The New Conservative Party’s (NCP) Action Plan 3×500 has created quite a buzz among economists, politicians and wider public due to its boldness in tackling small wage and pension tax burden, as well as reducing poverty among pensioners.
The existing government claims that the plan is impossible to implement due to its fiscal impact – it seems that the establishment parties have lost any ambitions and trust in Latvia and are willing to accept that Lithuania and Estonia have reached a higher level of development. We believe bold reforms are needed to exit the middle-income trap Latvia finds itself in.
What we offer
- A minimum salary of 500 euros from January 2019 (at the moment 430 EUR/month)
- A non-taxable income tax threshold of 500 euros from January 2019 (at the moment up to 220 EUR/month)
- A non-taxable threshold of 500 euros for pensions from January 2019 (at the moment 250 EUR/month)
In addition, the minimum pension will be raised to 200 euros from January 2019 (currently below 100 euros).
To address the demographic challenges, state family benefits will be raised up to 50 euros for one child (currently 11 EUR), 50+100 euros for two children (currently 33 EUR) and up to 300 euros for three children (currently 67 EUR +60 EUR bonus from the age of 1). This will be implemented in the next 3 years’ time.
What it costs
The NCP’s Economic Analysis Group has estimated that the total fiscal cost of the Action Plan 3×500 is around 250 million euros, of which the non-taxable threshold of 500 euros for salaries will cost around 145 million euros assuming that a sliding regressive non-taxable threshold will be put in place for salaries between 500 to 1000 euros (0 non-taxable threshold for salaries above 1000 euros).
Pensions’ non-taxable threshold will cost around 45 million euros: again, we plan to put in place a regressive sliding non-taxable threshold for pensions between 500 to 1000 euros (0 non-taxable threshold for salaries above 1000 euros).
The net fiscal effect of the minimum salary of 500 euros is estimated at 15 million euros based on the expected higher income tax revenue from shadow economy, while at the same time some public sector salaries will receive additions.
State family benefit reform will cost between 200-250 million euros and will need to be introduced gradually over 3-4 years’ period.
How to pay for it
We see different components as the source for additional budget income:
A higher budget deficit
To cover the costs of 250 million euros for the Action Plan 3×500 activities (0.8-1.07% of GDP fiscal cost), it will be necessary to temporarily increase the budget deficit from the current ca. 1% of GDP up to 1.5-2%, especially in 2019-2020 when the fiscal space will have been used by the current government for other budgetary needs. An increase of 1% of GDP gives an effect of around 280 million euros.
The so-called “reform clause” allows the Eurozone member states to depart from their medium term budgetary objectives (MTOs) in case of important structural reforms being enacted and agreed with Brussels. Latvia has used this flexibility twice – once for the pension reform and the second time in 2018 to raise health sector spending by some 250 million euros. With the help of the NCP’s Action Plan 3×500 we will address the long-criticised problem by the European Commission of the high tax wedge on low skilled labour and the high poverty levels among pensioners.
Due to high economic growth within the range of 4-5%, we expect the fiscal space to be positive again from 2021 onwards. To give an example, economic growth of 3% from GDP translates roughly into 3% tax income growth, which subsequently gives extra 200 million euros each year.
In addition, to create a fiscal buffer in the Treasury in case the borrowing conditions would suddenly worsen, the NCP plans to sell or float around 20% equity stakes of the biggest public companies in the Riga stock exchange. This would also improve governance standards in these mostly politically-affiliated state owned companies.
At least 10-20 million euros’ yield is expected from higher alcohol, tobacco and gambling taxes, while keeping tax rates in line with the Baltic neighbours’.
Although the NCP has announced that gambling places will be closed in Latvia in the coming years, and only 4- and 5-star hotels will be allowed to operate gambling places, gambling taxes will be raised significantly in the next few years to reduce incentives to run this business, while generating most income from mostly tourist frequented high end hotels.
Shadow economy in the construction sector constitutes around 35%, thus, getting extra revenue of some 30-40 million euros from envelope salaries is a conservative estimate. In this context, we support the industry in setting a threshold for a minimum salary of around 780 euros in the construction sector.
Zero based budgeting
Additional income of at least 20 million euros will be generated by careful reassessment of annual spending plans based on the principle of zero based budgeting. At the moment, most expenditure is simply rolled over automatically.
All the above-mentioned measures yield around 340-360 million euros, which is sufficient to cover the cost of the NCP’s priority measures: Action Plan 3×500 and the minimum pension of 200 euros.