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---

### Overview
- Lithuania raised defense spending from 0.9 percent of GDP in 2010 to 2 percent in 2020 and over 2.5 percent in 2023.
- Cross-party consensus exists to raise defense spending to 3 percent of GDP or more over the medium term, without a concrete agreement on sustainable financing.
- ECB monetary tightening raised short-term interest rates from 0 percent in 2022 to 4.5 percent by end-2023, increasing average government borrowing costs.

### Short-run and Long-term Expenditure Pressures
- Interest payments:
  - Increased from 0.4 percent of GDP in 2022 to 0.7 percent in 2023.
  - Projected to reach about 1.2 percent by 2030.
  - Additional increase in interest payments compared to baseline will amount to 1.3 percent of GDP by 2050.
- Military spending:
  - Additional defense outlays compared to the pre-war period amount to about 1.5 percent of GDP.
  - Lithuania raised defense spending to 2.5 percent of GDP by 2023 and announced plans to increase it to at least 3 percent by 2030.
- Climate-related fiscal cost:
  - Annual fiscal cost of ‘green transition’ in Lithuania is estimated to reach 2.2 percent of GDP by 2050 (EIB model).
- Aggregate long-term spending pressures:
  - Projected to amount to as much as 11.2 percent of GDP on an annual basis by 2050, about 30 percent of current government spending and almost three times the eurozone average.

### Demographics and Labor Force Trends
- Population and aging:
  - Lithuania population shrank from 3.7 million in 1991 to 2.8 million in 2023.
  - Old-age share increased from 18 percent of the working age population in 1991 to over 33 percent in 2023.
- Fertility and median age:
  - Global total fertility rate halved to 2.3 over the past 50 years.
  - Lithuania fertility fell from 2.03 in 1990 to 1.18 in 2023.
  - Median age increased from 31.5 in 1990 to 44 in 2023 (increase of 12.5 years).
- EU projections and dependency:
  - EU baseline projects Lithuania’s old-age dependency ratio will increase to 53.4 percent in 2050 and 67.5 percent by 2070.
  - EU Aging Report projects population will decline by 18.9 percent to 2.3 million in 2050 and by 13.7 percent to 2 million by 2070.
  - Those aged 65 and above will constitute 57.9 percent of the working age population by 2050.
- Workforce and participation:
  - Workforce declined by 20.6 percent from 1.9 million in 1991 to 1.5 million in 2023.
  - By 2050 workforce projected to shrink by 27.7 percent to 1.2 million.
  - Share of prime-age workers (25-54 years) projected to decline to 40.1 percent of total population in 2023 and 33.1 percent by 2050.
  - Share of economically inactive population aged 65+ increases from 38.3 percent of employed population aged 20-64 in 2023 to 68.8 percent by 2050.
  - Labor force participation: 90.3 percent for ages 25-54; 18.7 percent for ages 65-74.

### Fiscal Projections and Debt Dynamics
- Base projection without policy changes:
  - Gross public debt would increase by 36 percentage points of GDP from 35.6 percent in 2023 to 71.5 percent by 2050.
- Long-term spending pressures components (additional annual cost by 2050, Lithuania vs Euro Area):
  - Defense: 1.5 (Lithuania); 0.5 (Euro Area)
  - Interest payments: 1.3 (Lithuania); 0.8 (Euro Area)
  - Climate change: 2.2 (Lithuania); 0.8 (Euro Area)
  - Pension: 5.0 (Lithuania); 1.2 (Euro Area)
  - Healthcare: 1.2 (Lithuania); 1.1 (Euro Area)
  - Total: 11.2 (Lithuania); 4.4 (Euro Area)
- Pension spending:
  - With demographic changes and constant net replacement rate at about 30 percent, pension spending projected to increase by 5 percentage points of GDP from 6.9 percent in 2023 to 11.8 percent by 2050.
- Long-term spending pressures are defined relative to 2023 baseline levels for interest, healthcare, and pensions; pre-war military spending level in 2021; and 2011-2020 average for climate-related spending.

