Paper delivered at an international conference “Tax Competition and Competitiveness,” Vilnius

 

1.       General notes

1.1.     Like everything else, taxes have both the high side and the low side. If one disregards the loss of personal freedom caused by taxation, he can say that when taxes are paid, arithmetically society experiences no loss. So, if Janis pays tax to Raimonds, funds do not disappear, resources are simply redistributed. If money is distributed right, Janis even might be happier than before, and this creates a win-win tax payment. So this is definitely the high side of any taxation.

1.2.     The low side of taxes is a phenomenon, called a passive tax evasion. Let us imagine one of our Maxima stores built in Riga. A man comes Maxima searching for a Panasonic TV-set for no more than 150 lats. However such TV-set costs 155 lats including VAT, and 131 lats without VAT. So this man decides to become a passive tax evader – he avoids VAT by not buying a TV-set. In this case of passive tax evasion every party looses. This man has to use his twenty year old TV-set. We lose our margins. And government treasury looses VAT revenue. When taxes distort the economy, everybody loses.

2.       Profit tax, VAT

2.1.     Latvia has both the corporate income tax and the value added tax. These two taxes interfere with the flow of money from consumers to companies and divert the part of that flow to the coffers of the government. As described, consumers frequently avoid these taxes by cutting their consumption. Companies reduce the burden of these two taxes by investing less in Latvia or not investing at all. Convergence of the Latvian economy to the EU levels these days outweighs the negative effects of these taxes – level of investment and level of GDP growth in Latvia is impressive. But there are no limits for perfection. Lower rates of VAT and profit tax would benefit the investment rate in Latvia even more. And looking into medium term future – only reduction of these taxes can sustain economic growth in Latvia.

3.       Sin taxes

3.1.     Quite normally various sin taxes exist in Latvia and help people to abstain from vices, and prevent illnesses like alcoholism. Cigarette and alcohol taxes are tolerable at this point, but entering the EU will increase them.

3.2.     Latvians were never a nation suffering from laziness. But now, with the spread of western work ethics another disease threatens the population – workaholism. Fortunately, Latvia has two taxes to prevent or heal workaholics – personal income tax and social insurance tax. Instead of overworking Latvians are encouraged to come to Maxima stores, buy TV-sets there, and happily relax in their homes. However, sometimes substantially high rates of these two taxes can cause the spread of the illnesses even worse: such as black market and corruption.

4.       Customs

4.1.     Differing interpretations of import duty laws and customs regulations sometimes cause conflicts between customs officials and importers. Situation with the customs hopefully will improve a lot when Latvia becomes a full EU member.

5.       Real estate tax

5.1.     It is a great pity that plans to reduce real estate rate from 1.5% to 1% were shelved. If this would help encouraging Latvia to proceed, I would like to spread the rumor that Iceland has even bolder thoughts of eliminating real estate tax altogether.

6.       Summary

6.1.     One of the important characteristics of the tax system is the weight of all the tax laws and regulations taken together in kilos. I would grade the present Latvian tax system as light, compared to very complex ones applied in Western Europe or North America. For example, Latvia at this time has eight distinct taxes, but when I counted taxes of Denmark, I lost count after reaching fifty-five.

6.2.     At this time Latvian tax system is competitive enough to achieve strong economic growth, but tax rates have to be reduced in order to ensure long-term success for Latvia.