Why Latvia Is In Such A Mess

Hat Tip to Aleks Tapinsh – “No wonder this country is in such a mess. Someone posted this video of a payday at the Elkor electronics chain in Latvia. The paycheck as you can see comes in an envelope, in cash. No one pays any taxes. And everyone happy. Or not”.

Second example: Prime Minister Valdis Dombrovskis cited in a press conference in Riga yesterday the fact that some companies, including state-owned companies like Latvian Railways, had tried to cheat the social security system by significantly raising the wages of some of its employees (in his example from 1,000 lats a month to 12,000 lats a month), thus apparently raising their pay into the social security system. That way, if a person gets laid off, they’d get 70 percent of the new and improved wage.

Now two recent quotes from my blog interpreting yesterday’s comment from the Economy Minister – (Viz: “Representatives sitting in Washington and educated at Yale do not fully understand what is going on in Latvia”)

“To provide with logic behind quote of the economics minister, I believe he thought that the EC and IMF does not realize the scope and importance of grey economy in the country. With that figure hard to estimate (ranging from 15%-40%). Any increase of Tax base will only push the economy on the gray side both for individuals (tax exemption on income earned) and for companies (unaccounted cash revenue, forgone taxes,etc). Thus resulting in even less tax revenue that initially had and larger budget deficit to balance. As for VAT tax, as a sign of protest, some of the local companies have publically annouced the full closure of their business if the VAT is raised to 23%.”

“Yep, stupid comment when at the same time you are reaching out your hands to receive their money… That said, the IMF does not really fully understand if they think they can introduce e.g. a progressive income tax and raise more revenue. Very hard to do in a country that does not believe that higher taxes will benefit the population and where tax avoidance is an art mastered by most.”

This entry was posted in A Fistful Of Euros, Economics: Country briefings by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

8 thoughts on “Why Latvia Is In Such A Mess

  1. Unfortunately, this is Soviet heritage. In USSR you can survive if you have stolen the bread and the dressings from a factory. Despite to permanently increasing penalties for that, the stealing aggravated. Today when penalties are minimal, what else had to be expected by that?

    Maybe the best days for Latvia were in 90-ies when it was an economy of small very liberal private business, with small government (Williamsonian model). The standards of EU with overblown burecraucies has significantly decresed the competitivenes of Latvia.

    A solution is maybe shift to poll tax models, but this will be inacceptable for Angela & Co.

  2. I have been living in Latvia since 2003. Nearly everyone I know here is paid this way. Companies simply hire people officially for minimum wage and the rest is paid in cash. The only people I know who are not either work for the government or foreigners who are following the rules not realizing how few do.

  3. Dear Andreas, unfortunately foreign firms are among the ones who are especially keen to pay under table, because they have money sources not possible to observe by Latvian authorities. In addition those as Siemens and big pharma have extremely good experience with global bribing. So the tales about honest W-Europeans is not followed anymore in Latvia.

    You will be maybe surprised, but USSR did have much lower taxes as any successor today. It lived from the income of the governmental sector of economy. Tsarist Russia did not have any taxes in the present economic meaning at all. Anyway, it was very successful state after Stolipin reforms.

    I do not think that unavoidable tax system per se is something very valuable. It is of big importance only in countries with overblown bureaucracy as in the EU. In contrary, the endogenous economic model of Latvia is not of that sort. In healthy growth period 1996-2004 Latvia had pretty perfect market economy with low taxes.

    However, the events in 2008, at first the banking bailout, is an extreme deviation from market economy, and economy as Latvia is not able to digest and swallow such an abnormality. For a comparison – in 1995 there was an universal banking crisis in Latvia, no bailouts were offered, and as a result the crisis lasted only 3 months and GDP fall was just 1,6%.

    Present banking bailouts are mission impossible for economies as Latvia, and EU by imposing these bailouts to its members has killed Latvia. Generally, small economies can survive if they obey to laws of market economy, as opposed to extreme deviations from market economy as bailouts which will sink these economies.

  4. govs from Latvia, in your first post you are equating tax evasion and stealing. This is completely wrong.
    Tax evasion is not stealing, any business operating under market economy is motivated to pay as little taxes as possible it should be pretty obvious why.
    Seeing how horrible are governments of Latvia and Lithuania at managing money, especially with all that borrowing that is needed by supporting a peg, i should say that this tax evasion is actually a good thing: the sooner our governments run out of money, the sooner bureaucracy will have to shrink.
    As Edward pointed out this life support for economy from EU and IMF not sustainable in the long run.

    In Lithuania as our economy is doing a little better we aren’t borrowing from EU or IMF, but from financial markets directly with huge interest rates, and in doing this we are inflating our public debt very quickly.
    Politicians are taking the easy way and just raising taxes every few months making this shadow economy feedback process even quicker.

  5. Dear Mindaugas, tax evasion did not exist in USSR. So I do not equate, but relate. In privatising common goods these approaches are pretty equal.

  6. Dear govs!
    Comparisons with USSR not very reasonable. You paid tax, as well could avoid it engaging in certain activities, including “criminal”: speculation, hard currency dealing, pseudo-private entrepreneurship, etc. But Soviet state regulated GDP consumption outside of pure taxation much more: by setting prices, diverting resources.
    What regards argument on overblown bureaucracy its (argument) is considerably overblown itself.
    Consolidated public expenditure grew in Latvia from LVL 3.3 bill. in 2005 to 4.1 bill. in 2006 to 5.3 bill. in 2007 to 6.2 in 2008. This year it is expected to come down to 5.8 bill. when revenue is already close to 2006 level.
    Main components of this growth: pensions and salaries (teachers, medical personnel, policemen,librarians, etc.). To reach balance you have to cut at least 10% more- or devalue proportionally.

  7. Dear Hedgedog, in comparisons with USSR used here the focus was on everyday tax optimisation for average people, as in the video placed on top of the page. Nowhere my analysis is even touching hardcore crime as drugs, sex workers, organ transplants, kidnapping which of course did not pay taxes in the USSR, and do not pay today. I am not a specialist in submilitary and criminal economy.

    Regarding the inflation of Latvian public sector expenditure don’t forget that this happened in concommitance with 15+ % inflation, at the same time keeping the very extraordinary currency peg. If this peg had been loosenend already then, the lat vill revaluate, and the nominal inflation in lats would be smaller.

Comments are closed.