Economic Policies
#6Key Findings
Despite a loosening of its past focus on fiscal discipline, Estonia falls into the top ranks internationally (rank 6) with regard to economic policies. Its score in this area is unchanged relative to its 2014 level.
After a steep decline in GDP in mid-2020, growth returned to modest levels. The government engaged in robust fiscal support programs, boosting deficits and increasing the national debt. Companies received wage support in turn for keeping workers in employment, effectively combating poverty and preventing widespread job loss.
Employment rates returned to pre-crisis levels in 2021, with labor shortages becoming a bigger concern than unemployment. High tax rates on labor and strict immigration rules have prevented the country from attracting badly needed foreign workers.
While debt levels remain low by international standards, it now appears that balanced budgets are unlikely under the current tax system. This includes a flat income tax of 20%, and no appreciable capital taxes. There is widespread consensus that the system needs revision. Many cryptocurrency companies are registered in Estonia, prompting calls to bolster the currently lax regulatory requirements.
After a steep decline in GDP in mid-2020, growth returned to modest levels. The government engaged in robust fiscal support programs, boosting deficits and increasing the national debt. Companies received wage support in turn for keeping workers in employment, effectively combating poverty and preventing widespread job loss.
Employment rates returned to pre-crisis levels in 2021, with labor shortages becoming a bigger concern than unemployment. High tax rates on labor and strict immigration rules have prevented the country from attracting badly needed foreign workers.
While debt levels remain low by international standards, it now appears that balanced budgets are unlikely under the current tax system. This includes a flat income tax of 20%, and no appreciable capital taxes. There is widespread consensus that the system needs revision. Many cryptocurrency companies are registered in Estonia, prompting calls to bolster the currently lax regulatory requirements.
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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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9
9
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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7
6
7
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.
5
4
3
4
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.
2
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.
The implementation of economic and innovation policy is the responsibility of the Ministry of Economic Affairs and Communications. In parallel, the Ministry of Education and Research develops and coordinates implementation of the national R&D strategy. These two strategies are supposed to be complementary but duplication and lack of synergy between ministries have been continuous problems. Similarly, labor policy falls under the purview of the Ministry of Economic Affairs, Ministry of Education and Ministry of Social Affairs. Due to growing labor shortages, the Ministry of Interior, responsible for immigration, has also become an important actor in economic policy.
The global economic climate between 2019 and 2021 was dictated by the COVID-19 crisis, and the efforts of the government and the European Union to mitigate its effects. It has led to robust fiscal support programs, responsible for increased fiscal deficits and national debt. Overall, the Estonian economy has proven resilient to the COVID-19 crisis, except for some sectors such as hospitality and transport. While the Estonian economy runs in high gear, rising inflation, labor shortages and high pressure to boost wages could erode its competitiveness. Although income taxes are low, high tax rates on labor and strict policies on hiring immigrant workers prevent Estonia from attracting foreign labor, which is urgently required due to Estonia’s aging population.
As an EU member state, Estonia forms its economic policy in accordance with EU strategies and has adopted the long-term Estonia 2035 strategy, which describes a set of visionary targets with the overall objective of improving social well-being and sustainability. However, Estonia 2035 lacks a clear set of reforms that can be implemented and an aim for such reforms. Even if in some areas measurable targets are defined, the path to achieve them is not outlined.
The global economic climate between 2019 and 2021 was dictated by the COVID-19 crisis, and the efforts of the government and the European Union to mitigate its effects. It has led to robust fiscal support programs, responsible for increased fiscal deficits and national debt. Overall, the Estonian economy has proven resilient to the COVID-19 crisis, except for some sectors such as hospitality and transport. While the Estonian economy runs in high gear, rising inflation, labor shortages and high pressure to boost wages could erode its competitiveness. Although income taxes are low, high tax rates on labor and strict policies on hiring immigrant workers prevent Estonia from attracting foreign labor, which is urgently required due to Estonia’s aging population.
