Proposed consolidation would increase underground economy
I have been staring at the budget proposal for 2011 in what is best described as disbelief. And other news don’t make me any happier – is this really what is going to happen in the so–called consolidation efforts? Where are the visions and the much hyped–about ‘structural reforms’?
I mean – increasing VAT by one percentage point and the social tax by two points while at the same time aiming at combating the underground economy?!? Both of these measures will increase the size of the underground economy and the latter, already way too high, will erode Latvia’s competitiveness, exactly the opposite of what the ‘internal devaluation’ is supposed to achieve.
Just three quick comments:
1) Latvia may soon find out the hard way that it might be on the downward sloping part of the Laffer curve – the idea that at a certain point of taxation higher rates imply declining tax revenue, not an increasing one due to ever stronger incentives for tax evasion.
2) This budget proposal signals lots of horse trading and little vision and most of all reminds me of Ronald Reagan’s old quotation: “It has been said that politics is the second oldest profession. I have learned that it bears a striking resemblance to the first”.
3) And yet another argument/warning concerning e.g. higher VAT rates: Don’t expect them to go away again. My own country introduced VAT in as a ‘temporary’ measure in 1967.
And now I’ll go home and hope this budget proposal was just a bad dream…
Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga