Although the prospective Reform-Eesti 200 coalition has not yet clearly disclosed its plans, it has been publicly stated that the proposed 2 percent corporate income tax and the 2 percent income tax, applicable from the first euro, will not enter into effect next year.

According to Sõerd, the state's fiscal strategy had projected revenues of €157 million from the corporate income tax next year and €152 million from the personal income tax applied from the first euro, totaling €309 million.

However, the Ministry of Finance now estimates potential revenue from the corporate income tax to be less than €100 million. Nevertheless, he pointed out, a reduction of €252 million in state revenue would still need to be addressed. "But the plan in terms of funding sources is rather flimsy," he added.

According to ministry data from the end of January, last year's state budget deficit was significantly smaller than planned. While the budget forecasted revenues of €16.8 billion and expenditures of €19.6 billion, preliminary data shows revenues of €16.2 billion and expenditures of €17.1 billion.

Thus, while the budget had forecast a total difference of €2.8 billion between revenues and expenditures, data from the end of January indicated a difference of €1.1 billion — a reduction of €1.7 billion.

Sõerd stated that although last year's financial situation appears better than expected, it nonetheless is not advisable to make long-term spending and tax cut plans based on this data. For one thing, these are preliminary figures, and the Ministry of Finance has promised to review them; the actual situation may still be subject to significant revision.

For another, these figures include several one-off factors that are unlikely to recur in the future. Sõerd cited examples such as the pre-car tax car sales boom, increased dividend payouts before income tax hikes as well as the timing of salary and bonus payments in December.

Cuts and growth

Sõerd is rather pessimistic about spending cuts as well. He noted that tax reductions are permanent and cannot be covered by one-off measures.

He also agrees that since no one wants to change Estonia's pension system and both healthcare and education are already underfunded, it appears unlikely they will be able to come up with the necessary sums.

The new two-party coalition is not planning on any tax increases. "There really is no such plan," Sõerd confirmed. Neither significant economic growth nor increased tax revenues are expected either.

"There are very significant political risks, geopolitically speaking," the former finance minister noted. "Just look at what's happening in the U.S.' own financial markets; stock indexes there have sharply declined. Markets see substantial risks related to mutual tariffs, and the implementation of these tariffs will affect us as well."

Considering the expectations for future economic growth, he added, a conservative stance is justified.

Budget rules

Although the EU is discussing easing budget rules to increase defense spending, Sõerd does not find it feasible to lower taxes at the expense of this change.

Under the current fiscal strategy, Estonia plans to allocate 3.7 percent GDP to defense spending next year, or approximately €1.5 billion. In budget balance calculations, where, for example, 2 percent GDP could be allocated, the remaining €1.7 percent could mean €680 million available for other uses.

Even if Estonia's defense spending were increased to 5 percent GDP, or €2 billion, €1.2 billion could be excluded from balance calculations, still leaving €680 million of planned defense spending that could be used elsewhere. This would, of course, lead to even faster growth of the national debt.

Sõerd noted that Estonia already has the fastest-growing national debt in Europe; additional borrowing could make lending institutions nervous and loans more expensive.

"Borrowing is done on financial markets," he explained. "Financial markets aren't easily duped. Financial markets don't differentiate between loans for defense spending and loans for other purposes. Creditors, the institutions that lend to countries, pension funds and investment funds — they look at national debt levels and assess whether countries will be capable of servicing and refinancing their loans in the future."

Even just discussion in Europe about easing budget rules for defense spending has already led to an increase in eurozone government bond yields.

"Markets have already reassessed the risks," he pointed out.

A large deficit will inevitably make loans more expensive. "It also needs to be taken into account that if Estonia's deficit exceeds 3 percent, it will result in higher interest expenses," Sõerd said.

"By the way, interest expenses are one of the fastest-growing expenditure items in our budget," he highlighted. "Last year, we paid, if I remember right, €270 million. This will now increase every year."

Reducing the income tax exemption threshold

According to current plans, a flat personal income tax exemption of €700 is set to take effect in Estonia next year, costing the state budget €460 million.

Sõerd believes it would be reasonable to partially offset other planned tax eliminations by reducing this tax-free allowance.

"Since our budget continues to face a significant and ongoing deficit, perhaps we should lower the tax-free minimum back to €500 per month," the former finance minister suggested. "Increasing this tax-free income is a costly measure for the budget."

--

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