## 1. Level of Taxation in Europe, 2010

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### Overview of Lithuania’s fiscal adjustment (2009–12)
- Fiscal measures implemented: some 17 percent of GDP during 2009–12, about half frontloaded in 2009.
- Fiscal deficit: peak of 9.4 percent of GDP in 2009; estimated 3.2 percent of GDP in 2012.
- Public debt: around 40.7 percent of GDP as of end-2012, up from 15.5 percent of GDP at the end of 2008.
- Staff estimate of further adjustment needed: about 2 percent of GDP to meet authorities’ medium-term objective of a small structural deficit.
- Long-term pressure from population aging: expected to add 6 percent of GDP to public expenditures by 2060 (compared to 3 percent for Latvia and 0 percent for Estonia).
- Rationale for further adjustment: rebuild fiscal buffers under the currency board arrangement (CBA) so countercyclical fiscal policy can be used in future downturns.

### Composition and quality of consolidation measures (2009–2012)
- Overall role of expenditure vs. revenue:
  - Expenditure cuts accounted for around 70 percent of the total adjustment.
- Structure of expenditure-based measures in Lithuania (percent of measures; percent of GDP in parentheses):
  - Across the board cut: 9 pct. (1.1)
  - Current expenditure: wages: 24 pct. (3.02)
  - Current expenditure: non-wages: 24 pct. (3.04)
  - Social benefits: 26 pct. (3.34)
  - Subsidies: 4 pct. (0.5)
  - Capital expenditure: 13 pct. (1.63)
- Structure of revenue-based measures in Lithuania (percent of measures; percent of GDP in parentheses):
  - Labor tax: 12 pct. (0.53)
  - Other direct tax: property tax: 0 pct. (0.02)
  - Indirect tax: VAT: 22 pct. (0.92)
  - Indirect tax: excises: 20 pct. (0.87)
  - Other revenue: 34 pct. (1.44)
- Revenue-side specifics:
  - Around 0.8 percent of GDP in revenue increase from labor tax measures came from temporary reduction in the rate of social contribution transfers to Pillar II private pension funds: from 5.5 percent to 3 percent in 2009, further to 2 percent and 1.5 percent in 2010 and 2012, respectively.
- Quality over time:
  - Measures classified into permanent, semi-permanent, temporary, and deficit-postponing.
  - Less than one third of measures since 2009 were permanent and about one fifth merely postponed deficits into the future.

### Cross-country perspective on public sector size and adjustment
- Lithuania’s public sector in 2011:
  - One of the smallest in the EU: general government revenue and expenditure among lowest in EU.
- Overall tax burden:
  - Lithuania: around 27 percent of GDP (total taxes 27.2 percent of GDP).
  - Difference versus peers:
    - 11 percentage points of GDP lower than the EU average.
    - 5 percentage points of GDP lower than CEE peers.
- Drivers of the lower overall tax burden:
  - Lower taxation of capital and wealth:
    - Taxes on capital: Euro area 7.8; European Union 7.6; CEE 4.7; Lithuania 2.3 (percent of GDP).
    - Stock of capital (wealth) taxation: Euro area 2.3; European Union 2.5; CEE 1.2; Lithuania 0.7 (percent of GDP).
  - Specifics on property and wealth taxation:
    - Lithuania collected only 0.37 percent of GDP in property and land taxes in 2010.
    - Lithuania introduced property taxation on residential properties starting in 2012, but only residential properties with a value of over one million litas are taxed at a rate of one percent. The revenue from residential property tax in 2012 is estimated to have been about 0.02 percent of GDP.
    - Motor vehicles and net wealth are not taxed.
  - Lower direct taxes on labor:
    - Taxes on labor: Euro area 38.1; European Union 36.0; CEE 35.0; Lithuania 31.7 (percent of GDP).
    - Low and flat PIT statutory rate in Lithuania: 15 percent.
  - Consumption taxes:
    - Consumption taxes: Euro area 19.2; European Union 19.7; CEE 21.5; Lithuania 18.2 (percent of GDP).
    - VAT productivity low; tax administration weaknesses and compliance costs estimated at 2 percent of GDP.
    - Closing half of the VAT compliance gap would yield up to ¾ percent of GDP over the medium term.
    - Smuggling and cross-border shopping have reduced excise revenue.

### Implicit vs. statutory tax rates and tax productivity (2010)
- Implicit tax rates (percent of potential taxable base captured):
  - Capital and business income: CEE 14.5; Lithuania 6.8.
  - Corporations (implicit): Lithuania 4.9.
  - Consumption implicit: Lithuania 18.2.
  - Labor implicit: Lithuania 31.7.
- Statutory tax rates (standard rates used in comparison):
  - Corporations: Lithuania 15.0.
  - Consumption (VAT standard rate): Lithuania 21.0.
  - Labor (combined statutory measure used): Lithuania 55.0.
- Productivity of taxes (implicit/statutory ratios):
  - Corporations: Lithuania ratio about 0.33 (implicit 4.9 vs statutory 15.0).
  - Consumption ratio: Lithuania 0.87.
  - Labor ratio: Lithuania 0.58.
- Interpretation:
  - Gaps between implicit and statutory rates reflect generous allowances, exemptions, preferential rates, loopholes, and compliance gaps.
  - Lithuania’s implicit tax rates are below averages of both the EU and regional peers for corporate income, consumption, and labor taxes.

### Tax effort and unused tax capacity
- Lithuania’s tax effort in 2011 was 60.8, well below the average of 77.1 for its CEE peers, indicating relatively large potential to increase tax revenue to full capacity.
- Lithuania’s tax structure (Percent, 2010):
  - Consumption taxes: 42 percent (Lithuania) vs. 29 percent (EU average).
  - Taxes on labor: 49 percent (Lithuania) vs. 51 percent (EU average).
  - Taxes on capital and wealth: 9 percent (Lithuania) vs. 20 percent (EU average).
  - Within taxes on capital in Lithuania: on capital and business income: 6 percent; on stock of capital (wealth): 3 percent.
- Unused tax capacity can reflect either a deliberate low provision of public goods/services or inefficiencies in tax collection/administration.

### Progressivity, redistribution, and social protection
- Progressivity and the role of taxes in redistribution:
  - Lithuania’s tax system exhibits relatively limited progressivity, especially toward the high end of the income distribution.
  - Contributing features:
    - PIT: tax exempt thresholds for low income earners and a uniform flat tax of 15 percent for others, multiple allowances and exemptions that favor high income taxpayers, non-taxation of interest income and certain capital gains.
    - Social security contributions: uniform uncapped proportion of the wage; benefits are capped, imparting progressivity to the overall security system but reportedly creating compliance problems of under-reporting wages.
    - Consumption taxes: limited progressivity by design.
    - Limited taxation of wealth and capital reinforces limited overall progressivity.
  - Measured impacts:
    - Social benefits helped reduce the Gini coefficient by about 50 percent in 2010.
    - The tax system reduced the Gini coefficient by only 8 percent in 2010.
    - The relative redistributive role of taxes declined since 2006, possibly due to deterioration in tax compliance after the crisis and/or expansion of the informal economy.
- Poverty and social transfers:
  - The social benefits system protected the most vulnerable during the crisis: the at-risk-of-poverty rate before social transfers increased as a result of the crisis, but the at-risk-of-poverty rate after social transfers remained broadly at pre-crisis levels.
  - Lithuania’s at-risk-of-poverty rate after social transfers remains above that of most other regional peers.
  - At-risk-of-poverty definition: share of people with an equivalised disposable income (after social transfers) below 60 % of the national median equivalised disposable income after social transfers.
  - Gini coefficients: based on household equivalized income data with equivalence weights: first household member weight = 1; each subsequent adult = 0.5; each child under 14 = 0.3.

