Latvia's international lenders have not publicly confirmed Latvian Prime Minister Valdis Dombrovskis' statements that they are displeased with the tax plan. Photo by Aivis Freidenfelds and used courtesy of the State Chancellery.

RIGA — Latvian Prime Minister Valdis Dombrovskis said Tuesday that international lenders want the country to install a progressive income tax instead of lowering the non-taxable minimum income level.

According to reports, Dombrovskis told parliamentary budget committee members just one day after the 2010 budget was handed to the Saeima that Latvia’s lenders the European Commission and the International Monetary Fund are worried that the government’s revenue-raising measures are short-term and ineffective since the ultimate goal is to stabilize the economy and bring the budget deficit down to 3 percent of GDP in 2012. Dombrovskis hinted that creditors are also concerned that part of expenses might be rolled over to future years with simple accounting trickery that will be used to disguise a larger-than-expected budget deficit.

To be sure, that the European Union and IMF are not perfectly satisfied is not surprising news. But since both creditors have made few public statements about next year’s budget, their opinion has primarily been revealed through the reaction of Latvian ministers. In this sense, the question of the non-taxable minimum on income reveals much.

The 2010 budget calls for reducing the non-taxable minimum to 25 lats (€35) from 35 lats, while the minimum for dependents would be slashed to 25 lats from 63 lats. The government hopes to boost revenues by 56 million lats (€78 million) through these measures. What international creditors would prefer to see, Dombrovskis suggested, is the current flat tax abolished and the tax burden shifted to the wealthier strata of society.

However, some fear a progressive tax in Latvia would immediately lead to many entrepreneurs to transfer their businesses to Estonia and Lithuania. Also nothing is written about implementing a progressive income tax in the Supplemental Memorandum of Understanding that was signed by the EU and the Latvia in July. What is written in black and white, however, is that Latvia should raise the value-added tax from 21 to 23 percent “unless a compensating amount of measures can be found.” But as it came clear this fall the People’s Party, one of the four parties in the center-right coalition, is dead-set against either a hike in VAT and introducing a progressive income tax.

The party even objected to introducing a real estate tax, which is written into the Supplemental Memorandum, but eventually caved in after lenders insisted on the full 500 million lat (€700 million) consolidation, although the 0.1 percent of cadastral value tax eventually introduced was far lower than creditors has hoped.

In other words, the EU and the IMF are concerned about the “compensating measures” that Latvia has apparently come up with. Finance Minister Einars Repše has downplayed any differences that have arisen as a result of discussions between the government and international lenders.

“The lenders understand that this is an internal issue for Latvia. They can express their opinion, but they can hardly dictate a parliamentary democracy what taxes to introduce or not to introduce and what to do with the non-taxable minimum,” he told the Baltic News Service in a recent interview.

The Saeima convened on Tuesday to discuss the draft budget. It is expected that lawmakers will pass the budget in a first reading on Thursday and that by the end of the month the document will pass a third and final reading.