Lithuania joined the Organisation for Economic Co-operation and Development (OECD) in 2018, making it the 36th member and the most recent addition to our International Tax Competitiveness Index (ITCI). According to our Index, Lithuania’s taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. system is the fourth most competitive and neutral in the OECD, promoting sustainable economic growth and investment while raising sufficient revenue for government priorities.
Looking at the different areas of taxation, Lithuania ranks particularly well on corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es, individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es, and property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es, while consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. es and international tax ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s receive average scores. The Baltic state is currently implementing a significant reform of its labor taxes and considering multiple changes to its corporate income taxes, consumption taxes, and property taxes, potentially affecting the tax code’s future competitiveness.
Individual Income Taxes
Lithuania’s major labor tax reform shifts almost all employer-side social security contributions to employees by reducing employer-side contributions and increasing both employee-side contributions and personal income taxes. To avoid reductions in employees’ net wages, employers have been required to recalculate gross wages by increasing them by 28.9 percent.
The Baltic country has been relying heavily on tax revenue from social security contributions. In 2017, 41.4 percent of all tax revenue came from social security contributions and only 13 percent from personal income taxes, compared to OECD averages of 26.2 percent and 23.9 percent, respectively. In an effort to move labor taxation from social security contributions to personal income taxes, Lithuania has decreased its total social security taxes and switched from a 15 percent flat-tax to a two-bracket progressive personal income tax.
In 2019, the standard personal income tax rate increased from 15 percent to 20 percent and the top personal income tax rate of 27 percent applies to wages exceeding 120 times the average monthly wage. The top income tax threshold will be reduced to 84 times the average wage in 2020 and 60 times the average wage starting in 2021, gradually re-flattening the tax structure.
Source: Grant Thornton, “Tax Reform in 2019,” 2018, https://www.grantthornton.lt/globalassets/1.-member-firms/lithuania/pdf/tax-reform-2019.pdf.
|Personal Income Tax||15.00%||€150.00||20.00%||€257.80|
|Employee-Side Social Security Contributions||9.00%||€90.00||19.50%||€251.36|
|Employer-Side Social Security Contributions||31.18%||€311.80||1.79%||€23.07|
|Total Labor Cost||€1,311.80||€1,312.07|
In its 2020 budget, Lithuania is considering increasing its dividend tax rate from 15 percent to 20 percent, increasing taxes on nonemployment income such as royalties, rents, disposals of assets, gambling, and gifts from 15 percent to 20 percent, and making effective personal income tax rates more progressive for incomes above €35,000.
Business investments in machinery, buildings, and intangibles in Lithuania receive on average the third best tax treatment of all OECD countries, only after Estonia and Latvia. Lithuania’s short depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. schedules allow businesses to quickly recover investment costs for tax purposes, making investments overall less costly.
Lithuania also levies the third-lowest corporate income tax rate in the OECD at 15 percent, compared to an OECD average of 23.6 percent. However, the country is currently considering increasing the corporate rate to 20 percent and raising the tax rate on dividend income earned by businesses from 15 percent to 20 percent. For comparison, the other two Baltic countries, Estonia and Latvia, both operate a more competitive and neutral cash-flow tax on business profits, taxing profits only when they are distributed to shareholders.
Lithuania’s value-added tax (VAT)A Value-Added Tax (VAT) is a consumption tax assessed on the value added in each production stage of a good or service. Every business along the value chain receives a tax credit for the VAT already paid. The end consumer does not, making it a tax on final consumption. is structured as a standard 21 percent VAT rate levied on only half of final consumption due to multiple exemptions and reduced rates, leaving room for base-broadening measures. A VAT with a lower rate and broader base limits economic distortions while raising significant revenue.
To address Lithuania’s concentrated retail market, members of the parliament have proposed a tax on large sellers. The new tax would apply a rate of 1 percent on businesses if total consumer goods sold exceed €2 million a month (excluding VAT), a levy mainly faced by large retailers. In effect, this would be a revenue tax on sales of consumer goods exceeding the €2 million a month threshold. Such a move would go against the principle of neutral tax policy and create distortions by applying a separate tax on some businesses based on their sales volume.
Regarding excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. es, Lithuania is considering implementing a vehicle pollution tax, which would be based on a vehicle’s carbon emissions and collected when registering a vehicle. In addition, increases in excise duties on ethyl alcohol, tobacco, and certain fuels are currently being considered by parliament.
Lithuania is currently considering a bill to lower the threshold for nontaxable noncommercial real estate from €220,000 to €100,000, keeping the progressive property tax structure that ranges from 0.5 percent to 2 percent unchanged. If implemented, the number of individuals subject to the real property tax is estimated to increase from 3,700 to 37,000.
Looking to follow other eastern European countries such as Hungary, Poland, and Slovakia, Lithuania weighs introducing a bank tax. Banks would be subject to the 0.4 percent tax on assets exceeding €300 million. Although arguably a measure to address excessive risk-taking, bank taxes are narrow-based, distortionary, and can reduce competitiveness.
Lithuania’s tax system is among the most competitive and neutral in the OECD, which contributes to making it an attractive place for both domestic and foreign investment. Currently, there are multiple tax reform proposals under consideration, including increases in the corporate income tax rate and dividend tax rate and new taxes such as a bank tax and large trade tax.
If raising additional government revenue is required due to new spending priorities, it is important to do so in an economically efficient way. Narrow-based measures, such as the proposed bank tax and large trade tax, create distortions and can negatively impact economic growth. Instead, policymakers should be eyeing base-broadening measures such as levying its VAT on a larger share of final consumption, minimizing economic distortions.
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