### Policy implications and recommended revenue measures
- Rationale for shifting consolidation focus to revenue:
  - Most consolidation to date has taken place on the expenditure side.
  - Lithuania’s revenue-to-GDP ratio and level of taxation are low compared with the EU average and regional peers.
  - The tax system exhibits limited progressivity, especially toward higher incomes.
- Design principles for revenue measures:
  - Limit economic distortions and enhance progressivity.
  - Provide a stable source of revenue (favor broad-based, permanent measures over temporary ones).
  - Strengthen tax administration to ensure collection and compliance.
- Specific high-quality revenue measures and estimated yields:
  - Expanding wealth taxes:
    - Wealth taxes in Lithuania are about one quarter of the EU average and one half of the CEE regional average.
    - Raising wealth taxation to the CEE average could generate 0.8 percentage points of GDP in additional revenue.
    - Options and estimated yields:
      - Expanding immovable property taxation to include all residential properties could generate about 0.4 percent of GDP in additional revenue; broadening the residential property tax base by lowering the tax-free threshold could double revenue from property taxation.
      - Introducing annual motor vehicle taxes (license/registration fee) related to engine capacity (or weight) could generate about 0.4 percent of GDP in revenue.
  - Broadening tax bases by removing exemptions and closing loopholes:
    - Personal income tax (PIT) base:
      - Eliminating tax exemptions on interest income could generate 0.1 percent of GDP in revenue.
      - Restricting the exemption from capital gains tax on housing to only the sale of primary residences and subjecting all short-term gains on financial assets to a withholding tax at a rate of 15 percent can help generate additional revenue.
      - Subjecting all pension payments to income tax (moving away from an “EEE-based” pension and annuity regime) could generate about 0.5 percent of GDP in revenue.
    - Corporate income tax (CIT) base:
      - Broadening the CIT base could generate about 0.5 percent of GDP in additional revenue.
      - Specific measures include: (i) consolidating reduced/preferential CIT rates on small companies; (ii) expanding CIT to include realized gains on security transactions; (iii) removing CIT exemptions/preferential rates on investment incentives and tax holiday schemes in free economic zones.
      - Current preferential small company rule: a 5 percent rate (instead of 15 percent statutory rate) is applied to small companies defined as companies with: (i) less than 10 employees, or (ii) generating less than LTL 1 million in taxable revenue during tax period. The reduced rate was much higher (13 percent) before 2010 and could be restored to generate additional revenues.
- Tax administration:
  - Strengthening tax administration is essential to ensure revenue measures translate into revenue and to boost tax compliance.
  - There is anecdotal evidence of a large and pro-cyclical shadow economy in Lithuania; stronger tax compliance would help maximize gains from revenue-raising reforms.
- VAT and compliance:
  - VAT compliance costs estimated at 2 percent of GDP.
  - Closing half the VAT compliance gap could yield up to ¾ percent of GDP.

### Conclusions
- Lithuania has undertaken significant fiscal adjustment, largely on the expenditure side, but further efforts are needed to complete the adjustment.
- Lithuania’s revenue-to-GDP ratio is the lowest in the EU; the tax system relies heavily on labor and consumption taxes with very little taxation on capital and wealth.
- The tax system plays a limited role in income redistribution, particularly at the higher end of the income distribution.
- It is appropriate to shift future consolidation efforts toward high-quality revenue measures that:
  - Can generate considerable and relatively-stable revenue.
  - Can enhance progressivity at the higher end of the income distribution.
  - Would minimize adverse impacts on growth and competitiveness, given Lithuania’s ample scope to enhance revenue performance.
- Continued strengthening of tax administration is essential to realize revenue potential and improve compliance.

*Source: _wp13157 - 1. Level of Taxation in Europe, 2010.*

### 1. Level of Taxation in Europe, 2010 ................................................................................8

### 1. Level of Taxation in Europe, 2010

### Overview of Lithuania’s fiscal adjustment (2009–12)
- Fiscal measures implemented: some 17 percent of GDP during 2009–12, about half frontloaded in 2009.
- Fiscal deficit: peak of 9.4 percent of GDP in 2009; estimated 3.2 percent of GDP in 2012.
- Public debt: around 40.7 percent of GDP as of end-2012, up from 15.5 percent of GDP at the end of 2008.
- Staff estimate of further adjustment needed: about 2 percent of GDP to meet authorities’ medium-term objective of a small structural deficit.
- Long-term pressure from population aging: expected to add 6 percent of GDP to public expenditures by 2060 (compared to 3 percent for Latvia and 0 percent for Estonia).
- Rationale for further adjustment: rebuild fiscal buffers under the currency board arrangement (CBA) so countercyclical fiscal policy can be used in future downturns.

