Latvian finance minister Dana Reizniece-Ozola outlines to Stefanie Linhardt the government’s plans to tackle the shadow economy and devise a fair and sustainable mid-term tax strategy.

Dana Reizniece-Ozola

Q: You have just passed the budget for 2017. What are the main priorities?

A: The strength of Latvia is that we have been able to keep our fiscal stance of following strict austerity measures right after the crisis, and are now keeping a balanced budget with a minor deficit of 1.1% for 2017 and then 1% in 2018 and 0.7% in 2019. The debt amounts to 36% of gross domestic product [GDP], which is one of the lowest in the EU.

So the question may arise: how do we ensure the development of the country, within the limited fiscal space? The key answer to that is the quality of structural reforms. This is the solution for all the European countries – especially in the eurozone, which we see stumbling a little. Investment rates are pretty low despite the European Central Bank [ECB] actively working with quantitative easing, hoping to raise investment levels. Interest rates are dropping but lending has only recently been slightly revised.

In Latvia we have, first of all, revised our budgetary spending, ensuring that it becomes more efficient – and also demonstrating to the public that we know how to manage their money. [This is] because we would like to create a correlation in their minds that it is worth paying taxes and that they can trust that the money will be spent wisely and in the areas where they feel the priority lies.

We have planned major allocations for security, which is of high importance at this point, taking into consideration the geopolitical tensions in the region and the obligations we have taken as a NATO member state of increasing the budgetary allocations for security to 2% of GDP by 2018. In the next year, we will reach 1.7%.

The other two priority areas we are investing most in over the next year are education and healthcare, to meet the challenges in the labour market and the structural unemployment. This is nothing new in the EU in general but we are now taking active measures to improve the quality of our healthcare and education so that the labour force is qualitative and available in the long term.

Q: One of your targets is to raise tax revenue to one-third of GDP. What is your progress in that area?

A: I’m very satisfied with the results of 2016’s revenues because they were higher than they were supposed to be, taking into consideration we had to slightly correct our [GDP growth] rate downwards [to 1.9% from 3.1% expected earlier in the year, according to the Directorate-General for Economic and Financial Affairs of the European Commission]. This means that we have been quite successful in combating the shadow economy, which is still very [active] in Latvia at this point.

Our goal is for tax revenue to reach one-third of GDP in a few years’ time, preferably by 2020, and that is the reason why we are now actively working on reforms in two areas. One is combating the shadow economy, for which we have worked out a Shadow Economy Combating Plan. This has been done together with businesses, because we understand that without their involvement and active participation it is not going to be possible, while the representatives from the businesses have understood that a shadow economy distorts competition.

We are already taking measures in those areas where the shadow economy [costs the country the most], such as construction, transportation and trading, and very specific measures have been taken within the next year’s budgetary context.

The other area is the development of our mid-term tax strategy, which should be finalised by April 2017. We have invited experts from the World Bank and also the Organisation for Economic Co-operation and Development [OECD] is supporting us, since we became an OECD member state in the middle of 2016. And we are trying to figure out what the best suited tax strategy is for Latvia, aiming at three goals: increasing revenues, decreasing inequality – the income gap between the different layers of the society is still pretty high – and ensuring the competitiveness of businesses.

It is challenging, but I am pretty sure that it is possible. Once the budget has been passed we are launching an active discussion process [with areas of Latvian society] – we want to do it together with the trade unions and business organisations, so that they also understand and believe in what we decide. The most challenging point will be how progressive the tax system should be.

Q: One of the suggestions mentioned by the International Monetary Fund [IMF] in respect of taxation is for higher taxes on property. Is that something you are considering?

A: Those are the main conclusions of the World Bank as well. Latvia’s labour tax is probably a bit too high and it should be redistributed among the different income groups. So progressivity is proposed from their sides to ensure that labour tax is just, and compensating that with capital, consumer and immovable property tax.

Q: You have mentioned the shadow economy action plan. With regard to Latvian banks, in which a large part of the deposits held are from non-residents, continued financial sector vigilance is vital to mitigate real and reputational risks, according to the IMF. How far along are you with the implementation of enhanced regulations on anti-money laundering [AML] and counter-terrorism financing?

A: We are actively working on fighting illicit flows of money and fighting potential terrorism financing because there is a large share of non-residential transactions carried out through Latvia. That does increase the risk levels. What the government has clearly noted is that there is zero tolerance for that and this has been seen in new regulations, strengthening the enforcement of existing regulations and increasing the capacity of the financial regulator and the financing control office.

It is the banks’ obligation to ensure AML compliance and we have increased potential penalties for money laundering. This can reach 10% of a bank’s turnover in case of a breach of the regulations from the previous level of 10% from previous-year profit [typically only about €100,000].

The obligations for banks include gathering information on politically exposed persons, as well as other measures. From 2017 we are establishing a new bank account register, which will be used by the banking sector regulator and the state revenue service, comprising information on all account holders and actual beneficiaries. US auditors are carrying out AML control systems for the banks to see what the potential deficiencies are, enabling the banks to correct them. The banks have agreed to this and are paying for the service themselves.

Q: We spoke about the economy in 2016. What is your economic outlook for 2017?

A: For 2017 our GDP growth forecast is 3.5%, which is pretty high, but [attributable in the main] to the influx of EU structural funds into our economy. We have finally managed to deal with bureaucracy and prepared the programme documents. Our programmes will be launched in 2017, giving money to the economy. Also, our internal consumption is still growing, supported by low inflation rates and growth in the economy, and we [will] see that lending has revived as well, mainly to households. The government has done a lot to improve lending, for example through our special first house support programme, which helps the banks lend money to families.

Within our new tax strategy, we are now considering the introduction of a 0% reinvested revenue tax, as has existed in Estonia for many years, mainly for the reason that through this, we hope that small and medium-sized enterprises [SMEs] could become more bankable by getting their papers in order. This is currently a problem. Interest rates are low and banks have a lot of money so they should be keen to grant loans to SMEs – but so far SMEs are not providing the financial records to be able to get finance. 

Q: Are you planning any other measures to support economic growth?

A: We are looking to ensure a level playing field [for everyone] because uncertainty is one of the factors businesses blame European governments for. We promise businesses that they can sleep calmly; we won’t introduce any new taxes without their support.

While fiscal flexibility is restricted, monetary policy does not work: the introduction of structural reforms is the answer. There is a need to do it, not only to talk about it, even though structural reforms usually don’t make politicians more popular. There are some short-term losers with any reform but in the mid term and longer term, it will be the right way to go. 

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