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To shrink shadow economy, experts say cut taxes

  • Latvia

    11-04-2012

    Author: Ben Seeder
    Comments by Maris Vainovskis

    The Baltic Times, TBT#798, 11.04.2012.

    As Latvia's government slices state spending to bring its 2012 budget deficit down to under 3 percent of GDP - the level needed to qualify the country for entry into the euro in 2014 - experts say the plan to hit the deficit target is being threatened by "weak" at­tempts to fight tax dodgers.

    Up to 50 percent of Latvian com­panies avoid paying certain taxes through schemes such as "envelope pay" - where employees are paid cash and either kept off the books entirely, or with reduced "official" pay. The result is the state loses hun­dreds of millions of lats in annual revenue, increasing pressure on the budget at a critical period for Lat­via as it seeks to control inflation and reign in spending to adopt the single currency. Studies by the Stockholm School of Economics revealed the shadow economy widened during Latvia's economic crisis, when the government increased payroll tax to 25 percent - from 15 percent. Total labor taxes on employees, including the payroll tax and the social securi­ty contribution, are currently above 60 percent - the highest of the three Baltic States.

    This has induced many compa­nies to avoid the labor taxes, and tax experts and industry figures agreed that the government's measures against this have failed. Inese Olafsone, a director at the Confederation of Employers of Lat­via, said: "The government has pub­lished a plan to reduce the shadow economy, which in reality is full of small items - the measures are not serious. In fact, there are no real measures."

    "We are talking about the mea­sures against contraband and il­legal employment - the measures in the plan against these are too weak," she wrote in comments e-mailed to The Baltic Times.

    Gunta Kaulina, a senior man­ager at KPMG, speaking on the side­lines of the Taxes 2012 conference in Riga, said the Ministry of Finance has made "very little progress" in fighting the shadow economy. "Speaking from what I know personally from friends, I don't know any small business people who aren't using this system of en­velope pay. It is very popular and is very difficult for the State Revenue Service to catch," she said. "In my view, nobody can fight against the shadow economy until society changes its view about pay­ing taxes. The government has talk­ed about reducing the tax burden to 21 percent, so that will help, but the employment taxes on companies are still very, very high."

    The government's program to tackle tax dodgers is set out in the document Action Plan to Reduce the Shadow Economy and Promote Fair Competition, 2010-2013. Ac­cording to Juris Stinka, Deputy State Secretary on Tax Policy at the Ministry of Finance, 47 of the 66 measures in the plan have been implemented by the Ministry of Fi­nance. However, in an interview with The Baltic Times, he admitted that some of these had yet to pass parlia­ment or receive Cabinet approval.

    Others, such as the Ministry's plan to track cases of "envelope pay" by comparing companies' re­ported employee salaries with the average salaries reported in industry, were defeated by court chal­lenges. "Some of the measures have been delayed in parliament or the government, and work on them is ongoing. Some measures we have implemented later than specified in the plan," he said.

    Tax experts interviewed by The Baltic Times were sceptical about the effectiveness of the plan.

    Maris Vainovskis, a tax attor­ney at Eversheds Bitans in Riga, said many of the 66 proposals were fillers, such as the Ministry's pro­posal to "organize a discussion to assess opportunities" in changing punishments for tax code violations. Others include the measures to "develop concept papers," "or­ganize a discussion about options" for reducing ticket sales fraud, and "research the opportunities for improving cooperation" between dif­ferent state agencies. "They know the size of the problem; they do have a difficult task. I think the willingness is there to reduce this problem of the shadow economy, but I have some doubts about the effectiveness of some measures and their imple­mentation - the success rate in im­plementation is considerably lower than the rate of initiatives opened," Vainovskis said.

    "One of their best ideas was the average salary criteria for pub­lic procurements... I think this did have a real chance of detecting tax fraud, but this measure was de­feated in the Constitutional Court. Some of the other things on this list (the 2010-2013 plan) are not very in­teresting," he said. "I would agree that many of the problems of the shadow economy are based around smaller and me­dium sized companies, and I don't see anything here to force smaller companies to start paying taxes," he said.

    These included the proposed tax penalty amnesty, and a scheme to create a "white list" of compa­nies with track records of paying full taxes. The companies on the white list would receive certain tax benefits. "They should have widened the list a bit more and done something to attract smaller companies that are currently not paying taxes," he said. He welcomed the measure oblig­ing individuals to "declare" their assets to the tax authorities, but said it should have been introduced ten years ago.

    Other tax lawyers took similar views. "We have been talking about this declaration law for a long time. Now we have it, but the clever people will all have come up with clever schemes to avoid it," said Janis Taukacs, a partner at Sorainen law firm in Riga.

    Vainovskis also said some of the measures in the 2010-2013 plan were very harsh on Latvia's poorest, such as the so called 'benzinchiki' in eastern Latvia. These people previously earned a basic living by legally bringing alcohol, cigarettes and gasoline over the border from Russia and Belarus, where such products are cheaper. Vainovskis said the Ministry of Finance's measure to limit border crossings in the east to one per week removed a way of subsis­tence living in the country's poor­est regions.

    Experts agreed the proposal to reduce the payroll tax in stages down to 21 percent was welcome; Vainovskis said: "For Latvia to be competitive, payroll tax must go down to 15 percent, as it was before the crisis," he said.

    The Ministry of Finance's Stinka said more measures were planned for this year, including bringing in the tax penalty amnes­ty, new regulations on reporting cash transactions, and hiring 82 new auditors at the State Revenue Service. He said regulations to ease the tax burden on smaller busi­nesses were also being planned. He said the Ministry of Fi­nance's target to collect an ad­ditional 40 million lats from the shadow economy in 2012 would be achieved.

    "Beating the shadow economy is important not just for revenues, but also it is an important factor in attracting foreign investment. Foreign companies don't like operating in the shadow, and in an economy where many competitors have an unfair advantage by avoid­ing payment of taxes, this is not at­tractive to foreign investors. "The good part is we think the shadow economy has stopped growing, and we saw some increas­es in collection last year, about 30 million lats (42.8 million euros). About 75 percent of that in­crease was from the economic growth last year, and 25 percent was from companies and individu­als coming out of the shadow economy," he said.

    "The problem is that it is a difficult task to beat the shadow economy. There seems to be a disconnect in Latvians' minds, between the tax they pay and the services they receive from the state. They want increased state services but they do not want to pay tax for it.”

    Latvia's 2011 budget deficit came in at around 4 percent of gross domestic product, according to government figures - lower than its target of 4.5 percent. According to Ministry of Finance officials, the country is on track to meet its target deficit of 2.5 percent of GDP this year - if economic growth con­tinues in the country. Economist Janis Oslejs said continued eco­nomic growth in Latvia this year depended largely on the EU - Lat­via's biggest export destination.

     

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