As an EU member state, Estonia forms its economic policy in accordance with EU strategies and has adopted the long-term Estonia 2035 strategy, which describes a set of visionary targets with the overall objective of improving social well-being and sustainability. However, Estonia 2035 lacks a clear set of reforms that can be implemented and an aim for such reforms. Even if in some areas measurable targets are defined, the path to achieve them is not outlined.
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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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6
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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1
Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Recent labor market reforms have focused on the employability of disabled people in order to expand labor supply. Young people, especially NEET, have been another focus of ALMP. The evidence on policy efficiency remains mixed – career guidance has been by far the most widespread measure both for young and disabled people, but its quality is evaluated by the target groups as low (see Centar 2021). Unemployment among young people remains almost twice as high as the general rate. Several other targets in transition from unemployment to employment for various social categories were also not reached (Töötukassa 2021).
COVID-19 has substantially changed the planned course of reforms. In the first half of 2020, 17,534 enterprises (mostly in commerce and industrial sectors) received wage support from the Unemployment Insurance Fund (ca €256 million) to compensate for a loss in turnover and to keep workers in employment. Employers who benefited from this scheme were not allowed to fire workers in the following six months. A recent analysis (Praxis 2021) revealed that the measure effectively combated poverty (especially among those aged 50 and over) and kept about 65,000 people in employment.
In 2021, the economic situation stabilized – the employment rate recovered close to the pre-crisis level and the general unemployment rate remained below 10%. In the second half of 2021, labor shortages became a greater concern than unemployment. Immigration policy has remained strict, and hiring immigrant workers is administratively difficult and economically costly for enterprises. At the same time, the Act on Unemployment Insurance was amended in August 2020, allowing registered unemployed persons to take mini-jobs without losing their unemployment benefit.
Moreover, the unemployment benefit replacement rate for the first 100 days of unemployment increased from 50% to 60%, which has helped to reduce poverty among the unemployed. Platform and gig-economy workers are legally defined as self-employed, which means that they are not eligible for labor market support measures and cannot join a union in order to protect their rights.
Citations:
Centar (2021). Karjääriteenused Eestis: teel terviklahenduseni. Lõppraport. Tallinn. https://www.tootukassa.ee/sites/tootukassa.ee/files/karjaariteenuste_uuring_loppraport.pdf (accessed 02.01.2022)
Praxis (2021). COVID-19 sotsiaal-majanduslik mõju:Töötukassa töötasu hüvitis 2020. Tallinn
Eesti Töötukassa (2021). Majandusaasta aruanne 2020. https://www.tootukassa.ee/sites/tootukassa.ee/files/tootukassa_aastaaruanne_2020.pdf (accessed 02.01.2022)
COVID-19 has substantially changed the planned course of reforms. In the first half of 2020, 17,534 enterprises (mostly in commerce and industrial sectors) received wage support from the Unemployment Insurance Fund (ca €256 million) to compensate for a loss in turnover and to keep workers in employment. Employers who benefited from this scheme were not allowed to fire workers in the following six months. A recent analysis (Praxis 2021) revealed that the measure effectively combated poverty (especially among those aged 50 and over) and kept about 65,000 people in employment.
In 2021, the economic situation stabilized – the employment rate recovered close to the pre-crisis level and the general unemployment rate remained below 10%. In the second half of 2021, labor shortages became a greater concern than unemployment. Immigration policy has remained strict, and hiring immigrant workers is administratively difficult and economically costly for enterprises. At the same time, the Act on Unemployment Insurance was amended in August 2020, allowing registered unemployed persons to take mini-jobs without losing their unemployment benefit.
Moreover, the unemployment benefit replacement rate for the first 100 days of unemployment increased from 50% to 60%, which has helped to reduce poverty among the unemployed. Platform and gig-economy workers are legally defined as self-employed, which means that they are not eligible for labor market support measures and cannot join a union in order to protect their rights.
