Where should we get the money? Rapid increase of child benefits leads to a tax rise

From left: Jaanus Karilaid (KE), Kristina Kallas (Estonia 200), Kaja Kallas (RE), Riina Sikkut (SDE), Helir-Valdor Seeder
From left: Jaanus Karilaid (KE), Kristina Kallas (Estonia 200), Kaja Kallas (RE), Riina Sikkut (SDE), Helir-Valdor Seeder Photo: Kollaaž
  • The initiators of the bill would use excess revenue to pay for it
  • Critics say that this would speed up price rise
  • Hard choices ahead in the taxes issue

The alleged motivation for the rise of family benefits that drove the government’s relationship to breaking point is to alleviate the impact of price increase. But dumping several hundred million euros in the economy can give the opposite effect. And where should we find permanent sources of income to meet the cost?

Total cost of the bill submitted by the Center Party, the Social Democrats, Isamaa and EKRE would be EUR 246 million. Its result would be the increase of child benefits and support of large families from February 1 of next year. The bill has caused a quarrel among the coalition parties: the Reform Party argues that although they do not oppose the raising of child benefits, the Center Party has not given enough time or bothered to consider how to meet the significant cost.

On Tuesday, Kaja Kallas emphasized to Järva Teataja that the Reform Party would not be opposed to raising child support, but this could be discussed together with the state budget. «It seems to me that if you are in the government, this is not an unreasonable thing to ask. You have to be responsible in the government; it is not your personal money you are handing out, but the taxpayer’s money.»

The explanations of the initiators of the bill are rather vague but the general narrative tends to be that the money for raising the benefits would come from extra revenues due to the overall price increase and the economic growth.

Jaanus Karilaid, leader of the Center Party faction, noted when answered about meeting the cost that the EUR 246 million would not disappear anywhere but would return to the Estonian society. «As of now, the excess revenue is over 20 percent. The state budget consists of taxes and loans. We want to make a financial reservation and it is already taken into account when drafting the 2023 budget. »

True, Raoul Lättemäe, head of the fiscal policy department of the Ministry of Finance, admitted that the following years’ tax revenues will be lower than expected while drafting the 2022 state budget last autumn, and in that sense, increased tax revenue does not cover the costs offered.

But Helir-Valdor Seeder, Chairman of Isamaa, said that meeting the cost is a matter of priorities. «Every government has to set its priorities and proceed from its commitments and the laws in force. Just like the present coalition made a timely decision regarding extraordinary pension increase and the average pension income tax exemption, which has a major impact on the state budget.»

Seeder went on: «If they are now beginning to draft next year’s state budget, they will take into account that this law has been adopted and it brings along obligations. The funding of the increase of children’s and family benefits should be treated the same way. When they convene in the autumn and begin discussing the state budget and the state budget strategy for the coming years, they would already know the legal obligations, the government’s priorities. This is how the complete budget is drafted.»

Tax increase cannot be avoided?

However, the Social Democrat Riina Sikkut pointed out that this is a fixed cost, moreover an indexed fixed cost, which will grow year by year; therefore it is clear that the cost can only be met at the expense of fixed income. «It is not possible to do this at the expense of some loan or annual individual decisions. The source of coverage must be some kind of permanent mechanism – and it can only be tax revenue,» she noted.

Therefore in the long run, the political parties should be ready to open a serious debate on raising taxes. «It is not possible to get more social protection, health care or better funded higher education with the present trend of the tax burden. This particular bill of family benefits also highlights the problem very sharply,» she said.

Unfortunately, it is obvious that, for purely political reasons, no one wants to decide on tax increase before the election. «I have repeatedly mentioned that the favorite topic of politicians is taxes. Everyone seems to be an expert on this subject, but they are actually prepared to make only popular decisions before the election. Regrettably, raising taxes is not such a decision,» Sikkut speculated. «Therefore, difficult decisions can be made by a new government which has received a strong mandate, when the coalition is still strong and there is some understanding or agreement on taxes.»

Heido Vitsur, an economic expert, agreed with her: «In the end, everything comes down to what we really want. Do we want to keep our tax system stable or support children?» he raised the question.

According to him, a country aspiring towards Nordic level of welfare – something Estonia generally wants – cannot be maintained with a low tax burden we have. Child benefits are in themselves a measure clearly following a Nordic model. It is probably also necessary in a situation where we have slightly over 13,000 childbirths a year while the retiring classes date back to the period when the number of births was 20,000 and higher. «If we want to keep the tax system stable and do nothing about it, then I cannot see any sources of funding for increasing child benefits. Taking money from where it is already scarce and giving it to children is not a wise thing to do,» said Vitsur

Representatives of both the Center Party and Isamaa remain restrained when discussing tax issues and refer to the forthcoming election campaign. «Speaking of current taxes, we have submitted our proposals to the Riigikogu regarding the reduction of excise duties on diesel fuel and petrol to the minimum permitted by the European Union and the reduction of VAT on electricity, gas and central heating,» Seeder pointed out. If these are current and fast solutions, then the long-term solutions will remain the domain of the 2023 election program.

Speeding up price rise?

