Latvia's budget could be between 2 and 4.2 billion euros larger if the country's economic growth had developed like that of Lithuania or Estonia.

This possibility is highlighted by estimates from an expert at the Employers' Confederation of Latvia (LDDK). If Latvia had developed over the last 15 years as Lithuania has, the national budget revenue would be approximately 2 billion euros higher, assuming the tax burden remained the same. Conversely, if development in Latvia had followed the Estonian scenario, it would be 4.2 billion euros higher, and under certain secondary conditions, even 5 billion euros higher than the levels planned in the 2024 budget. Furthermore, even while maintaining the budget deficit level provided for in the approved 2024 state budget law, expenditure could be 2.27 billion euros higher in the Lithuanian development scenario and more than 4.7 billion euros higher in the Estonian development scenario. These are very significant sums, although, of course, money alone is not enough to provide all services essential to society, as questions regarding the presence and availability of appropriately qualified specialists are current in several areas.

What if?

“These are only provisional estimates based on the assumption of what would have happened if Latvia's economic development had not lagged behind its neighbours,” explains LDDK expert Pēteris Leiškalns. He points out that the latest available data are currently for 2022, when GDP per capita in Lithuania was 14% higher, and in Estonia 29% higher, than in Latvia.

“This means that the volume of GDP Latvia has not achieved in this year's comparable prices, calculated against Lithuania, is more than 6 billion euros, of which, with an identical tax burden, approximately 2 billion euros would be an additional contribution to the state budget, while approximately 4 billion euros would remain at the disposal of households and businesses. In turn, when calculating against Estonia, Latvia's unachieved GDP volume is more than 13 billion euros, of which approximately 9 billion euros would remain at the disposal of households and businesses, while more than 4 billion would be an additional contribution to the state budget,” assesses P. Leiškalns. He admits that Latvia's backwardness raises many questions about the current attitude of the Latvian state (officials) towards business, the existing tax policy and its results, and perhaps – whether and who should take responsibility for the theoretically unearned billions.

“Clear and truthful answers to these questions would be very useful for shaping future policy. The government's position on many issues critical to business could depend on them in the future, particularly in tax policy, which is the determining factor for economic indicators. In turn, it will depend on these whether we can bridge the gap of backwardness, or whether the state will finally be able to obtain the volume of funds necessary for financing society's needs without harming households and businesses,” summarises P. Leiškalns, drawing attention to the fact that higher GDP per capita means a correspondingly higher self-financing capacity for households and businesses, which, in turn, gives the state the opportunity to raise the tax burden “painlessly” – by one to two percentage points.

“Countries that need rapid growth must not be hasty with it, as that can hinder development,” emphasises Pēteris Leiškalns.

The budget blanket is too small

The basic contradiction: on one hand, people's needs and desires are unlimited, while on the other, the amount of available resources is limited.

“This means the budget will never be big enough to satisfy all desires,” notes P. Leiškalns. However, in his opinion, the Latvian situation is not about high-level desires, but about the state's ability to fund essential public services to at least a minimally sufficient extent, for example, education, healthcare, social security, external and internal security, culture, science, as well as infrastructure maintenance and development, etc.

“Up until now, when viewing any proposal to increase the sufficiency level of funding for a service necessary for society, the conclusions of officials are almost always uniform and full of resignation: we understand it is needed, but there is only so much money. The only exceptions are when this clause is not mentioned before votes on increasing the remuneration of officials, as well as the conclusion of one very high-ranking official that there is as much money as never before,” concludes P. Leiškalns. There are not enough funds to finance the needs that society must solve collectively.

“The blanket is far too small; every budget adoption is to a certain extent a tug-of-war over this small blanket, where any shift in favour of one position happens at the expense of another,” concludes P. Leiškalns. In his view, the fact that in recent years the additional funding requests of ministries exceed 2 billion euros annually, while the Ministry of Finance's proposal is usually ten times smaller, as well as the “sinking into deeper debt” over the last few years, serve as evidence of this.

