Expert: VAT increase to cause shopping boom and additional price hikes

Lenno Uusküla.
Lenno Uusküla.

Estonia's VAT rate climbing to 22 percent from 2024 and income tax to the same level from 2025 will cause a shopping boom and higher prices this year. That is why Lenno Uusküla, chief economist for Luminor, believes tax changes should be made in small incremental steps.

Tax changes should affect people's behavior as little as possible. Estonia will be hiking its VAT rate by 2 percentage points to 22 percent from the start of next year, which will also see traders increase their prices. Lenno Uusküla, chief economist for Luminor bank, told ERR that people are already living in anticipation of higher prices, meaning that major purchases will be made before the year's end, especially if an appliance needs replacing.

"This will cause a slight consumption boom toward the year's end and in anticipation of the VAT hike. Of course, a shopping boom gives traders the chance to hike their prices too," Uusküla said, adding that this might cause people to make unsound decisions.

The economist suggested that hiking the tax rate by just a single point would not send people rushing to the store or see sellers adjust their prices.

"While prices were set to come down, the VAT hike will keep them where they are. Traders will see that there is demand, and why lower prices now if they'll go back up a short while later anyway."

This also means that the hotter the shopping spree toward the end of this year, the more consumption will fall early 2024. Uusküla said that the VAT rate has been used to time consumption in different countries.

"There have been periods of a temporarily lower VAT rate in the USA to motivate consumption and liven up the economy. Once the incentive is no longer deemed necessary, the rate bounces back to the previous level. VAT has been used to create waves of consumption. But if the goal is not to affect people's behavior, it would make sense to hike the rate in small incremental steps," the economist said.

Earlier income tax returns

2025 will see the income tax rate hiked. This means that income from 2024 should be declared before the year is out. In other words, people should get their employers to pay out end-of-year bonuses or profits in December, Uusküla pointed out.

"A few days will make the difference between surrendering €200 or €220 on every €1,000 made. Our net income is set to fall by 2.5 percent, making money collected in 2024 more valuable."

And just as with VAT – while a single person's shopping will make no difference, the situation changes if everyone does it at once.

"If a single customer wants to buy a loaf of bread, the shop is sure to have it. If everyone wants bread at the same time, that is when we get a problem. This is where the economy starts to limit an individual's behavior as everyone is trying to run in the same direction at the same time. We had a period where we lowered our income tax rate by a single point annually, gradually coming down from 26 percent to 20 percent, and these changes were small enough not to alter consumer behavior."

Pension asset withdrawals to pick up speed

Because pension asset withdrawals are tax deductable, more people could opt for pulling out of the second pension pillar in late 2024. Or reversely, people might dial back pension contributions because the return will be bigger next year. But Uusküla advises restraint.

"Investing in financial markets is a long-term project and it pays to maintain a steady line. Annual returns are usually much greater than the 2-point tax change. But there might be psychological pressure, which would not be created if tax changes were made by a single point. That would dissolve in service fees and the like. But a hike of 2 points means real sums are at stake."

Thirdly, car tax. If Estonia lays down a high tax overnight hoping people will alter their behavior and adopt smaller, cheaper or more environmentally friendly cars, Uusküla said it is clear the Estonian fleet will not change in the span of a single year. If only because we import fewer cars than are already in use.

"If you know that a diesel car will be subject to a very high tax in the future, you will not buy that car if the tax is a problem for you. Rather, we need a tax that sports a long-term outlook," the economist said.


Follow ERR News on Facebook and Twitter and never miss an update!

Editor: Urmet Kook, Marcus Turovski

Hea lugeja, näeme et kasutate vanemat brauseri versiooni või vähelevinud brauserit.

Parema ja terviklikuma kasutajakogemuse tagamiseks soovitame alla laadida uusim versioon mõnest meie toetatud brauserist: