For quite a while – a long while – tax reform has been the major policy agenda item in Latvia.

For some time the idea for personal income tax reform was a higher non-taxed minimum together with a decrease of the income tax rate from 23% to 20%. In late June this was changed into a proposal with different tax rates (a progressive tax system) and the proposal now looks like (at least that’s what I think – and who knows what exactly will be the final outcome?):

A 20% tax rate for income above the non-taxed minimum but below 20,000 EUR per year, i.e. 1666 EUR per month. A 23% rate for incomes between 1666 EUR and 4583 EUR (namely 55,000 EUR per year) and a 31.4% rate for incomes above 55,000 EUR per year/4583 EUR per month. A reduction of the solidarity tax though I am not sure what the exact proposal looks like. A maximum non-taxed minimum of 200 EUR for (presumably?) incomes still of 440 EUR or below, declining to 0 for incomes of 1000 EUR or more and an increase in the employee social tax from 10.5% to 11%.

If so – who gains and who loses from this proposal and by how much?

Swedbank, together with the Ministry of Finance, has developed a wage calculator: Plug in your gross income (or the income you dream of…) and it delivers the after-tax (“in-hand”) amount plus your gain or loss compared to the current system.

I sat down, plugged in a lot of numbers (as default I chose zero dependents and no additional tax relief), made some calculations and got the following results. Figure 1 shows how many percent a person gains or loses compared to his/her gross salary per month.

**Figure 1: Percentage gain/loss for various gross monthly incomes**

Source: *Swedbank *wage calculator together with own calculations

As is easily seen, low incomes make rather significant gains percentage-wise while middle incomes see modest gains of about 1%. The upward blip in percentages after 1000 EUR per month are due to the non-taxed minimum having reached zero – an extra euro of income no longer results in a reduction of the non-taxed minimum and thus, implicitly, extra taxation. Then the percentages again start decreasing when the higher marginal tax rate of 23% kicks in at 1666 EUR per month and again when the highest marginal tax rate of 31.4% kicks in at 4583 EUR per month. The impact of the latter is ameliorated by lower solidarity tax.

All incomes up to 5063 EUR per month stand to gain from this proposal, i.e. 98-99% of all incomes since 5063 EUR per month is at the VERY high end of the income distribution. After 5063 EUR per month the percentage losses keep increasing but, quite frankly, very modestly so. As an example, an income of 100,000 EUR per month (not exactly what a simple Head of Department is paid….) stands to lose 679 EUR from the reform or a mere 0.67% of the gross wage.

Since the biggest changes are at the low incomes it might be worth zooming in – this is what Figure 2 does by concentrating on income up to 500 EUR per month.

**Figure 2: Percentage gain/loss for various gross monthly incomes**

Source: *Swedbank *wage calculator together with own calculations

Incomes around 220 EUR should gain the most, percentage-wise, which is due taking advantage of a higher non-taxed minimum. Really low wages actually lose out a bit – this is due to the higher social tax while no income tax is paid in neither the new nor the old system. The biggest gain in terms of EUR is for incomes of 440 EUR (namely 24.33 EUR per month), which is just before the non-taxed minimum starts decreasing with higher income.

A quick overall evaluation could be the following:

1) The reform proposal benefits incomes at the low end. Very low end, e.g. compared to the size of the minimum wage.

2) It has rather limited impact on the middle classes.

3) It benefits almost all salary earners.

4) And very high incomes are not losing all that much.

And most interestingly, of course, is the fact that Latvia, which has for so many years praised the virtues of the flat tax system now seems to move to a system of quite a bit of progressivity, at least by Eastern European standards. A very distinct change of policy.

PS/disclaimer: Calculations were exclusively made using the aforementioned *Swedbank *wage calculator – whether it will reflect the final outcome of the tax reform remains to be seen. There may, as we speak, be other interpretations of the tax reform, not least in the context of the solidarity tax but I have relied 100% on the wage calculator for the calculations presented here

*Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga and a member of the Fiscal Discipline Council of Latvia*

*Points of view presented here are my own and not necessarily those of the Fiscal Discipline Council. *

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