## 1. Benchmarking Tax Revenues

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### Motivation and fiscal context
- Lithuania faces a near-term need to boost defense spending, adding to long-term spending pressures related to ageing and green transition.
- Defense spending is expected to increase by an additional 2 percent of GDP relative to previous 2024 projections and would reach 5 percent annually from 2026-30.
- The EU “escape clause” was activated in July 2025 for 15 member states, including Lithuania, allowing for the exemption of up to 1.5 percent of GDP in defense budgets from deficit calculations.
- Mobilizing tax revenues is identified as an essential component of a multi-year fiscal package to ensure fiscal sustainability.

### Government proposals and expected revenue impact (summary)
- PIT
  - Current schedule: 20/32 for thresholds of 0-60 (with non-taxable amount) and >60 average wages.
  - Proposal: 20/25/32 for thresholds of 0-36 (with non-taxable amount), 36-60, and >60 average wages; pooling all types of income together (with some exceptions, e.g. dividends); additional tax bracket at 25 percent.
  - Estimated revenue impact: 0.23 percent of GDP (Ministry of Finance estimates; percent of projected 2026 GDP).
- CIT
  - Current rates: 16 percent and 6 percent reduced rate.
  - Proposal: 17 percent rate (also on dividend income) and 7 percent reduced rate; introduction of instant depreciation of certain fixed assets; limitations on deductions of tax losses.
  - Estimated revenue impact: 0.05 percent of GDP.
- Property taxes
  - Current: EUR 150,000 non-taxable threshold and 0.5-2 percent tax rate for non-commercial immovable property owned by individuals (revenues allocated to state budget); other property 0.5-3 percent set by municipalities (allocated to municipal budgets).
  - Proposal:
    - Non-commercial property owned by individuals:
      - (a) primary residence – non-taxable threshold of EUR 450,000 and tax rates ranging from 0.1 to 1 percent set by municipalities (revenues to municipal budgets).
      - (b) other property – EUR 50,000 non-taxable threshold and progressive tax rates ranging from 0.2 to 1 percent set by law (revenues allocated to the State Defense Fund until 2030).
    - Commercial property – additional 0.2 percent tax; revenue allocated to the State Defense Fund.
  - Estimated revenue impact: 0.08 percent of GDP (except from primary residence for which the size of impact will depend on decisions taken by the municipalities).
- VAT
  - Current reduced rates: 5 and 9 percent.
  - Proposal: increase 9 percent rate to 12 percent; lower rate for books to 5 percent; no VAT relief for heating, hot water and firewood.
  - Estimated revenue impact: 0.09 percent of GDP.
- Sugar tax
  - Proposal: excise duty in EUR/hl differentiating by sugar content per 100 ml.
  - Estimated revenue impact: 0.03 percent of GDP.
- Insurance tax
  - Proposal: 10 percent tax for all non-life insurance premia.
  - Estimated revenue impact: 0.12 percent of GDP.
- Total estimated revenue impact of government proposals: 0.6 percent of GDP (Ministry of Finance estimates; percent of projected 2026 GDP).

### Benchmarking tax system and tax potential
- Aggregate and gaps
  - Lithuania’s tax-to-GDP ratio reached 22.3 percent in 2023, below the EU average of 26.1 percent.
  - Estimated tax capacity (potential): 30.6 percent of GDP.
  - Actual collection: 22.3 percent of GDP.
  - The gap indicates room for revenue mobilization through structural reforms and improved tax administration.
- Composition and indicators (percent of GDP or percent where stated)
  - PIT: Revenue: 7.5; Rates: 0/15/20/32 (statutory as reported); Top rate: 32.0.
  - CIT: Revenue: 2.1; Rate: 16.0; Productivity: 14.0.
  - VAT: Revenue: 8.3; Rate: 21.0; C-efficiency: 52.6.
  - Property tax: Revenue: 0.3.
  - Excise tax: Revenue: 3.0.
- Relative position
  - Lithuania relies more on VAT and excise duties; property taxes contribute a smaller share compared to other EU nations.
  - Property taxes in Lithuania are substantially lower than EU advanced economies, which collect about four times more.

### Personal Income Tax (PIT) system characteristics and reform scenarios
- Current PIT structure and distributional effects
  - The PIT has a complex marginal rate structure with low progressivity driven by the basic allowance phase-out and varying statutory rates.
  - Two thirds of the population’s income is below 12 average wages (below EUR 20,000) taxed at a marginal tax rate of 30 percent.
  - Only 0.1 percent of the population earns income above 120 average wages subject to the highest tax rate of 32 percent.
  - Lithuania faces some of the highest income inequality relative to comparator countries.
- Government plan (proposal to be implemented Jan 2026)
  - Incomes below 36 average wages: 20 percent rate.
  - Incomes between 36 and 60 average wages: 25 percent rate.
  - Income above 60 average wages: 32 percent rate.
- Scenario-based reform options and revenue implications
  - “Progressive 1” scenario: streamlining the marginal rate schedule, preventing higher marginal tax rates for lower-income earners, and adding more middle-income tax brackets could yield up to 0.5 percent of GDP in additional funds.
  - “Progressive 2” scenario: an even more progressive tax schedule could raise over 1 percent of GDP.
  - Removing the phase-out of the basic allowance completely would lower tax revenues by more than 1 percent of GDP.
- Marginal rate structure (current brackets)
  - Bracket 1: 0 – 8,964 : 0%
  - Bracket 2: 8,965 – 11,088 : 20%
  - Bracket 3: 11,089 – 26,004 : 30%
  - Bracket 4: 26,005 – 34,371 : 23.6%
  - Bracket 5: 34,372 - 114,162 : 20%
  - Bracket 6: >114,162 : 32%
- Analytical tools and caveats
  - PIT scenario outputs are based on the IMF’s Personal Income Tax Analysis (PITA) tool.
  - The Kakwani progressivity index and World Inequality Database (WID) data are referenced; results should be interpreted with caution due to survey limitations and underreporting at the top of the distribution.
  - The PITA tool does not include social security contributions.