### Composition and quality of consolidation measures
- Overall role of expenditure vs. revenue:
  - Expenditure cuts accounted for around 70 percent of the total adjustment.
- Structure of expenditure-based measures in Lithuania (2009–2012) (percent of measures; percent of GDP in parentheses):
  - Across the board cut: 9 pct. (1.1)
  - Current expenditure: wages: 24 pct. (3.02)
  - Current expenditure: non-wages: 24 pct. (3.04)
  - Social benefits: 26 pct. (3.34)
  - Subsidies: 4 pct. (0.5)
  - Capital expenditure: 13 pct. (1.63)
- Structure of revenue-based measures in Lithuania (2009–2012) (percent of measures; percent of GDP in parentheses):
  - Labor tax: 12 pct. (0.53)
  - Other direct tax: property tax: 0 pct. (0.02)
  - Indirect tax: VAT: 22 pct. (0.92)
  - Indirect tax: excises: 20 pct. (0.87)
  - Other revenue: 34 pct. (1.44)
- Revenue-side specifics:
  - Around 0.8 percent of GDP in revenue increase from labor tax measures came from temporary reduction in the rate of social contribution transfers to Pillar II private pension funds: from 5.5 percent to 3 percent in 2009, further to 2 percent and 1.5 percent in 2010 and 2012, respectively.
- Quality over time:
  - Measures classified into permanent, semi-permanent, temporary, and deficit-postponing.
  - Less than one third of measures since 2009 were permanent and about one fifth merely postponed deficits into the future.

### Cross-country perspective on public sector size and adjustment
- Lithuania’s public sector in 2011:
  - One of the smallest in the EU: general government revenue and expenditure among lowest in EU (figures presented in Figures 6 & 7).
- Overall tax burden:
  - Lithuania: around 27 percent of GDP (total taxes 27.2 percent of GDP in Table 1).
  - Difference versus peers:
    - 11 percentage points of GDP lower than the EU average.
    - 5 percentage points of GDP lower than CEE peers.
- Drivers of the lower overall tax burden:
  - Lower taxation of capital and wealth:
    - Taxes on capital: Euro area 7.8; European Union 7.6; CEE 4.7; Lithuania 2.3 (percent of GDP).
    - Stock of capital (wealth) taxation: Euro area 2.3; European Union 2.5; CEE 1.2; Lithuania 0.7 (percent of GDP).
  - Specifics on property and wealth taxation:
    - Lithuania collected only 0.37 percent of GDP in property and land taxes in 2010.
    - Lithuania introduced property taxation on residential properties starting in 2012, but only residential properties with a value of over one million litas are taxed at a rate of one percent. The revenue from residential property tax in 2012 is estimated to have been about 0.02 percent of GDP.
    - Motor vehicles and net wealth are not taxed.
  - Lower direct taxes on labor:
    - Taxes on labor: Euro area 38.1; European Union 36.0; CEE 35.0; Lithuania 31.7 (percent of GDP).
    - Low and flat PIT statutory rate in Lithuania: 15 percent.
  - Consumption taxes:
    - Consumption taxes: Euro area 19.2; European Union 19.7; CEE 21.5; Lithuania 18.2 (percent of GDP).
    - VAT productivity low; tax administration weaknesses and compliance costs estimated at 2 percent of GDP.
    - Closing half of the VAT compliance gap would yield up to ¾ percent of GDP over the medium term.
    - Smuggling and cross-border shopping have reduced excise revenue.

### Implicit vs. statutory tax rates and tax productivity (2010)
- Implicit tax rates (percent of potential taxable base captured):
  - Capital and business income: Euro area 27.5; European Union ...; CEE 14.5; Lithuania 6.8 (Table 3 structure indicates categories).
  - Corporations (implicit): 4.9 (Lithuania) compared with higher implicit averages in EU/CEE.
  - Consumption implicit: 18.2 (Lithuania).
  - Labor implicit: 31.7 (Lithuania).
- Statutory tax rates (standard rates used in comparison):
  - Corporations: 15.0 (Lithuania statutory rate).
  - Consumption (VAT standard rate): 21.0 (Lithuania statutory VAT in table context).
  - Labor (combined statutory measure used): 55.0 (Lithuania statutory labor benchmark in table context).
- Productivity of taxes (implicit/statutory ratios):
  - Corporations: Lithuania ratio about 0.33 (implicit 4.9 vs statutory 15.0).
  - Consumption ratio: Lithuania 0.87.
  - Labor ratio: Lithuania 0.58.
- Interpretation:
  - Large gaps between implicit and statutory rates reflect generous allowances, exemptions, preferential rates, loopholes, and compliance gaps.
  - Lithuania’s implicit tax rates are below averages of both the EU and regional peers for corporate income, consumption, and labor taxes.

