Economic Policies
#13Key Findings
Showing progress in recent years, Lithuania falls into the upper-middle ranks internationally (rank 13) in the area of economic policies. Its score on this measure has improved by 0.2 points since 2014.
While the country did experience a sharp mid-2020 decline in GDP, growth returned almost immediately to modest levels, with a performance that exceeded that in most other EU states. After years of budgetary surpluses, the balance turned negative in 2020, with a 7.2% deficit. The gap was projected to narrow in subsequent years. Public debt rose to the moderate level of 47% of GDP.
The unemployment rate jumped sharply to nearly 8.5% in 2020, falling below 8% in 2021. Wage growth continued nonetheless. A structural mismatch between skilled labor demand and supply is worsening. Overall tax revenues are low in cross-EU comparison, with VAT playing a significant role. Labor taxes diminish economic competitiveness. Tax evasion is an ongoing problem.
The pandemic and migrant crises delayed urgently needed reforms in areas such as the labor market and energy infrastructure. Inflation rates were the euro zone’s highest in late 2021. R&D expenditures are comparatively low, with little research performed in the private sector.
While the country did experience a sharp mid-2020 decline in GDP, growth returned almost immediately to modest levels, with a performance that exceeded that in most other EU states. After years of budgetary surpluses, the balance turned negative in 2020, with a 7.2% deficit. The gap was projected to narrow in subsequent years. Public debt rose to the moderate level of 47% of GDP.
The unemployment rate jumped sharply to nearly 8.5% in 2020, falling below 8% in 2021. Wage growth continued nonetheless. A structural mismatch between skilled labor demand and supply is worsening. Overall tax revenues are low in cross-EU comparison, with VAT playing a significant role. Labor taxes diminish economic competitiveness. Tax evasion is an ongoing problem.
The pandemic and migrant crises delayed urgently needed reforms in areas such as the labor market and energy infrastructure. Inflation rates were the euro zone’s highest in late 2021. R&D expenditures are comparatively low, with little research performed in the private sector.
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How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?
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Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
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6
Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
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3
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3
Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
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1
1
Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
Lithuania has demonstrated remarkable economic progress in the last decades. In 1995, its GDP per capita was second-to-last of all countries surveyed in the SGI report. By 2021, Lithuania had surpassed 13 more countries on this measure, including Spain. Furthermore, the country has been surprisingly resilient in the face of numerous shocks, such as the global financial crisis, the Russian embargo against EU goods and the COVID-19 crisis. During the first year of the pandemic in 2020, Lithuania’s GDP growth was second-best in the EU. Lithuania’s economic policies have created a reliable economic environment, thus enhancing the country’s competitive capabilities and improving its attractiveness as an economic location.
In its 2020 Doing Business report, the World Bank ranked Lithuania at 11th place out of 190 countries. The criteria receiving the most positive assessments included registering property (ranked 4th), enforcing contracts (ranked 7th) and dealing with construction permits (ranked 10th). Meanwhile, resolving insolvency (ranked 89th) was assessed least positively. Lithuania climbed three positions in the 2020 report, from 14th place out of 190 countries in 2019. This is attributable to the fact that obtaining electricity services was made simpler through the launch of an integrated digital application and a reduction in the cost of new connections, as well as to the fact that minority investor protections have been strengthened thanks to the clarification of ownership and oversight structures. In 2020, the government significantly reformed the insolvency regime, with Lithuania now having one of the most efficient insolvency regimes in the OECD. In the Global Competitiveness Report 2019, the World Economic Forum ranked Lithuania at 39th place out of 141 countries (up by one position), with the nation scoring particularly well with regard to its macroeconomic environment (ranked 1st) and ICT adoption (ranked 12th).
The European Commission has identified the following challenges to Lithuania’s long-term competitiveness: unfavorable demographic developments, labor market deficiencies and high emigration rates, rising levels of poverty and social exclusion, a lack of competition and interconnections in the country’s infrastructure (particularly its energy system), low energy efficiency (especially in the case of buildings), a low level of R&D spending, and poor performance with respect to innovation. Recent increases in energy prices and increasing wages in the labor market have raised potential concerns about the Lithuanian companies’ competitiveness, although so far it has not hindered the very rapid expansion of exports. Lithuania has experienced a very rapid increase in prices – in November 2021, the annual inflation rate reached 9.3%, which was the highest rate in the euro zone.
The Šimonytė government has yet to start implementing substantial structural reforms, as its attention has been mostly focused on managing the twin crisis of the pandemic and the migrant flows from Belarus. Nevertheless, in 2022, it plans to start implementing significant reforms in the fields of education, taxation, the civil service and healthcare. Current discussions include increasing the rate and base of the real estate tax, eliminating certain personal-income tax exemptions, and restructuring automobile taxation to tackle pollution. Given that these reforms were postponed until the second half of the current parliament’s term, there are doubts as to whether there will be enough resolve to push them through. The divergent positions on tax reform among even among the governing coalition partners is one sign of the potential difficulties ahead in implementing the planned reforms.