### Pension System Findings and Projections
- Net replacement rate for the pay-as-you-go system:
  - Currently 28.9 percent in Lithuania (lowest in EU).
  - Set to decline to 20 percent by 2050 under current trajectory.
  - If maintained at about 30 percent, demographic shifts still project pension spending rise to 11.8 percent of GDP by 2050.
- Accrued total pension entitlements increased from 217 percent of GDP in 2019 to 275 percent in 2021.
- With declining replacement rate, public pension expenditure projected to remain around 7 percent of GDP amid shrinking and aging population, but demographic-driven pressures can raise spending substantially.
- Structural details:
  - Second pillar: individual accounts funded by an employee contribution of 3 percent of gross salary, with an additional state incentive of 1.5 percent of the national average wage in the previous year.
  - Government’s annual contribution to the second pillar currently amounts to about €300 million (0.4 percent of GDP).
  - Removing the state incentive in the second pillar (about 0.5 percent of GDP) could be feasible if management efficiency is strengthened and early withdrawal is disincentivized.
  - Real returns on private pension accounts could be taxed progressively as an alternative to increasing payroll tax rates.

### Social Security and Pension Policy Scenarios
- Replacement rate scenarios (from the source’s Figure 7 and analysis):
  - Declining replacement rate scenario: replacement rate falls toward 20 percent by 2050.
  - Steady replacement rate scenario: replacement rate maintained near current levels (about 30 percent).
  - Cost of raising replacement rate to ILO-recommended 40 percent by 2050 would increase pension spending by about 7 percentage points of GDP compared to the no policy change scenario where replacement rate declines to 20 percent.
- Distributional and means-testing considerations:
  - Means testing of pensions proposed to align benefits with individual economic status, mitigate fiscal cost, and enhance progressivity.

### Healthcare: Projections, Drivers, and Policy Responses
- System and spending:
  - Single-payer compulsory insurance mainly funded through the National Health Insurance Fund (NHIF); municipalities organize primary and social care.
  - Total health expenditure: 7.8 percent of GDP in 2023 vs. EU average of 9.5 percent.
  - One-third of health spending comes from out-of-pocket payments.
  - Per capita total health expenditure: €1,335 in Lithuania vs. EU average of €3,269.
- Projected public healthcare spending:
  - Modeled formula: HE/GDP = (HE_{0–64} per pop_{0–64} / GDP)_workers * pop_{0–64}/workers * (1 + α * pop_{65}/pop_{0–64})
  - Using UN demographic projections, public healthcare spending projected to increase by 1.2 percentage points from 5.3 percent of GDP in 2023 to 6.5 percent of GDP by 2050.
- Age-related utilization and cost statistics:
  - Persons aged 65 and over account for over 50 percent of total hospitalization days while being about 20 percent of the population.
  - Average length of hospital stay: 8.7 days for patients aged 65+ vs. 6.4 days for the younger cohort.
  - Average cost of a patient with multimorbidity: €378.7 for ages 18-24; €665.1 for ages 55-64; €797.6 for ages 75-84.
- Upside risks to projections:
  - Increased age-specific utilization from greater prevalence of chronic diseases and higher consumption of healthcare with longer life expectancy.
  - Supply-side cost increases from more expensive medical technology, experimental treatments, and higher wage inflation as the workforce shrinks.
- Policy responses recommended:
  - Allocate more resources to preventive care: Lithuania has a preventable and treatable mortality rate of 540 per100,000 vs. EU average of 272 per100,000.
  - Lengthen working lives via healthy aging to raise retirement ages and contribute to labor supply and fiscal revenues.
  - Evaluate cost effectiveness of medical treatments and technology; strengthen competition and cost-containment measures, particularly for pharmaceuticals.

