Estonian Corporate Tax Regime: Model for Lithuania?
Lithuania ranks sixth in the Global Tax Competitiveness Index but it has the least attractive corporate tax regime in the Baltic region. It taxes retained and reinvested profits and applies a personal income tax when dividends are paid out. The effective combined tax rate stands at 27.7 percent. Estonia and Latvia tax only redistributed profits, at 20 percent. Estonian and Latvian companies can retain and reinvest profits tax-free, and this provides a ready source of investment capital for firms and an important competitive advantage in the race for foreign direct investment. Not surprisingly, Estonia and Latvia boast the most competitive tax systems among OECD countries.
Eliminating double taxation of business earnings would put Lithuania on the same footing with its Baltic neighbours and would accelerate Lithuania’s sluggish technological advancement and productivity growth. COVID-19 has heightened the need for a more competitive tax system favouring investment, business development, job creation and income growth.
Last year the Lithuanian Free Market Institute embarked on a project to promote the adoption of the Estonian tax model. Before Lithuania’s 2020 general elections, we presented our reform proposal in a policy handbook Election 2020. Towards Liberty and Prosperity (Lith.) and a mandate for leadership. Four parliamentary political parties embraced our reform proposal in their 2020 election programs. The new coalition government of conservatives and liberals put a revision of the corporate tax system in their work programme.
At the beginning of 2021, LFMI was invited to join an official task force convened by the Ministry of Finance to develop a plan for a comprehensive revision of Lithuania's multiple tax exemptions. Revision of the corporate income tax system was named a priority. The task force includes all major stakeholders, including representatives of the government, parliament, President of Lithuania, the Bank of Lithuania, and 20+ major business associations.
Following debates, the Estonian model is now being considered as one of two main reform alternatives. The other two reform options involve expanding existing corporate income tax exemptions for R&D and introducing tax breaks for companies increasing wage levels.
LFMI played a major role in consolidating public opinion on the reform. We built the case for reform in a research report “Corporate taxation favouring investment and growth” which we presented widely to all major stakeholders, including the prime minister and relevant. The report analyses the importance of investment for productivity and income growth and presents comparative data on Lithuania and the EU. It compares the effects of double taxation of corporate profits (retained and redistributed) with those of a tax regime which taxes only redistributed profits. The paper gives a comprehensive account of the existing CIT exemptions. With this analysis, it reinforces the argument that a steady expansion of CIT exemptions and allowances over the past two decades only confirms political recognition that taxation of retained and reinvested profits is a serious hindrance to investment growth. The paper also looks at the impact of the CIT regime on the level of business profits and budget revenues and presents evidence on the positive outcomes of the Estonia reform.
In collaboration with the Lithuanian Confederation of Industrialists, LFMI organised a conference “Lithuanian Economy: Challenges of Post-Covid Rehabilitation”. Following this conference, we issued a joint open letter to the government and the President calling for a pro-investment growth tax reform and the adoption of the Estonian business tax model.
We supported our recommendations with an extensive media campaign which generated 190 media hits. We appeared in the main media outlets and produced three dedicated editions of a radio programme we host on Lithuania’s prime time news radio station, Ziniu Radijas.
Decisions about the tax reform are expected to be made this year and we remain hopeful that Lithuania will follow Estonia, Latvia and recently Poland which reformed their CIT systems to increase their country’s competitiveness and well-being.
As discussions are intensifying for a global minimum corporate tax rate, our regioncan and should provide a counterweight to these tax harmonization trends and defend their tax systems. After all, tax competition seems to remain the only effective safeguard against government expansion now that all other institutions are dramatically failing us.
The LFMI's project “Business Taxation for Investment and Growth” was supported by the Friedrich Naumann Foundation for Freedom.
The Lithuanian Free Market Institute (LFMI) is an independent non-profit think-tank founded in 1990. The think-tank promotes the ideas of individual freedom and responsibility, free market and limited government through policy analysis, advocacy and educational activities. Their areas of expertise are property rights, taxes and public finances, business regulation, competition policy, energy policy, labor markets, social security, and healthcare. LFMI is a member of the 4liberty.eu network.