### Key findings and tax policy directions
- Scope to boost revenues through:
  - Improving VAT efficiency (VAT C-efficiency is 52.6 percent, below Estonia’s 67.8 percent).
  - Increasing progressivity of the PIT while protecting lower-income households by smoothing marginal rate spikes driven by the basic allowance phase-out.
  - Raising property tax revenues, particularly on non-primary and commercial property, where current collections are low.
  - Limited additional scope to raise excise taxes given already high excise levels relative to advanced economies.
  - Enhancing CIT revenue productivity through rate adjustments and base measures (including instant depreciation and loss limitation in the government proposal).
- Aggregate estimate
  - Estimated aggregate revenue from the government’s proposed package: 0.6 percent of GDP (Ministry of Finance estimates; percent of projected 2026 GDP).

---

### Corporate taxes, property taxes, and indirect taxes — detailed considerations

### Corporate Income Tax (CIT)
- Recent changes and revenue effect
  - CIT was raised from 15 to 16 percent in January 2025; reduced rate rose from 5 to 6 percent.
  - This is projected to generate an additional 0.04 percent of GDP in tax revenues.
  - A proposal to increase the rate from 16 to 17 percent could potentially yield an additional EUR 111.5 million in revenue (when full impact comes into effect, also excluding other CIT related changes).
- International context and productivity
  - Lithuania currently raises more CIT revenue than its Baltic counterparts, which tax only distributed (not retained) profits at a 20 percent rate.
  - Lithuania’s 16 percent rate is below the 21-22 percent averages in EU advanced economies and Nordic countries.
  - Low CIT productivity raises concerns about economic and political costs of further rate increases.
- Policy focus
  - Prioritize addressing exemptions that erode revenue rather than large rate increases.
  - Highlighted exemption: EUR 300,000 turnover threshold for the reduced 7 percent rate creates a steep tax cliff when firms grow.
  - Suggested approaches: introduce a graduated rate or lower the EUR 300,000 threshold.

### Property Taxes
- Current structure and revenues
  - Two property taxes: land tax ranges from 0.01 percent to 4 percent of assessed value; immovable property tax ranges from 0.5 percent to 3 percent for real estate over EUR 150,000.
  - Property tax revenues currently equal 0.3 percent of GDP.
  - Municipalities administer property taxes and grant exemptions.
- 2026 tax policy change (partial base broadening)
  - Primary residences:
    - Municipalities set a non-taxable threshold of EUR 450,000.
    - Tax rates range from 0.1 percent to 1 percent.
    - Revenue directed to municipal budgets.
  - Other properties:
    - EUR 50,000 non-taxable threshold.
    - Progressive tax rates from 0.2 percent to 1 percent set by law.
    - Revenue allocated to the State Defense Fund until the end of 2030.
  - Commercial properties face an additional 0.2 percent tax; revenue allocated to the State Defense Fund.
- Targets and equity design
  - Reasonable target range for property tax revenues: between 1 and 2 percent of GDP.
  - Recommendations:
    - Levy according to the benefits principle.
    - Individualized tax relief based on means testing.
    - Access to a tax deferral regime to protect vulnerable owners until asset transfers.

### Indirect Taxes — VAT
- Current framework and gaps
  - Standard VAT rate: 21 percent, with exemptions and reduced rates.
  - Compliance gap improved to 14.6 percent from 24.0 percent in 2018.
  - 2022 policy gap: EUR 3,281 million (33.2 percent of potential revenue), decomposed into 22.7 percent non-actionable exemption gap, 6.0 percent actionable exemption gap, and 4.5 percent rate gap (EUR 446 million).
  - Proposed law would raise the reduced rate from 9 percent to 12 percent, adding EUR 80 million in annual revenue.
- VAT efficiency metrics and revenue potential
  - VAT C-efficiency in Lithuania: 52.6 percent in 2022.
  - Improvement scenarios:
    - Improving to European EMs level (55.6 percent) could yield an additional 0.5 percent of GDP.
    - Improving to the average of Latvia and Estonia (61 percent) would yield an additional 1.3 percent of GDP.
- Policy measures to improve VAT efficiency
  - Strengthen digitalization: expand the State Tax Inspectorate’s i.MAS system with real-time e-invoicing and AI analytics (i.MAS launched in 2016).
  - Reduce carousel fraud via regional cooperation and promoting digital payments.
  - Simplify compliance for small businesses: consider raising the VAT registration threshold (currently EUR 45,000) and offering pre-filled returns.
  - Strengthen oversight of cross-border trade with stricter controls and Baltic collaboration.
  - Target VAT evasion hotspots through sector-specific audits and pilot Poland’s split payment model.

