Social partners criticise harsh budget for 2010

On 1 December 2009, after prolonged debates with the social partners, Latvia’s parliament accepted the 2010 budget. Under the new budget, government expenditure for 2010 will be reduced to 2004 levels and tax rates will be increased. The changes will have a direct impact on employees’ living and working conditions and on the competitiveness of employers. As a result, both the trade union and employer side have been critical of the budget.

Economic context

After achieving independence, Latvia sought to develop its national economy in accordance with the so-called ‘Washington Consensus’ – whereby strict fiscal and monetary policy would have to be implemented for a successful transition to the market economy. The advantage of this policy is predictable development; however, not all transition economies show long-term development. Only in 2004 did Latvia succeed in reaching the output level comparable to that in 1990.

The country’s entry to the European Union in 2004 brought large foreign capital inflows into the national economy, and from 2005 experts at national level and later at international level warned about a possible ‘overheating’ of the economy. The first indicators of this were:

• a growth in gross domestic product (GDP) – that is, to 10.6% in 2005, 12.2% in 2006 and 10.3% in 2007, although this was followed by a 4.6% decline in 2008;

• consumer price growth – of 6.6% in 2005 and 2006, 10.1% in 2007, 15.4% in 2008 and 3.5% in 2009;

• a negative current account balance – that is, -12.5% of GDP in 2005, -22.5% in 2006, -22.3% in 2007 and -13% in 2008.

After entering the EU, the Latvian economy showed the most vulnerable development trends among the new and old Member States, with the highest inflation level in the EU, the worst balance of payment deficits, the smallest exports-to-imports ratio and the fastest GDP growth.

A downturn in the global economy soon started to impact on Latvia’s financial system and, as a result, the government was forced to seek external financial help in 2009. The country received a €7.5 billion loan for stabilisation; however, it undertook to follow the conditions of international institutions to ensure the recovery of its national economy. Similar to the previous economic transition, a strict fiscal policy is to be followed – in particular, a decrease in government expenditure in order to reduce the budget deficit to its lowest possible level.

Budget provisions for 2010

After prolonged debates with the social partners, on 1 December 2009 the parliament (Saeima) adopted Latvia’s revised budget for 2010. Budgetary tax changes include significant tax increases as well as new taxes. At the same time, government expenditure is to be reduced to 2004 levels. The 2010 amendments will involve the following tax changes, which will have a direct impact on employees’ living and working conditions and on the competitiveness of employers.

• Personal income tax is to be increased to 26% – moreover, instead of the previous 15% rate, the 26% tax rate is to be applied to performers of economic activities and copyright receivers.

• Property tax is to be introduced at a rate of between 0.1% and 0.3%, depending on the land ownership value of apartment buildings.

• The term for repayment of overpaid personal income tax from the state budget is to be lengthened from three to 12 months.

• The tax rate for self-employed persons is to be raised to the general personal income tax income rate of 26%.

• Personal income tax will apply to pension funds and life insurance investments.

• Personal income tax will also apply to companies’ service passenger cars that are used by employees for personal reasons.

• The annual amount of non-taxable employers’ gifts is to be reduced from the minimum monthly wage of LVL 180 (about €254 as at 3 March 2010) to zero.

• Personal income tax will apply to gifts exceeding LVL 1,000 (€1,410) a year if they have been received by single persons (not married or in a relationship) until the third generation with the gift receiver.

• Personal income tax relief for dependents is to be reduced to LVL 25 (€35) a month from LVL 63 (€89) a month in 2009 – an additional personal income relief will apply for dependents in large families to the amount of LVL 10 (€14) a month.

• The monthly tax-free allowance is to be reduced from LVL 35 (€49) to LVL 25 (€35).

Trade union reaction

In its discussions with the government, the Free Trade Union Confederation of Latvia (Latvijas Brīvo arodbiedrību savienība, LBAS) continued to emphasise the antisocial character of the new budget. On 1 December 2009, LBAS organised a picket outside the parliament, drawing about 500 participants from all regions of Latvia and most LBAS organisations. In a letter directed to the chair of the parliament, the trade union representatives indicated that instead of the expected economic stabilisation, the budget will only serve to increase the tax burden. At a time when combating unemployment should be a central priority for the government, the impending economic policies will instead only raise unemployment levels.

The trade union representatives pointed to the long-term effects of the budget policies on the national economy, which they claim will force both low and high-qualified workers to leave the country. They urged the government to reduce expenditure in state institutions, and to ensure sufficient financial support for education, science and healthcare. The trade unions also encouraged the government to look for constructive economic recovery measures, ‘to stop the destruction of the national economy and especially of small and medium-sized business’ (LBAS news update No. 132, 18 December 2009).

Employers’ view

At the end of 2009, during its dialogue with the government on the 2010 budget, the Employers’ Confederation of Latvia (Latvijas Darba devēju konferderācija, LDDK) argued that the tax increases do not constitute a compromise, but are the easiest solution for the government (reported in Diena newspaper, 25 November 2009). LDDK believes that if the new budget is accepted, the competitiveness of Latvian business in the Baltic market will decrease. From LDDK’s point of view, there is an alternative solution – that is, reducing the expenditure of state institutions and combating the informal economy instead of raising taxes.

The employers believe that during the budget review process, it was important to evaluate the state’s functions in order to avoid unnecessary budgetary expenditure. They also emphasise the need to focus on creating a competitive state national economy.

In a joint statement issued on 26 November 2009, LDDK along with LBAS, the Latvian Chamber of Commerce and Industry ( Latvijas Tirdzniecības un rūpniecības kamera**,** LTRK) and the Latvian Association of Local and Regional Governments (Latvijas pašvaldību savienība, LPS) highlighted that it is a premature step to increase taxes in a period of economic crisis. They added that the new budget is only ‘well balanced’ on paper because some of its activities will actually reinforce the recession in practice.

Commentary

In the present economic downturn, an increase in tax rates as well as the introduction of new taxes could deepen the recession. Nevertheless, the economic downturn could also be exploited to attract foreign investment and boost employment levels. In their discussions about the budget’s impact on the national economy, the trade unions and employer organisations underlined the effect of higher taxes on entrepreneurship, arguing that each new tax or tax increase will have a negative impact on the competitiveness of Latvian business.

LDDK considers that, in 2010, the risk of a growth in the informal economy will be as relevant as ever, as it is linked to a high tax burden and bureaucracy. From the employers’ perspective, the informal economy poses a threat to fair competition. LDDK is therefore urging the government to discuss the issues of a reduction in taxes and measures to combat the informal economy.

Irina Curkina, Institute of Economics, Latvian Academy of Sciences