Income tax changes to leave permanent hole in the budget

Euros. Source: Leonhard Foeger/Reuters/Scanpix

The Ministry of Finance has lifted the veil from the new coalition's first round of tax changes, which will grant higher-paid workers an income tax exemption, hike the income tax rate and excise duties. While income tax changes will amount to a negative effect on the state budget, this will be offset through other taxes.

The package of proposed bills sent to the coalition partners on Wednesday is made up of four separate pieces of draft legislation dealing with income tax, gambling tax and excise duties. The Finance Ministry expects other ministries to comment on the proposed changes by May 2.

Minister of Finance Mart Võrklaev (Reform) said at a press briefing that the coalition wants to pass the tax changes before Midsummer Day so they could enter into force from next year. The changes in this first package are just the most urgent of the new government's plans for taxes.

Others include environmental taxes, introducing a car tax in Estonia and expanding the tax base of local governments, Võrklaev said, adding that more analysis and discussions with target groups are needed first.

Effect of tax bills:

Source: Ministry of Finance

Of the proposed measures, income tax changes have the most profound effect. The Reform Party's election promise of abolishing Estonia's so-called tax hump system will see the basic exemption reach higher-paid people and be increased from 2025.

The ministry's explanatory memo only outlines the fiscal effect of the change in tandem with hiking the income tax rate from 20 percent to 22 percent. Planned abolition of various tax exceptions also have compensatory effect. Tax refunds on home loan interest, spouses and second and third children will be abolished.

"Doing away with the 'tax hump' will help a lot of people keep more money [after taxes] and weather other tax hikes. While we are hiking the tax rate, everyone's basic exemption will be €700, meaning that the total effect of labor taxes will fall," Võrklaev said.

The current system sees people's basic exemption gradually fall starting from a monthly income of €1,200 to reach €0 at an income level of €2,100.

While corporate tax [on distributed profits] is set to go up slightly, the effect of changes will be negative for the state budget in the long run. The current option of a reduced tax rate on regular dividends will also disappear.

Kadri Klaos, head of the public finances department of the Finance Ministry, said that they expect 20 percent of corporate profits to be taken out of Estonia.


The second major tax change from the Wednesday package of measures would see the VAT rate hiked from 20 percent to 22 percent.

The Finance Ministry's bill reads that consumption taxes, which make up 39 percent of the total tax burden in Estonia, are high as it in Estonia.

Kadri Klaos said that the VAT hike is estimated to hike prices by 1.67 percent and inflation by 1.4 percent.

Another substantial change is abolishing accommodation providers' current special 9-percent VAT rate. While the coalition initially calculated that this could yield €38 million, the Finance Ministry finds €20 million to be a more realistic figure if we facture in the resulting drop in tourism.

Excise duties

The third part of tax changes unveiled on Wednesday concerns hiking excise duties on alcohol and tobacco. These should be hiked by 5 percent per year, which is expected to yield an additional €10-30 million on alcohol and €3.5-25 million on tobacco products. The Ministry of Finance's calculations put likely resulting price advance at 2.8 percent annually for beer and 6.9 percent for vodka.

To offset the changes, the ministry plans to fix the duty on fiscally marked diesel at the lowest level permitted in the EU. No other changes are planned, meaning that the excise duties on other motor fuels should go ahead next year based on previous plans.

Finally, the coalition also wants to hike gambling taxes, which is forecast to bring €8-13 in additional revenue annually.

The Finance Ministry said in its comment that Estonia's taxation of remote gambling is the lowest in the EU (same as Malta) and it will make sure the sector remains attractive also in the future.

Võrklaev: additional taxes to help reduce the deficit

The public sector in Estonia is currently €1.7 billion in the hole, of which the Finance Ministry hopes to patch €200 with the Wednesday tax package.

Minister of Finance Mart Võrklaev told "Aktuaalne kaamera" in an interview that while an additional €200 per year is not much, it is what the Estonian people can afford. But Võrklaev added that other taxes will help reduce the deficit further.

"Today, we came out with one part of the tax package. The part we want to get passed this summer so it can take effect from next year. Putting it all together, our goal is to reach a nominal deficit of 3 percent of GDP in 2024. These plans put us on target. If we add to that other tax changes we need to prepare and turn into legislation later this year, we will manage to pay for additional defense funding and improve our fiscal position further. Nothing has changed in the grand scheme of things. It's just that the plans are becoming more concrete and maturing on the level of legislation," the minister explained.

"Car taxes, environmental fees – all of it is still to come and will allow us to continue improving our fiscal situation from one year to the next, including defense spending," he said.


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Editor: Marcus Turovski

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