### Conclusion and staff priorities
- High-level findings
  - Changes to PIT, VAT, and property taxes would have sizeable revenue impacts while producing other economic benefits.
  - PIT and property tax reforms could mobilize more revenue and make the tax system more progressive, addressing high societal inequality and providing more fiscal autonomy to municipalities.
  - Improving VAT efficiency through digitalization, reducing carousel fraud, and simplifying compliance would increase tax revenues.
  - CIT reform should prioritize addressing exemptions rather than large rate increases.
- Staff recommendations and revenue impact ranges
  - PIT (existing schedule: 0/15/20/32): Increase progressivity by eliminating phase-out and lower income bracket distortions; revenue impact: 0.2 – 1 percent of GDP.
  - CIT (existing rate: 16 percent): Limit large CIT rate increases beyond 18 percent, and address exemptions; revenue impact: 0 – 0.1 percent of GDP.
  - Property revenues (existing: 0.3 percent of GDP): Broaden base and limit exemptions, use means-testing; revenue impact: 0.5 – 1.5 percent of GDP.
  - VAT (existing rate: 21 percent): Increase efficiency through digitalization, improving compliance, reducing carousel fraud; revenue impact: 0.5 – 1.3 percent of GDP.
- Methodological notes
  - PIT reforms estimated using the IMF Personal Income Analysis (PITA) tool.
  - CIT reforms estimated using government revenue estimates from historical CIT changes.
  - Staff estimates and benchmarking used for property tax and VAT reforms.

---

### Potential growth, migration, and productivity dynamics

### Methodology and core assumptions for potential growth
- Potential output constructed from a production function with inputs labor, capital, and TFP, using an HP-filter to obtain potential levels for each input.
- Capital accumulation: K_{t+1} = I_t + (1−δ) K_{t−1}.
- TFP growth: ∆log(A_t) = ∆log(Y_t) − α∆log(K_t) − (1−α) ∆log(L_t).
- Forecasts for fixed investment and the unemployment rate are taken from the latest IMF staff forecast.
- Depreciation rate (δ) is held fixed at its average 2015-2023 level.
- Forecasts for the working age population are from Eurostat.
- Labor input defined in hours worked: L_t = WorkingAgePop_t * LaborForceParticipation_t * (1 − UnemploymentRate_t) * AverageHoursWorked_t.
- Labor force participation rate and hours worked are kept constant over the scenario horizon at their 2023 levels.

### Capital, labor, and TFP inputs and projections
- Real capital stock growth is expected to slow from 5.5 percent in 2024 to 4.5 percent in 2030.
- Labor
  - Baseline migration scenario: working age population assumed to shrink by 1.1 percent per year.
  - European Commission baseline: labor force decrease around 7 percent from 2025 to 2030, around 1.3 percent per year.
  - Labor contribution to potential growth expected to be around -0.7 percent in 2030.
- TFP
  - Historical average TFP growth around 1.6 percent.
  - TFP growth was negative in 2022-2024.
  - Medium-term assumption: TFP growth picks up to close to 1 percent (historical average over 2012-2024).
- Demographics
  - Population share aged 60+ increased from 19 percent in 2000 to 28 percent in 2023 and is projected to increase to 31 percent by 2030.

### Scenario analysis — migration and potential growth
- Eurostat migration scenarios (working age population): low (downside), medium (baseline), high (upside).
- Labor force changes across scenarios
  - Downside migration: labor force shrinking by 1.5 percent per year.
  - Upside migration: labor force shrinking by 1.0 percent per year.
  - The average labor force growth rate in the upside migration scenario is similar to a scenario with zero net migration.
- Net migration thresholds
  - Preventing the labor force from shrinking would require positive net migration of around 20,000 people per year—levels reached in 2020-23.
  - This is equivalent to yearly net migration of around 0.7 percent of the population.
- Eurostat absolute net migrant numbers (working age population)
  - Baseline cumulative net migration around -20,000 from 2025 to 2030.
  - Low migration scenario around -45,000.
  - High migration scenario around 5,000.
  - No migration scenario: labor force falls by 6.4 percent from 2025 to 2030.
- Potential growth effects
  - Potential growth could be 0.2 percent lower or higher in the upside or downside Eurostat migration scenarios relative to baseline.
  - Sustained migration closer to recent years would increase potential growth strongly.
- Sensitivities
  - A decrease in hours worked back to 2022 levels could reduce potential growth by up to 0.2 percent.
  - Effects on GDP per capita depend on the evolution of TFP; analysis assumes higher migration improves TFP growth.