### Tax effort and unused tax capacity
- Lithuania’s tax effort is low compared with CEE peers (Figure 8).
- Unused tax (difference between tax capacity and actual revenue) can reflect either a deliberate low provision of public goods/services or inefficiencies in tax collection/administration.

### Policy implications and directions suggested by the analysis
- Shift consolidation focus from expenditure to revenue, given:
  - Lithuania’s revenue-to-GDP ratio is low compared with EU peers (lowest in the EU in 2011).
  - Expenditure-based consolidation so far relied heavily on cuts with deteriorating quality over time.
- Design revenue measures to:
  - Limit economic distortions and enhance progressivity.
  - Provide a stable source of revenue (favor broad-based, permanent measures over temporary ones).
- Strengthen tax administration:
  - Base-broadening tax reforms effective only if supported by a well-functioning revenue administration able to efficiently collect and administer taxes.
- Consider expanding property taxation and capital/wealth taxation given low current yields:
  - International experience shows property tax revenue has risen in OECD and transition economies; Lithuania’s property tax revenue (0.37 percent of GDP in 2010) is low relative to peers at similar income levels.
- Address VAT productivity and compliance:
  - Reduce compliance costs (estimated at 2 percent of GDP) and close VAT compliance gaps; closing half the VAT compliance gap could yield up to ¾ percent of GDP.

*Source: _wp13157 - 1. Level of Taxation in Europe, 2010.*

### 60.8 in 2011, Lithuania’s tax effort is

### _wp13157 - 60.8 in 2011, Lithuania’s tax effort is

### Tax effort and tax structure
- Lithuania’s tax effort in 2011 was 60.8, well below the average of 77.1 for its CEE peers, indicating relatively large potential to increase tax revenue to full capacity.
- Lithuania’s tax structure (Percent, 2010):
  - Consumption taxes: 42 percent (Lithuania) vs. 29 percent (EU average).
  - Taxes on labor: 49 percent (Lithuania) vs. 51 percent (EU average).
  - Taxes on capital and wealth: 9 percent (Lithuania) vs. 20 percent (EU average).
  - Within taxes on capital in Lithuania: on capital and business income: 6 percent; on stock of capital (wealth): 3 percent.
- EU average tax structure (Percent, 2010):
  - Taxes on consumption: 29 percent.
  - Taxes on labor: 51 percent.
  - Taxes on capital, of which on capital and business income: 14 percent; of which on stock of capital (wealth): 6 percent.

### Progressivity and the role of taxes in redistribution
- Lithuania’s tax system exhibits relatively limited progressivity, especially toward the high end of the income distribution.
- Key contributing features:
  - PIT in Lithuania offers tax exempt thresholds for low income earners and a uniform flat tax for all others, together with multiple allowances and exemptions that favor high income taxpayers, including non-taxation of interest income and certain capital gains.
  - Social security contributions are calculated as a uniform uncapped proportion of the wage (note: social security contributions are not capped while benefits are capped, imparting progressivity to the overall security system but reportedly creating compliance problems of under-reporting wages).
  - Consumption taxes exhibit limited progressivity by design, as lower income households typically have a higher propensity to consume.
  - Limited taxation of wealth and capital reinforces limited overall progressivity.
- Measured impact on inequality (based on staff estimates and household data):
  - Social benefits helped reduce the Gini coefficient by about 50 percent in 2010.
  - The tax system reduced the Gini coefficient by only 8 percent in 2010.
  - The relative redistributive role of taxes declined since 2006, possibly due to deterioration in tax compliance after the crisis and/or expansion of the informal economy.

