Tax System Is Under Pressure
Estonia’s tax system was established in 1994. Its salient features are simplicity and emphasis on economic growth, and it includes few exceptions. In 2019, the general tax burden in Estonia was 33.1% of the GDP (EUR 9.4 billion). Compared to countries around the world, our tax burden places us in the upper quarter; however, in the European context, we are in the lower quarter.
In the future, the tax system will be affected by the ageing population which increases the pressure on social protection. In addition, the spreading of work in company forms impacts social tax revenue by reducing taxes on labour. Although the inequality of incomes has decreased in Estonia over the recent years, asset inequality has increased, threatening long-term economic growth and tax revenue. All the while, the spreading of digital economy offers to the tax system new opportunities to make tax decisions faster with lower administrative costs and better targeting. The fifth major factor is the climate change, with its combating measures bringing in temporary additional tax revenue.
While developing a future-proof tax structure, we created three scenarios based on development trends.
The scenario “Digital World” asked how the tax system could be adapted to the digital age. The long-term goal in this scenario is to eliminate social tax altogether and to transfer the funding of social protection to sources that take the growing diversity of revenues better into account. Digital economy and start-up companies whose main asset is highly qualified workforce welcome the lowering of the social tax burden; on the other hand, they have to reckon with the growth of the income tax burden to fund the social budget of the state.
The scenario “Equal Start” asked how the tax system should react to the growing inequality. Many trends of the economic environment, such as the increasing price of assets and the rapid development of digital economy has tended to benefit mostly owners of real estate and financial assets over a longer period of time, thus increasing asset inequality. This trend is further exacerbated by money-printing and negative interest rates. Deepening inequality feeds dissatisfaction and protest which blocks the reforms and projects that are directed at economic development, to the detriment of economic growth. This scenario projects the introduction of progressive income tax and the creation of a two-component property tax: 1) tax on real estate, and 2) tax on other property.
The scenario “Environmental Crisis” asked how the tax system can be brought into conformity with the green transition. Opting for this trend means that the society sees the fight against climate change as the biggest challenge facing Estonia. We need to understand that environmental taxes cannot be the source of long-term tax revenue. When ecologically harmful practices become less prevalent, the budget revenue decreases as well. The scenario introduced a three-level car tax as one of the changes in taxation.
In real life, countries are facing all these questions at once, not one-by-one, and different scenarios must be combined. But outlining the so-called clean scenarios allows us to better understand the pros and cons of each one, as well as the tensions between different development choices.