“The state debt as a percentage of GDP is not high for Latvia; however, one has to pay interest on it, which, with the growth of the debt volume and the price of money, is becoming increasingly expensive. This year 338 million euros are provided for these purposes, while next year – almost half a billion,” calculates P. Leiškalns. In his view, the most modest estimates show that the state budget would need at least an additional 2 billion euros; accordingly, a 4 billion euro increase would allow the government not only to provide financing for all ministry requests but to invest more in growth and, possibly, reduce the burden of state debt. We do not have these billions.

Produce more – more money

Money in the state wallet does not appear out of thin air, and for countries that do not have oil or similar resources, the only real source of income is Gross Domestic Product (GDP). To correctly compare these figures between countries with different population sizes, GDP per capita is usually compared.

“Judging in this way, we look sad against the backdrop of Western countries, but... one should not be overly saddened by that. It is understandable that we lag behind countries where a normal market economy has existed for centuries. If only... there were not neighbouring countries with an almost identical history, simply put, 'it's a dead end'. We have such neighbours and, to the trouble of our tax policy and business environment creators, their GDP per capita is significantly higher than in Latvia,” explains P. Leiškalns. One cannot put spilled water back, but such analysis can serve as a reference point for discussion: what and how to do so that in the future the differences with neighbouring countries do not grow, but on the contrary – shrink, and furthermore at the expense of Latvia's development, not the stagnation or recession of our neighbours.

In P. Leiškalns' view, one of the reasons for Latvia's low level of growth is a pseudo-left-populist tax system inconsistent with a development economy. Its decisive influence on the national economy, in his opinion, is very well formulated in the introduction to the report Tax Foundation, International Tax Competitiveness Index 2022: “The structure of a country's tax code is a determining factor for its economic performance. A well-structured tax code is easy for taxpayers to comply with, can promote economic development, and at the same time raise sufficient revenue for government priorities. Conversely, poorly structured tax systems can be costly, distort economic decision-making, and harm the domestic economy.”

Must understand where money comes from

“Latvia must be able to break out of the vicious circle: budget insufficiency forces the setting of relatively high effective tax rates for medium and higher salaries; this does not promote investment in higher value-added segments, as a result of which salaries are relatively low; in turn, it is impossible to fund services necessary for society in the required amount from low salaries at reasonable rates, which forces even higher effective tax rates on medium and higher salaries, which again leads to the displacement of the next salary level from Latvia to neighbouring countries,” says P. Leiškalns.

He reminds us that the pace of economic growth is vitally important, and when competing in the unified European Union market, there are questions about competitive tax policy, finance, energy resources, human resources policy, as well as the bureaucratic burden compared to competitor countries. P. Leiškalns emphasises that the surtax on labour above the net salary level is the highest in Latvia, and its differentiated non-taxable minimum promotes not only a low-wage economy but also an envelope-wage economy.

“To see the changes in the tax burden more clearly, a 1000 euro net salary can be divided into 500 euro parts.

Conclusion: for the first 500 euros net, the employer must pay 199 euros in taxes, but for the second 500, under the existing model, they must pay 467 euros. Thus – more than twice as much as for the first 500 euros. This is a very serious pressure on low remuneration and the shadow economy,” explains P. Leiškalns. In his view, Latvia must move towards the Estonian system, where from 2025, the experiment with a differentiated non-taxable minimum is set to end. Public administration in Latvia must understand and accept that the entrepreneur is the state's client, upon whose actions in the specific environment created by officials and politicians it will depend what society, including politicians and officials, will be able to distribute. The more entrepreneurs invest in this country, the higher the qualification of potential employees will be, the more people will be employed, and the higher value-added will be created in every workplace; the higher the ability of entrepreneurs will be to pay higher salaries and higher taxes, from which both public administration, including politicians, is maintained, and necessary services for society are funded. The opposite will happen if, for some reason, entrepreneurs are reluctant to invest in this country or invest primarily in lower value-added segments.

Revenue and expenditure for 2024 (billions of euros, LDDK calculation)