### Education, Labor Market, Immigration, and Efficiency Reforms
- Education:
  - Education spending projected to decline by 0.5 percent of GDP by 2050 due to population aging.
  - Reform objectives: reduce structural unemployment, strengthen work flexibility, enhance adult learning, and address skills mismatch.
- Labor market and older workers:
  - Encourage greater flexibility in work arrangements, including increased part-time work.
  - Introduce education and training policies to reskill the aging workforce.
  - Eliminate taxes and benefits that favor early retirement.
  - Improve infrastructure for greater digitalization and better transportation links.
- Immigration and workforce:
  - Number of foreign workers increased by 56,000 to 142,000 in 2023; the great majority (131,400) nationals outside the EU.
  - Return of Lithuanian workers is gaining momentum and can help stabilize workforce.
  - Net migration projections should not be assumed stable absent active policy measures.
- Efficiency of public spending:
  - Lithuania scores poorly in efficiency of public health expenditure and underperforms in PISA despite high enrollment.
  - Rationalizing the extensive school network and improving healthcare efficiency could deliver better outcomes with less spending.

### Revenue Options and Tax Policy
- Fiscal context:
  - Long-term fiscal pressures from national security, climate change, and population aging amount to over 11 percent of GDP by 2050.
  - Lithuania’s tax-to-GDP ratio in 2022 was 31.6 percent vs. EU average of 40.2 percent.
  - Labor income accounts for over 55 percent of total tax revenue in Lithuania.
- Specific revenue options and estimates:
  - Social security contributions and taxing pensions: limited space to increase contributions; pension income could be taxed at progressively higher marginal rates.
  - Adjusting effective CIT: CIT yields 2.3 percent of GDP vs. EU average of 3.3 percent; room exists by eliminating exemptions and, if necessary, raising the statutory CIT rate.
    - Note: The CIT rate is set to increase from 15 to 16 percent on January 1, 2025.
  - Rationalizing tax expenditures: tax concessions and exemptions (excluding the non-taxable allowance) amount to around 3 percent of GDP; simplifying tax expenditures could generate about 3.2 percent of GDP.
  - Introducing a carbon tax: an economy-wide carbon tax of US$75 per metric ton of CO2 emissions covering sectors excluded in the EU ETS would raise about 1.5 percent of GDP in revenues.
  - Modernizing the property tax regime: property tax revenue currently 0.3 percent of GDP vs. EU average of 2.1 percent; bringing real estate taxes to the EU level could generate about 1.8 percentage points of GDP.

### Fiscal Strategy and Rules (Box 1 summary)
- Legal framework:
  - Fiscal rules established in the Constitutional Law on the Implementation of the Fiscal Treaty (CLIFT) of 2014 and the Republic of Lithuania Law on Fiscal Discipline (LFD) of 2007.
  - CLIFT is a form of structural balance rule with an expenditure correction mechanism and has prominence over the LFD in case of conflict.
- Operational targets and escape clauses:
  - Operational target requirements and medium-term objective provisions (structural budget deficit of 1 percent of GDP if debt < 60 percent of GDP and risks low; not higher than 0.5 percent of GDP otherwise).
  - Expenditure growth limit and five ‘escape clauses’ (including weak economy, strong fiscal position, and no deterioration relative to original budget).
- Rules for other general government units:
  - All general government budgets except the state pension fund must target a structural balance (on accrual basis) or surplus.
  - Pension fund’s structural deficit can deteriorate only when projected output gap is negative.
  - Smaller units (below 0.3 percent of GDP) can exceed revenues by no more than 1.5 percent when output gap is projected negative.
- Policy implications:
  - Preserve non-climate related capital expenditure and systematically consider long-term spending pressures from climate change and population aging in multi-year fiscal strategy.
  - Given ample fiscal space and strong macroeconomic fundamentals, pursue small adjustments over an extended period rather than abrupt, large-scale reforms.
  - A well-balanced strategy entrenched in fiscal rules is needed to credibly ensure long-run fiscal sustainability in the face of national security needs, the ‘green transition’, and adverse demographic transitions.

### Key Policy Recommendations (aggregate)
- Expenditure-side measures:
  - Pursue pension and healthcare reforms to prevent expenditures rising as projected.
  - Implement labor market reforms to reduce structural unemployment, strengthen work flexibility, enhance adult learning, and encourage longer working lives.
  - Consider less-restrictive immigration policies to increase labor supply.
- Revenue-side measures:
  - Rationalize tax concessions and exemptions.
  - Raise effective corporate income tax (CIT) and value-added (VAT) rates where feasible.
  - Introduce an economy-wide carbon tax and increase other environmental taxes.
  - Modernize the property tax regime.
- Fiscal strategy guidance:
  - Use a comprehensive, rule-based policy framework that combines expenditure measures, structural reforms, and revenue changes to credibly safeguard long-term fiscal sustainability.
  - Keep debt financing below the country’s fiscal capacity and sensitive to external macroeconomic circumstances (term structure of real interest rates and long-run growth rates).