### Poverty and social transfers
- The social benefits system protected the most vulnerable during the crisis:
  - The at-risk-of-poverty rate before social transfers increased as a result of the crisis, but the at-risk-of-poverty rate after social transfers remained broadly at pre-crisis levels.
- Lithuania’s at-risk-of-poverty rate after social transfers remains above that of most other regional peers.
- Definitions and data notes:
  - The at-risk-of-poverty rate is defined as the share of people with an equivalised disposable income (after social transfers) below the at-risk-of-poverty threshold, set at 60 % of the national median equivalised disposable income after social transfers.
  - Gini coefficients are calculated based on household equivalized income data with equivalence weights: first household member weight = 1; each subsequent adult = 0.5; each child under 14 = 0.3.

### Fiscal stance and recommended shift to revenue-side consolidation
- Rationale for shifting consolidation focus to revenue:
  - Most consolidation to date has taken place on the expenditure side.
  - Lithuania’s revenue-to-GDP ratio and level of taxation are low compared to the EU average and regional peers.
  - The tax system exhibits limited progressivity, especially toward higher incomes.
- International examples cited where revenue-side measures helped fiscal adjustment: Canada, Finland, Ireland, New Zealand (eliminating exemptions and expanding tax bases, taxing previously non-taxed sources of revenue).

### Specific high-quality revenue measures and estimated yields
- Expanding wealth taxes:
  - Wealth taxes in Lithuania are about one quarter of the EU average and one half of the CEE regional average.
  - Raising wealth taxation to the CEE average could generate 0.8 percentage points of GDP in additional revenue.
  - Options and estimated yields:
    - Expanding immovable property taxation to include all residential properties could generate about 0.4 percent of GDP in additional revenue; broadening the residential property tax base by lowering the tax-free threshold could double revenue from property taxation (IMF staff calculations).
    - Introducing annual motor vehicle taxes (license/registration fee) related to engine capacity (or weight) could generate about 0.4 percent of GDP in revenue; this tax is also environmentally friendly.
- Broadening tax bases by removing exemptions and closing loopholes:
  - Personal income tax (PIT) base:
    - Eliminating tax exemptions on interest income could generate 0.1 percent of GDP in revenue.
    - Restricting the exemption from capital gains tax on housing to only the sale of primary residences and subjecting all short-term gains on financial assets to a withholding tax at a rate of 15 percent can help generate additional revenue.
    - Subjecting all pension payments to income tax (moving away from an “EEE-based” pension and annuity regime) could generate about 0.5 percent of GDP in revenue.
  - Corporate income tax (CIT) base:
    - Broadening the CIT base could generate about 0.5 percent of GDP in additional revenue.
    - Specific measures include: (i) consolidating reduced/preferential CIT rates on small companies; (ii) expanding CIT to include realized gains on security transactions; (iii) removing CIT exemptions/preferential rates on investment incentives and tax holiday schemes in free economic zones.
    - Current preferential small company rule: a 5 percent rate (instead of 15 percent statutory rate) is applied to small companies defined as companies with: (i) less than 10 employees, or (ii) generating less than LTL 1 million in taxable revenue during tax period. The reduced rate was much higher (13 percent) before 2010 and could be restored to generate additional revenues.
- Implementation note: Hungary, Finland, Ireland, Canada, and New Zealand experience referenced for similar measures.

### Tax administration
- Strengthening tax administration is essential to ensure revenue measures translate into revenue and to boost tax compliance.
- There is anecdotal evidence of a large and pro-cyclical shadow economy in Lithuania; stronger tax compliance would help maximize gains from revenue-raising reforms.

### Conclusions
- Lithuania has undertaken significant fiscal adjustment, largely on the expenditure side, but further efforts are needed to complete the adjustment.
- Lithuania’s revenue-to-GDP ratio is the lowest in the EU; the tax system relies heavily on labor and consumption taxes with very little taxation on capital and wealth.
- The tax system plays a limited role in income redistribution, particularly at the higher end of the income distribution.
- It is appropriate to shift future consolidation efforts toward high-quality revenue measures that:
  - Can generate considerable and relatively-stable revenue.
  - Can enhance progressivity at the higher end of the income distribution.
  - Would minimize adverse impacts on growth and competitiveness, given Lithuania’s ample scope to enhance revenue performance.
- Continued strengthening of tax administration is essential to realize revenue potential and improve compliance.

*Source: IMF staff analysis as presented in the supplied content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp13157.pdf_