The main test for public finances is stopping the growth of the debt burden, which requires reducing the deficit, which, according to various forecasts, will increase in the coming years compared to the current state, and next year even exceed 5% of GDP. Rising debt burdens caused by living beyond one's means will undermine the economy's competitiveness and long-term growth prospects, threatening jobs and prosperity. :format(webp)/nginx/o/2024/07/05/16201613t1h05ef.jpg)
Economist of the Bank of Estonia Rasmus Kattai. Photo: Estonia Pank
The main test for public finances is to stop the growth of the debt burden, for which it is necessary to reduce the deficit , which, according to various forecasts, will increase in the coming years compared to the current state, and next year will even exceed 5% of GDP. Rising debt burdens caused by living beyond one's means will undermine the economy's competitiveness and long-term growth prospects, threatening jobs and prosperity.
Translation: Sergey Svetlov
The new coalition agreement aims to reduce the deficit. There is no plan to achieve a balanced position in one or two years, and this would not be the best course, since cutting fiscal support too quickly would damage the economy in the form of a sharp reduction in government orders.
However, a gradual exit from the deficit will also be noticeable, and since this is only possible by limiting government spending and/or increasing tax revenues, improving fiscal discipline inevitably involves short-term pain for long-term benefits. The sooner the budget improvement begins, the less damage the intermediate deviation will have time to cause.
The government decided to increase tax revenue by increasing existing tax rates, while keeping the structure of the tax system roughly the same as before.
The most noticeable impact will probably be the increase in the VAT rate, which, like the increase earlier this year, will raise the general price level by a further 1.5% from next summer and, in addition, will reduce the purchasing power of the population by 2% at the expense of income tax. tax from 2026.
Consumption accounts for about half of economic growth, so both taxes will leave a significant mark on economic activity. The impact of raising excise taxes will be less significant, and the question remains how much, in addition to the official rise in price of the consumer basket, the purchase of taxable goods abroad will increase and how much the state's tax revenues will improve.
A new element in the tax system is the so-called classical corporate income tax, which, according to experience, is the least favorable type of tax for economic growth. It is planned to introduce a temporary tax rate of 2% on the profits of legal entities, which, due to its insignificance, will probably not have a large impact on the competitiveness and attractiveness of the business environment. However, this is a fundamental change in the tax system and the only element of the coalition agreement that broadens the tax base.
Until now, the Estonian tax system, compared to other European Union countries, has focused on labor and consumption taxes, while the role of property taxes, which are relatively less of a constraint on economic growth, has been very small in tax revenues. An increase in the share of property taxes in Estonia was recommended by many international institutions, such as the IMF and the OECD.
Since the revenue and spending measures combine to reduce the deficit and inject about a billion euros of extra money into the economy next year, or just over two percent of GDP, in a rough and mechanical calculation this would also reduce economic growth by about 2% compared to previously predicted.
On the other hand, the future performance of the economy in the coming years will depend on the success of economic stimulus measures, including cutting bureaucracy, speeding up planning processes and increasing efficiency more broadly.
Putting government fiscal policy on a more stable path could potentially send a positive signal to both foreign investors and creditors. For example, deteriorating fiscal discipline was one of the reasons for the downgrade of Estonia's credit rating, which generally means higher borrowing costs and slower economic growth.
