Tax changes criticized by associations and Bank of Estonia

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The central government is boosting its revenue at the expense of local counterparts and is on course to wound the tourism sector by hiking its VAT rate, the Association of Estonian Cities and Municipalities said of the Finance Ministry's tax change plans. The Bank of Estonia and the Estonian Employers Confederation have also voiced criticism.

The Association of Estonian Cities and Municipalities has told Minister of Finance Mart Võrklaev (Reform) that even though the government's own rules provide that draft legislation affecting local governments' rights, obligations or organization needs to be coordinated with the latter, this has not been done. The deadline for providing feedback is too short for any in-depth analysis or consultations with members.

Head of the association Veiko Luhalaid said that the bill's explanatory memos include neither analysis nor effects on local budgets. The organization also described as inaccurate the memos' claim that changes do not concern regional development or local government organization to a notable degree.

Luhalaid said that because planned changes do affect local government budgets, additional effects analysis is in order, adding that VAT hikes herald millions in extra expenses for local governments.

"This constitutes growing state revenues also at the expense of local governments, which clashes with the goal of recent negotiations for boosting local governments' financial capacity and autonomy," the association finds.

Luhalaid said that taxation of dividends is also set to have a negative effect and come at the expense of local governments, while the bill includes nothing on how to offset local governments' falling revenue.

"Falling tourist numbers due to the accommodation sector's VAT hike cannot be overlooked either. This will undermine interest in Estonia as a travel destination, which will in turn negatively impact air links." Luhalaid wrote.

Employers: Changes have a considerable negative effect for the economy

The Estonian Employers Confederation also criticized the feedback deadline of just three working days. The confederation finds that fixing up state finances should start with a more effective state apparatus and efforts to keep costs in check, instead of tax hikes.

Head of the confederation Arto Aas said that while individual tax hikes might seem innocent at first, the whole package could seriously harm the economy by reducing investment confidence and tax receipt. Rural businesses are seen as coming under the most pressure. The association also finds that the coalition agreement makes scant mention of measures that could help boost economic growth.

"We would like to emphasize that businesses can only cope with tax hikes in the conditions of a stable business environment and when sources of growth, such as capital, qualified labor etc. can be improved," Aas said, adding that recent trends point to the opposite.

Employers consider the decision to abolish accommodation providers' special VAT rate as the biggest single problem, considering that the tourism sector has suffered in the coronavirus crisis and also as a result of the Ukraine war.

"Secondly, accommodation sales are mostly aimed at foreign residents and, therefore, constitute export of services. While the general goods and services export VAT rate is zero, that of accommodation providers will now jump from 9 percent to 22 percent," Aas said.

The employers have suggested postponing the accommodation sector's tax hike beyond this spring or introducing a different tax rate that would fall somewhere between 9 and 22 percent.

The confederation is also critical of abolishing the lower tax rate for regularly distributed profits from 2025 as it is found to violate the principle of economic stability. Currently, companies that distribute profits at least three years in a row qualify for a lower income tax rate on dividends.

It also proposes a longer transition period for the dividend taxation change and for excise duties to be analyzed on an annual basis and reduced when necessary to avoid the emergence of harmful cross-border trade.

Central bank: Changes might not serve purpose

Governor of the Bank of Estonia Madis Müller told the Finance Ministry that the tax changes package is a step in the right direction as it is sensible to try and find public revenue in a situation where Estonia's loan burden is ballooning.

But the Bank of Estonia also finds that the package of measures might not be enough to lower Estonia's fiscal deficit to 3 percent of GDP.

Müller said that the government should consider whether abolishing the more favorable regular dividends tax rate is justified. The Bank of Estonia also finds there is no reason to retain the special tax regime of commercial banks that have to settle corporate tax on profits in advance, unlike all other businesses in Estonia.

He explained that while banks currently have the regular dividends exception, the government's new bill would hit them with the full force of a traditional corporate tax system where their profits would be taxed irrespective of whether dividends are paid or not.

Müller said that, on the one hand, balanced economic development relies on equal taxation, while, secondly, it is the role of banks to finance the economy and people's activities, which is why it is beneficial to motivate banks to hold on to profits as capital.

The Ministry of Finance sent the tax change plans out for a round of coordination last week and the deadline for feedback was Tuesday of this week. Laws to be amended include the Income Tax Act, Defense Forces Service Act, VAT Act, Gambling Act, and the Alcohol, Tobacco, Motor Fuel and Electricity Excise Duties Act.


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Editor: Marcus Turovski

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