*Source: wpiea2024201-print-pdf (IMF).*

### 0.9 percent of GDP in 2010 to 2 percent in 2020 and over 2.5 percent in 2023 (Figure 1). There is

### wpiea2024201-print-pdf - 0.9 percent of GDP in 2010 to 2 percent in 2020 and over 2.5 percent in 2023 (Figure 1). There is

### Overview
- Lithuania raised defense spending from 0.9 percent of GDP in 2010 to 2 percent in 2020 and over 2.5 percent in 2023.
- Cross-party consensus exists to raise defense spending to 3 percent of GDP or more over the medium term, without a concrete agreement on sustainable financing.
- ECB monetary tightening raised short-term interest rates from 0 percent in 2022 to 4.5 percent by end-2023, increasing average government borrowing costs.

### Short-run and Long-term Expenditure Pressures
- Interest payments:
  - Increased from 0.4 percent of GDP in 2022 to 0.7 percent in 2023.
  - Projected to reach about 1.2 percent by 2030.
  - Additional increase in interest payments compared to baseline will amount to 1.3 percent of GDP by 2050.
- Military spending:
  - Additional defense outlays compared to the pre-war period amount to about 1.5 percent of GDP.
  - Lithuania raised defense spending to 2.5 percent of GDP by 2023 and announced plans to increase it to at least 3 percent by 2030.
- Climate-related fiscal cost:
  - Annual fiscal cost of ‘green transition’ in Lithuania is estimated to reach 2.2 percent of GDP by 2050 (EIB model).
- Aggregate long-term spending pressures:
  - Projected to amount to as much as 11.2 percent of GDP on an annual basis by 2050, about 30 percent of current government spending and almost three times the eurozone average.

### Demographics and Labor Force Trends
- Population and aging:
  - Lithuania population shrank from 3.7 million in 1991 to 2.8 million in 2023.
  - Old-age share increased from 18 percent of the working age population in 1991 to over 33 percent in 2023.
- Fertility and median age:
  - Global total fertility rate halved to 2.3 over the past 50 years.
  - Lithuania fertility fell from 2.03 in 1990 to 1.18 in 2023.
  - Median age increased from 31.5 in 1990 to 44 in 2023 (increase of 12.5 years).
- EU projections and dependency:
  - EU baseline projects Lithuania’s old-age dependency ratio will increase to 53.4 percent in 2050 and 67.5 percent by 2070.
  - EU Aging Report projects population will decline by 18.9 percent to 2.3 million in 2050 and by 13.7 percent to 2 million by 2070.
  - Those aged 65 and above will constitute 57.9 percent of the working age population by 2050.
- Workforce and participation:
  - Workforce declined by 20.6 percent from 1.9 million in 1991 to 1.5 million in 2023.
  - By 2050 workforce projected to shrink by 27.7 percent to 1.2 million.
  - Share of prime-age workers (25-54 years) projected to decline to 40.1 percent of total population in 2023 and 33.1 percent by 2050.
  - Share of economically inactive population aged 65+ increases from 38.3 percent of employed population aged 20-64 in 2023 to 68.8 percent by 2050.
  - Labor force participation: 90.3 percent for ages 25-54; 18.7 percent for ages 65-74.