### Labor productivity, constraints, and reform priorities
- Recent performance
  - Capital deepening remains very low.
  - TFP growth turned negative in recent years after pre-pandemic strength.
- Constraints to investment and innovation
  - Lack of access to credit reported by a large share of non-financial corporations.
  - Total expenditure in R&D remains relatively low for both government spending and private business R&D.
  - Few firms take advantage of available tax incentives for business R&D (OECD, 2025).
  - Only about half of Lithuanians have basic or above basic digital skills.
  - Nearly 80% of firms have low or very low digital intensity.
- Potential benefits of AI
  - AI adoption could enhance TFP growth by between 0.11 percentage points per year (Misch et al., 2025) and 0.29 percentage points per year (Bergeaud, 2024) under baseline scenarios.
  - Policy should balance technological diffusion, job transitions, and measures to mitigate job replacement and inequality risks.
- Structural reform priorities (selected, with stated priorities)
  - Labor Market: Boost ALMPs, life-long learning, apprenticeships, strengthen collaboration with firms when designing activation programs and training — Priority: High.
  - Education: Adapt training and university curriculum to market needs; improve vocational training — Priority: High.
  - Financial Market: Deepen capital markets and facilitate financing for SMEs, boost venture capital — Priority: Medium to high.
  - Innovation and R&D: Consolidate research institutions, simplify access to public R&I support, incentivize business R&I — Priority: Medium to high.
  - Enabling reform: allow more frequent updates of the property register to improve collateral value for loans, especially for SMEs.

*Source: https://www.imf.org/-/media/files/publications/cr/2025/english/1ltuea2025002-source-pdf.pdf*

### 1. Benchmarking Tax Revenues ________________________________________________________ 5

### 1. Benchmarking Tax Revenues

### Motivation and fiscal context
- Lithuania faces a near-term need to boost defense spending, adding to long-term spending pressures related to ageing and green transition.
- Defense spending is expected to increase by an additional 2 percent of GDP relative to previous 2024 projections and would reach 5 percent annually from 2026-30.
- The EU “escape clause” was activated in July 2025 for 15 member states, including Lithuania, allowing for the exemption of up to 1.5 percent of GDP in defense budgets from deficit calculations.
- Mobilizing tax revenues is identified as an essential component of a multi-year fiscal package to ensure fiscal sustainability.

### Government proposals and expected revenue impact (summary of Table 1)
- PIT
  - Current schedule: 20/32 for thresholds of 0-60 (with non-taxable amount) and >60 average wages.
  - Proposal: 20/25/32 for thresholds of 0-36 (with non-taxable amount), 36-60, and >60 average wages; pooling all types of income together (with some exceptions, e.g. dividends); additional tax bracket at 25 percent.
  - Estimated revenue impact: 0.23 percent of GDP (Ministry of Finance estimates; percent of projected 2026 GDP).
- CIT
  - Current rates: 16 percent and 6 percent reduced rate.
  - Proposal: 17 percent rate (also on dividend income) and 7 percent reduced rate; introduction of instant depreciation of certain fixed assets; limitations on deductions of tax losses.
  - Estimated revenue impact: 0.05 percent of GDP.
- Property taxes
  - Current: EUR 150,000 non-taxable threshold and 0.5-2 percent tax rate for non-commercial immovable property owned by individuals (revenues allocated to state budget); other property 0.5-3 percent set by municipalities (allocated to municipal budgets).
  - Proposal:
    - Non-commercial property owned by individuals:
      - (a) primary residence – non-taxable threshold of EUR 450,000 and tax rates ranging from 0.1 to 1 percent set by municipalities (revenues to municipal budgets).
      - (b) other property – EUR 50,000 non-taxable threshold and progressive tax rates ranging from 0.2 to 1 percent set by law (revenues allocated to the State Defense Fund until 2030).
    - Commercial property – additional 0.2 percent tax; revenue allocated to the State Defense Fund.
  - Estimated revenue impact: 0.08 percent of GDP (except from primary residence for which the size of impact will depend on decisions taken by the municipalities).
- VAT
  - Current reduced rates: 5 and 9 percent.
  - Proposal: increase 9 percent rate to 12 percent; lower rate for books to 5 percent; no VAT relief for heating, hot water and firewood.
  - Estimated revenue impact: 0.09 percent of GDP.
- Sugar tax
  - Proposal: excise duty in EUR/hl differentiating by sugar content per 100 ml.
  - Estimated revenue impact: 0.03 percent of GDP.
- Insurance tax
  - Proposal: 10 percent tax for all non-life insurance premia.
  - Estimated revenue impact: 0.12 percent of GDP.
- Total estimated revenue impact of government proposals: 0.6 percent of GDP (Ministry of Finance estimates; percent of projected 2026 GDP).

### Benchmarking tax system and tax potential
- Lithuania’s tax-to-GDP ratio reached 22.3 percent in 2023, up from earlier years but below the EU average of 26.1 percent.
- Tax capacity and gap:
  - Estimated tax capacity (potential): 30.6 percent of GDP.
  - Actual collection: 22.3 percent of GDP.
  - The gap indicates room for revenue mobilization through structural reforms and improved tax administration.
- Composition and characteristics (Table 2 highlights)
  - PIT
    - Revenue: 7.5 (in percent of GDP)
    - Rates: 0/15/20/32 (statutory as reported)
    - Top rate: 32.0 (in percent)
  - CIT
    - Revenue: 2.1 (in percent of GDP)
    - Rate: 16.0 (in percent)
    - Productivity: 14.0 (in percent)
  - VAT
    - Revenue: 8.3 (in percent of GDP)
    - Rate: 21.0 (in percent)
    - C-efficiency: 52.6 (in percent)
  - Property tax
    - Revenue: 0.3 (in percent of GDP)
  - Excise tax
    - Revenue: 3.0 (in percent of GDP)
- Relative position
  - Lithuania collects a lower share of tax revenue relative to GDP compared with EU averages; its structure relies more on VAT and excise duties while property taxes contribute a smaller share compared to other EU nations.
  - Property taxes in Lithuania are substantially lower than EU advanced economies, which collect about four times more.

