Estonian Fiscal Policy On Track: IMF

by Tatiana Smolenskaya, Tax-News.com, Moscow

29 October 2009

The International Monetary Fund, in its Article IV consultation with Estonia, commended the country's government on fiscal measures taken to bring its deficit within the Maastricht criterion of 3%. Nethertheless the IMF has urged that an additional 1% of gross domestic product (GDP) safety net of measures should be found to reduce its risky dependence on one-off non-tax revenues.

The IMF report noted that Estonia has carried out comprehensive fiscal reforms centred on three areas: firstly, through structural reforms, such as increases in VAT and excise rates, adjustment in benefits (pension, sickness, and unemployment), as well a consolidation of public functions; secondly, one-off measures, such as land sales, and larger than usual dividend payments by state-owned enterprises; and lastly by postponing investment and earmarked spending cuts, which potentially could be reversed when there is fiscal space to do so.

“Budget implementation in Estonia has held up remarkably well, given that the economic contraction has been only marginally smaller than in its Baltic neighbors. This can be attributed to a better starting position, strong budget institutions and tax collection. Nevertheless, non-tax revenues, the health fund and deficits of local governments present considerable risks to meeting the budget targets. Continued consolidation at all government levels is warranted during the remaining months of the year,” observed the IMF.

Going forward, the IMF has welcomed decisions taken in the draft 2010 budget to mitigate unemployment, but suggested that further decisions need to be taken to protect against unforeseen deterioration in tax revenues, advocating that Estonia decide upon measures equal to 1% of GDP.

“Following the boom years, which resulted in a surge of revenues, the tax base will be gradually eroded through the reorientation of the economy towards exports which are lightly taxed,” the IMF explained.

The report recommended that:

“In keeping with Estonia’s admirably simple tax system, a first step could be to further eliminate poorly targeted allowances and exclusions, especially within personal income taxes and VAT."

"Significant deferral benefits in the corporate income tax could also be reviewed. Consideration should be given to the further use of environmental and other taxes—such as an annual motor vehicle tax or real estate taxes—which would broaden the tax base and reduce economic distortions.”

“An increase of the VAT rate would also support a shift from nontradable to tradable sectors and could potentially be used to offset an increase of the personal income allowance or a reduction of Estonia’s relatively high payroll taxes."

"Finally, there may also be further scope for rationalizing public services and administration while improving efficiency and preserving important functions like tax administration.”

Recommended