Government to increase tax free allowance

As of 1 January 2007, the government has decided to increase the tax free allowance threshold, as well as tax relief for dependent persons. Although generally expressing support for an increase in wage norms, the Latvian trade union and employer confederations argue that the government did not consider the interests of the social partners before making such a decision. As a result, the National Tripartite Cooperation Council has established a working group to study further increases in wage norms.

On 27 June 2006, the Latvian government approved an increase in the tax free allowance threshold and in tax relief for dependent persons. As of 1 January 2007, the personal tax free allowance will be increased from €45 to €57 per month. Tax relief for dependent persons will also be increased from the current €31 per month to €40 per month, from the same date.

The new tax free allowance threshold equates to 15% of the current gross monthly average wage (€382) and to 44% of the minimum wage (currently €128). Moreover, taking into account the high inflation rate (6.8% in 2005), the tax free allowances represent about 36% of the monthly average value of the ‘minimum basket’ of consumer goods and services per capita.

For a long time, the personal tax free allowance stood at €30 per month; however, from 1 January 2005, it was increased to €37 a month and subsequently to €45 a month from 1 January 2006 (LV0406101N). The new tax free allowance changes will necessitate an amendment to the Law on Personal Income Tax, which is the law accompanying the state budget of 2007.

In addition to the increase in personal tax free allowances, the government has also announced its intention to reduce the current rate of personal income tax from 25% to 15%.

Social partners dissatisfied with level of increase

Increasing the personal tax free allowance had long been one of the demands of the Free Trade Union Confederation of Latvia (Latvijas Brivo Arodbiedribu savieniba, LBAS), which had been requesting an increase to €57 since 2005. The Latvian Employers’ Confederation (Latvijas Darba Deveju konfederacija, LDDK) had also supported this demand.

Nevertheless, despite the government’s recent resolution to increase tax free allowances, both LBAS and LDDK expressed dissatisfaction about the relatively small increase in these allowances and the fact that the government had not consulted with the social partners prior to such a vital decision. In a media interview, the Deputy Chair of LBAS, Livija Marcinkevica, outlined that, at the meeting of the National Tripartite Cooperation Council (Nacionalas trispusejas sadarbibas padome, NTSP), the social partners had agreed that the tax free allowance should represent 60% of the minimum monthly wage of the respective year.

The trade unions believe that increasing the tax free allowance will be more beneficial to low-income earners than reducing the personal income tax rate will. On the other hand, local authority income generated from personal income tax will decrease by about 4% as a result of such increases in tax free allowances; the revenue received by the state from social payments will also decrease by about the same amount.

New working group established

On 30 June 2006, a number of days after the government passed its resolution, the social partners agreed at an NTSP meeting to establish a working group aimed at evaluating the potential for further increases in the minimum wage and in personal tax free allowances. It should be noted that the trade unions have always regarded the two issues of increasing the minimum wage and increasing personal tax free allowance as being interlinked, while the government has always viewed them as separate issues.

The new working group will consist of six people – two each representing the NTSP, LDDK and LBAS. The group will be expected to file its proposals by September 2006.

Meanwhile, the Ministry of Welfare has developed two models for increasing the minimum wage – one to €156 and the other to €170.

Commentary

Although the increase in personal tax free allowances represents a long-awaited decision, it may also create additional risks. Such increases reduce the amount of state and municipal funding available for education, health protection and social insurance needs. Nonetheless, the social partners are hopeful that lower taxes will facilitate the legalisation of undeclared work and thus counteract much of the drop in state revenue.

Raita Karnite, Institute of Economics, Latvian Academy of Sciences

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