Streamlining the regulatory environment for businesses is one of the few areas where some progress has been achieved, especially in terms of the number of procedures and days required to start a new business. However, inefficient government bureaucracy remains the second-most-problematic factor with regard to doing business in the country, according to surveyed business executives. In the Global Competitiveness Report 2019, the World Economic Forum ranked Lithuania at 85th place out of 141 countries with regard to the burdens imposed by government regulation, and 91st with regard to the efficiency of the legal framework in challenging regulations. Additional efforts are necessary to promote Lithuania’s transition to a circular economy, as the country’s economy remains very resource-inefficient, with landfill remaining the cheapest way of treating industrial waste.
A recent challenge has emerged as a result of Lithuania’s stance vis-à-vis Taiwan. After Lithuania agreed in 2021 to let Taiwan establish a diplomatic office in the country, and further said it intended to open a trade office in Taiwan, Chinese reaction was very harsh. China recalled its ambassador to Lithuania, and the Lithuanian ambassador to China was asked to leave. Furthermore, Lithuanian businesses started encountering problems exporting goods into China. While Lithuanian bilateral trade with China is rather modest, a potentially much more worrying tendency for Lithuania’s economy is that China apparently has informally signaled that it would also target any company from other EU countries that is doing business in Lithuania. As a result, business representatives have expressed grave concerns about the negative effects on FDI and Lithuania’s participation in global supply chains. This factor, together with growing geopolitical tensions caused by Russia’s invasion of Ukraine, has contributed to higher uncertainty.
Citations:
OECD, OECD Economic Surveys, Lithuania, 2020, https://www.oecd-ilibrary.org/economics/oecd-economic-surveys-lithuania-2020_62663b1d-en
World Bank Group, Doing Business Report 2020: http:// https://www.doingbusiness.org/en/doingbusiness
Stability Programme of Lithuania for 2021, April 2021:https://ec.europa.eu/info/sites/default/files/2021-lithuania-stability-programme_en.pdf
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2017: https://ec.europa.eu/info/sites/inf o/files/2017-european-semester-country-report-lithuania-en.pdf
European Commission recommendation for a Council recommendation delivering a Council opinion on the 2021 Stability Programme of Lithuania, Brussels, 2.6.2021, COM(2021)515 final, https://ec.europa.eu/info/sites/default/files/economy-finance/com-2021-515-1_en_act_part1_v3.pdf
The 2019 Global Competitiveness Report of the World Economic Forum: http://www3.weforum.org/docs/WEF_TheGlobalCompetitivenessReport2019.pdf
In its 2020 Doing Business report, the World Bank ranked Lithuania at 11th place out of 190 countries. The criteria receiving the most positive assessments included registering property (ranked 4th), enforcing contracts (ranked 7th) and dealing with construction permits (ranked 10th). Meanwhile, resolving insolvency (ranked 89th) was assessed least positively. Lithuania climbed three positions in the 2020 report, from 14th place out of 190 countries in 2019. This is attributable to the fact that obtaining electricity services was made simpler through the launch of an integrated digital application and a reduction in the cost of new connections, as well as to the fact that minority investor protections have been strengthened thanks to the clarification of ownership and oversight structures. In 2020, the government significantly reformed the insolvency regime, with Lithuania now having one of the most efficient insolvency regimes in the OECD. In the Global Competitiveness Report 2019, the World Economic Forum ranked Lithuania at 39th place out of 141 countries (up by one position), with the nation scoring particularly well with regard to its macroeconomic environment (ranked 1st) and ICT adoption (ranked 12th).
The European Commission has identified the following challenges to Lithuania’s long-term competitiveness: unfavorable demographic developments, labor market deficiencies and high emigration rates, rising levels of poverty and social exclusion, a lack of competition and interconnections in the country’s infrastructure (particularly its energy system), low energy efficiency (especially in the case of buildings), a low level of R&D spending, and poor performance with respect to innovation. Recent increases in energy prices and increasing wages in the labor market have raised potential concerns about the Lithuanian companies’ competitiveness, although so far it has not hindered the very rapid expansion of exports. Lithuania has experienced a very rapid increase in prices – in November 2021, the annual inflation rate reached 9.3%, which was the highest rate in the euro zone.
The Šimonytė government has yet to start implementing substantial structural reforms, as its attention has been mostly focused on managing the twin crisis of the pandemic and the migrant flows from Belarus. Nevertheless, in 2022, it plans to start implementing significant reforms in the fields of education, taxation, the civil service and healthcare. Current discussions include increasing the rate and base of the real estate tax, eliminating certain personal-income tax exemptions, and restructuring automobile taxation to tackle pollution. Given that these reforms were postponed until the second half of the current parliament’s term, there are doubts as to whether there will be enough resolve to push them through. The divergent positions on tax reform among even among the governing coalition partners is one sign of the potential difficulties ahead in implementing the planned reforms.
Streamlining the regulatory environment for businesses is one of the few areas where some progress has been achieved, especially in terms of the number of procedures and days required to start a new business. However, inefficient government bureaucracy remains the second-most-problematic factor with regard to doing business in the country, according to surveyed business executives. In the Global Competitiveness Report 2019, the World Economic Forum ranked Lithuania at 85th place out of 141 countries with regard to the burdens imposed by government regulation, and 91st with regard to the efficiency of the legal framework in challenging regulations. Additional efforts are necessary to promote Lithuania’s transition to a circular economy, as the country’s economy remains very resource-inefficient, with landfill remaining the cheapest way of treating industrial waste.
A recent challenge has emerged as a result of Lithuania’s stance vis-à-vis Taiwan. After Lithuania agreed in 2021 to let Taiwan establish a diplomatic office in the country, and further said it intended to open a trade office in Taiwan, Chinese reaction was very harsh. China recalled its ambassador to Lithuania, and the Lithuanian ambassador to China was asked to leave. Furthermore, Lithuanian businesses started encountering problems exporting goods into China. While Lithuanian bilateral trade with China is rather modest, a potentially much more worrying tendency for Lithuania’s economy is that China apparently has informally signaled that it would also target any company from other EU countries that is doing business in Lithuania. As a result, business representatives have expressed grave concerns about the negative effects on FDI and Lithuania’s participation in global supply chains. This factor, together with growing geopolitical tensions caused by Russia’s invasion of Ukraine, has contributed to higher uncertainty.
Citations:
OECD, OECD Economic Surveys, Lithuania, 2020, https://www.oecd-ilibrary.org/economics/oecd-economic-surveys-lithuania-2020_62663b1d-en
World Bank Group, Doing Business Report 2020: http:// https://www.doingbusiness.org/en/doingbusiness
Stability Programme of Lithuania for 2021, April 2021:https://ec.europa.eu/info/sites/default/files/2021-lithuania-stability-programme_en.pdf
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2017: https://ec.europa.eu/info/sites/inf o/files/2017-european-semester-country-report-lithuania-en.pdf
European Commission recommendation for a Council recommendation delivering a Council opinion on the 2021 Stability Programme of Lithuania, Brussels, 2.6.2021, COM(2021)515 final, https://ec.europa.eu/info/sites/default/files/economy-finance/com-2021-515-1_en_act_part1_v3.pdf
The 2019 Global Competitiveness Report of the World Economic Forum: http://www3.weforum.org/docs/WEF_TheGlobalCompetitivenessReport2019.pdf
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How effectively does labor market policy address unemployment?
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Successful strategies ensure unemployment is not a serious threat.
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Labor market policies have been more or less successful.
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Strategies against unemployment have shown little or no significant success.
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Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Though Lithuania’s labor market proved to be highly flexible during the financial crisis, which could be due to low compliance with the Labor Code, very decentralized labor bargaining and high levels of labor mobility, persistent labor market challenges continue to undermine economic competitiveness. Prior to the pandemic, unemployment rates had been declining, but a mismatch between labor supply and market demand had become the main hurdle in the labor market. It is increasingly difficult for businesses to find suitable skilled labor. Although immigrant workers from Ukraine and Belarus increasingly fill job vacancies in sectors such as construction and transport, immigration procedures are complex and create significant barriers to employment. Skills shortages have emerged in some sectors of the economy, posing an increasing challenge in the tight labor market. In its 2019 report, the European Commission noted a number of challenges such as a shrinking labor force, skills shortages and territorial disparities. However, even as business organizations have increasingly called for a relaxation of immigration procedures, thus allowing for labor migration, policymakers have retained a cautious attitude on respect to this issue.
The pandemic brought its own challenges. The unemployment rate jumped significantly, especially in the “vulnerable” sectors such as accommodation and transport. However, wage growth also continued at a fast pace, supported by the government’s countercyclical policies, as noted by the IMF. For the first time, the average after-tax wage has exceeded the symbolic threshold of €1,000. At the same time, Lithuania currently performs worse than most of its SGI peers on measures such as the unemployment rate, the incidence of low pay and long-term unemployment rates. In the coming years, the labor shortage and structural mismatches between the supply and demand of skilled labor will be among the biggest constraints on the economy’s continued convergence to the EU average. An IMF staff report concluded in November 2021 that “(s)ustained productivity growth, supported by the implementation of politically difficult but needed structural reforms, is the only way to support high wage growth and convergence with Western Europe.”
In the Global Competitiveness Report 2019, Lithuania was ranked highest with regard to the flexibility provided in determining wages (ranked 5th out of 141 countries). However, rules for hiring foreign labor were considered very restrictive (ranked 112th out of 141 countries), and the reported noted that the tax system has a very negative effect on incentives to work (ranked 131st out of 141 countries). Implementation of the new Labor Code has made hiring-and-firing practices more flexible, thus improving the country’s position in this area (59th out of 141 countries in 2019).
In recent years, the minimum wage has been increased a number of times. The minimum monthly wage was increased from €642 to €730 (before taxes) at the beginning of 2022. Though the increase in the minimum wage has helped increase economic consumption, a high minimum-wage-to-average-wage ratio increases the risk of unemployment for low-skilled workers.
