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OECD recommends Latvia to improve fiscal policy, tax system and public sector capacity

Latvia needs to improve fiscal policy, reform the tax system, improve public sector capacity and attract investment to boost growth, the Organization for Economic Co-operation and Development (OECD) has concluded in its latest economic review of Latvia.

The OECD report concludes that Latvia needs to speed up structural reforms in the face of slowing economic convergence and the consequences of the Ukraine war. Experts point out that Russia’s war of aggression against Ukraine has led to higher energy prices and disruptions in trade and supply chains, affecting economic growth. Even before the pandemic and the war, economic convergence had slowed.

Latvia’s fiscal position is expected to ease this year and remain neutral in 2025, despite inflationary pressures, the OECD said. With fiscal deficits high and public debt above the medium-term target, fiscal policy should be gradually tightened to reduce fiscal deficits and inflationary pressures, the report recommends.

The war in Ukraine has led to increased defense and internal security spending, and the government is committed to further increasing spending on education and health, which is why the OECD recommends increasing spending efficiency, redistributing spending and increasing tax revenues, including from income and property taxes, and reducing tax expenditures.

The OECD’s latest report highlights the need to reform the tax system.

A key problem highlighted is that high social contributions for low- and middle-income earners discourage the formalization of employment relationships. Informal employment relationships are common and progressivity of personal income tax remains low. To address these problems, the OECD recommends reducing the labor tax burden on the low-income group, for example through reduced social security contributions at lower incomes or by increasing the progressivity of personal income taxes.

Low property tax revenues are also problematic, while many municipalities depend on central government transfers for key spending priorities. In addition, cadastral property values are not linked to market prices. In this context, the OECD recommends increasing property taxes based on regularly updated market values, while continuing to provide tax reductions for the poorest households on their main residence.

The OECD expects Latvia to phase out tax expenditures and subsidies on environmentally harmful items such as fossil fuels and to consider carbon levies on sectors not covered by the EU Emissions Trading Scheme, as Latvia has not reduced its greenhouse gas emissions since the turn of the millennium. OECD experts have concluded that this is due to low emission levies on the transport and construction sectors and the persistence of subsidies and tax expenditures on fossil fuels and other environmentally harmful items.

Five recommendations in the OECD report include a section on how to improve public sector capacity, increase spending efficiency and fight tax evasion and corruption.

The OECD notes that institutional memory and the quality and effectiveness of public policy have been undermined by high staff turnover and a lack of digital and management skills, so Latvia should make public sector jobs more attractive and improve training for those working in the sector.

As the OECD points out, centralized procurement is more efficient and it would be advisable to merge existing procurement offices, improve their information technology and staff capacity, and reduce legal exemptions from compulsory centralized procurement.

Under-declaration of income and wages is widespread in Latvia, which is why mandatory electronic filing of income tax returns should be introduced, while further reducing the administrative burden through automatic filing of returns, the OECD notes

Unlike many OECD countries, Latvia has not implemented plans to establish a centralized lobbying register, which should be done to increase transparency and reduce the undue influence of special interest groups.

The OECD included the most recommendations – seven – in the section on attracting investment to boost growth.

Competition in the financial system is weak, which is why interest rates on funding are not being reduced and why legal and investigative tools should be strengthened to enable the Competition Council to monitor anti-competitive behavior in financial markets, the report recommends.

The OECD also highlights the fact that high costs and information asymmetries mean that customers rarely switch banks and that household savings are low. The experts call on Latvia to extend its platform on payment account fees to include information on bank deposit rates as well as other fees, such as minimum fees for refinancing loans, and to provide standard packages and contracts for switching credit institutions.

Capitalization on the stock market is very low and, unlike in the other Baltic states, none of the large state-owned companies is listed on a stock exchange. The OECD urges acceleration of plans to list the shares of government owned companies.

While the establishment of the Economic Court of Justice in 2021 has improved the situation in complex commercial disputes and in cases of major economic crime, money laundering and corruption, the court’s powers and resources need to be increased, says the OECD, pointing also to the still lengthy bankruptcy proceedings.

Latvia should set up a tripartite training fund and improve cooperation in training design and implementation between companies and training providers, as a lack of digital and management skills hampers digital adaptation and innovation, the report recommends.

The OECD assesses that Latvia continues to have a weak regulatory framework and the impact of the presence of state-owned enterprises on competition, and that the Competition Council’s powers to conduct market investigations and initiate regulatory and state ownership justifications should be strengthened to ensure competitive neutrality.

The 2024 OECD Economic Survey is the fifth for Latvia, the first having been published in February 2015. The OECD aims to help governments by providing them with the best possible analysis, research, recommendations and solutions in almost every area of economic policy.

Source: BNS

(Reproduction of BNS information in mass media and other websites without written consent of BNS is prohibited.)

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