### Personal Income Tax (PIT) system characteristics and reform scenarios
- Current PIT structure and distributional effects
  - The PIT has a complex marginal rate structure with low progressivity driven by the basic allowance phase-out and varying statutory rates.
  - Two thirds of the population’s income is below 12 average wages (below EUR 20,000) taxed at a marginal tax rate of 30 percent.
  - Only 0.1 percent of the population earns income above 120 average wages subject to the highest tax rate of 32 percent.
  - Lithuania faces some of the highest income inequality relative to comparator countries.
- Government plan (proposal to be implemented Jan 2026)
  - Incomes below 36 average wages: 20 percent rate.
  - Incomes between 36 and 60 average wages: 25 percent rate.
  - Income above 60 average wages: 32 percent rate.
- Scenario-based reform options and revenue implications
  - “Progressive 1” scenario: streamlining the marginal rate schedule, preventing higher marginal tax rates for lower-income earners, and adding more middle-income tax brackets could yield up to 0.5 percent of GDP in additional funds.
  - “Progressive 2” scenario: an even more progressive tax schedule could raise over 1 percent of GDP.
  - A note on distributional trade-offs: removing the phase-out of the basic allowance completely—thus smoothing out marginal rate increases completely—would lower tax revenues by more than 1 percent of GDP.
- Marginal tax rate structures (Table 3 excerpts)
  - Current System brackets (EUR and %):
    - Bracket 1: 0 – 8,964 : 0%
    - Bracket 2: 8,965 – 11,088 : 20%
    - Bracket 3: 11,089 – 26,004 : 30%
    - Bracket 4: 26,005 – 34,371 : 23.6%
    - Bracket 5: 34,372 - 114,162 : 20%
    - Bracket 6: >114,162 : 32%
  - “Government Plan” brackets and rates reflect the Jan 2026 proposal (see above).
  - “Progressive I” and “Progressive II” define alternative phase-out rules and statutory rates, producing implicit marginal rates such as 25, 28 and 30 percent in Progressive I and statutory rates of 20, 28 and 32 percent in Progressive II.
- Analytical tools and caveats
  - PIT scenario outputs are based on the IMF’s Personal Income Tax Analysis (PITA) tool.
  - The Kakwani progressivity index and World Inequality Database (WID) data are referenced; results should be interpreted with caution due to survey limitations and underreporting at the top of the distribution.
  - The PITA tool does not include social security contributions, which could affect tax burden and decisions.

### Key findings and policy directions highlighted in the note
- There is scope to boost revenues through:
  - Improving VAT efficiency (VAT C-efficiency is 52.6 percent, below Estonia’s 67.8 percent).
  - Increasing progressivity of the PIT while protecting lower-income households by smoothing marginal rate spikes driven by the basic allowance phase-out.
  - Raising property tax revenues, particularly on non-primary and commercial property, where current collections are low.
  - Limited additional scope to raise excise taxes given already high excise levels relative to advanced economies.
  - Enhancing CIT revenue productivity through rate adjustments and base measures (including instant depreciation and loss limitation in the government proposal).
- Estimated aggregate revenue from the government’s proposed package: 0.6 percent of GDP (Ministry of Finance estimates; percent of projected 2026 GDP), comprising individual measures with estimated impacts listed above.

*Source: https://www.imf.org/-/media/files/publications/cr/2025/english/1ltuea2025002-source-pdf.pdf*

### 10. Corporate taxes are subject to competitive pressures in an international context, while

### 10. Corporate taxes are subject to competitive pressures in an international context, while

### Corporate Income Tax (CIT)
- CIT rate changes and recent revenue effect:
  - CIT was raised from 15 to 16 percent in January 2025; reduced rate rose from 5 to 6 percent.
  - This is projected to generate an additional 0.04 percent of GDP in tax revenues, based on revenue changes linked to previous CIT hikes and reflecting the lower productivity of the CIT as a revenue source.
  - A recent proposal suggests a further CIT hike of one percentage point, from 16 to 17 percent, which could potentially yield an additional EUR 111.5 million in revenue (when full impact comes into effect, also excluding other CIT related changes), contingent on stable corporate profits and compliance levels.
- International and regional context:
  - Lithuania currently raises more CIT revenue than its Baltic counterparts, which tax only distributed (not retained) profits at a 20 percent rate.
  - Lithuania’s 16 percent rate is characterized as competitive internationally and remains below the 21-22 percent averages in EU advanced economies and Nordic countries like Finland and Sweden.
- Productivity and policy focus:
  - Limited scope to raise substantial revenues through CIT hikes due to Baltic region’s inclination to maintain competitive corporate tax rates.
  - Low CIT productivity in Lithuania raises concerns about economic and political costs of further rate increases.
  - Policy recommendation: focus on addressing exemptions that erode revenue rather than large rate increases.
    - Specific exemption highlighted: EUR 300,000 turnover threshold below which small businesses qualify for the reduced 7 percent rate, creating a steep tax cliff when firms shift from 7 to 17 percent as they grow.
    - Suggested approaches: introduce a graduated rate or lower the EUR 300,000 threshold to capture more firms under the standard rate.