Kaspar Oja, economic adviser to President Alar Karis, noted that in addition to inflation, Estonia has been suffering from a budget deficit for a longer time. He emphasized that speeding up economic growth and therefore also price rise through budget policy is something that should be avoided in order to curb inflation. «In the present situation we should direct extra money where it is absolutely necessary: ​​national defense, refugees. But we must be very careful. We have to realize that if we direct more money into the economy, inflation will accelerate further,» Oja explained.

«Its share is so small,» Seeder answered when asked whether the increase in child benefits would boost inflation rate. He explained that regarding the causes of the rapid price rise, a significant share of the price increase comes from outside Estonia and the prices of energy carriers. «Thus, the increase of child benefits and the pension reform, to which the prime minister refers as the main causes of inflation, are absolutely not true. Their impact on inflation is not that great, but it will make it possible to alleviate the sharp rise in prices through concrete measures.»

According to Oja, however, it is difficult to assess the actual impact of the increased child benefit on inflation. One of the major causes of inflation is indeed related to the energy sector. On the other hand, the extremely rapid recovery of the economy is an important factor. «We have recovered very quickly from the corona crisis. In principle, only Ireland has recovered faster across Europe. But behind Ireland’s rapid recovery are the multinational companies, which are not very closely tied to Ireland’s own economy. Therefore, it can be said that we have shown the fastest recovery,» Oja explained.

«We have an environment where inflationary pressures are high and Estonia’s highest inflation is clearer in comparison with other countries. The pension reform has also contributed to this by adding a lot of free money to the economy. So I do think that adding money to the economy could speed up inflation.»

Why universal support?

Although the Center Party has historically been a supporter of graduated income tax, they have on several occasions in the last year advocated universal direct supports, which would reach the people’s bank accounts regardless of their income. Conversely, during Kaja Kallas’ term as the prime minister, the Reform Party has defended the distribution of subsidies based on the principle of need.

Jaanus Karilaid justified the change of trend with excessive bureaucracy. «We could see regarding the energy subsidies that about 15-20 percent of the people who applied had a lot of trouble compiling the application, but later it turned out that there was hope and expectation all right but no support. In our opinion, the universal support is more practical. We do not think it is reasonable to constantly prove that you need support. I know that the Reform Party would like to make child benefits necessity-based, but then they should also come up with a very precise mechanism for how this could work in practice.»

The system should be smart

Kristina Kallas, the leader of Eesti 200 party, also emphasized in her criticism of the child benefits bill it lacks smartness and instead focuses on pure populism.

«At present, total populism and politicking are taking place, disguised as child benefits. Increasing child benefits this way will not solve the real problem of families’ impoverishment. Presently the Riigikogu and the political parties there are displaying their inability to solve this important problem. Since autumn, high energy prices have once again become reality for many Estonian families, in addition to rising inflation,» said Kallas.

She added: «To overcome this crisis we need a smart country that can offer personal solutions to people’s problems instead of being involved in outright populism. We need to be able to reform our public service system so that in situations where we need to help someone, we do so personally and smartly, according to necessity. It would also put an end to the populist politics that paralyze our government several times a year.»

The proposal needs to be analyzed

Keit Pentus-Rosimannus. 
Keit Pentus-Rosimannus. Photo: Remo Tõnismäe

The proposal needs to be analyzed; otherwise saddling the taxpayers with a permanent commitment of EUR 300 million could painfully backfire at a later moment. Because of the war in Ukraine unleashed by our neighboring state, we are now in a very turbulent period with a great deal of uncertainty about economic developments.

A month ago the forecast showed that we are heading into a recession. The summer economic forecast, which will be completed in August, will certainly provide better knowledge and a basis for making such extensive decisions.

Keit Pentus-Rosimannus (RE), Minister of Finance

Tax revenue exceeded expectations

 Kadri Klaos
 Kadri Klaos Photo: Erik Tikan

Tax revenue in the first three months of this year has been slightly higher than forecast, because the impact of the sanctions did not reach March tax revenue, but the annual outlook contains high risks and no significant changes can be predicted at the moment. With the spring forecast, we revised the tax revenue forecast for 2023 downwards compared with the autumn forecast, mainly due to the slower-than-expected growth of the wages. Taking into account the indirect effects of the supplementary budget, the tax revenue of 2023 would decrease by 123 million euros compared with the state budget.

We shall release an updated forecast in the second half of August. By then, we will certainly have more up-to-date information about how sanctions and higher-than-expected energy prices have affected the economy and tax revenues.

Kadri Klaos, head of the public finance service of the Ministry of Finance

Inflation is not a perpetuum mobile

Tax revenues in the coming years will be lower than we expected when preparing the 2022 state budget last autumn and in this sense the increased tax revenue will not cover the proposed costs. In addition, the state budget is currently in deficit, and the government’s policy so far has been aimed at reducing the deficit, which means that the government probably also wants to direct the additional tax revenues primarily in reducing the deficit.

On the one hand, inflation seems to keep tax (VAT) revenue higher due to the rising prices. In reality, however, high inflation as well as the sanctions and giving up Russian goods will dampen income growth. This in turn has a negative effect on tax revenues.

Inflation is not a perpetuum mobile for the economy, where everyone would shrug, pay more for their consumption and the state can collect more taxes. Someone’s wallet is still shrinking, and that someone is curbing their consumption, which reduces the demand in the economy, and some companies will have to make their employees redundant. Raoul Lättemäe, head of the fiscal policy department of the Ministry of Finance.