This week, Lithuania’s newly elected Parliament approved the candidacy of 45-year-old Social Democrat (LSDP) Gintautas Paluckas (picture) as new Prime Minister. Elena Leontjeva, President of the Lithuanian Free Market Institute, discusses what to expect from the new government coalition he just formed.
The new coalition has made it clear that its aim is to ensure adequate funding for defence and national security. It has promised to reform the second pillar of pension funds as a priority. In addition, it has proposed a tax reform, with a specific component: progressive taxation for higher earners, irrespective of their income.
How can one ensure that these aims and pledges do not contradict each other so that the goals that are important to all citizens can be achieved quickly, smoothly and with consensus? After all, this parliamentary majority promises a people-oriented, inclusive policy, which sounds like a good commitment, yet the key to delivering it is not to ignore reality.
To protect against external threats, we must increase defence spending. The outgoing Government has identified defence as a budgetary priority but has not backed up its words with real funding. The same 3% of gross domestic product (GDP) is to be allocated for defence for the next three years.
Although it is evident that the budget for the coming year, at least, cannot be significantly adjusted, what can be guaranteed is the growth of the only variable, i.e. GDP. The key to that is not to deter domestic and foreign investors with additional risks. The new parliamentary majority has already managed to add one political peril to the current geopolitical risks. They promise, however, to make amends and to translate into concrete deeds the great pledges of the coalition agreement: “We will grow Lithuania’s economy, […] we will promote the development of national businesses throughout Lithuania, […] we will improve the country’s investment climate”.
Lithuanian Parliament today approved my new position as Deputy Chair of Foreign Affairs Committee representing opposition to the current socialdemocrat-led coalition. New Chair – Ambassador @MotuzasR Hope 4continuity on most important issues of Lithuanian foreign&security policy. pic.twitter.com/gAo20TOAC2
— ŽygimantasPavilionis🇱🇹🇺🇦🇪🇺🇺🇸🇹🇼🇮🇱 (@ZygisPavilionis) November 21, 2024
The risk of capital flight
This is indeed the first priority because the capital flight that has begun could render all the budget estimates and commitments meaningless. If outflows are difficult to measure, spending on gross fixed capital formation alone was 3.9% lower in the first half of 2024 compared to the corresponding period in 2023, which means that production capacity will fall accordingly. Meanwhile, if the conditions for capital, investors, and thousands of companies operating in Lithuania are stable and only improving, GDP can grow at the same annual rate as it did during the best of times, e.g. by 5% or more. It would allow to increase spending on defence, social protection and other needs by more than any budget line shuffle: we could allocate an extra €130 million annually for defence, €336 million for social protection, and €170 million for education, assuming GDP growth of 5%.
The second major pledge of the new coalition reads: “We will reform the second pillar of the pensions system, strengthening the right of the saver to manage their accrued funds, including the contribution by employers“. For if the interests of those voters who no longer wish to save for their future pension are to be considered, then those who do want to continue to save should similarly be taken into account. The experience of the Western countries and the recommendations of the World Bank suggest that tax-free contributions to the second pillar should be increased to 10%, with the option of perhaps giving people a choice of how much they should set aside at a given stage in their lives.
In doing so, we would allow those who do not want to save to leave the system while allowing those who still want to save to actually save for their retirement. This would be a nice unifying gesture by the new government, demonstrating that the goal is individual welfare not only today but also in retirement, and that the aim of public policy is to prepare for the demographic pothole by transferring part of the financial burden to those who are able and willing to bear it.
The third pledge: “The tax system must be efficient, transparent and socially just”. It is promised to raise the personal allowance of tax-free income every year and to tax the highest income earners at progressive rates, regardless of the income type, while protecting low-income small businesses from additional taxes.
Progressive taxation is not a new concept. The Conservatives also intended to tax higher earners at higher rates, regardless of their income. The problem is that such a move would radically contradict the pledge to improve the investment climate and would encourage any dormant capital to flow abroad. The consequences of such capital flight would manifest in company closures, shrinking jobs and rising unemployment. Therefore, if the aim of tax reform is to increase budget revenues, not rates, and especially not to penalise those who generate the higher added value desired by any government, then it is necessary to undertake reforms that do exactly what the state needs, i.e. raise budget revenues, not rates.
Failure to do so – the painful experience of our neighbours proves this – will result in politicians having to grapple with declining budget revenues, plugging budget holes with borrowing, and abandoning their generous promises to voters.
Lithuania: the Lithuanian parliament has supported Gintautas Paluckas (LSDP-S&D) in the formation of a new government coalition, which consists of LSDP (S&D), DSVL (G/EFA), NA (*) with 88 in favour, 34 against, and 6 abstentions.
The new government has 86 seats out of 141 in…
— Europe Elects (@EuropeElects) November 21, 2024
Left-wing governments always stress their pragmatism and willingness to mobilise, to unite, to grow Lithuania’s economy as well as the opportunities for prosperity it offers. A government programme is always a good opportunity (and imperative) to calibrate electoral promises with reality: the risk of recession, great capital mobility, dependence on the decisions of thousands of companies.
In the current geopolitical context, a strong and growing economy with solid foreign and domestic investment is the key to national resilience.
Serving in Government is also a good teacher of humility: an MP mandate and a Ministerial portfolio allow one to overwrite the law but not the reality. Yet it is reality that has to be obeyed even at the top.
Disclaimer: www.BrusselsReport.eu will under no circumstance be held legally responsible or liable for the content of any article appearing on the website, as only the author of an article is legally responsible for that, also in accordance with the terms of use.