### Property Taxes
- Current structure and revenues:
  - Two property taxes currently in place:
    - Land tax ranges from 0.01 percent to 4 percent of assessed value.
    - Immovable property tax ranges from 0.5 percent to 3 percent for real estate over EUR 150,000 (targeting high-value buildings).
  - Property tax revenues currently equal 0.3 percent of GDP.
  - Municipalities administer property taxes and grant exemptions, producing discretionary decision making at the municipal level and potential local tax competition.
- 2026 tax policy change (partial base broadening) — main features:
  - Distinct provisions for residential and commercial properties.
  - Primary residences:
    - Municipalities set a non-taxable threshold of EUR 450,000.
    - Tax rates would range from 0.1 percent to 1 percent.
    - Revenue directed to municipal budgets.
  - Other properties:
    - EUR 50,000 non-taxable threshold.
    - Progressive tax rates from 0.2 percent to 1 percent set by law.
    - Revenue allocated to the State Defense Fund until the end of 2030.
  - Commercial properties would face an additional 0.2 percent tax, with revenue also allocated to the State Defense Fund.
- Targets and equity design:
  - Reasonable target range for property tax revenues: between 1 and 2 percent of GDP (significantly higher than current 0.3 percent).
  - Equity and administration recommendations:
    - Levy according to the benefits principle (property owners benefit from public goods like infrastructure).
    - Individualized tax relief based on means testing for individual applications.
    - Access to a tax deferral regime that taxes the most vulnerable parts of the population only when assets change ownership, to prevent permanent revenue loss.

### Indirect Taxes — VAT
- Current VAT framework and gaps:
  - Standard VAT rate: 21 percent, with exemptions and reduced rates.
  - Compliance gap improved to 14.6 percent from 24.0 percent in 2018.
  - 2022 policy gap: EUR 3,281 million (33.2 percent of potential revenue), decomposed into:
    - 22.7 percent non-actionable exemption gap,
    - 6.0 percent actionable exemption gap,
    - 4.5 percent rate gap (EUR 446 million), mainly from accommodation, restaurant, and pharmaceutical sectors.
  - Proposed law would raise the reduced rate from 9 percent to 12 percent for essentials like accommodation, transport, and cultural events, aiming to simplify the system and align it with the 21 percent rate, adding EUR 80 million in annual revenue.
- VAT efficiency metrics and revenue potential:
  - VAT C-efficiency in Lithuania: 52.6 percent in 2022.
  - Comparisons:
    - Lower than Latvia and significantly below Estonia, but comparable to European AEs.
  - Improvement scenarios:
    - Improving to European EMs level (55.6 percent) could yield an additional 0.5 percent of GDP in revenue.
    - Improving to the average of Latvia and Estonia (61 percent) would yield an additional 1.3 percent of GDP.
- Policy measures to improve VAT efficiency:
  - Strengthen digitalization:
    - Expand the State Tax Inspectorate’s i.MAS system with real-time e-invoicing and AI analytics (i.MAS launched in 2016).
  - Reduce carousel fraud via regional cooperation and promoting digital payments to shrink the informal economy.
  - Simplify compliance for small businesses:
    - Consider raising the VAT registration threshold (currently set at EUR 45,000) and offering pre-filled returns (as in Estonia).
  - Strengthen oversight of cross-border trade with stricter controls and Baltic collaboration.
  - Target VAT evasion hotspots through sector-specific audits (e.g., agriculture and fuel), and pilot Poland’s split payment model where buyers pay VAT directly to a tax authority account.

### Conclusion and Priorities
- High-level findings:
  - Changes to the PIT, VAT, and property taxes would have sizeable revenue impacts while also producing other economic benefits.
  - Changes to the PIT and property tax systems could mobilize more revenue and make the tax system more progressive, addressing high societal inequality and providing more fiscal autonomy to municipalities.
  - Improving VAT efficiency through digitalization, reducing carousel fraud, and simplifying compliance would increase tax revenues.
  - CIT reform should prioritize addressing exemptions rather than large rate increases.
- Specific staff recommendations (Table 4 summary, revenue impact ranges preserved):
  - PIT (existing schedule: 0/15/20/32):
    - Proposal: Increase progressivity by eliminating the current system of phase-out and lower income brackets.
    - Revenue impact: 0.2 – 1 percent of GDP.
  - CIT (existing rate: 16 percent):
    - Proposal: Limit large CIT rate increases beyond 18 percent, and address exemptions.
    - Revenue impact: 0 – 0.1 percent of GDP.
  - Property revenues (existing: 0.3 percent of GDP):
    - Proposal: Broaden property tax base and limit exemptions. Use means-testing.
    - Revenue impact: 0.5 – 1.5 percent of GDP.
  - VAT (existing rate: 21 percent):
    - Proposal: Increase efficiency through digitalization, improving compliance, reducing carousel fraud.
    - Revenue impact: 0.5 – 1.3 percent of GDP.
- Methodological notes:
  - Revenue impact of PIT reforms estimated using the IMF Personal Income Analysis (PITA) revenue mobilization tool.
  - CIT reforms estimated using government revenue estimates from historical CIT changes.
  - Staff estimates and benchmarking used to assess revenue impact of property tax and VAT reforms.