Citations:
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2019: https://ec.europa.eu/info/sites/info/files/file_import/2019-european-semester-country-report-lithuania_en.pdf
The 2019 Global Competitiveness Report of the World Economic Forum: http://www3.weforum.org/docs/WEF_TheGlobalCompetitivenessReport2019.pdf
IMF, STAFF REPORT FOR THE 2021 ARTICLE IV CONSULTATION, 2021, file:///C:/Users/Vytautas/Downloads/1LTUEA2021001.pdf
The pandemic brought its own challenges. The unemployment rate jumped significantly, especially in the “vulnerable” sectors such as accommodation and transport. However, wage growth also continued at a fast pace, supported by the government’s countercyclical policies, as noted by the IMF. For the first time, the average after-tax wage has exceeded the symbolic threshold of €1,000. At the same time, Lithuania currently performs worse than most of its SGI peers on measures such as the unemployment rate, the incidence of low pay and long-term unemployment rates. In the coming years, the labor shortage and structural mismatches between the supply and demand of skilled labor will be among the biggest constraints on the economy’s continued convergence to the EU average. An IMF staff report concluded in November 2021 that “(s)ustained productivity growth, supported by the implementation of politically difficult but needed structural reforms, is the only way to support high wage growth and convergence with Western Europe.”
In the Global Competitiveness Report 2019, Lithuania was ranked highest with regard to the flexibility provided in determining wages (ranked 5th out of 141 countries). However, rules for hiring foreign labor were considered very restrictive (ranked 112th out of 141 countries), and the reported noted that the tax system has a very negative effect on incentives to work (ranked 131st out of 141 countries). Implementation of the new Labor Code has made hiring-and-firing practices more flexible, thus improving the country’s position in this area (59th out of 141 countries in 2019).
In recent years, the minimum wage has been increased a number of times. The minimum monthly wage was increased from €642 to €730 (before taxes) at the beginning of 2022. Though the increase in the minimum wage has helped increase economic consumption, a high minimum-wage-to-average-wage ratio increases the risk of unemployment for low-skilled workers.
Citations:
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2019: https://ec.europa.eu/info/sites/info/files/file_import/2019-european-semester-country-report-lithuania_en.pdf
The 2019 Global Competitiveness Report of the World Economic Forum: http://www3.weforum.org/docs/WEF_TheGlobalCompetitivenessReport2019.pdf
IMF, STAFF REPORT FOR THE 2021 ARTICLE IV CONSULTATION, 2021, file:///C:/Users/Vytautas/Downloads/1LTUEA2021001.pdf
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How effective is a country’s tax policy in realizing goals of revenue generation, equity, growth promotion and ecological sustainability?
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Taxation policy fully achieves the objectives.
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Taxation policy largely achieves the objectives.
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Taxation policy partially achieves the objectives.
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1
Taxation policy does not achieve the objectives at all.
Lithuania has the third-lowest tax-to-GDP ratio in the EU, with tax revenues (including social contributions) at 30% of GDP in 2019 (compared with an EU average of 40%), although this ratio is forecast to increase by 0.7 percentage points by 2022 (highest growth in the EU).
A significant share of government revenue is generated from indirect taxes, especially the value-added tax (VAT), which remains relatively high at 21% (increased from 18% during the financial crisis a decade ago), while environmental and property taxes are relatively low. Taxes on labor (personal-income tax and social security contributions), although reduced somewhat in recent years, are a barrier to the competitiveness of Lithuanian businesses. Furthermore, there is significant tax evasion. According to the European Commission, the VAT gap (as a percentage of theoretical VAT liability) is significantly higher than the EU average – in 2018, it was the third-highest in the EU. Potential tax revenues are still influenced by the country’s significant shadow economy, extensive tax avoidance, widespread tax exemptions and low tax morale. An improvement in VAT and excise-tax collection has been noted in recent years; this is attributed partially to improvements in tax administration and partially to a reduction in fuel and tobacco-product smuggling from Russia’s Kaliningrad region and Belarus (due to the general decline in trade with Russia).
In terms of horizontal equity, there are mismatches between various groups of economic actors with similar tax-paying abilities. Labor is taxed somewhat more heavily than capital, while specific groups such as farmers and lawyers benefit from tax exemptions. Previous governments have reduced the number of exemptions provided to various professions and economic activities with regard to personal-income tax, social security contributions and VAT. Social security contributions were reduced after the 2019 reform (but the personal-income tax was increased). The ceilings for these contributions (reintroduced in 2019) start at a very high level, but are gradually decreased.
Overall, in terms of vertical equity, the tax system’s ability to effect redistribution is relatively small in Lithuania. The tax system to a certain extent imposes a higher tax burden on those with a greater ability to pay taxes, insofar as large companies pay larger sums than do small companies. Moreover, while for many years, Lithuania had a flat income tax of 15%, it was changed to a progressive system with two brackets – 20% and 32%. A further element of progressivity is introduced through the use of an untaxed income threshold, thus favoring those receiving lower wages.
