Tax incentives: Additional tax revenue without increasing taxes

Estonia has long been recognised for its progressive economic policies, including a unique and competitive system, but the need for increasingly inventive financial strategies has remained. The state can increase its revenue with increased taxes and redistribute it through subsidies and more bureaucracy, but tax incentives are a fairer and more transparent means of stimulating the economy.

In order to promote the knowledge-based economic model, Estonia could take the lead from comparable jurisdictions such as Ireland, Switzerland, Singapore, and the UK in terms of tax incentives and aim to position itself as a thriving financial centre, a hotbed for start-ups, a preferred location for corporate headquarters, and an attractive destination for top professionals.

The economic blockade with Russia has made Estonia a peripheral country in the Western economic bloc. Consequently, the adoption of a tax reduction strategy has become imperative to prevent capital flight, attract foreign investment, and stimulate resilience.

I propose two possible ways in which Estonia can raise its public budget without traditional tax increases, using instead a strategic tax incentive to increase state budget and competitiveness:

1. Incentive for persons not permanently resident in Estonia (non-domiciled regime).

Imagine a person who becomes a tax resident in Estonia while retaining tax residence in his home country. Their income from abroad - such as rental income, dividends or wages - may be subject to double taxation in Estonia. In order to increase Estonia's economic attractiveness, it is essential to introduce a different tax regime for new taxpayers (non-domiciled individuals) for the first ten years of their residence, thus avoiding taxation of foreign income.

This is also the period when these individuals, such as highly paid professionals or entrepreneurs temporarily earning their living in Estonia, would contribute heavily to the state budget through social taxes without ever qualifying for an Estonian state pension. An alternative approach involves the conclusion of more double tax treaties, which are currently limited in number and scope in Estonia and a lengthy process.

Countries like the UK, Ireland, France, Spain, Cyprus and Malta have already successfully implemented similar tax regimes. Such tax policies help to position Estonia as an attractive destination for global talent and businesses seeking a tax-friendly environment.

2. Tax cap for high-income earners:

The introduction of an annual tax cap is vital to attract high earners to Estonia. Similar regimes in Switzerland, Italy and Greece have shown good results.

The economic stimulus for destination countries is likely to go beyond the multiplier effect of the investment itself. Investing €1 million in a company as inward capital can help create jobs and additional demand for local businesses.

Imagine the impact if 30,000 such individuals were attracted to Estonia - a direct contribution of €3 billion a year in taxes to the national budget, not to mention the indirect impact and investment. To put this into perspective, Estonia recently received a similar number of Ukrainian refugees.

The tax reform fits in well with Estonia's existing policy, contrasting the concept of progressive taxation with the Marxist ideology familiar from the Soviet era. A high progressive or graduated income tax is, as is well known, the second point of Karl Marx's Communist Manifesto, written in 1848.

A capped tax regime could, in fact, apply to all citizens to prevent the wealthy from leaving the country. It would only be a step forward, as Estonia already has a tax exemption for the less well-off and a flat-rate tax for everyone above a certain amount.

Statistics show that less than 1% of Estonian tax residents earn at least € 100,000 a year, and 0.06% earn more than €500 000. Therefore, a negative impact on the tax base is unlikely.

The more wealthy taxpayers in Estonia, the more tax relief could be allowed for people with lower incomes. Such an approach would ensure a fair tax environment that is easy to administer and incentivises value creation. Estonia could make it easier for high-income earners to obtain a residence permit, recognising that some 448 million EU citizens can move freely to Estonia without any obstacles.

In addition, tax incentives for pensioners or researchers, for example, could be considered.

Summary:

The opportunity for Estonia's economic recovery lies in introducing favourable tax policies that attract talent, increase the tax base without raising taxes, and make the country an attractive destination for the super-rich, thus stimulating investment and growth by creating entrepreneurship and capital inflows.

This could be Estonia's economic policy's trump card —a chance to repeat the Swiss success story in its own way, going from a poor country to a richer European nation.

A similar article in Estonian was also published in the leading Estonian business magazine "?rip?ev" https://www.aripaev.ee/arvamused/2024/03/15/taavi-tammoja-eesti-majanduse-taassund-labi-maksusoodustuste