Latvia needs to improve its fiscal policy, reform its tax system, improve the public sector’s capabilities and attract investments in order to promote growth, as mentioned in OECD’s latest economic outlook for Latvia.
OECD concluded that Latvia needs to speed up its structural reforms because of the slowing of economic convergence and the war in Ukraine. Experts not that Russia’s aggressive war in Ukraine has caused high energy prices and disruptions in commerce and supply chains, which affects economic growth.
Economic convergence had slowed down even before the pandemic and the war.
The organisation notes that Latvia’s fiscal position will recover slightly this year and will remain neutral in 2025 despite inflation pressure. Fiscal deficit is high and the state debt is higher than the medium-term index. This is why the country should gradually tighten fiscal policy in order to lower fiscal deficit and lower inflation pressure, the report mentions.
The war in Ukraine has led to an increase in defence and internal security spending, and the government is committed to continuing to increase spending on the education and health sectors, so the OECD recommends increasing spending efficiency, redistributing spending and increasing tax revenues from income and property tax, and reducing tax spending.
In its latest report, OECD stresses the need to reform the tax system.
One of the main problem stressed in the report concerns the high social contributions for people with low and medium income, which dissuade people from wanting to register official job relations. Unofficial working relationships are common, and the progressiveness of personal income tax remains low. In order to address these problems, the OECD recommends reducing the tax burden on labour for the low-income earners, for example by reducing social insurance contributions at lower incomes or by increasing the progressiveness of personal income taxes.
Low property tax revenues are also problematic, while many municipalities depend on central government transfers to key spending priorities. In addition, the values of cadastral properties are not tied to market prices. In this context, the OECD recommends raising periodic taxes on real estate on the basis of regularly updated market value, while continuing to ensure tax reductions for the poorest households for their main residence.
OECD expects Latvia will gradually drop tax expenditures and subsidies for various environmentally unfriendly positions, such as fossil fuel, and will adopt CO2 emission contributions for sector not covered by the EU emission quota trade system, because Latvia has not lowered greenhouse gas emissions since the turn of the millennium. OECD experts have concluded that the reason for all that is emission levies on the transport and construction sectors are low and subsidies and tax expenditures on fossil fuels and other environmentally harmful items are maintained.
OECD also notes that institutional memory and pubic policy quality and efficiency suffer from high staff turnover, as well as the lack of digital and management skills. This means Latvia needs to promote the attractiveness of jobs in the public sector and improve training for people employed in the sector.
According to OECD, centralised procurements are more effective. This is why it would be best to unite existing procurement bureaus, improve their technologies and workers’ skills, as well as lower legal exceptions on mandatory centralised procurements.
Incomplete declaration of income and salaries is widespread in Latvia, therefore mandatory electronic filing of income tax returns should be introduced, while continuing to reduce the administrative burden with automatic filing of returns, OECD notes.
Unlike many OECD countries, Latvia has not implemented plans to create a centralised lobbying register, which would help promote transparency and reduce the influence of undesired groups.
Seven of OECD’s recommendations concern attraction of investments to promote growth.
There is weak competition in the finance system, therefore, interest rates on financing are not reduced, and therefore the legal and investigative instruments should be strengthened in order for the Competition Council to be able to monitor anti-competitive behaviour in financial markets, recommended in the review.
OECD also underlines the fact that it is because of high costs and information asymmetry clients rarely change banks. On top of that, the household deposit level is low. Experts invite Latvia to expand the platform for payment account commission in order for them to include information about bank deposit rates, as well as other charges, such as minimal fee for refinancing loans, as well as ensure standard package and contracts for the switch of credit institutions.
The capitalisation on the stock market is very high, and unlike other Baltic States, none of the biggest Latvian state companies are quoted at the exchange.
OECD urges acceleration of plans for listing public companies on the stock exchange.
Latvia should establish a tripartite learning fund and improve cooperation in the development and implementation of training between companies and training providers, as the lack of digital and managerial skills hampers digital adaptation and innovation, recommended in the review.
According to OECD, Latvia still has poorly assessed regulation and the impact of the presence of state-owned enterprises on competition, therefore, the powers of the Competition Council to conduct market investigations and to propose an assessment of the regulatory and state ownership justification in order to ensure competition neutrality should be increased.
OECD reports are published every two years. The 2024 economic report on Latvia is the fifth – the first report was published in February 2015. The OECD aims to provide governments with assistance by providing them with the best possible analysis, research, recommendations and solutions in almost every area of economic policy.
Also read: Latvia behind Estonia and Lithuania capital market development-wise, INVL says
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