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The Lithuanian Economy - February 8, 2013

The Lithuanian Economy - February 8, 2013

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Published by Swedbank AB (publ)
The Lithuanian Economy - February 8, 2013: Public finances are sound, but shadow economy remains a problem
The Lithuanian Economy - February 8, 2013: Public finances are sound, but shadow economy remains a problem

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Published by: Swedbank AB (publ) on Feb 11, 2013
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The Lithuanian Economy
Monthly newsletter from Swedbank’s Economic Research Department byVaiva
Šečkutė and Laura Galdikienė
No.1 • 8 February2013
Economic Research Department. Swedbank AB.SE-105 34 Stockholm.Phone +46-8-58591000E-mail: ek.sekr@swedbank.com www.swedbank.comLegally responsible publisher:MagnusAlvesson, +46-8-58593341.
Nerijus Mačiulis
, +370 5 2582237. Vaiva
Šečkutė
,+370 5 258 2156
, Laura Galdikienė, +370 5 258 2275
Public finances are sound, but shadow economyremains a problem
National budget revenue last year increased by 7.9% compared with 2011and was 0.6% higher than planned. Revenues from personal income andprofit taxes were significantly above plans; however, revenues from valueadded taxes (VAT) and excise duties were lower.There are indications thatthe efficiency of VAT and excise dutiescollection deteriorated last year.
Interest rate developments have been favourable lately; however, theborrowing need for 2013 is estimated at LTL 7.3 billion, and the currentample liquidity situation in the financial markets will not be permanent. Tostrengthen the revenue base and reduce borrowing needs, it is important tocontinue to fight the shadow economy.
Higher-than-planned budget revenues
Budget collection in 2012 reflected the strongperformance of the Lithuanian economy. Annualnational budget revenue increased by 7.9% andwas 0.6% higher than planned. The forecast of theMinistry of Finance was rather conservative, andemployment and profits increased more thanexpected. The more rapid job creation was the mainreason why unemployment last year decreasedmore than the ministry forecast. Personal incometax revenues were 5.9% higher than planned, andprofit tax revenues exceeded the target by 21.8%.Strong employment growth and increasingprofitability explain these developments.
State budget revenues in 2012, m LTL
99.397.6105.598.7121.8-400004000800012000160002000024000Budget (EUsupp.excl)VATPITExcisedutiesProfit tax961001041081121161201242012 actual2012 plan2011 actualPlan execution, % (rs)Source: Ministry of Finance.
 Also,revenues from social security funds exceededexpectations, and expenditures grew by less thanplanned. Revenues were 3.8% higher than plannedand 5.1% higher than a year ago. The number of insured has increased more than the number of employed –by 31,900 and 21,400respectively,indicating a somewhat smaller unofficialremuneration.
Shadow economy still larger than expected
The tax collection plans for VAT and excise dutieswere too ambitious – revenues were, respectively,2.4% and 1.3% lower than planned. During 2012,the efficiency of VAT collection must havedeteriorated. According to our estimation, the c-efficiency ratio
1
decreased from 46.2% in 2011 to45.0% in 2012. The ratio of excise tax revenue tohousehold consumption fellmarginally – from 4.7%to 4.6%. If the efficiency ratios had not decreased,VAT and excise revenue would have been slightlyabove the plan. However, there were someincrease in excise duties and the income level fromwhich VAT is applied was lifted in 2012. This meansthat excise duties collection efficiency probablydecreased more and VAT – somewhat less.Onereason for the unfulfilled expectations was thefailure to introduce cash registers in all coveredmarket places. Too many exceptions were
1
The ratio of VAT revenue to consumption,divided by the standard tax rate.
 
The Lithuanian Economy 
Monthly newsletter from Swedbank’s Economic Research Department, continued No. 1 8 February2013
2 (4)
introduced, and the majority of nonfood productscontinued to be sold unofficially and not taxed.Even though these ratios are only approximate, asthe exact tax base is not calculated, there are other signs that the shadow economy might not bedecreasing in some areas. Overall tax revenue as apercent of GDP and as a share of domesticdemand decreased in the third quarter last year.
General government balance and tax revenues
10152025200720082009201020112012-12-606121824General government balance, % of GDP (rs)Tax revenue, % of domestic demandTax revenue, % of GDPSources: Ministry of Finance and Swedbank.
Moreover, according to the Nielsen “empty-pack”survey, the share of smuggled cigarettes inLithuania increased significantly in the last quarter of 2012 after decreasing for one-and-a-half years.
A share of smuggled cigarettes in Lithuania, %
12.621.341.543.034.630.829.335.410152025303540452009Q22010Q22011Q22012Q2Source: Nielsen empty pack survey.
Public finances will continue to improve
This year, income tax revenue will be supported byfurther increases in employment and fastergrowthof wages. Revenues from VAT and excise dutiesare to a large extent dependent on householdsentiment and consumption growth, the latter of which is forecast to fall from a growth of 4% lastyear to 3% this year. This is mainly due to risingprices of necessities and the probability that thesavings rate will not decrease much further.We expect Lithuania will maintain fiscal disciplinethis year. The budget deficit will decrease to 2.5%,and public debt is estimated to fall from its peak of 40.9% of GDP in 2012 to 38.4% of GDP in 2013.Still, borrowing needs for 2013 are estimated at LTL7.3 billion. It is planned that the main part (75-80%)will be raised in the domestic market. Interest ratedevelopments have been favourable. At the end of January, Lithuania borrowed EUR 400 million for five years at 2.63% annual interest--one of thelowest rates in its history.
Lithuania’s credit default swaps (CDS), basis points
50100150200250300350400450
     D    e    c   -     1     1     J    a    n   -     1     2     F    e     b   -     1     2     M    a    r   -     1     2     A    p    r   -     1     2     M    a    y   -     1     2     J    u    n   -     1     2     J    u     l   -     1     2     A    u    g   -     1     2     S    e    p   -     1     2     O    c     t   -     1     2     N    o    v   -     1     2     D    e    c   -     1     2
CDS (USD, 5 year)CDS (USD, 10 year)Source: Bloomberg.
Reducing the size of the shadow economyshould be a priority
The current excess liquidity in financial markets willnot be permanent, nor will the low interest rates.One way to alleviate the borrowing needs of thegovernment would be to reduce the size of theshadow economy. In 2012, the shadow economy inLithuania was measured to account for about 26%of the GDP.
2
More efficient tax collection wouldstrengthen public balances and ease the pressurearisingfrom decreasing support from EU structuralfunds. Therefore, one of the main priorities of thegovernment should be to increase its efforts tomake the shadow economy official and, thereby,reduce tax evasion.The size of the shadow economy not only affectspublic finances through lost tax income but alsoincreases the tax burden for those who operatelegally. Therefore, in order to compensate for thelost tax revenues from decreased labour taxation,
2
Lithuanian Free Market Institute, “Lithuanian ShadowEconomy,”,2012.
 