Citations:
Centar (2021). Karjääriteenused Eestis: teel terviklahenduseni. Lõppraport. Tallinn. https://www.tootukassa.ee/sites/tootukassa.ee/files/karjaariteenuste_uuring_loppraport.pdf (accessed 02.01.2022)
Praxis (2021). COVID-19 sotsiaal-majanduslik mõju:Töötukassa töötasu hüvitis 2020. Tallinn
Eesti Töötukassa (2021). Majandusaasta aruanne 2020. https://www.tootukassa.ee/sites/tootukassa.ee/files/tootukassa_aastaaruanne_2020.pdf (accessed 02.01.2022)
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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.
Estonia is internationally recognized for its simple and transparent tax system. Besides the modest income tax (standard rate of 20%), capital is not taxed at all (except very marginal land tax), which violates the principle of horizontal equity. Motor fuel, energy and gas excises – which had increased rapidly in previous periods – were decreased in 2021 (prior to spring 2022) in order to cope with the COVID-19 impact. Environmental taxes were not a policy priority in 2019–2021.
Retained and reinvested profits are exempt from corporate income tax in Estonia, and the country resisted the global corporate tax overhaul under the aegis of the OECD. Estonia long claimed that this agreement will hamper the international competitiveness of small countries, but ultimately chose not to be cast out by the international community.
Internally, there is widespread consensus that the current tax system needs revision due to decreasing tax returns, an aging population, increasing inequality and environmental pressures, but no substantial debates have started yet. The Estonian parliament’s Foresight Centre provided three scenarios for a sustainable tax system, but these were dismissed outright by the minister of finance, Keit Pentus-Rosimannus (Reform Party), who promised to come up with their own suggestions by late 2022. Thus, it is unclear what direction tax debate will take over the coming years.
One of the main challenges comes from the Estonian welfare system, which is financed almost entirely (80%) through social insurance contributions. High labor costs may weaken the country’s economic position and could lead to labor relations abuses. Even more importantly, social insurance contributions alone cannot provide sufficient financing for social services given an aging population and changing work patterns, which destabilize social tax receipts. The public pension funds have persistently accumulated debt and the health insurance fund is under a long-term financial austerity policy. The future of the social welfare budget has been weakened as a result of the funded pensions reform (2021), which made the previously mandatory second pillar voluntary. The amended law allows people to withdraw their long-term pension savings before the pension age in full and this option was used by about a quarter of insured persons. This populist decision to “free” citizens’ money improved tax revenues in 2021, as the withdrawn funds attracted income tax, but reduced social tax revenues, as individual contributions to the second pillar from people who exited the system ceased.
Citations:
Foresight Center (2021). https://www.riigikogu.ee/en/foresight/future-proof-tax-structure/ (accessed 07.01.2022)
Retained and reinvested profits are exempt from corporate income tax in Estonia, and the country resisted the global corporate tax overhaul under the aegis of the OECD. Estonia long claimed that this agreement will hamper the international competitiveness of small countries, but ultimately chose not to be cast out by the international community.
Internally, there is widespread consensus that the current tax system needs revision due to decreasing tax returns, an aging population, increasing inequality and environmental pressures, but no substantial debates have started yet. The Estonian parliament’s Foresight Centre provided three scenarios for a sustainable tax system, but these were dismissed outright by the minister of finance, Keit Pentus-Rosimannus (Reform Party), who promised to come up with their own suggestions by late 2022. Thus, it is unclear what direction tax debate will take over the coming years.
One of the main challenges comes from the Estonian welfare system, which is financed almost entirely (80%) through social insurance contributions. High labor costs may weaken the country’s economic position and could lead to labor relations abuses. Even more importantly, social insurance contributions alone cannot provide sufficient financing for social services given an aging population and changing work patterns, which destabilize social tax receipts. The public pension funds have persistently accumulated debt and the health insurance fund is under a long-term financial austerity policy. The future of the social welfare budget has been weakened as a result of the funded pensions reform (2021), which made the previously mandatory second pillar voluntary. The amended law allows people to withdraw their long-term pension savings before the pension age in full and this option was used by about a quarter of insured persons. This populist decision to “free” citizens’ money improved tax revenues in 2021, as the withdrawn funds attracted income tax, but reduced social tax revenues, as individual contributions to the second pillar from people who exited the system ceased.
