RIGA - Prime Minister Valdis Dombrovskis (Unity) announced on Nov. 19, following a marathon Cabinet session on the 2011 national budget, that agreement has been reached on deficit consolidation measures in the amount of 240 million lats (342.8 million euros), reports news agency LETA. Agreement with the international lenders called for 280 million lats, but as the premier explained, this promise will be met as the government next year, counter to what was previously planned, will not increase the contribution percentage from 2 percent to 4 percent for second pillar pensions, thereby guaranteeing 44.9 million lats in the social budget. As a result, the total amount of consolidation measures is to be 285 million lats.
The original idea by the government was to actually reduce the amount of social contributions to the second pension pillar, cutting the amount to 1 percent or even to 0.5 percent, but this was objected to by the international lenders, who did not consider this to be a sustainable medium-term measure. Therefore, the level of contributions to the second pension pillar will remain at the current 2 percent.
Finance Minister Andris Vilks (Unity) told reporters on Nov. 22 that the well-balanced options drawn up for consolidation of the 2011 state budget should have no negative impact on potential economic growth next year. He admitted, however, that the measures set could curb growth, but certainly not to an extent where the planned 3.3 percent economic upswing would not be reached. He even sees a possible 4 percent figure here.
Vilks also pointed out that since the 2011 budget has been drawn up while projecting the situation for 2012, based on a conservative scenario, the necessary consolidation measures in 2012 will probably be “minimal.”
As a result of the planned tax changes, residents with smaller salaries will be the winners, whereas income of those who receive larger salaries will decrease, Dombrovskis told reporters after the ruling coalition’s Nov. 22 meeting.
The government plans to reduce personal income tax from the current 26 percent to 25 percent, increase the tax-exempt minimum to 45 lats and the benefit for dependent persons to 70 lats, as well as raise the minimum monthly wage from 180 lats to 200 lats, and the social insurance rate from 33.09 percent to 35.09 percent.
The prime minister said that, for example, a family with one dependent person with monthly salaries totaling under 500 lats will actually earn more after the tax changes are introduced, whereas for the same family with salaries totaling over 500 lats, the incomes will drop. “This means that for most employees, the tax burden will decrease, but it will increase for those who receive large salaries,” explained Dombrovskis.
The Cabinet of Ministers decided that the standard value added tax rate would be increased to 22 percent, whereas the property tax rate for apartments and private homes would be doubled. Dombrovskis said that the reduced VAT rate would also be increased, from 10 percent to 12 percent, whereas reduced VAT rate on electricity would be lifted altogether. According to the Finance Ministry’s estimates, increasing the VAT rates would bring in an additional 68 million lats to the budget, whereas the higher property tax - an extra 6.9 million lats.
According to Dombrovskis, predictions that third quarter macroeconomic indicators would have a positive effect on the consolidation amount have proved to be justified. “As the government decides on specific measures for consolidating the budget, great attention must be paid to creating opportunities for the growth and development of business. This is important for the future growth of our country and our full recovery from the crisis.”
Vilks noted that the swift recovery of the Latvian economy had convinced the lenders that the consolidation amount could be much lower than previously forecast, which was in the area of 395-440 million lats.
Agreement has also been reached on the Finance Ministry’s medium-term macroeconomic and financial policy framework for the years 2011 to 2013. Based on the latest GDP growth indicators as of the third quarter of 2010, the ministry predicts a decrease in GDP for 2010 of 0.4 percent, with growth of 3.3 percent expected in 2011. GDP is then expected to grow 4 percent in 2012 and 3.9 percent in 2013.
Evaluation of the current economic and fiscal situation and projections indicate that the government’s goal of a national budget deficit below 3 percent of GDP in 2012 will require consolidation in two years time totaling 590 million lats, says the Finance Ministry.
This means that after next year’s cuts, consolidation in 2012 of 310 million lats will depend on expected gains from economic growth, and also on whether qualitative reforms will be implemented in the sectors with major state financial input, like education and health care.
The Finance Ministry underlines that the consolidation project must be viewed in a two-year period so that tough decisions won’t have to be left for the last minute, i.e. for the 2012 budget. Also, certain consolidation measures could result in higher inflation; therefore it would be better to carry them out in 2011, not 2012.
The recommendations published by the World Bank and International Monetary Fund for reducing the state budget showed that the lenders see the largest possible cuts within social spending. The World Bank’s suggestions for budget consolidation amounted to 274-345 million lats in 2011, and 193-199 million lats in 2012.