RIGA - Parliament has voted to raise the value added tax (VAT) starting from the first of the year, increasing the base rate to 21 percent from the current 18 percent, and the VAT reduced rate to 10 percent from 5 percent.
Under the amendments of the VAT law, the reduced rate of 10 percent will be imposed on medicines, heating and electricity supplies to households, as well as domestic public transport services, publishers and newspapers, medical equipment and medical goods and natural gas supplies to households.
The increase will cause inflation to go up in Latvia, experts say, but the impact will not be as strong as it seems now.
"To preserve their businesses, most entrepreneurs will have to cope with this increase themselves. Shoppers' behavior can be seen already, and it is going to become even more reluctant in terms of consumption," said Andris Vilks, chief economist at SEB Banka.
The economist explained that this is not a sudden downfall, and is something that may continue well into 2009.
"Purchasing power has been falling for some time already, and unfortunately it will keep falling next year as well at an even more rapid rate, not because of inflation but because of dropping wages and rising unemployment," said Vilks
The downward trend of inflation will nevertheless continue and remain strong, slowing only during the first months of 2009, Vilks predicted.
Morten Hansen, an economist with the Stockholm School of Economics, said that the tax hike would harm the economy in the short term, but that it would ultimately be necessary as a prerequisite for the IMF loan package.
"Increasing VAT will actually worsen the recession a bit since it will reduce our spending even more. But it is a measure taken as part of a precondition from the IMF concerning government budget stability. Without the VAT increase there would be a gaping hole in the budget," Hansen said.
"A VAT increase will harm those people who spend most of their earnings - these are typically low-income people. As such a VAT increase may be seen as unfair but at three percentage points it is not actually detrimental for anyone," he said.
Many were surprised by the proposed VAT increase to 21 percent on print materials, newspapers, books and magazines 's which would have amounted to a quadrupling of the tax rate as publishers were moved from the reduced to the regular VAT scheme.
Though that initial proposal did not go through, printed media will still face a doubling of the current tax rate.
Even President Zatlers said that, despite his occasional annoyance toward the press, it is still something to be proud of and to support.
"As far as possible, it is necessary to support the free press, as it is a value that really exists in Latvia and of which we are proud. Sometimes we can barely stand it, but it is a great value, and we realize it only at a moment of crisis and when we are in great trouble," Zatlers said.
Above all, Zatlers stressed that it should not be necessary for media to look for sponsors because they are unable to support themselves. Both he and the general public are worried that sponsored media would lead to influenced and biased content.
"I would not like to comment details and every figure, as there are too many of them, but clearly, during this time of austerity we have to protect what ensures full press and media freedom. And it can be ensured only on condition that the media are able to sustain themselves, that they can take care of themselves and they do not have to look for, I will say it openly, sponsors that determine the content of publications, profit and maybe also purely political influence," the president said on public television.
The Latvian Association of Press Publishers (LAPP) has raised many objections to the government's plan to raise the print VAT, a move they worry may bankrupt many press publications.
The press association's head, Guntars Licis, said the association has had tough talks with Latvijas Pasts mail services provider on cutting delivery costs to make press editions affordable for readers, especially in the further, more remote regions of Latvia.
He added that subscriptions for next year's press deliveries have already ended, and subscribers are expected to receive newspapers and magazines at the price based on the 5 percent and not 10 percent value added tax.
Licis said press publishers were ready to take action, adding that the LAPP is a member of an international association, just as Latvia is a member of the EU.
All Latvia's largest press editions on Dec. 11 protested against the plans to raise the VAT rate, warning that the move may lead to a collapse of the whole industry. On Dec. 11, all daily papers, including Diena, NRA, Latvijas Avize and a number of Russian-language dailies, had printed front pages with pictures of a tombstone mourning the death of the press in 2009.
The parliament decided that in 2009 a VAT rate of 10 percent will be imposed on media and press subscription fees, including newspapers and other periodicals, but in 2010 the VAT rate for the press will still be raised to 21 percent.
The VAT base rate of 21 percent will also be imposed on hotels, motels, guest houses and other facilities of this type, centralized water supplies, sewerage and waste management services, burial services, as well as tickets to sports events and movie theaters.
The VAT base rate will also apply to hairdressing services, house renovation and reconstruction services, as well as some firewood and wood supplies to individual consumers.
Peteris Strautins, a senior social economics expert at Latvia's Swedbank, pointed out that the pressure of deflation will force companies cover part of the increased VAT costs themselves, but that consumers will have to pay the remaining portion of the increase. Consumers, however, are likely to be less affected thanks to sustained price drops.
The tax increase is expected to provide additional revenues to the government budget. Concurrently, prices for goods and services will go up, which is likely to further reduce consumption and fuel inflation. The price increase is expected to hit low-income households first.
In regards to the current global economic crisis the existing VAT rates are no longer able to ensure the planned and necessary budget revenues, the Finance Ministry said in a press release.
In November 2008, Latvian consumer prices declined 0.4 percent from the previous month, while annual inflation dropped to 11.8 percent from 13.8 percent in October.
The amendments are to take effect on Jan. 1, 2009.