With regard to the competitiveness of Lithuania’s tax environment, tax rates themselves – for example, the standard tax on profits of 15% – are not the primary challenge to businesses. Rather, the frequent changes to the tax code are a greater concern. Changes to tax rules are usually initiated when elections approach or when there are changes in the ruling coalition. The current ruling coalition of conservative and liberal parties, however, has been very cautious with respect to tax reforms, with the reforms outlined in the government program aimed at the removal of remaining tax exemptions. It set up a working group after starting its work, but by late 2021 the working group had stopped its meetings due to disagreements among the coalition partners. In addition, in 2021 the government introduced temporary VAT reductions for the businesses most affected by the COVID-19 pandemic, and in early 2022 used similar measures to soften the sudden increase in heating prices for households resulting from an increase in natural gas prices in Europe.
Many analysts and several international institutions, such as the IMF and the OECD, have for many years been recommending both shifting and expanding the tax burden to somewhat reduce labor taxation and substantially increase property and environmental taxes. Lithuania’s tax rates in these areas are among the lowest in the European Union. In 2021, Minister of Environment Gentvilas proposed a revamp to the auto taxes by abolishing the registration tax and introducing an annual one, which would be gradually increased in the coming years. He suggested this as a way of addressing negative externalities and reducing emissions, although the opponents criticized the tax for not targeting the precise externalities and for being regressive. The parliament rejected the proposal in early 2022 amid disagreement among coalition partners and criticism from the opposition.
Citations:
EU Commission, Taxation trends in the European Union 2021, https://op.europa.eu/en/publication-detail/-/publication/d5b94e4e-d4f1-11eb-895a-01aa75ed71a1/language-en
EU Commission, Study and reports on the VAT gap in the EU-28 Member States, https://op.europa.eu/en/publication-detail/-/publication/48f32ee9-f3dd-11ea-991b-01aa75ed71a1
A significant share of government revenue is generated from indirect taxes, especially the value-added tax (VAT), which remains relatively high at 21% (increased from 18% during the financial crisis a decade ago), while environmental and property taxes are relatively low. Taxes on labor (personal-income tax and social security contributions), although reduced somewhat in recent years, are a barrier to the competitiveness of Lithuanian businesses. Furthermore, there is significant tax evasion. According to the European Commission, the VAT gap (as a percentage of theoretical VAT liability) is significantly higher than the EU average – in 2018, it was the third-highest in the EU. Potential tax revenues are still influenced by the country’s significant shadow economy, extensive tax avoidance, widespread tax exemptions and low tax morale. An improvement in VAT and excise-tax collection has been noted in recent years; this is attributed partially to improvements in tax administration and partially to a reduction in fuel and tobacco-product smuggling from Russia’s Kaliningrad region and Belarus (due to the general decline in trade with Russia).
In terms of horizontal equity, there are mismatches between various groups of economic actors with similar tax-paying abilities. Labor is taxed somewhat more heavily than capital, while specific groups such as farmers and lawyers benefit from tax exemptions. Previous governments have reduced the number of exemptions provided to various professions and economic activities with regard to personal-income tax, social security contributions and VAT. Social security contributions were reduced after the 2019 reform (but the personal-income tax was increased). The ceilings for these contributions (reintroduced in 2019) start at a very high level, but are gradually decreased.
Overall, in terms of vertical equity, the tax system’s ability to effect redistribution is relatively small in Lithuania. The tax system to a certain extent imposes a higher tax burden on those with a greater ability to pay taxes, insofar as large companies pay larger sums than do small companies. Moreover, while for many years, Lithuania had a flat income tax of 15%, it was changed to a progressive system with two brackets – 20% and 32%. A further element of progressivity is introduced through the use of an untaxed income threshold, thus favoring those receiving lower wages.
With regard to the competitiveness of Lithuania’s tax environment, tax rates themselves – for example, the standard tax on profits of 15% – are not the primary challenge to businesses. Rather, the frequent changes to the tax code are a greater concern. Changes to tax rules are usually initiated when elections approach or when there are changes in the ruling coalition. The current ruling coalition of conservative and liberal parties, however, has been very cautious with respect to tax reforms, with the reforms outlined in the government program aimed at the removal of remaining tax exemptions. It set up a working group after starting its work, but by late 2021 the working group had stopped its meetings due to disagreements among the coalition partners. In addition, in 2021 the government introduced temporary VAT reductions for the businesses most affected by the COVID-19 pandemic, and in early 2022 used similar measures to soften the sudden increase in heating prices for households resulting from an increase in natural gas prices in Europe.
Many analysts and several international institutions, such as the IMF and the OECD, have for many years been recommending both shifting and expanding the tax burden to somewhat reduce labor taxation and substantially increase property and environmental taxes. Lithuania’s tax rates in these areas are among the lowest in the European Union. In 2021, Minister of Environment Gentvilas proposed a revamp to the auto taxes by abolishing the registration tax and introducing an annual one, which would be gradually increased in the coming years. He suggested this as a way of addressing negative externalities and reducing emissions, although the opponents criticized the tax for not targeting the precise externalities and for being regressive. The parliament rejected the proposal in early 2022 amid disagreement among coalition partners and criticism from the opposition.
