Finnish trade unions are trembling at the prospect of a tax paradise for the country's firms just across the Gulf of Finland when Estonia joins the European Union.
Estonia's system of low taxes, approved by the European Commission, the EU's executive arm, will be a magnet for Finnish firms looking to improve their bottom line, the unions say.
In Finland, corporate income tax is 29 percent while in Estonia it is 26 percent and there is no tax on reinvested corporate profits. The personal income tax rate is progressive in Finland and may reach up to 60 percent; in Estonia it is set at 26 percent.
The EU has agreed to allow Estonia to preserve these tax rates upon accession, but Finnish trade unions are crying foul.
"When you have a common market and soon a common currency, and services are free to cross the border, problems will arise due to the very different levels of taxation in Estonia and Finland," said Matti Viialainen, deputy head of the Central Organization of Finnish Trade Unions. "In the case of many businesses, it will be very lucrative to operate under the Estonian flag or from Estonia instead of highly-taxed Finland. I am worried that due to the huge gap in taxation, Finland will become a loser in terms of employment and tax revenues."
Viialainen also mentioned Estonia's favorable value added tax system, which releases companies with an annual turnovers of less than 16,025 euros from registering for VAT. In the EU the barrier is only 5,000 euros and in Finland 8,400 euros.
Tax-free trading on Estonian ships will disappear when Estonia joins the EU, but tobacco will be taxed at a lower rate until 2009, thereby boosting shopping tourism from Finland, he said.
However, Estonian officials dismiss such claims. Prime Minister Siim Kallas said that rather than fearing an outflow of companies, other nations should follow Estonia's example and lower their taxes.
The Finns, Kallas said, were "over-dramatizing the situation." There has never been a limit on foreign investments in Estonia, so there will not be a sudden inflow of Finnish money.
"So it is definitely not correct to state that Estonia is a tax paradise," he said.
Aku Sorainen, an attorney at the Finnish Sorainen Law Offices in Tallinn, agrees with Kallas. Sorainen said that Finns often misunderstood the full concept of Estonian tax system, due to it being so different and modern.
"Public comments in Finland have often ignored the fact that the distribution of company profits in Estonia is taxed more or less the same as in Finland," he said. And because the social taxes paid by the employer are higher in Estonia (33 percent) than in Finland (about 20 percent), Estonia could be a model for Finland in how to create a simpler tax system that encourages entrepreneurship, investment and hard work by employees, he said.
"Employees are often discouraged from working more in Finland since increased salaries would also mean increased tax rates," Sorainen said.
Kallas said lower taxes did bring advantages to the state.
"Estonia certainly wants to preserve the comparatively low taxation level for a long time," Kallas said. "I suggest other countries move toward decreasing taxes rather than pressuring others to increase theirs."
The Finnish trade unions think the heavy tax burden should be gradually decreased in Finland, Viialainen said. This has also been the policy of Finnish Prime Minister Paavo Lipponen. According to next year's proposed budget, the tax rate will be decreased by 1 percent next year.
But it is hard for Finland to decrease the tax rate while trying to uphold a social-welfare system, he said, and so it is difficult for the country to compete internationally on low tax levels. He suggested that the EU set tax standards to avoid harmful competition between member states.
Viialained said that taxation was an internal matter for Estonia, but EU negotiators should have considered the issue more carefully.
"When Estonia is a member of the same union, then the common internal market is not totally (the country's) own business any more," he said. "That is why I hope Estonians understand our criticism."