### Fiscal Projections and Debt Dynamics
- Without expenditure/revenue measures, gross public debt would increase by 36 percentage points of GDP from 35.6 percent in 2023 to 71.5 percent by 2050.
- Long-term spending pressures components (Lithuania vs Euro Area, additional annual cost by 2050):
  - Defense: 1.5 (Lithuania); 0.5 (Euro Area)
  - Interest payments: 1.3 (Lithuania); 0.8 (Euro Area)
  - Climate change: 2.2 (Lithuania); 0.8 (Euro Area)
  - Pension: 5.0 (Lithuania); 1.2 (Euro Area)
  - Healthcare: 1.2 (Lithuania); 1.1 (Euro Area)
  - Total: 11.2 (Lithuania); 4.4 (Euro Area)
- With demographic changes and constant net replacement rate at about 30 percent, pension spending projected to increase by 5 percentage points of GDP from 6.9 percent in 2023 to 11.8 percent by 2050.
- Long-term spending pressures are defined relative to 2023 baseline levels for interest, healthcare, and pensions; pre-war military spending level in 2021; and 2011-2020 average for climate-related spending.

### Pension System Findings and Projections
- Net replacement rate for the pay-as-you-go system:
  - Currently 28.9 percent in Lithuania (lowest in EU).
  - Set to decline to 20 percent by 2050 under current trajectory.
  - If maintained at about 30 percent, demographic shifts still project pension spending rise to 11.8 percent of GDP by 2050.
- Accrued total pension entitlements increased from 217 percent of GDP in 2019 to 275 percent in 2021.
- With declining replacement rate, public pension expenditure projected to remain around 7 percent of GDP amid shrinking and aging population, but demographic-driven pressures can raise spending substantially.
- Formula for public pension expenditure as share of GDP is presented explicitly in the source text (preserving technical structure).

### Policy Recommendations and Reform Options
- Expenditure-side measures:
  - Pursue pension and healthcare reforms to prevent expenditures rising as projected.
  - Labor market reforms to reduce structural unemployment, strengthen work flexibility, enhance adult learning, and encourage longer working lives to increase average effective retirement ages.
  - Consider less-restrictive immigration policies to increase labor supply.
- Revenue-side measures (designed to mobilize additional revenue in a growth-friendly and inclusive manner):
  - Rationalize tax concessions and exemptions.
  - Raise effective corporate income tax (CIT) and value-added (VAT) rates.
  - Introduce an economy-wide carbon tax and increase other environmental taxes.
  - Modernize the property tax regime.
- Fiscal strategy guidance:
  - Use a comprehensive, rule-based policy framework that brings expenditure measures, structural reforms, and revenue changes together to credibly safeguard long-term fiscal sustainability.
  - Keep debt financing below the country’s fiscal capacity and sensitive to external macroeconomic circumstances (term structure of real interest rates and long-run growth rates).

*Source: https://www.imf.org/-/media/files/publications/wp/2024/english/wpiea2024201-print-pdf.pdf*

### 2.1 in Europe and elsewhere appear to have had no significant impact (Thevenon, 2011; Cohen,

### 2.1 in Europe and elsewhere appear to have had no significant impact (Thevenon, 2011; Cohen, Dehejia, and Romanov, 2013; Sobotka, Matysiak, and Brzozowska, 2019; Doepke et al., 2023; Zhang et al., 2023)

### Social security reforms: overview and rationale
- A new round of social security reforms should be considered to address macro-fiscal challenges in Lithuania’s fast-aging society.
- The statutory retirement age is set to gradually increase to 65 years for both men and women by 2026.
- Linking the statutory retirement age to longevity is recommended to have a significant effect on pension spending as a share of GDP and to help maintain actuarial balance over the long run.

### Pensions: benefit adjustments and distributional design
- Current replacement rate for the pay-as-you-go system in Lithuania is about 30 percent.
- The ILO recommends a minimum replacement rate of 40 percent.
- The cost of raising the replacement rate to 40 percent by 2050 would increase pension spending by about 7 percentage points of GDP compared to a no policy change scenario in which the replacement rate is set to decline to 20 percent.
- Means testing of pensions is proposed to align benefits with individual economic status, mitigate fiscal cost, and enhance progressivity (Kudrna, Tran, and Woodland, 2022).
- Figure 7 (Public Pension Spending) presents scenarios:
  - with declining replacement rate
  - with steady replacement rate
- Pillar structure and private incentives:
  - Second pillar currently: individual accounts funded by an employee contribution of 3 percent of gross salary, with an additional state incentive of 1.5 percent of the national average wage in the previous year, which could be gradually replaced by the employer’s contribution.
  - Third pillar is funded completely by private savings with no limit on amount and frequency of contributions.
  - Removing the state incentive in the second pillar (about 0.5 percent of GDP) could be feasible if management efficiency is strengthened and early withdrawal is disincentivized.
  - The government’s annual contribution to the second pillar currently amounts to about €300 million (0.4 percent of GDP).
- Real returns on private pension accounts could be taxed progressively, as an alternative to increasing payroll tax rates.

