Background of Budgetary Revenues...
During the Soviet era, Latvia was a mainecontributor to the USSR budget, making financial transfers equivalent 20.2% of GDP.(World Bank, 1995). In 1991 those transfers stopped and resulted in a Latvian surplus of 6.4% in GDP for the year(EIU, 1995). However, social outlays continued to increase deficit in 1992 and 1993. The 1993 budget ended the year with a deficit of approximately 2.9% of GDP (EIU, 1995). A new system of taxation was introduced in January 1991, which included a separate profit tax for companies and enterprises. In 1993, the profit tax was levied at a rate of 45% for banking insurance and trade, 35% for state enterprises and state companies, and 25% for all other private companies. Personal income tax came into effect on January 1, 1994, levied at a rate of 25% on the first Lats4.800 and 35% on the remainder of the profit(EIU, 1995). The value-added tax (VAT) was first introduced at a standard rate of 10% in 1992, and was raised from 12% to 18% in November of 1993 on most products excluding food (however the VAT was raised to 18% on food products in March of 1994). The government has also begun to finance the deficit through the issuance of Treasury bills.
Composition of Budgetary Revenues...
Fiscal reform measures which have been implemented since 1990 have changed the structure of budget revenues, becoming similar to the structrue of revenues in Western Europe. Income tax revenues have continued to increase while taxes on enterprises and domestic goods and services have decreased. Social security contributions to total revenue have risen to levels similar to those in Western Europe. New taxes which have been implemented are described below according to World Bank information as of the end of 1995.
Profit tax. This tax is levied on the net earnings of enterprises, cooperatives, and private entities. Self-employed persons may pay either the profit tax of the individual income tax. The tax rate of the profit tax fluctuates between 25% and 45% depending on the institution. Lottery, casino, and gambling profits pay a profit tax of 65%. There are exemptions for associations which are run for charities, health, and the handicapped. Legal deductions include expenditures by enterprises for social purposes. "Adjustments in the value of fixed assets to an inflation index are currently infrequent and do not follow clear rules.".(EIU, 1995).
Personal income tax. This tax is levied on individual's wage income, including bonuses, and the income of legal entities formed by individuals. The basic rate is 25% with a marginal tax rate of 35% applying to income which exceeds 20 times the nontaxable minimum.
Social security tax. This tax is levied on salaries, wages, fees, royalties, and other rewords for work. The tax is payable in the following proportions by employees and employers. Employers contribute 37% and employees 1%. For handicapped employees, the employer pays 8%.
Value-added tax. This tax is levied on goods and services at the manufacturing/import, wholesale, and retail stages. The standard rate is 18%, with a reduced rate of 10% being applied to meat, fish, milk, and feed products. This reduced VAT rate was switched over to the standard rate in 1994. There are still exemptions, including medical supplies, concerts and theaters, and transit services.
Excise taxes and customs duties. Excise taxes are levied on the imports of products by individuals or enterprises. Customs duties are levied on imports and exports, with export duties ranging from 5% to 100% and import duties ranging from 2% to 20%.
Other taxes. These taxes include a property tax, land tax, and a natural resource tax. The property tax is placed on fixed assets of state enterprises and unfinished buildings. A tax of 0.5% is place on property with a value of Lats1,500 or more. A maximum rate of 4% is applied to property exceeding a value of lats2.5million. The tax is paid entirely to the local government. The land tax is placed on the use of land by individuals and enterprises. The tax is paid directly to the respective district, village, city, or municipal district budget. Exemptions include transportation routes and individual farms up to the first five years whose conditions are unsatisfactory. The natural resources tax was introduced to discourage excessive use of natural resources and accrues in the Environment Protection Fund. The tax consists of three parts: a tax on the use of natural resources, a tax on pollution, and punitive fines for excessive use of natural resources and pollution. Tax rates are determined by the Environmental Protection Committee.
Non-tax revenues. These revenues include fees which are collected on documents and official services performed by the state, and user charges for various public services including water and sewage.
Composition of Budgetary Expenditures...
Subsidies and transfers which once accounted for 60% of the government expenditures have decreased significantly with reform efforts. Subsidies on food (with meat and dairy products receiving the largest share) which once accounted for 90% of the total subsidies, have been dramatically reduced since 1991(World Bank, 1995). Other subsidy expenditures which have been reduced include price support for: agricultural producers, agro-industry subsidies, direct transfer to low-profit farms, housing maintenance, and heating.
Social security expenditures have increased dramatically to almost one-third of total expenditures by 1991, with over two-thirds of the fund expenditures being pension benefits. Expenditures related to defense and administration have been transferred to the general budget.
Debt...
Like other Baltic states, Latvia is currently liable for a portion of the debt inherited from the former Soviet Union. However, Latvia "disclaims responsibility for the Soviet debt based on the grounds that its annexation to the Soviet Union was illegal under international law" (EIU, 1995). The total external debt has been estimated at $60.6 million. Of this debt, $26 million was long-term publicly guaranteed debt and $34.6 was an IMF credit (EIU, 1995).
Latvia has also recently tapped into the international bond markets. The government borrowed $40 million through a two-year bond issue, organized by Nomura Securities, on the Japanese and international markets. The international bond market was an alternative to the Latvian treasury bill market where demand has declined as a result of the bank failure. The bonds are rumored to pay a low coupon rate of 5.4%, due to low yen interest rates. Demand for domestic Treasury bills has recently begun to increase, although most interest is centered on the short-term bills. Interest is beginning to increase slightly in longer-term bills.
EIU forecasts that Latvian foreign debt will rise to $500 million by the end of 1996 and $690 million by the end of 1997. Debt-service costs will most likely continue to remain low as much of the credit is available on concessionary terms. Recent loan agreements include a 17-year $14 million credit from the World Bank for rehabilitating the heating system, credits to assist in privatization, and transport infrastructure (EIU, 1995).
Recent budgetary conditions...
Efforts to improve budgeting, budget execution, and accountability in government finances continue in Latvia. Budgetary law entitled "Law on Budget and Financial Management" was passed by Parliament in April of 1994. This law sets rules regarding formulating, approving, financing, implementing, and auditing the annual budgets of central and local governments. According to this law, the Cabinet of Ministers must submit annual central government budget proposals to Parliament by October 1 for approval of the year preceding the new budget. If the annual budget has not been approved prior to the implementation date, the government must operate with the preceding year's budget allocations until the new budget is approved. "The law also regulates government borrowing and lending, the granting of guarantees, and the budgetary powers and procedures for local governments." (IMF, 1995).
The budget law also creates a Treasury Department within the Ministry of Finance which is responsible for the execution, reporting, and accounting of the state budget. (A Treasury area was created by the Ministry of Finance in 1993 which was mainly responsible for the auction of short-term (28 day) treasury bills.) The Treasury Department, since creation, has eventually expanded to include other functions such as the responsibility of assets and liabilities and the social security system.
Efforts were also made to increase efficiency in the collection of taxes. The State Finance Inspection Board, responsible for the collection of domestic taxes, and the Customs Department, responsible for foreign trade taxes, were combined in accordance with law passed by Parliament in 1993. The new department, the State Revenue Service, began work in mid-1994.
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