08.2018, 14:38

Bank of Lithuania presents position regarding tax and pension system reform

BC, Vilnius, 06.08.2018.Print version
With the Government having launched a public consultation, the Bank of Lithuania presents its assessment of and proposals for the presented changes in the tax and pension system. The assessment relays the results of the central bank’s analysis of whether the changes are well-suited to tackle two major corresponding issues: insufficient capacity in public finances and the adverse impact of demographic factors on the pension system.

Tax changes

The Bank of Lithuania supports the proposed tax changes that are aimed at reducing the taxation of labour as well as stepping up the fight against shadow economy; however, experts at the Bank of Lithuania believe that such changes would not strike at the root cause of the most severe problem of Lithuania’s public finances – low budget revenue and expenditure relative to the size of the economy. In terms of the revenue-to-GDP ratio, Lithuania lags significantly behind the EU average. An insufficient budget limits the country’s capacity to provide adequate funding for social and health protection, education, the pension system, etc.


Results of the Bank of Lithuania’s ex-ante evaluation reveal that the overhaul of the tax system would lead to a loss in general government budget of up to 600 mln EUR in three years, which would be an additional drag on the above-mentioned revenue-to-GDP ratio. The Government plans to recover part of revenue by reducing shadow economy and accelerating economic growth. However, in the Bank of Lithuania’s view, this would not compensate for all the losses sustained in the short-term; therefore, firm fiscal actions that would increase the state budget, income redistribution and adequate financing of public services are a must. This could be achieved through the increase of revenue from property taxes as well as renouncing of some ‘privileged’ business forms.   

Currently the tax burden for a person working under an employment contract can be two, three or even more times heavier than the burden for a person who is self-employed or works under a business licence. This means that the self-employed may pay much lower taxes even if they earn higher income than the employed. The Bank of Lithuania proposes to level the uneven playing field in terms of taxation. 

It also proposes to expand the property tax base. In terms of revenue from property taxes, Lithuania falls behind many EU countries. The Government-proposed taxation of non-primary homes does not fundamentally change the situation as, according to the Bank of Lithuania, only a small amount would be collected on a national level (in 2019 – approximately 10–11 mln EUR). The Bank of Lithuania proposes to impose a tax on all residential real estate (RE), taking into account the most socially-sensitive groups, i.e. the tax should be progressive, setting a low threshold for tax-exempt value: lower priced RE property should be subject to a lower tax. The model proposed by the Bank of Lithuania would enable to increase government revenue from non-commercial RE taxes almost ten times. The increase of property taxes and reduction of labour taxation would, at the same time, bring out more funds “from the shadow” – concealing income is easier than hiding RE property. 

The Bank of Lithuania also proposes to waive various benefits and exemptions that distort the situation in the market, primarily the exemption from VAT on centralised heating and hot water. In light of future changes in the pension system, it also proposes to give up personal income tax (PIT) reliefs for people that have unit-linked life assurance and participate in the Pillar 3 pension fund scheme. Moreover, the Bank of Lithuania also proposes to eliminate the reduced 5% income tax rate and apply a uniform tax rate of 15% to all corporates. 

According to Bank of Lithuania provisional calculations, implementation of the above-named tax measures, excluding the fight against the shadow economy, would enable the public finance sector to additionally collect at least 300 mln EUR, which could be allocated to major policy areas. 

The Bank of Lithuania proposes to enhance the Government’s measures for reducing shadow economy (merging of the employee and employer contributions to SoDra, the use of IT and reverse VAT, the proposal not to allow companies that do not pay taxes to participate in public procurement) by creating a register of non-conforming taxpayers. This would limit the possibilities for persons who systematically organise tax fraud and evasion schemes to establish companies and manage them.


Restructuring of the pesions system

The Bank of Lithuania is largely in favour of the proposed restructuring of the pension system. Lithuania’s pension system has been severely undermined by negative demographic factors: high rate of emigration on the one side and a decline in birth rates and population ageing on the other. As a result, the static system which is financed solely with PAYG payments faces serious challenges. Without implementing any changes, each generation would receive an increasingly lower pension relative to previous income, and would be facing risk of poverty in the long run. To ensure adequate income levels in old age, a proper solution to the issue would be to ensure that each generation ‘brings along’ a pre-accumulated financial reserve in addition to the pension paid by the State. 


In the opinion of the Bank of Lithuania, the proposed pension reform is an adequate response to demographic challenges. It encourages saving for old age without playing off current pensioners against the future ones, which is important as only an integral pension system can ensure more sustainable and larger pensions. The Bank of Lithuania particularly welcomes the proposed measures that could significantly reduce pension fund fees, which in turn would lead to residents accumulating more. It also supports the mandatory application of life-cycle funds as this would enable young persons to earn higher return and help preserve the accumulated assets until retirement. 

One of the particularly important aspects of the pension system is the link between income received while working and the future pension. The Bank of Lithuania proposes to make this link even stronger. The proposed changes to the tax and pension system would lead to the transfer of the basic pension from SoDra to the state budget. The transfer of all basic pension commitments deprives the possibility of strengthening the link between the amount of pension contributions and the size of the future pension. Consequently, in the Bank of Lithuania’s opinion, it is necessary to transfer only part of instead of the entire basic pension, for example, no more than a half. In addition, it proposes to depoliticise the calculation of basic pension. 

For the benefit of future pensioners, the Bank of Lithuania also proposes to centralise the administration of pension annuities. Concentrating this in a single public non-profit institution would ensure an economy of scale and more effective risk management. As a result, pension annuities would cost less and the pensioner’s income would be higher.   

Seeking to encourage the general public to be better informed about their pension and to simplify this process, the Bank of Lithuania calls on implementing a pension accumulation system that would be based on a one-stop-shop principle where a person could check their future pension in real time. 

The Bank of Lithuania emphasises that the pension system requires long-term stability for it not to depend so much on economic, demographic and political cycles. A transparent and sound system, functioning for a long period of time without essential changes, would ensure the confidence of residents and increase incentives to pay taxes in good faith.

More: https://www.lb.lt/en/news/bank-of-lithuania-presents-position-regarding-tax-and-pension-system-reform






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