### Revenues and payroll tax considerations
- Raising the rate of pension contributions or the upper limit of income subject to payroll tax could increase revenues but may negatively impact labor force participation (Gruber and Wise, 2002; Liebman, Luttner, and Seif, 2008; Breda, Haywood, and Wang, 2022).
- The tax on labor income is already high in Lithuania; increasing payroll contributions further may hinder employment growth.
- Taxing pension income at progressively higher marginal rates is suggested as a revenue option that may be less distortionary.

### Healthcare reform: system, projections, and drivers of cost
- Lithuania’s health system: single-payer compulsory insurance mainly funded through the National Health Insurance Fund (NHIF), with municipalities organizing primary and social care.
- Total health expenditure in Lithuania was 7.8 percent of GDP in 2023, compared to an average of 9.5 percent in the EU.
- One-third of health spending comes from out-of-pocket payments, primarily for prescribed and over-the-counter pharmaceuticals except for eligible groups (children, elderly, disabled and patients with certain diseases including cancer, tuberculosis and some chronic diseases).
- On a per capita basis, total health expenditure in Lithuania amounts to €1,335, less than half of the EU average of €3,269.
- Public healthcare expenditure as a share of GDP is modeled as:
  HE/GDP = (HE_{0–64} per pop_{0–64} / GDP)_workers * pop_{0–64}/workers * (1 + α * pop_{65}/pop_{0–64})
- Using UN demographic projections, public healthcare spending in Lithuania is projected to increase by 1.2 percentage points from 5.3 percent of GDP in 2023 to 6.5 percent of GDP by 2050.
- Age-related utilization and costs:
  - Persons aged 65 and over account for over 50 percent of total hospitalization days while being about 20 percent of the population.
  - Average length of hospital stay: 8.7 days for patients aged 65+ vs. 6.4 days for the younger cohort.
  - Average cost of a patient with multimorbidity increases with age: €378.7 for ages 18-24; €665.1 for ages 55-64; €797.6 for ages 75-84 (Nedzinskiene et al., 2021).
- Upside risks to healthcare cost projections:
  - Increased age-specific utilization from greater prevalence of chronic diseases and higher consumption of healthcare with longer life expectancy.
  - Supply-side cost increases from more expensive medical technology, experimental treatments, and higher wage inflation as the workforce shrinks.

### Healthcare policy responses
- Allocate more resources to preventive care: Lithuania has a preventable and treatable mortality rate of 540 per100,000 vs. EU average of 272 per100,000.
- Lengthen working lives via healthy aging to raise retirement ages, add to economic growth, attenuate skill shortages, limit pension spending, and contribute to tax revenue (working longer can maintain cognitive function and lower risk of dementia).
- Evaluate cost effectiveness of medical treatments and technology; strengthen competition and cost-containment measures, particularly for pharmaceuticals.

### Education and labor market reforms
- Education spending is projected to decline by 0.5 percent of GDP by 2050 due to population aging, but reforms remain necessary.
- Key objectives:
  - Address structural unemployment.
  - Strengthen flexibility of work arrangements and human capital through adult learning.
  - Encourage longer working lives by removing barriers and disincentives to working longer.
- Tapping potential of older workers:
  - Encourage greater flexibility in work arrangements, including increased part-time work.
  - Introduce education and training policies to reskill the aging workforce.
  - Eliminate taxes and benefits that favor early retirement.
  - Improve infrastructure for greater digitalization and better transportation links.
- Immigration to enlarge the workforce:
  - Number of foreign workers increased by 56,000 to 142,000 in 2023, the great majority (131,400) nationals outside the EU.
  - Return of Lithuanian workers is gaining momentum and can help stabilize workforce.
  - Net migration projections should not be assumed stable absent active policy measures.

