RIGA - Latvian authorities agreed with the internation lenders to consolidate next year’s budget by 395 - 440 million lats (628.5 million euros). Most likely, deficit narrowing will be achieved by increasing real estate taxes, pensions and reductions in the other social benefits.
The missions of the International Monetary Fund and the European Commission said during their visit in Riga that Latvia’s economy appeared to bottom out and there is restored confidence. Gross domestic product contracted by 6 percent for the first quarter of 2010, compared to an 18 percent drop in 2009.
“The international lenders said there were signs that the economy is starting to stabilize. We decided that next year Latvia will borrow only 400 million euros instead of 1 billion euros, which means our lenders will be only the IMF, the EC and the World Bank, not the countries. Still, next year’s consolidation will reach from 394 to 440 million lats,” said Prime Minister Valdis Dombrovskis.
According to the Ministry of Finance, one third of this amount will be collected by tax increases, but the rest of the budget narrowing, to 6 percent of GDP, will be reached by expenditure cuts and structural reforms in the public sector. The prime minister declined to confirm this proportion.
“Policy implementation over the past year has helped restore confidence. But much remains to be done with the government remaining committed to cutting the deficit and strengthen the financial system to maintain the peg to the euro and move toward adopting the single currency,” said Mark Griffiths, the IMF mission chief for Latvia.
It is important to change the taxation system in Latvia in order to lower the grey economy sector, said the European Commission’s mission chief Gabriele Giudice.
“One important part of the revenues in this country is the revenue which is not there. Latvia is reported to have one of the highest shares in the grey economy. We are not calling for higher tax rates; we are calling for making sure that everybody pays.”
A real estate tax increase is one of the options for how to narrow the budget deficit, however, the European Commission is not going to push through any measure, said Giudice.
The other options of reaching the 2011 deficit target of 6 percent of GDP are provided by the Welfare Ministry. It is suggested to raise social tax from 33.09 percent, to 46.8 percent, but the other choice is for retirement pension cuts and social benefits reform. These austerity measures could help to cover the social budget deficit of 215.6 million lats. The last option, mentioned by the Welfare Ministry, is described as “doing nothing,” which could lead to the state’s failure to provide any type of social payments.
There is no doubt that there will be higher real estate tax, said Alf Vanags, Director of the Baltic International Center for Economic Policy Studies (BICEPS).
“We will not know much before the national elections, but I am sure about the real estate tax. It will bring more revenue without hurting poor people. I understand very well that pensions are always a very emotional thing, but we have seen large pensions during the economic boom and it has to be somehow recovered.”
It is very likely that there will be fewer ministries, but there is no large room for cuts and the other structural reforms in the public sector, because the state has to function and there is a limit what you can do, said Vanags.
“I do not see any evidence of the government’s success in defeating the grey economy sector. Basically, in a culture where not paying taxes is regarded as a good thing, it is very hard to change people’s behavior.”
The next time the IMF and the European Commission representatives will visit Riga is in the autumn.