Employers: Indexations need to be frozen in Estonia until growth returns

The Estonian Employers' Confederation has proposed to the leaders of the coalition parties that the state suspend indexing public expenditures until economic growth is restored or permanently reform the indexing system.
Kai Realo, head of the Estonian Employers' Confederation's council, and the organization's CEO Hando Sutter have sent an appeal to the chairs of ruling parties: Kristen Michal (Reform), Kristina Kallas (Eesti 200) and Lauri Läänemets (SDE). In their message, they express serious concern about the state of the country's finances on behalf of Estonian businesses and the largest employers.
"Although you have promised that the government you lead will not introduce more new taxes, maintaining the current tax burden, given the growth of government expenditures and political decisions, does not seem sufficiently convincing or reassuring. Economic growth requires investment certainty, which a rising tax burden does not provide. To ensure that both your government and future administrations have the ability to maintain or reduce the tax burden, public expenditures must be decisively limited," the employers write.
The expenses of the government sector have grown by approximately 70 percent over the past six years compared to pre-crisis levels. During the same period, nominal economic growth, according to data from the Bank of Estonia, has been only 45 percent.
"In real terms, the economy has not grown for three years, which means government expenditures are increasing significantly faster than the economy can support. Such unfunded spending has raised the national debt from 9 percent to 24 percent of GDP, and this year, Estonian taxpayers will pay approximately €300 million in interest on the national debt. This money must be diverted from other expenditures critical to society," the message stated.
The employers highlight that Estonia's tax burden will increase this year from the pre-crisis level of 33.1 percent of GDP in 2019 to 35.8 percent.
"Although this is slightly below the European Union average, it is likely the highest tax burden among Eastern European countries and significantly higher than the OECD average of 33.9 percent in 2023. The rise in the tax burden harms the competitiveness of Estonia's economy and increases uncertainty for businesses, investors and consumers."
The employers note that while politicians often cite defense spending as the primary driver of increased expenditures, this is not the case.
Defense spending accounts for 12 percent of expenditure growth and 8 percent of the entire state budget. The largest increases compared to pre-crisis levels, however, have been in social expenditures (31 percent) and healthcare (17 percent).
"Social expenditures have grown primarily due to pension increases driven by indexing, with unsustainability further exacerbated by extraordinary pension hikes," the employers pointed out.
They emphasized that Estonia is currently experiencing stagflation — economic contraction for the third consecutive year alongside rising prices.
"In such conditions, linking government expenditures to wage or price growth is unsustainable. This is a new situation for Estonia and addressing it requires a reassessment of current policies. According to economic analysts, stagflation may not pass quickly."
The employers believe that Estonia's primary fiscal policy objective in the near term should be balancing the state budget, which will require changes to how expenditures are indexed.
"This is necessary to offset the impact of extraordinary policy changes that have disrupted the balance of the state budget or social security funds. Examples include extraordinary pension hikes, wage agreements for healthcare workers, increased unemployment benefit funding from the Unemployment Insurance Fund and the transfer of ambulance and other previously state-funded costs to the Health Insurance Fund."
According to the employers, the indexing of certain government sector expenditures significantly reduces fiscal flexibility. Budget deficits and tax increases also contribute to inflation. The Bank of Estonia estimates that the impact of tax increases will account for one-third of expected inflation between 2025 and 2027. Inflation, in turn, drives up government expenditures through indexing and rising wage expectations.
"A budget deficit may be justified in times of crisis to stimulate the economy through investments. However, in recent years, increased government spending and tax burdens have fueled already rapid wage and price growth. This has led to a sharp increase in government expenditures linked to indexing, which is mostly based on wage growth or the consumer price index. By 2025, the impact of indexing alone, even excluding defense expenditures, will reach approximately €500 million."
In summary, the Estonian Employers' Confederation proposes that, to mitigate the impact of indexing, relevant expenditures be frozen until economic growth resumes or permanently restructured. Under the proposed changes, expenditure growth would be indexed against either the consumer price index, another index or nominal economic growth, with the lowest of these applied.
"During stagflation, expenditures must not grow faster than the economy," the employers stressed, recommending that the government incorporate these proposals into the next fiscal strategy for 2026-2029.
"Otherwise, this fall and in the coming years, we will face the problem of lacking resources to cover rising expenditures. If the economy does not grow, tax increases alone will not suffice to keep up with the even faster-growing government expenditures," they warned.
--
Follow ERR News on Facebook and Twitter and never miss an update!
Editor: Urmet Kook, Marcus Turovski