### Expenditure reforms for greater efficiency
- Lithuania has scope to strengthen efficiency in government spending; the Expenditure Assessment Tool (EAT) benchmarks spending and outcomes against comparators.
- Education efficiency:
  - Lithuania stands at the lower end of EU countries in PISA performance despite high enrollment.
  - Rationalizing the extensive school network could provide savings and support curriculum modernization to address skills mismatch.
- Healthcare efficiency:
  - Lithuania scores poorly in efficiency of public health expenditure and has lower healthy life expectancy than EU average.
  - Bringing the healthcare system up to EU efficiency could achieve similar outcomes with less spending via preventive care and reduced costs for pharmaceuticals and hospitals.

### Potential sources of additional revenue
- Long-term fiscal pressures from national security, climate change, and population aging amount to over 11 percent of GDP by 2050.
- Lithuania’s tax-to-GDP ratio in 2022 was 31.6 percent vs. EU average of 40.2 percent.
- Labor income accounts for over 55 percent of total tax revenue in Lithuania.
- Population aging will reduce personal income tax (PIT) and social security contributions; consumption-related taxes fall less steeply.
- Policy options identified:
  - Increasing social security contributions and/or taxing pensions: limited space to increase contributions, but pension income could be taxed at progressively higher marginal rates.
  - Adjusting the effective CIT rate: CIT yields 2.3 percent of GDP in revenues vs. EU average of 3.3 percent; room exists by eliminating exemptions and, if necessary, raising the statutory CIT rate.
    - Note: The CIT rate is set to increase from 15 to 16 percent on January 1, 2025.
  - Rationalizing tax expenditures: tax concessions and exemptions (excluding the non-taxable allowance) amount to around 3 percent of GDP; simplifying tax expenditures could generate about 3.2 percent of GDP.
  - Introducing a carbon tax: an economy-wide carbon tax of US$75 per metric ton of CO2 emissions covering sectors excluded in the EU ETS would raise about 1.5 percent of GDP in revenues and contribute to climate change mitigation (Cevik, 2024).
  - Modernizing the property tax regime: property tax revenue currently 0.3 percent of GDP vs. EU average of 2.1 percent; bringing real estate taxes to the EU level could generate about 1.8 percentage points of GDP.

### Realigning fiscal targets and strategic considerations
- Lithuania follows a rule-based fiscal framework targeting a structural balance or surplus of the general government, with an expenditure correction mechanism and a debt anchor imposed by the EU framework.
- The deficit cannot exceed the medium-term objective (currently set at -1 percent of GDP) when the output gap is negative.
- Structural fiscal position in 2015-19 was a structural surplus of around 0.5 percent of potential GDP.
- Given low debt and deficits, the structural fiscal target can be set at the present level consistent with steady state public debt around 36 percent of GDP, providing space to support the economy during downturns and facilitate structural reforms without breaching the 3 percent deficit limit under the EU framework.
- Fiscal strategy recommendations:
  - Preserve non-climate related capital expenditure.
  - Systematically consider long-term spending pressures from climate change and population aging in multi-year fiscal strategy.
  - Note past public investment was below 3 percent per year in the five years prior to COVID-19, resulting in no growth in capital stock and an infrastructure gap.
  - Risk: discretionary spending is already low and could crowd out modest capital spending; near-term risk is small given large EU funding, but EU financial support may decline over the long run as Lithuania converges toward average EU income levels.

*Source: wpiea2024201-print-pdf*

### Box 1. Lithuania’s Fiscal Rules

### Box 1. Lithuania’s Fiscal Rules

### Overview
- Fiscal rules are established in the Constitutional Law on the Implementation of the Fiscal Treaty (CLIFT) of 2014 and the Republic of Lithuania Law on Fiscal Discipline (LFD) of 2007.
- The CLIFT has prominence over the LFD in case of conflict and is best described as a form of structural balance rule with an expenditure correction mechanism.
- Fiscal anchors include a (structural) balance target in the form of a medium-term objective and a debt anchor imposed by the EU framework.