Citations:
Foresight Center (2021). https://www.riigikogu.ee/en/foresight/future-proof-tax-structure/ (accessed 07.01.2022)
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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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6
Budgetary policy achieves most standards of fiscal sustainability.
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3
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3
Budgetary policy achieves some standards of fiscal sustainability.
2
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Budgetary policy is fiscally unsustainable.
Estonia has followed a strict fiscal policy for decades. As a result, the country has Europe’s lowest public debt as a percentage of GDP and can meet future financial obligations without placing extra burdens on future generations. The overall tax burden has remained fairly stable throughout the years.
While in 2019 the government stated that it would achieve a balanced budget in 2020, the COVID-19 crisis turned those promises upside down. Between 2020 and 2021, the budget turned deeply negative and government spending was supported by increased borrowing, albeit from very low levels previously. According to Ülo Kaasik, the vice-president of the central bank, the current tax system offers no hope to balance the budget in the foreseeable future and either increasing the tax base or significantly cutting spending is necessary. The incumbent liberal government will most likely opt for the latter.
The current state of and forecasts regarding the future of social security funds in Estonia pose the largest risk to fiscal sustainability. At present, the national public pension fund runs a deficit equivalent to nearly 2% of GDP each year. The recent government decision to make second-pillar pension schemes voluntary and allow insured persons to withdraw savings prior to retirement poses a significant challenge to the government’s ability to secure citizens’ welfare while adhering to the principles of fiscal sustainability and intergenerational fairness. The Health Insurance Fund and Unemployment Insurance Fund lost part of their autonomy over their budgets when the funds’ reserves were merged with the government liquidity reserves in 2011–2012.
Citations:
Postimees (2. January 2022). Interview with Ülo Kaasik. https://majandus.postimees.ee/7421246/ulo-kaasik-rahatrukita-oleks-vaesus-suurem (accessed 07.01.2022)
While in 2019 the government stated that it would achieve a balanced budget in 2020, the COVID-19 crisis turned those promises upside down. Between 2020 and 2021, the budget turned deeply negative and government spending was supported by increased borrowing, albeit from very low levels previously. According to Ülo Kaasik, the vice-president of the central bank, the current tax system offers no hope to balance the budget in the foreseeable future and either increasing the tax base or significantly cutting spending is necessary. The incumbent liberal government will most likely opt for the latter.
The current state of and forecasts regarding the future of social security funds in Estonia pose the largest risk to fiscal sustainability. At present, the national public pension fund runs a deficit equivalent to nearly 2% of GDP each year. The recent government decision to make second-pillar pension schemes voluntary and allow insured persons to withdraw savings prior to retirement poses a significant challenge to the government’s ability to secure citizens’ welfare while adhering to the principles of fiscal sustainability and intergenerational fairness. The Health Insurance Fund and Unemployment Insurance Fund lost part of their autonomy over their budgets when the funds’ reserves were merged with the government liquidity reserves in 2011–2012.
Citations:
Postimees (2. January 2022). Interview with Ülo Kaasik. https://majandus.postimees.ee/7421246/ulo-kaasik-rahatrukita-oleks-vaesus-suurem (accessed 07.01.2022)
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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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3
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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.
Research, development and innovation (RDI) are frequently stressed as national development priorities, reflected in the National Development Plan of Research, Innovation and Entrepreneurship 2021–2035 (TAIE). The new strategy should bring research closer to the economy, where outcomes, so far, have been modest. The Estonian Research Council (ETAG) has stated that national strategies “have not triggered any significant changes in the R&D structures and strategies of universities or companies.”
Public and private R&D expenditures have remained stagnant or even decreased; the shortage of funds remains one of the main obstacles to promoting RDI. The promise to increase public RDI expenditure to 1% of GDP over the next three years has not been fulfilled and RDI expenditures stagnated at 0.71% of GDP for 2019–2021.