Citations:
EU Commission, Taxation trends in the European Union 2021, https://op.europa.eu/en/publication-detail/-/publication/d5b94e4e-d4f1-11eb-895a-01aa75ed71a1/language-en
EU Commission, Study and reports on the VAT gap in the EU-28 Member States, https://op.europa.eu/en/publication-detail/-/publication/48f32ee9-f3dd-11ea-991b-01aa75ed71a1
Graph View
To what extent does budgetary policy realize the goal of fiscal sustainability?
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Budgetary policy is fiscally sustainable.
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Budgetary policy achieves most standards of fiscal sustainability.
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Budgetary policy achieves some standards of fiscal sustainability.
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Budgetary policy is fiscally unsustainable.
Despite relatively high rates of economic growth, the government in power between 2012 and 2016 was only able to reduce the budget deficit toward the end of its political term. The goal of introducing the euro in 2015 preserved the government’s determination to maintain the deficit at a level below 3% of GDP, while the fiscal-discipline law provided an incentive to maintain a balanced fiscal policy as the economy kept growing. In the 2016 – 2019 period, Lithuania actually registered budgetary surpluses. The pandemic contributed to a very significant growth in the fiscal deficit and overall debt in 2020, as a result of contracting tax revenue and increased expenditure. The deficit stood at 7.2% of GDP in 2020, but was projected by the European Commission to fall to 4.1%, 3.1% and finally 1.1% in the 2021 – 2023 period. Gross public debt jumped up by 10 percentage points in 2020 (to 47% of GDP), but is projected to remain rather stable until 2023. In contrast to all previous crises, Lithuania adopted an expansionary fiscal policy stance. Given the Lithuanian economy’s comparatively very good performance during the pandemic, some analysts have argued that fiscal policy was too loose, contributing to overheating and inflationary pressures.
Lithuania faces a number of challenges in terms of keeping its public finances sustainable over the long run. Factors such as projected expenditures (and potentially lower tax revenues) related to an aging population, a relatively restrictive immigration regime, and the vulnerability of the country’s small and open economy to external shocks pose significant risks. The government is revising the state budgeting system, with the purpose of extending the time horizon for budgeting and strengthening the link between expenditure and overall economic policy. Economic growth during the pandemic that was better than initially forecasted, along with accelerating inflation, allowed the government to collect more tax revenues than planned; this in turn allowed it to increase funding for wages in the education and healthcare sectors as well as for pensions in 2022.
As noted by many observers and politicians, including current Prime Minister Šimonytė, there is a fundamental tension within the Lithuanian fiscal regime due to a mismatch between the extensive obligations the state has committed to on the one hand, and tax revenue that is insufficient to finance all those obligations adequately. The tax reform that came into effect in 2019 somewhat reduced government revenues due to the easing of the overall tax burden on labor. The Šimonytė government has halted any major tax reforms for 2021, but plans to introduce substantial changes starting in 2023. In particular, there are plans to eliminate certain exemptions, and to restructure (and increase) environmental taxation as well as property taxes.
Citations:
OECD, Economic Surveys: Lithuania, 2020
European Commission, Autumn 2021 Economic Forecast: From recovery to expansion, amid headwinds, 2021, https://ec.europa.eu/info/business-economy-euro/economic-performance-and-forecasts/economic-forecasts/autumn-2021-economic-forecast_en
Lithuania faces a number of challenges in terms of keeping its public finances sustainable over the long run. Factors such as projected expenditures (and potentially lower tax revenues) related to an aging population, a relatively restrictive immigration regime, and the vulnerability of the country’s small and open economy to external shocks pose significant risks. The government is revising the state budgeting system, with the purpose of extending the time horizon for budgeting and strengthening the link between expenditure and overall economic policy. Economic growth during the pandemic that was better than initially forecasted, along with accelerating inflation, allowed the government to collect more tax revenues than planned; this in turn allowed it to increase funding for wages in the education and healthcare sectors as well as for pensions in 2022.
As noted by many observers and politicians, including current Prime Minister Šimonytė, there is a fundamental tension within the Lithuanian fiscal regime due to a mismatch between the extensive obligations the state has committed to on the one hand, and tax revenue that is insufficient to finance all those obligations adequately. The tax reform that came into effect in 2019 somewhat reduced government revenues due to the easing of the overall tax burden on labor. The Šimonytė government has halted any major tax reforms for 2021, but plans to introduce substantial changes starting in 2023. In particular, there are plans to eliminate certain exemptions, and to restructure (and increase) environmental taxation as well as property taxes.
Citations:
OECD, Economic Surveys: Lithuania, 2020
European Commission, Autumn 2021 Economic Forecast: From recovery to expansion, amid headwinds, 2021, https://ec.europa.eu/info/business-economy-euro/economic-performance-and-forecasts/economic-forecasts/autumn-2021-economic-forecast_en
Graph View
To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?