### Operational target and structural balance provisions
- Operational target: Each year, except in exceptional circumstances (an event outside the control of the authorities or a severe economic downturn), at least one of the following conditions must be met:
  - The structural budget balance of the general government is in surplus.
  - If not in surplus (and below the medium-term objective), it should be improving except when the output gap is negative.
  - When the output gap is negative, the structural budget deficit can remain below the medium-term objective, which is:
    - a structural budget deficit of 1 percent of GDP if debt is less than 60 percent of GDP and the risks to debt sustainability are low, and
    - not higher than 0.5 percent of GDP otherwise.
  - If the structural budget balance is worse than the medium-term objective, the targeted improvement should be met. The structural adjustment target is set if:
    - (i) the deficit (actual or planned) reaches 3 percent of GDP; or
    - (ii) the structural budget deficit is worse than the medium-term objective.
  - The adjustment target is set so that the medium-term objective is reached within two-to-four years, depending on whether the deviation from the medium-term objective is smaller or bigger than 2 percentage points of GDP.

### Expenditure growth limit and escape clauses
- Expenditure growth limit: If the average general government balance in the previous five years is negative, budget appropriations should grow by less than half of the average growth of potential GDP during the same period.
- The Law specifies five ‘escape clauses’ under which the expenditure rule would not apply, including:
  - Weak economy and weaker economy relative to the EU: The projected output gap for the budget year is negative or Lithuania’s nominal GDP growth is less than the average 5-year GDP growth in the EU plus 2 percentage points.
  - Strong fiscal position: The average general government balance during the last [4 years and the projection for the current year] is in surplus of at least 0.1 percent of GDP.
  - No deterioration relative to the original budget: In case of budget revisions, the balance of the revised budgets is not worse than the original one and if the improvement in the planned nominal general government balance is higher than 1 percentage points of GDP.

### Rules for other parts of the general government
- All general government budgets except the state pension fund (and smaller units) must be planned, approved, amended, and implemented targeting a structural balance (on accrual basis) or surplus.
- The pension fund’s structural deficit can deteriorate only when the projected output gap is negative.
- For smaller general government units (below 0.3 percent of GDP), expenditures can only exceed revenues (by no more than 1.5 percent) when the output gap is projected to be negative.

### Key long-term fiscal challenges and projections
- Demographic trends:
  - Lithuania’s population declined by almost 25 percent from 3.7 million in 1991 to 2.8 million in 2023.
  - Over the next two and half decades, these demographic shifts are projected to lower population by about 20 percent to 2.3 million, increase the median age of the population over 48, and increase the share of those aged 65 and above to 58 percent of the working age population.
- Long-term fiscal pressure and debt projections:
  - Long-term spending pressures in Lithuania are projected to amount to as much as 11.2 percent of GDP on an annual basis by 2050, which is about 30 percent of the current level of government spending and almost three times the eurozone average.
  - Absent expenditure and revenue measures, gross public debt would increase by 36 percentage points of GDP from 35.6 percent in 2023 to 71.5 percent by 2050.
- Macroeconomic and structural risks:
  - The projected increase in current expenditures including age-related spending will likely cause a contraction in capital spending and undermine productivity growth over the long run.
  - A shrinking and aging labor force could limit innovation and productivity growth, increase labor costs and reduce international competitiveness, while shifting the fiscal burden to a smaller workforce.

### Policy implications and recommendations
- Address long-run repercussions through a comprehensive strategy of structural reforms and policy changes to:
  - reduce the fiscal burden of pensions and healthcare;
  - enhance revenue mobilization;
  - draw on the potential of older workers;
  - increase immigration to enlarge the workforce.
- Given ample fiscal space and strong macroeconomic fundamentals, Lithuania can pursue small adjustments over an extended period rather than a “big bang” approach that could be distortionary and politically contentious.
- A well-balanced strategy entrenched in fiscal rules is needed to credibly ensure long-run fiscal sustainability in the face of national security needs, the ‘green transition’, and adverse demographic transitions.

*Source: Box 1. Lithuania’s Fiscal Rules, wpiea2024201-print-pdf (IMF).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2024/english/wpiea2024201-print-pdf.pdf_