Friday, August 29, 2008

Crisis Resolution

(Btw, this is post 401 on AnTyx. In three years...)

I hate to say "I told you so", but I've mentioned on multiple occasions that in all the time since the restoration of independence, no Estonian government has ever served a full term, from one election to the next. The current cabinet may have come together around a PM with a massive vote of confidence, but that didn't exactly last - and now the coalition is creaking at the seams, again.

The bone of contention is tax reform. The ruling party has accumulated a lot of goodwill with their tax reduction policy: over several years, personal income tax would drop from 26% to 18%. At the same time, the tax-free minimum would keep growing (this is the base earnings amount per month that does not incur any income tax at all). The upshot is that everybody in Estonia would get more money in their pockets in January than they did in December, without begging their employer for a raise. The electorate has really appreciated it, and the Reform Party has been a member of every coalition in memory.

Of course, we're now in the middle of an economic crisis. The upshot for the government is that they are not getting as much tax as they planned to, and the budget falls short. Which it absolutely cannot do: by law, the government is not allowed to have a budget deficit. The shortfall in the 2008 tax revenue has prompted budget cuts in various branches of government, some layoffs, and a lot of shit-slinging between ministries controlled by different coalition parties.

Now the government is preparing the 2009 budget, which it has to submit to the parliament for approval by the end of September. While the Bank of Estonia says we're past the worst of it and the economy will start to bounce back next year, it still won't be a return to happy days, and the government needs to figure out a way to cut spending, or increase revenue, or (preferably) both.

And so the coalition's second-biggest party, the right-wing IRL, is pushing the PM to freeze the tax cuts. Leaving the income tax rates at this year's levels is supposed to bring in an extra 2,5 billion kroons over the original calculations.

At first the Prime Minister was against the idea - naturally; but now it seems as if he is coming around. Ansip has tried to strong-arm the coalition before, and it has never worked out well for him. He kept Mart Laar out of the Foreign Minister's chair because Laar had more popular approval than the PM - and bore the blame of the April riots, leaving Laar in the wings and blameless. He tried to push through some suspect legislation to the benefit of a particular company - and the rest of the coalition promptly supported a rival's unpopular bill to restrict the sales of alcohol. This is a representative democracy at work: with a true multiparty system, even the big dog can't afford to get too arrogant.

So now Ansip is talking about maybe stopping further tax cuts. But is it a good move?

Estonia's economic miracle is largely attributed to two things: a balanced budget, and the lack of any corporate taxes. The former is now under threat. The latter has been a subject of much discussion for the last couple of years, not least because the other EU states are a bit miffed: it's a strong disbalance in the common market, giving Estonia a competitive advantage that the other member states will struggle to match. The government has had to fight hard against EU officials to retain the no-corporate-tax rule. An odd case of the government actually making a proper effort to not get more money.

The income tax cuts, on the other hand, are far less critical to the overall economic health of the country. Estonia needs foreign capital. Personal income tax cuts are of no consequence to the investors, and on the other hand, they are not that much help to the population at large. Businesspeople with stock portfolios and significant financial interests will certainly get a significant bonus if their tax falls by another percentage point - but to the majority of the voters, January's raise comes down to a couple of hundreds of kroons, maybe. It's certainly a very nice thing to have, but it's not critical. If the extra revenue from freezing further tax cuts will balance the budget, save the social services from further layoffs, and keep the economy healthy, then it is entirely reasonable for the state to ask its people to make that sacrifice.

And if it does work, what a boon for Ansip! His once-high approval ratings have been tumbling ever since his failed attempt to be a politician. It is now high time for the Reform Party whips to stop the madness and return to their true purpose in the Republic of Estonia: that of the quietly competent economy buffs, secure in their coalition spot because they are the ones who know how to keep the money rolling in. Freezing the tax cuts is a small price to pay to relieve the crisis; if the government pulls it off, and Reform takes the credit, it will go a long way to undoing the damage done by three years of Ansip's misguided shenanigans.

With pressure from IRL and the rest of the coalition, it now seems almost inevitable that Ansip will take the plunge and drop the tax cuts. The only question is whether it will be enough.


AndresS said...

Totally agree with you! People love to hear about tax cuts but truth is most of the cuts never amount to much extra in your wallet. The American idea that taxes have to be constantly be cut has leeched it's way into most societies these days and when times get tough that mind set needs to change.

Giustino said...

Good post. I see the scheduled decline in taxation as being a bit of a gimmick from the economic liberals.

Foreign investors don't choose where to put their money by taxation policy alone, though I am sure it is a wet dream to the Swedes and Finns who can work so close to their nanny states in such a different business environment.

Investors also need infrastructure development -- better roads, transport links, communication links, financial links, as well as a skilled labor force.

I mean the taxation system can be as simple and effective as you like, but if you a) have a hard time getting to your subsidiary and b) all your employees are drunk losers who constantly demand salary raises then c) you are probably going to move your business elsewhere.

Jim Hass said...

American taxes are different in that they rise automatically with growth due to their progressive rate structure-- they have to be cut just to keep from growing in relative size over time.
I agree with justin. From an outsider's perspective, its a question of value for money. Is my net better off moving my business there considering all costs and benefits.
Russian income taxes may be much lower, but the value they provide maybe much lower too. Would you rather be protected by Russian Federation police and courts or just about any one else in the EU? Or health care for yourself and associates, or roads, etc.
Value for money--price and quality--Porche or Lada? What do you want and can afford.


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