OECD recommends Latvia to improve its fiscal policy, tax system and public sector capacity / Diena

In the report, the OECD concludes that due to the slowdown of economic convergence and the consequences of the war in Ukraine, Latvia must accelerate structural reforms. Experts say Russia’s war of aggression against Ukraine has led to higher energy prices and disruptions to trade and supply chains, affecting economic growth. Even before the pandemic and the war, economic convergence had slowed.

The organization states that Latvia’s fiscal position will relax this year and will remain neutral in 2025, despite inflationary pressure. The fiscal deficit is high and public debt is higher than the medium-term target, so fiscal policy should be gradually tightened to reduce the fiscal deficit and reduce inflationary pressures, the report suggested.

The war in Ukraine has increased defense and internal security spending, and the government has committed to further increase spending on education and health, so the OECD recommends increasing spending efficiency, redistributing spending and increasing tax revenues, including from income and property taxes, and reducing tax spending.

The latest OECD report emphasizes the need to reform the tax system.

The main problem highlighted is that high social contributions for people with low and medium incomes reduce the desire to formalize employment relationships. Informal employment relationships are common and personal income tax progressivity remains low. To address these problems, the OECD recommends reducing the labor tax burden on the low-income, for example by reducing social insurance contributions for lower incomes or by increasing the progressivity of personal income taxes.

Low property tax revenues are also problematic, while many municipalities depend on central government transfers for key spending priorities. In addition, cadastral property values ​​are not linked to market prices. In this regard, the OECD recommends raising periodic taxes on real estate based on regularly updated market values, while continuing to provide tax breaks to the poorest households for their primary residence.

The OECD expects that Latvia will gradually abandon tax expenditures and subsidies for environmentally harmful items, such as fossil fuels, and consider carbon dioxide emission fees for industries not covered by the European Union’s emission allowance trading system, since Latvia has not reduced greenhouse gas emissions since the beginning of the millennium. throw away OECD experts have concluded that the reason for this is that emissions taxes for the transport and construction sectors are low, and subsidies and tax expenditures for fossil fuels and other environmentally harmful items are maintained.

The five recommendations in the OECD report are included in the section on how to improve the capacity of the public sector, increasing the efficiency of spending and fighting tax evasion and corruption.

The OECD states that institutional memory and the quality and efficiency of public policy have been undermined by high staff turnover, as well as a lack of digital and management skills, therefore Latvia should increase the attractiveness of public sector positions and improve the training of those working in the sector.

Policy impact analysis is weak both before and after the event, which reduces the efficiency of public services and spending, and therefore OECD recommends Latvia to improve data infrastructure and knowledge of methodology for analysis of spending and benefits and impact, as well as to promote cooperation between public sector institutions.

As the OECD emphasizes, centralized procurement is more efficient, therefore it would be desirable to unite the existing procurement offices, improve their information technology and employee capabilities, how to avoid mandatory centralized procurement by reducing legal exceptions.

Incomplete declaration of income and wages is widespread in Latvia, therefore mandatory filling of electronic income tax declaration should be introduced, while continuing to reduce the administrative burden with automatic filling of declarations, according to the OECD

Unlike many OECD countries, Latvia has not implemented plans to create a centralized lobbying register, which should be done in order to increase transparency and reduce the influence of inappropriate special interest groups.

The OECD included the most recommendations – seven – in the section on investment attraction to promote growth.

There is weak competition in the financial system, which is why interest rates on financing are not reduced, and therefore legal and investigative tools should be strengthened so that the Competition Council can monitor anti-competitive behavior in the financial markets, the report recommends.

The OECD also highlights the fact that customers rarely switch banks due to high costs and information asymmetry, and the level of household deposits is low. Experts call on Latvia to expand the platform on payment account commissions to include information on bank deposit rates, as well as other fees, such as minimum fees for refinancing loans, and to provide standard packages and contracts for changing credit institutions.

Capitalization on the stock market is very low, and unlike the rest of the Baltic States, none of the large state-owned companies are listed on the stock exchange. OECD urges acceleration of plans to list shares of state-owned companies on the stock exchange.

Investments by pension funds, mostly in foreign assets, have had low returns, while many local companies have difficulty accessing funding through domestic capital markets, so the OECD is calling for higher tier-2 pension investments and concentration limits on single-issuer assets, real estate and private investments, while ensuring appropriate risk management and governance processes.

Although the establishment of the Court of Economic Affairs in 2021 has improved the situation in complex commercial disputes and in cases of major economic crimes, money laundering and corruption, the powers and resources of the court must be increased, according to the OECD, also pointing to the still long bankruptcy processes.

Latvia should establish a tripartite training fund and improve cooperation in training development and implementation between companies and training providers, as a lack of digital and management skills hinders digital adaptation and innovation, the report recommends.

In the OECD assessment, regulation and the impact of the presence of state-owned enterprises on competition are still poorly assessed in Latvia, therefore the powers of the Competition Council to conduct market investigations and to propose an evaluation of the justification of regulatory and state ownership rights should be increased in order to ensure the neutrality of competition.

Such OECD reports are published every two years. The 2024 economic report on Latvia is the fifth – the first report was published in February 2015. The OECD aims to assist governments by providing them with the best possible analysis, research, recommendations and solutions in almost every area of ​​economic policy.