World Bank suggests Latvia adopts progressive income tax

The forthcoming report from the WB, which will summarize the findings from a year-long review, finds that tax revenues in Latvia are lower than in many similar countries, while social inequality remains higher in comparison to many European Union (EU) countries.

The tax revenue-to-GDP ratio in Latvia, at some 29%, is one of the lowest in the EU, being 10% below the EU average and about 5% points below the Organization for Economic Cooperation and Development (OECD) average.

“Latvia needs to find ways to increase revenues to meet its spending needs, especially supporting investment in education and skills for people,” says Carlos Pinerua, the World Bank Country Manager responsible for Latvia.

“Currently, inequalities in Latvia are higher than in other, comparable countries. However, short-term prospects for growth are good, which should make it easier to raise more revenue to target assistance to low-income workers and families,” he said.

The Word Bank’s report shows that collecting an additional 3% of GDP in tax revenues, as targeted by the government, will require substantial changes to the country’s tax system, as well as to a number of complementary policies. The report focuses on four areas: broadening the tax base, increasing tax rates, reducing tax evasion, and increasing tax progressivity.

The review shows that increases in tax compliance and decreases in tax evasion are simultaneously achievable. Phasing out the current microenterprise tax regime could help reduce tax avoidance and unfair tax competition. This move could also increase contributions to social security and reduce the relatively high tax on low-income labor, which could encourage formal employment, the WB points out.

The report also notes that the most appropriate instruments for tackling inequality are direct personal income taxes and benefits. More progressivity in the personal income tax system could help reduce the inequality in Latvia, particularly if combined with means-tested social assistance.

According to World Bank calculations, the introduction of a three-tier personal income tax scale (19%, 23% and 33%) combined with an earned-income tax credit, would both decrease inequality and increase budgetary revenues.

“This review offers a list of measures designed to increase tax revenue from 29% of GDP at present to the government target of 32%,” said Emilia Skrok, Senior Economist at the World Bank and co-author of the report. “In recent years, the Latvian economy has suffered from volatility and vulnerability, thus it needs to build a fiscal buffer which will increase the resilience of the country.”

Meanwhile the Finance Ministry is proposing its own tax reform, which would see reducing the income tax, hiking the minimum wage and changing the corporate tax.