Mirian Ejibia ISET MA: eugeorgia.info
Key component of Estonian Model calls for exempting undivided profit from tax burden. After introduction of Estonian Model in Georgia, a major part of business entities will be partly exempted from profits tax.
These bodies will be taxed if profits will be issued in the form of dividends or they will distribute profits in the way unrelated to the company’s business activities. Consequently, Estonian Model taxes profits not in the profits reception moment, but in the profits distribution process.
Government of Georgia announced inauguration of preparatory works for Estonian Model establishment in 2015. Purpose of introduction of this model was to make positive effect on various economic directions. According to Former Finance Minister Nodar Khaduri, Estonian Model will intensify economic growth, expand access to financial resources, increase liquidity of business assets and grow capital in business sector; Moreover, business sector is expected to become more resistant to crisis periods; foreign investments inflow will increase and tax registration-administration will be simplified; To put simply, Georgian Government expects Estonia’s successful reforms to stimulate economic growth in Georgia too. However, it is clear that Estonia’s success cannot guarantee the same model will be efficient in Georgia too.
Success of the Estonian model was driven by consecutive and long-term preparations for major changes. Estonian officials had carried out other reforms for preparing the mentioned reform and these efforts continued for many years, almost 10 years, in practice. Naturally, gradual injection of similar reforms in the economy was entirely reshaping tax environment that was also effecting the state economy stage by stage.
Estonia launched important tax reforms in 1995, while profits tax system was reformed in 2000 (corporate tax on profits). As a result, undivided profits were not taxed by profits tax. Before the reforms, for example, in 1999, profits tax ratio in total tax revenues was 6% in Estonia and the interest rate constituted 21%. Profits tax is an important source of budget revenues in Georgia and worldwide. Consequently, it is painful process for the Authorities to partly restrict these budget revenues, but international experience suggests that in short-term period profits tax burden alleviation results in slowdown of budget revenues, while in long-term period this fiscal policy is expected to grow tax revenues. These expectations justified in case of Estonian Model. In 2000 Estonia’s total profits tax revenues sharply declined and its ratio in total tax revenues fell to 2.3% from 6%. However, economists and financiers express suppositions that reduction of this type of tax revenues was caused by slowdown in economic growth paces.
Starting 2001, after implementation of the reform, ratio of profits tax revenues has been growing. The main thing is that ratio of revenues from profits tax preconditions Estonia’s GDP growth trend (ratio of profits tax revenues in total tax revenues).
At this stage, there are a great number of research works that appraise results of Estonia’s tax reforms. Results of Estonian tax model reformation are compared to contemporary economic indicators of neighboring Lithuania and Latvia. A major part of research works prove advantage of alleviated tax burden. For example, according to one of the reports, profits tax reduction improved financial conditions of companies operating in Estonia, namely, liquidity of their capital rose, money assets in floating capital and on bank accounts have increased, which, compared to Lithuanian and Latvian companies, enabled Estonian companies to overcome the 2008 financial crisis less painfully.
International Tax Competitiveness Index also proves advantage of Estonian Model that measures efficacy of taxation system of countries of Organization for Economic Cooperation and Development (OECD) in terms of business doing. Estonia has been demonstrating highest scores in this component over the past years.
In Georgia, which practices liberal tax system, we should expect less benefits from Estonian Model introduction compared to Estonia, where 21% tax was abolished on undivided profits, while Georgia plans to abolish 15% tax on reinvested or collected profits. Research works conducted by Aleksandre Lungvist (New York University) and Mikhail Smolinski (Federal Reserve System) strengthen opinion that profits tax reduction brings significant positive results only if such a fiscal policy is carried out amid economic recession. Researchers also suppose that only large-scale profits tax reduction can bring real economic-social benefits.
Perspectives of Estonian Model should be highlighted from other aspects too. When access to financial resources is complicated for small and medium business sectors in Georgia, free undivided profits that accumulate more resources for reinvestments acquire special importance. «Research and Development» are necessary for many Georgian companies. Estonian Model stimulates similar reinvestments. It is unimaginable for Georgian companies to penetrate EU market without additional financial costs. Untaxed undivided profits of potential exporters may be directed for expanding the mentioned exports potential on EU market. Introduction of Estonian Model will be profitable in terms of tax administration too, because the problem with calculation of profits tax is not novelty for Georgian financial sector. Estonian model will alleviate financial reporting. This model will also grow efficacy of operation of Georgian taxation structures. For example, Estonian model implies that some expenditures that are not related to company’s business activities will be taxed by profits tax rate to avoid shady distribution of profits in the form of expenditures, because, on the one hand, companies will face difficulties with shady distribution of profits tax and, on the other hand, taxation structures will more accurately carry out their activities. As a result of introduction of this model, we will receive a taxation environment necessary for more efficient and faster economic development.
According to certain considerations, profits tax is an fiscal instrument that enables to allocate resources from developed business organizations to beginner companies, thanks to state interference. This signifies taxes collected from developed business sector may be directed for support of beginner businesses in various forms thanks to efforts of state structure, including through tax preferences.
It should be noted that profits tax ranks third in Georgia’s state budget in terms of tax revenues over the past 4 years, following VAT and incomes tax.
In 2012 its ratio in total tax revenues made up 12.76%; in 2013 — 12.11%; in 2014 — 13.78% and in 2015 — 12.8%. arithmetical average of these indicators are twice higher compared to the 1999 same indicator of Estonia. This signifies that introduction of Estonian model in Georgia may be more painful for state budget. However, when discussing allocation of financial resources between beginner and established business bodies, we should rely on experience that demonstrates that financial resources may be found in the country in order to finance or support one segment of business sector without growth in tax burden on another segment.
would not succeed in Estonia without stable macroeconomic environment. Only profits tax reduction cannot stimulate growth in foreign investments inflow and cannot ensure strong signal to business bodies for reinvestments if domestic business sector representatives or foreign investors are alarmed by national currency volatility, overwhelming political cycles or protectionist tendencies.
Therefore, we should not be confident that Estonian Model is able to independently incentivize significant economic growth. Success of this taxation model depends on creating conditions and environment that are naturally required for attaining economic development.