The Lithuanian Economy 
Monthly newsletter from Swedbank’s Economic Research Department, continued No. 1 8 February2013
3 (4)
tax reform should also involve measures to fight theshadow economy.The smuggling of cigarettes, alcohol, fuel, and other goods accounts for about one-third of the shadoweconomy.Illegal work and unofficial remuneration,unaccounted sales of goods and services, andsales of illegal goods and services also account for a significant part of lost revenues.The main reasons for illegal work and unofficialremuneration are the inefficient enforcement of taxcollection rules and high labour taxation. In 2012,the tax wedge
3
on labour in Lithuania was almost40%. In addition, rigid labour market regulation, aswell as the complicated tax system, has a negativeeffect on employers‘ willingness to engage in legalemployment relations. One important way to dealwith illegal work and tax evasion would be tocontinueeasing the tax burden on labour (such as,e.g., incountries like Ireland, Cyprus, and Malta,where labour tax rates are half those of Lithuania's).In a country with a weak tax morale, shifting the taxburden from labour to unproductive assets (e.g.,personal cars) could be more efficient in loweringtax evasion. Easing the regulations of employmentrelations and simplifying the tax system could alsohelp to reduce the levels of illegal work. In addition,the fines should be sufficiently high, so that theexpected costs of fraudulent behaviour exceed thebenefits. Also, tax law compliance could beimproved by making the manager of the company,instead of the owner, responsible for illegalemployment. Moreover, limiting the time period inwhich the unemployment and social benefits can bereceived might be a helpful measure againstunemployment benefit fraud;itwould also stimulatea faster return of the unemployed to the labour market.Most important, however, is in our view isthe lackof strongnegative consequences for an employeereceiving an unofficial wage. Therefore, it would beuseful to tie the services and benefits the personreceives from the state to taxes paid by creating“virtual accounts” or a “points” system, whereby aperson could track his taxes paid and the publicservices “earned.”In order to reduce the volumes of unaccountedsales of goods and services, it is necessary toeliminate legal possibilities for this kind of behaviour, not only by narrowing the range of business activities that can be carried out usingbusiness certificates, but also by expanding the
3
The tax wedge is defined as the difference between thecost of the employer and the take-home pay of theemployee.
mandatory use of cash registers. Sinceunaccounted sales are especially widespread in therestaurant sector, one of the ways to lower themwould be to forgo the use of nonfiscal receipts
4
. Another measure to deal with unaccounted salesand tax evasion is to restrict the use of cash for payments; this approach is becoming increasinglypopular in some EU countries, such as Italy, Spain,Greece, and Romania. This could entail setting acertain money limit above which all payments mustgo through the banking system, and restricting cashpayments of wages in business and public sectors,as well as of all transfers by the government.In order to fight smuggling, it is necessary to useregular administrative measures effectively,includingstrengthening border protection, andincreasing fines for violating customs formalitiesand bribing officials. The risks of being caught andof being punished still remain relatively low, and thisencourages criminal activities. Furthermore,lowering the scale of smuggling and the sales of those goods requires spreading the responsibilityfor such crimes to all levels, i.e., punishing not justthe direct smuggler, but also the people involved inthe distribution and retail sale of those goods, aswell as the final consumers. Another priority shouldbe to reduce the widespread corruption amongstcustoms officers and politicians, and thereby limittheir cooperation with smugglers and the tolerancefor smuggled goods.One of the most important reasons for the largeshadow economy in Lithuania is the weak taxmorality. The inefficiency of the public sector,corruption, and low quality of public services reducepeople’s willingness to pay taxes and induces themto engage in illegal activities. In order to deal withthis problem, the government should strive toimprove the quality of services (e.g., healthcareandhigher education), enhance the efficiency opublic institutions, and lower the level of corruption.Implementing such difficult reforms will require astrong political will. Tangible results will take timebut reforms will pay off in the long term.
Vaiva ŠečkutėLaura Galdikienė
 
4
Only fiscal receipt ensures that the sum the customer  pays will be properly accounted and all taxes will be paid.

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