### (Beginning of) Potential Growth and Migration — key points
- Demographics and labor force:
  - Lithuania faces severe demographic pressures; fertility rate around 1.5 percent since the 1990s.
  - Working-age population fell from 2.34 million in 1998 to 1.81 million in 2019, then rose to 1.89 million in 2024 due to positive net migration.
  - European Commission projects further decreases in the working-age population over coming decades.
- Role of migration:
  - Recent immigrants have been successfully absorbed into the Lithuanian labor market.
  - Legislative amendments enabled easier migration for high-skilled workers despite the reduction of non-EU workers quota in 2025.
  - Immigration can mitigate the impact of aging on the labor force and support potential output growth, conditional on integration and capital adjustment.
- Quantitative modeling approach:
  - The note uses a Cobb-Douglas production function with constant returns to scale to explore migration scenarios’ effects on potential growth through 2030.
  - Labor share is held constant at an average value of 51% (Penn World Tables, 1995–2023).
  - Finding: potential growth could be 0.2 percent lower or higher in a low- or high-migration scenario.

*Source: INTERNATIONAL MONETARY FUND — Republic of Lithuania, chapter excerpts provided in the supplied content.*

### 7.      Potential growth estimates over the scenario horizon rely on several assumptions in

### 7. Potential growth estimates over the scenario horizon rely on several assumptions in line with IMF staff forecasts

### Methodology and core assumptions
- Potential output constructed from a production function with inputs labor, capital, and TFP, using an HP-filter to obtain potential levels for each input.
- Capital accumulation equation used: K_{t+1} = I_t + (1−δ) K_{t−1}.
- TFP (A_t) computed as the Solow residual with growth: ∆log(A_t) = ∆log(Y_t) − α∆log(K_t) − (1−α) ∆log(L_t).
- Forecasts for fixed investment and the unemployment rate are taken from the latest IMF staff forecast.
- Depreciation rate (δ) is held fixed at its average 2015-2023 level (implicitly calculated from the capital accumulation equation).
- Forecasts for the working age population are from Eurostat.
- Labor input defined in hours worked: L_t = WorkingAgePop_t * LaborForceParticipation_t * (1 − UnemploymentRate_t) * AverageHoursWorked_t.
- Labor force participation rate and hours worked are kept constant over the scenario horizon at their 2023 levels.

### Capital, labor, and TFP inputs and projections
- Real capital stock growth is expected to slow from 5.5 percent in 2024 to 4.5 percent in 2030.
- Labor:
  - In the baseline migration scenario, working age population assumed to shrink by 1.1 percent per year.
  - Baseline projections by the European Commission indicate a decrease in Lithuania’s labor force by around 7 percent from 2025 to 2030, around 1.3 percent per year.
  - Assuming constant labor force participation and a slight increase in hours per worker (but below pre-Covid levels), labor will contribute negatively to potential growth at around -0.7 percent in 2030.
- TFP:
  - Historical average TFP growth around 1.6 percent.
  - TFP growth was negative in 2022-2024 due to a large terms of trade shock and labor hoarding.
  - Over the medium-term, TFP growth is assumed to pick up again to close to 1 percent (the historical average over 2012-2024).
- Demographics:
  - Population share aged 60+ increased from 19 percent in 2000 to 28 percent in 2023 and is projected to increase to 31 percent by 2030.

### Scenario analysis — migration and potential growth
- Eurostat migration scenarios for working age population: low (downside), medium (baseline), high (upside).
- Labor force changes across scenarios:
  - Downside migration scenario: labor force shrinking by 1.5 percent per year.
  - Upside migration scenario: labor force shrinking by 1.0 percent per year.
  - The average labor force growth rate in the upside migration scenario is similar to a scenario with zero net migration.
- Net migration and thresholds:
  - Preventing the labor force from shrinking would require positive net migration of around 20,000 people per year—levels reached in 2020-23.
  - This is equivalent to yearly net migration of around 0.7 percent of the population.
- Eurostat absolute net migrant numbers (working age population):
  - Baseline cumulative net migration around -20,000 from 2025 to 2030.
  - Low migration scenario around -45,000.
  - High migration scenario around 5,000.
  - In a no migration scenario, the labor force falls by 6.4 percent from 2025 to 2030.
- Potential growth effects under migration scenarios:
  - Potential growth could be 0.2 percent lower or higher in the upside or downside Eurostat migration scenarios relative to baseline.
  - Sustained migration closer to levels seen in recent years would increase potential growth strongly.
- Sensitivities:
  - A decrease in hours worked back to 2022 levels could reduce potential growth by up to 0.2 percent.
  - Effects on GDP per capita depend on the evolution of TFP; analysis assumes higher migration improves TFP growth.

