Tax revenues lag but are not critical; everything depends on economic development / Article

It is true, as Baiba Brusbārde, an economist of the Bank of Latvia, told the LSM.lv portal – currently, in any case, expenses should be carefully evaluated and an ill-considered tax reform, which can reduce tax revenues, should be avoided. She emphasized that the current budget and tax revenue situation is difficult.

“Budget planning has been optimistic, and tax revenues are not coming as planned. High inflation, which increases tax revenues, is no longer there, but rapid economic growth, which would increase tax revenues, is not yet,” the economist emphasized.

IN SHORT:

• The Ministry of Finance and the European Commission reduce Latvia’s GDP growth forecasts for this year.
• The beginning of the year was not very successful for the economy; problems in export markets should be expected.
• Bank economist: higher expectations for the second half of the year, when the economy could grow faster.
• Latvia’s economy is developing more slowly than predicted; tax revenue lower than expected.
• Plan overflow for workforce taxes at the beginning of the year; the VAT revenue plan has not been met.
• Economist of the Bank of Latvia: Budget deficit may exceed 3% of GDP; possible EC objections.
• FM: budget increase – bad scenario, allows spending cuts.
• Economist: Dramatic budget consolidation unlikely.

Growth forecasts are falling

It should be reminded that this year’s state budget was adopted at the end of last year, assuming that Latvia’s gross domestic product (GDP) will grow by 2.5% in 2024, while the budget deficit will be kept at 2.8%. On the other hand, the general government debt was forecast at 18.6 billion euros, or 41% of GDP.

In February, the Ministry of Finance updated its forecasts, taking into account the economic situation and its development trends. Unfortunately, the forecasts had to be reduced. According to updated forecasts, Latvia’s GDP will increase by 1.4% in 2024, FM now estimates. The European Commission (EC) also reduced its economic forecasts for Latvia, predicting that our country’s GDP will increase by 1.7% this year.

The beginning of this year (January, February) has not been very successful for Latvia’s economy, because we had to reckon with problems in the export markets, where demand is decreasing.

Namely, in February of this year, the value of the export of Latvian goods decreased by 7.4% less compared to January. There are still labor issues, with unemployment rates low, all of which puts pressure on wages. Likewise, consumers are still spending their money very carefully – the retail turnover at the beginning of the year has decreased compared to the beginning of 2023. However, already in March, the situation started to improve a little, said Mārtiņš Āboliņš, a member of the Fiscal Discipline Council and an economist at “Citadele” bank. He added that expectations for the second half of the year – that the economy will grow faster – are also higher.

However, if everyone hopes that at the beginning of the summer the European Central Bank (ECB) could start reducing interest rates, which would also encourage more borrowing and stimulate growth again, unfortunately, we have to expect that instability in the world will not decrease and this is caused by concerns about the further development of events both in Ukraine and also in the Middle East. In addition, even though politicians keep repeating that Latvia is safe, the majority of foreign investors, evaluating the current investment climate in Latvia, highlight the geopolitical situation. It is true that the unavailability of qualified labor, high labor costs and ill-considered regulatory framework are also mentioned as problems.

Finance Minister Asheradens admitted to the LSM.lv portal that currently the economy is developing more slowly than predicted.

“The data on the execution of tax revenues of the general budget for the first quarter show that they are behind the plan by 35.6 million, so the execution is almost 99%,” said the minister.

He also added that the Ministry of Finance will submit more accurate macroeconomic indicators and updated forecasts for this and the next four years to the government on Friday, April 26.

Tax revenues administered by the State Revenue Service (SRS) in the 1st quarter of 2024 are more than 3.2 billion euros, which is 4% more than in the first months of 2023. The tax revenue plan administered by the SRS has been fulfilled by 99.3%.

According to the SRS data, there is an overflow of the plan for labor taxes at the beginning of the year, while the value added tax (VAT) revenue plan has not been fulfilled.

Table. Taxes administered by SRS.

(Click to enlarge):

SRS listed the main reasons that have affected tax revenues. Namely, there was an increase in the average income of the employed (+12.1%), as well as an increase in natural resource tax rates, an increase in the average amount of dividends or costs equivalent to dividends declared by one company (+19.5%), a decrease in the number of companies that declared withholding corporate income tax (-11.8%), a sharp drop in the total value of transactions for taxpayers – energy companies (-30.6%), the calculated customs tax has decreased, where the biggest drop is observed for fertilizers (-520.59 thousand euros).

The largest tax revenues have been provided by wholesale and retail businesses, as well as public administration and defense.

The situation is not critical

“In any case, we cannot talk about the fact that the kind of budget consolidation that Latvia had to experience during the global economic crisis more than ten years ago should take place,” emphasized Āboliņš.

He pointed out that the worst scenario that could happen this year is that the budget revenues will not be as high as planned, most likely it will not be possible to collect more taxes than planned, and as a result of all this, the budget deficit will have to increase, which could exceed 3%.

“Of course, all this could also refer to next year’s budgeting process.

There is a lot of need, but there may not be any extra money to distribute. It will be difficult politically,” the economist added.

Brusbārde, the economist of the Bank of Latvia, admitted that in the assessment of the central bank, the budget deficit this year and next year will exceed 3% of GDP, taking into account modest economic growth and large-scale state needs. However, the economist warned: “If we do not comply with Europe’s new fiscal rules, the European Commission could intervene, reducing our policy options and demanding budget consolidation, which would limit the possibility of granting additional funding, for example, to the health sector.”

On the other hand, the Ministry of Finance cites the increase of the budget as one of the worst-case scenarios, and that is why it also allows a reduction in expenses if it is really necessary.

Asheraden stated in the media that it is important to stick to the planned budget deficit of 2.8% of GDP, because the EC has introduced a new economic management mechanism for managing the finances of the Eurozone, which will focus not only on the issue of the deficit, but will also determine a new management mechanism for the countries, determining the rights of the countries increase or decrease costs for the next four years.