Budget blues 36

Foto: Jānis Saliņš, F64
Morten Hansen
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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

Komentāri (36)

wushu.lv 24.11.2010. 08.24

I am an attorney and cannot micro-enterprise because I cannot legally form a SIA. Would love to, but can’t. Regardless of past policy, any taxpayer today has the right to ask our elected officials what, exactly, we are getting for our tax payments. Health care is “cash and carry.” Education for our children? Sorry state. Basic infrastructure? Wobbly. On the other hand, the public sector is living pretty well as far as I can see, working short hours, not bothering to turn up at all on Friday. And in many cases their actual function is imaginary and with some basic restructuring the jobs would cease to exist. And don’t even get me started on the endless stream of taxpayer-funded Ministry parties, “pilsētas festivāli” and similar absurdities. Policy is being made with little or no vision as to who, exactly, is meant to be generating the tax revenue to pay for it all. And the demographic trends, net emigration and birth rate, mean that there will be ever fewer on the paying side and ever more on the receiving end. There, that’s all for today, have to get to work to try to actually earn something. Appreciate the debate and wish my fellow commentators a productive and revenue-generating day…you can be sure that VID does too.

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Juris Millers 23.11.2010. 12.24

This whole crisis is a bad dream, but that does not mean that if we close our eyes it will go away.

VAT is the easiest tax to control and it also is a consumption tax (as opposed to wage taxes), so it is a natural and very good way to raise taxes. It naturally taxes richer people more (including people that make money via capital gain).

The social tax bump is unfortunate, but needed in the long term, as our social support system has long been under-budgeted.

Structural reforms may come, but you can’t put them in a budget, because you can not depend on getting any reasonable and quantifiable saving from structural reforms.

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    magic2009 > Juris Millers 24.11.2010. 12.34

    The increase in revenue generated by imposing more expensive grocery prices on rich people pales in comparison to the growth in the underground economy and the increasing burden on the growing poor segment of society. Sure, it is an easier solution, but far from the most effective. What is needed is a way to collect more of the existing taxes and in my view, public sector income tax is one of the biggest areas of loss for government. Is there anyone here who can honestly tell me that all their firm’s services are provided with appropriate receipts (and taxes are paid), 100% of wages taxed (including “envelope” salaries), and all non-cash perks (company car,trips, bonuses, etc) are taxed? …. I didn’t think so…

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    Dzintars > Juris Millers 23.11.2010. 12.49

    True, higher income people will pay more in VAT due to their generally higher level of spending but VAT is nevertheless seen as regressive (meaning that lower income people are hurt relatively more) since low income people tend to spend a bigger share of their income than higher income people.

    It is here that e.g. the luxury car tax makes sense – low income people don’t(?) drive Porsche Cayenne so won’t be hurt by such a tax.

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wushu.lv 23.11.2010. 17.42

Morten, I’m totally with you. I am self-employed, operate a totally legal tax-paying business and am seeing my (scant) profits wither before my eyes, swallowed up by taxes. My income tax this year has already jumped from 15% to 26%. Not an amount I can pass along to clients, since the market simply won’t bear it. Where is the vaunted consolidation? Why do we still have such a bloated public sector and Byzantine bureaucracy? I can only put it down to “crisis fatigue,” or the erroneous belief that the global economic skies are clearing when a glance at any international headline will tell us the opposite is true. Or the belief that Latvia will yet again prove the exception to the Laffer curve and every other economic rule. Terrible policy and the only possible outcome is to push ever more into the cash sector, leaving those of us who by belief or profession must stay “white” bearing an ever more disproportionate share of the burden. Ugh. Absolutely the dead opposite of what should be done to stimulate growth. I voted for this government in the belief they would steer a prudent economic course, but the early signs are inauspicious.

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    a_oleinika > wushu.lv 23.11.2010. 18.15

    And waht was the tax before it got down to 15%? And how long ago was it? 🙂
    Why not to try micro-enterprise?

    I am a self-employed, too. I am critical of this tax policy as well, but the individual-micro segment (especially services) does not have reasons to complain more than it had in the “fat years”, except for those couple of years, when taxation for this segment was notably decreased. (Obviously unsustainably.)

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