### Key findings
- Trend in potential growth has been decreasing over time, driven primarily by lower TFP growth; capital contributed most historically, labor a negligible role.
- Capital deepening and TFP weakness explain the slowdown in potential growth, while recent growth was driven largely by labor accumulation.
- Demographic pressures (aging and shrinking working age population) are a significant medium-term drag on potential growth.
- Labor contribution to potential growth is limited even with migration; improving productivity growth is critical to offset labor-related drags.
- Uncertainty surrounding projections is high due to interactions between capital deepening, TFP, and labor dynamics.

### Policy recommendations and implications
- Provide favorable conditions for migration and ensure effective integration into the labor market to stabilize potential growth.
- Address skills mismatch to improve the productivity-enhancing impact of migrants and domestic labor.
- Continue legislative and policy measures to attract high-skilled non-EU workers and allow for non-EU migration of lower-skilled workers where needed to fill vacancies and alleviate skills mismatches.
- Inform and engage the local population about migration benefits, ensure adequate provision of public services, and consider compensating potential losers to maintain social acceptance.
- Deepen understanding of capital intensity and TFP developments and implement structural reforms to unlock their potential; next SIP will examine driving forces and constraints and discuss structural reforms to raise capital accumulation and productivity.

*Source: Excerpt from IMF staff analysis in the Republic of Lithuania chapter (content unit provided).*

### 7.      The contribution of key components of labor productivity growth remains lackluster.

### 7.      The contribution of key components of labor productivity growth remains lackluster.

### Drivers of labor productivity and recent performance
- Capital deepening, a key driver of labor productivity growth, remains very low in Lithuania.
- TFP growth, after displaying strong dynamics during the decade before the pandemic, has turned negative in more recent years.
- Sectoral composition: real gross value added data underpin the assessment of sectoral value added and relative sectoral performance (information & communication, manufacturing, trade/transport/accommodation & food, professional/scientific/technical/administrative & support, etc.).

### Constraints to firm investment and innovation
- Firms face persistent constraints in investment; low capital intensity partly reflects insufficient investment by Lithuanian firms.
- Lack of access to credit is reported by a large share of non-financial corporations.
- Total expenditure in Research and Development (R&D) remains relatively low in Lithuania for both government spending and private business R&D expenditure.
- Few firms take advantage of the available tax incentives for business R&D (OECD, 2025).
- Digital skills limitations: only about half of Lithuanians have basic or above basic digital skills.
- Digital take-up in the business sector is limited: nearly 80% of firms have low or very low digital intensity in Lithuania, despite available performing digital infrastructure.

### The potential benefits of AI
- Lithuania has invested significantly in digitalizing its economy, hosts one of the main Fintech Hubs of Europe, and has adopted a national AI strategy.
- Adoption of AI technologies by firms is relatively limited compared to EU averages.
- Enhancing AI preparedness could generate non-negligible productivity gains in the medium- to long-run.
  - Variants of the simple framework proposed by Acemoglu (2024) and applied by subsequent studies suggest AI adoption could enhance TFP growth in Lithuania by between 0.11 percentage points per year (Misch et al., 2025) and 0.29 percentage points per year (Bergeaud, 2024) under baseline scenarios.
- Policy emphasis should balance facilitating technological diffusion, job transition and AI adoption among firms with measures to mitigate risks of job replacement and deepening inequality.

### Structural reform priorities to unlock productivity growth
- Structural reforms are essential to support a lasting recovery in labor productivity growth and expansion of activity in high-value-added sectors, enabling income convergence.
- Key reform areas and priorities (as summarized in Table 1):
  - Labor Market — Boost ALMPs to address skill mismatches
    - Strengthen ALMPs, including life-long learning and apprenticeships and reskill and retrain especially of older workers, and increase its funding.
    - Strengthen collaboration with firms when designing activation programs, including training.
    - Priority: High
  - Education — Education reform to address skill mismatches
    - Adapt PES-provided training and university curriculum to market needs and strengthen collaboration with firms.
    - Improve vocational training system, university courses targeting to address skills mismatch by producing those jobs the labor market needs.
    - Priority: High
  - Financial Market — Deepening of capital markets and facilitating access to financing for SMEs
    - Capital markets in Lithuania are not well developed, limiting investment and innovation, especially for SMEs.
    - Lithuanian firms tend to remain small and would benefit from facilitated access to financing for innovation (including boosting venture capital to ease financial conditions) targeting young growing firms.
    - Priority: Medium to high
  - Innovation and R&D — Innovation, R&D, and digitalization
    - Consolidating research institutions, simplifying access to public R&I support and incentivizing business R&I investment.
    - Priority: Medium to high
- Additional enabling reform: allow for more frequent updates of the property register to provide a more updated and credible value of collateral for loans, especially important for SMEs.

*Source: Excerpt from IMF country chapter "7. The contribution of key components of labor productivity growth remains lackluster."*

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_Source: https://www.imf.org/-/media/files/publications/cr/2025/english/1ltuea2025002-source-pdf.pdf_