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Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
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Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
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Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
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1
Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
Lithuania’s economy is characterized by the exploitation of cheap factors of production rather than innovation-led growth. According to the EU Innovation Scorecard, the country performs below the EU average, falling into the “moderate innovators” group. At the same time, Lithuania has made very substantial progress over the years; for example, its innovation index score jumped from 61.2% of the EU average in 2014 to 92.1% in 2021. Moreover, the share of this sum spent by the business sector is low (totaling just 0.56% of GDP in 2020), as research and innovation policy is dominated by the public sector and highly dependent on EU funds. Within the country’s innovation system, research is oriented only weakly to the market, research products are not supported with sufficient marketing or commercialization efforts, investment is fragmented, funding levels are not competitive with other European states. Although some sectors of the Lithuanian economy are export-oriented and have strong potential for growth, Lithuanian industry is in general dominated by low- and medium-low-level manufacturing sectors.
Lithuanian authorities have used EU structural funds to improve the country’s R&D infrastructure. So-called science valleys have been developed, integrating higher-education institutions, research centers and businesses areas that work within specific scientific or technological areas. However, using this new research infrastructure efficiently remains a major challenge, and cooperation between industry and research organizations remains rather weak. The government has also supported the sector through financial incentives (in particular, an R&D tax credit for enterprises) and regulatory measures. Demand-side measures encouraging innovation are less developed. Excessively bureaucratic procedures are still an obstacle to research and innovation, while the existing system of innovation governance is rather complex, with limited synergies between the several implementing agencies and support schemes. Due to the lack of funding and the rules for calculating the salaries of scholars participating in EU-funded programs such as Horizon 2020, incentives to apply to such programs are weak.
The 2012 – 2016 government developed a new smart-specialization strategy intended to focus resources in science and technology areas in which Lithuania can be internationally competitive, although it has been criticized for investing too heavily in the construction of new buildings and renovation of low-ranking universities’ campuses. In 2016, the parliament approved new science and innovation policy guidelines, which were proposed by the president. The guidelines proposed restructuring the research and higher-education systems, supporting innovation development, improving coordination of science and innovation policy, and monitoring science and innovation policy implementation. In June 2017, the parliament approved a resolution to optimize Lithuania’s state universities. The plan proposed merging the existing state universities into two comprehensive universities in Vilnius and Kaunas, and regional science centers (branches of other Lithuanian universities) in Klaipėda and Šiauliai. However, after intense lobbying by representatives of the existing universities, the initial plan was amended, and the government’s ambitions of reducing the overall number of higher-education institutions were scaled back and delayed. By the end of 2019, the implementation of the optimization plan had produced results only in the city of Kaunas.
In its 2019 staff working document, the European Commission recommended the development of a coherent policy framework supporting science-business cooperation, and the consolidation of the various agencies that oversee research and innovation policies in Lithuania. In line with this, the Šimonytė government aims to implement an innovation-sector structural reform by consolidating several institutions into one agency responsible for innovation.
Whereas salaries and stipends for researchers at universities are relatively low (in both international context and compared to average compensation in the country), one positive development has been the fact that both the Skvernelis and Šimonytė governments have been increasing funding, which has resulted in rather robust wage growth in the sector. Furthermore, although they still comprise a relatively low share in the total economy, Lithuania has seen very rapid growth in several high value-added sectors, such as biotechnology, lasers, and financial services and technologies. For instance, the biotech industry grew by more than 90% in 2020. Lithuania has also become one of the leaders in the EU in creating a fintech ecosystem.
Citations:
The EU Innovation Scoreboard 2021 is available at https://ec.europa.eu/info/research-and-innovation/statistics/performance-indicators/european-innovation-scoreboard_en
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2019: https://ec.europa.eu/info/sites/info/files/file_import/2019-european-semester-country-report-lithuania_en.pdf
Lithuanian authorities have used EU structural funds to improve the country’s R&D infrastructure. So-called science valleys have been developed, integrating higher-education institutions, research centers and businesses areas that work within specific scientific or technological areas. However, using this new research infrastructure efficiently remains a major challenge, and cooperation between industry and research organizations remains rather weak. The government has also supported the sector through financial incentives (in particular, an R&D tax credit for enterprises) and regulatory measures. Demand-side measures encouraging innovation are less developed. Excessively bureaucratic procedures are still an obstacle to research and innovation, while the existing system of innovation governance is rather complex, with limited synergies between the several implementing agencies and support schemes. Due to the lack of funding and the rules for calculating the salaries of scholars participating in EU-funded programs such as Horizon 2020, incentives to apply to such programs are weak.
The 2012 – 2016 government developed a new smart-specialization strategy intended to focus resources in science and technology areas in which Lithuania can be internationally competitive, although it has been criticized for investing too heavily in the construction of new buildings and renovation of low-ranking universities’ campuses. In 2016, the parliament approved new science and innovation policy guidelines, which were proposed by the president. The guidelines proposed restructuring the research and higher-education systems, supporting innovation development, improving coordination of science and innovation policy, and monitoring science and innovation policy implementation. In June 2017, the parliament approved a resolution to optimize Lithuania’s state universities. The plan proposed merging the existing state universities into two comprehensive universities in Vilnius and Kaunas, and regional science centers (branches of other Lithuanian universities) in Klaipėda and Šiauliai. However, after intense lobbying by representatives of the existing universities, the initial plan was amended, and the government’s ambitions of reducing the overall number of higher-education institutions were scaled back and delayed. By the end of 2019, the implementation of the optimization plan had produced results only in the city of Kaunas.