Estonia is one of the few countries worldwide that does not have tax exemptions for enterprise-led R&D activities, nor is there any R&D-related risk-sharing between the public and private sectors. High costs and high risks undermine private sector motivation for investing in R&D. The government policy toward this problem has been to encourage innovation and the transfer of scientific knowledge to enterprises via special grant schemes (NUTIKAS, ResTA, SekMO) by supporting collaboration between R&D institutions and companies. As a result of these efforts, private sector R&D expenditure exceeds that of the public sector.
R&D policy measures have been much more successful in developing scientific research, as indicated by an increased number of highly ranked international publications and the improved international rankings of main Estonian universities. Advances in the development of patents, high-tech products and services are noticeable but less prominent. In recent years, the number of R&D personnel in the private sector has increased by 45% in contrast to a decrease (-3%) in the public sector.
Citations:
ETAG (2021). TA statistika rahvusvahelises võrdluses.https://www.etag.ee/wp-content/uploads/2022/01/TA-statistika-rahvusvaheline-vordlus_jaanuar-2022_07012022.pdf (accessed 07.01.2022)
Public and private R&D expenditures have remained stagnant or even decreased; the shortage of funds remains one of the main obstacles to promoting RDI. The promise to increase public RDI expenditure to 1% of GDP over the next three years has not been fulfilled and RDI expenditures stagnated at 0.71% of GDP for 2019–2021.
Estonia is one of the few countries worldwide that does not have tax exemptions for enterprise-led R&D activities, nor is there any R&D-related risk-sharing between the public and private sectors. High costs and high risks undermine private sector motivation for investing in R&D. The government policy toward this problem has been to encourage innovation and the transfer of scientific knowledge to enterprises via special grant schemes (NUTIKAS, ResTA, SekMO) by supporting collaboration between R&D institutions and companies. As a result of these efforts, private sector R&D expenditure exceeds that of the public sector.
R&D policy measures have been much more successful in developing scientific research, as indicated by an increased number of highly ranked international publications and the improved international rankings of main Estonian universities. Advances in the development of patents, high-tech products and services are noticeable but less prominent. In recent years, the number of R&D personnel in the private sector has increased by 45% in contrast to a decrease (-3%) in the public sector.
Citations:
ETAG (2021). TA statistika rahvusvahelises võrdluses.https://www.etag.ee/wp-content/uploads/2022/01/TA-statistika-rahvusvaheline-vordlus_jaanuar-2022_07012022.pdf (accessed 07.01.2022)
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To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?
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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.
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The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
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The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
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The government does not contribute to improving the regulation and supervision of financial markets.
Estonia actively participates in developing and securing financial stability and transparency in global financial markets. Estonia is a member of the Council of Europe’s MONEYVAL monitoring body. Several domestic bodies have been established to combat money laundering, such as the Governmental Committee for the Coordination of Money Laundering Prevention, the Financial Intelligence Unit (FIU) and the Estonian Financial Supervision Authority (FSA). The FIU is an independent unit of the Estonian Police and Border Guard Board, and the FSA is an independent body that supervises all financial sector participants. In recent years, the FSA has had a prominent role in combating money laundering in the Estonian financial sector. Because of the internationally prominent cases of money laundering in the Danske Bank and the Estonian branch of Swedbank (the largest bank in the country), the Estonian government introduced several measures to prevent similar cases in the future. One of the government’s key policy proposals is to make clients fully responsible for proving the legality of their funds. In cases of suspected money laundering or terrorist financing, the FIU analyses and verifies information taking measures where necessary and forwarding materials to the competent authorities upon detection of a criminal offense.
Currently, the key topic is regulation of crypto companies registered in Estonia. Estonia was one of the first countries to set minimum levels to register a crypto company. As a result, a myriad of foreign-owned crypto companies were registered in Estonia. Current government policy is to turn around the initial very lax regulatory requirements, and avoid potential damage to the national financial system and reputation.
Currently, the key topic is regulation of crypto companies registered in Estonia. Estonia was one of the first countries to set minimum levels to register a crypto company. As a result, a myriad of foreign-owned crypto companies were registered in Estonia. Current government policy is to turn around the initial very lax regulatory requirements, and avoid potential damage to the national financial system and reputation.