Latvians on Estonia's tax hikes: We'll be watching the outcome with interest

TALLINN - The planned tax increases in Estonia have also sparked a debate in Latvia, where analysts pledge to keep a close eye on developments in Estonia.

"Estonia, Latvia and Lithuania are facing a similar challenge in terms of how to find the means to service growing defense expenditures and debt. Inflation has increased pressure on government spending, especially after the significant budget deficits that emerged during the Covid-19 pandemic," said Martins Abolins, economist at Citadele Bank. "For example, Estonia's budget deficit in 2023 was 3.4 percent of GDP and is expected to exceed the three percent mark also in 2024. These deficit levels are not sustainable and are growing, and extra defense spending, which probably is not temporary, will force the Baltic states to look for new sources of funding."

According to Abolins, from an economic perspective, tax increases are not positive in the short term, as they may undermine economic recovery.

"There's little in terms of alternatives though. Governments can either increase revenues, reduce non-essential expenditures, or continue with large budget deficits. The latter is not sustainable at all," Abolins said.

Rating agencies have already downgraded the credit ratings of Latvia and Estonia, and the European Union's budget rules require member states to reduce budget deficits starting next year.

"If taxes have to be raised, consumption taxes are probably a better option than taxes on labor or capital, because they do not affect competitiveness," Abolins added.

Analysts in Latvia are following what is happening in Estonia with interest. The state budget of Latvia for next year has not yet been approved or specific proposals tabled. Lithuania will continue with its current plan and extend the additional bank tax introduced in 2023 to 2025.

Abolins does not foresee a large increase in cross-border trade as a result of higher taxes in Estonia.

"It will certainly have an impact on consumer behavior, but mostly in niche markets such as fuel and alcohol retail. At the same time, a difference in VAT rates of just two percent is unlikely to lead to a significant increase in cross-border purchases, although a small impact may be felt in border areas," he added.