Feature: The case for a progressive income tax in Estonia

One of the effects of recent changes to the tax-free income amount are making it easier for people with lower salaries to get bank loans.
One of the effects of recent changes to the tax-free income amount are making it easier for people with lower salaries to get bank loans. Source: (Peeter Langovits/Postimees/Scanpix)

Estonia’s income tax scheme based on a flat rate worked well during the boom years. But as EU structural support payments are about to shrink, the government is looking for new sources of revenue, and inequality is growing, it is time Estonia considered coming up with a progressive income tax of its own, Federico Plantera writes.

Today, flat-rate tax systems look good to CEOs, foreign investors, and those income earners who are in the top 10 percent of the income distribution pyramid. But they don’t promote equality in wage earnings, and in most cases can’t provide the state with an overall sufficient amount of tax revenue to effectively respond to the shocks of economic crises and crunches in growth and productivity. On top of that, a significant part of the population who has contributed to make economic growth a reality do not get their fair share.

Estonia’s flat-rate tax system has been in place for 24 years, undoubtedly contributing to an economy in transition and helping to drive the country into a free-market system following the collapse of the Soviet Union. Flat-rate taxes were popular with Eastern European countries throughout the 1990s, with the Estonian experience paving the way to this trend. In 1994 it was set to 26 percent on both personal income and distributed corporate profits, ten years later the first cut to 24 percent followed, and after further reductions today stands at 20 percent. No corporate income tax on reinvested profits and a rate ranging from 14 to 20 percent on distributed profits complete a system built to reward private initiative and entrepreneurship.

The non-taxable annual income was recently raised to €6,000 a year. This measure taken by the current government represents a step forward towards the protection of low-income earners as part of the system. But is this enough to tackle inequality across the deciles of the spectrum? Absolutely not.

Looking at general government debt as a percentage of GDP, Estonia plays the part of the poster boy among OECD countries with its solid 13-percent ratio most other European countries right now can only dream of. But this kind of macroeconomic data on country performance doesn’t always give us an accurate picture of the real well-being of the population – actually, it does so only in the rarest of cases.

It doesn’t take a lot to expose the problem. While the flat-rate tax has paid off to quite an extent in developing the Estonian economy since the early 1990s, it hasn’t had a positive impact on redistribution strategies and the closing of income gaps between the wealthiest and the poorest strata of the population. It’s time for this country to come up with a progressive system of taxation of its own, one that is proportional to everyone’s material possibilities.

First off, let’s do away with the false assumption that such a system would harm growth rates at a national level. Redistribution per se does not directly lower economic growth (OECD 2014), while inequalities certainly do.

Naturally policies don’t always have the same positive outcome in all cases, so what we need here is a proper debate over the quality of the measures to be taken. Do we go for cash benefits or active labor market policies? Universalism and social security, or means-tested targeting?

The scope of the measures to be taken matters as much as the final result, where we need to decide whether the final aim should be to fight absolute poverty or rather concentrating on the lower 40 percent of income earners instead.

Or just protect the interests of the few, rather than inject a healthy dose of social solidarity into the system.

It is estimated that relative poverty among lower-middle class households and widespread inequalities have caused an average loss in economic growth of 4 percent for all the countries that showed significant levels of inequality before the economic crisis, while a smaller wealth gap has helped other countries (e.g. France and Spain) to keep up with forecasted growth rates in the immediate post-crisis period.

Estonia is the one EU country among the OECD’s members that has seen disposable income inequalities grow the most between 2007 and 2014 (OECD 2016). This brings up the question who has de facto recovered from the last economic crisis.

In absence of bold income support policies and similar means to redistribute wealth, flat-rate tax systems turn out to be intensely regressive. Yes, we all pay the same rate on our incomes, but as basic cost of living and consumption taxes rise, an upward redistribution becomes inevitable. When the GDP grows at a faster pace than households’ economic resources, it is that very same growth that hampers people’s possibilities to keep up with previous living standards.

If someone earning €1,000 a month and someone earning €800 a month both spend €400 a month on the rent of their apartment, it is clear whose disposable income is more affected by fixed costs such as excise duties and VAT – both are taxes we all pay, and not at the same proportional rate, but in the same amount in absolute numbers.

In this system having a job is no longer a guarantee not to slip into relative poverty, as more than 40 percent of non-standard workers in Estonia (which include people with temporary employment, part-time and on-call work agreements, dependent self-employment, agency work) not only fare higher risks than residents of other advanced democracies of seeing their earnings drop, but also remain in the lowest quintile of the household income distribution pyramid (OECD 2015).

Looking at the combined effect of in-work poverty and regressive effects of consumption taxes, it becomes clear that material deprivation is something that matters not only to recipients of unemployment benefits and disability allowances or the elderly, but to labor market outsiders and to society as a whole as well.

Let’s make an experiment. Have a look at this news release by Statistics Estonia about the year 2014 by Statistics Estonia, and then check out this one of December 2017. The change is so marginal in relation to national growth rates and increases in the top 10 percent share of income earners that it becomes statistically insignificant.

With nearly 276,000 people or 21.1 percent of the Estonian population living in relative poverty today, the need for a more just redistribution of wealth cannot be dismissed as a typically leftist demand anymore. Someone is still waiting for the wealth to trickle down, maybe even these two Estonians out of ten. Sorry to be popping the bubble here, but they’re waiting for something that won’t ever happen.

Estonia has the possibilities and the resources to change its direction. Opposing a progressive tax system isn’t just worrying about losses in potential foreign investment, but actually supports the distortions that lead to less equality. It’s a good time now to make a change.


Federico Plantera is a journalist and political commentator for one of Italy's largest online news portals, Il Fatto Quotidiano. Plantera holds an MA in political science and international relations and has done research into comparative social policy at the University of Strathclyde in Glasgow as well as the Paris Institute of Political Studies (Sciences Po). After shorter stays in 2014 and 2016, Plantera moved to Estonia in 2017.

Editor: Dario Cavegn

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