In its 2019 staff working document, the European Commission recommended the development of a coherent policy framework supporting science-business cooperation, and the consolidation of the various agencies that oversee research and innovation policies in Lithuania. In line with this, the Šimonytė government aims to implement an innovation-sector structural reform by consolidating several institutions into one agency responsible for innovation.
Whereas salaries and stipends for researchers at universities are relatively low (in both international context and compared to average compensation in the country), one positive development has been the fact that both the Skvernelis and Šimonytė governments have been increasing funding, which has resulted in rather robust wage growth in the sector. Furthermore, although they still comprise a relatively low share in the total economy, Lithuania has seen very rapid growth in several high value-added sectors, such as biotechnology, lasers, and financial services and technologies. For instance, the biotech industry grew by more than 90% in 2020. Lithuania has also become one of the leaders in the EU in creating a fintech ecosystem.
Citations:
The EU Innovation Scoreboard 2021 is available at https://ec.europa.eu/info/research-and-innovation/statistics/performance-indicators/european-innovation-scoreboard_en
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2019: https://ec.europa.eu/info/sites/info/files/file_import/2019-european-semester-country-report-lithuania_en.pdf
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To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?
10
9
9
The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
8
7
6
7
6
The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
5
4
3
4
3
The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
2
1
1
The government does not contribute to improving the regulation and supervision of financial markets.
Lithuanian authorities contribute to improving financial-market regulation and supervision. Lithuania joined the euro area and the single European banking supervisory system in 2015. The Lithuanian Ministry of Finance and the Bank of Lithuania (the country’s central bank) are involved in the activities of EU institutions and arrangements dealing with international financial markets (including the European Council, the European Commission, the European Systemic Risk Board’s (ESRB) Advisory Technical Committee, the European supervisory authorities, etc.). Lithuanian authorities are involved in the activities of more than 150 committees, working groups and task forces setup by the European Council, the European Commission, the ESRB’s Advisory Technical Committee and other European supervisory authorities. Lithuanian authorities support inclusive euro area decision-making, which includes EU members that are not members of the euro area, as well as the completion of the banking union.
In addition, the Bank of Lithuania cooperates with various international financial institutions and foreign central banks, in part by providing technical assistance to central banks located in the EU’s eastern neighbors. Lithuania’s Financial Crime Investigation Service cooperates with EU institutions, international organizations and other governments on the issue of money laundering. The country has lent its support to many initiatives concerning the effective regulation and supervision of financial markets. In recent years, the Bank of Lithuania has tightened regulation of short-term lending practices to target so-called fast-credit companies and attract foreign financial institutions. At the same time, the Bank of Lithuania has attempted to attract fintech companies to Lithuania in the context of the United Kingdom’s withdrawal from the EU, although recently Lithuanian authorities have changed their approach by emphasizing risk control over expansion. An important goal was to foster competition in a banking sector heavily dominated by Nordic banks. Lithuania is regarded as having one of the world’s most highly developed fintech-sector regulatory frameworks. Recently, the Bank of Lithuania initiated debates on making Lithuania a center of excellence for anti-money laundering activities. MONEYVAL assessed the bank in early 2019 as a supervisor that proactively implements anti-money laundering measures.
Citations:
The Bank of Lithuania, February 11, 2019: https://www.lb.lt/en/news/bank-of-lithuania-acknowledged-as-a-supervisor-that-proactively-implements-anti-money-laundering-measures
In addition, the Bank of Lithuania cooperates with various international financial institutions and foreign central banks, in part by providing technical assistance to central banks located in the EU’s eastern neighbors. Lithuania’s Financial Crime Investigation Service cooperates with EU institutions, international organizations and other governments on the issue of money laundering. The country has lent its support to many initiatives concerning the effective regulation and supervision of financial markets. In recent years, the Bank of Lithuania has tightened regulation of short-term lending practices to target so-called fast-credit companies and attract foreign financial institutions. At the same time, the Bank of Lithuania has attempted to attract fintech companies to Lithuania in the context of the United Kingdom’s withdrawal from the EU, although recently Lithuanian authorities have changed their approach by emphasizing risk control over expansion. An important goal was to foster competition in a banking sector heavily dominated by Nordic banks. Lithuania is regarded as having one of the world’s most highly developed fintech-sector regulatory frameworks. Recently, the Bank of Lithuania initiated debates on making Lithuania a center of excellence for anti-money laundering activities. MONEYVAL assessed the bank in early 2019 as a supervisor that proactively implements anti-money laundering measures.
Citations:
The Bank of Lithuania, February 11, 2019: https://www.lb.lt/en/news/bank-of-lithuania-acknowledged-as-a-supervisor-that-proactively-implements-anti-money-laundering-measures