Estonia is to tax systems what Ryanair is to airlines
The Estonian tax system is hailed around the globe as a stroke of genius. That’s a lot like calling Ryanair the best airline in the world.
Ryanair is the epitome of the no-frills airline. It’s as uncomfortable as it is devious. As anyone who has ever flown with them knows, with Ryanair, things aren’t quite as advertised.
The same goes for the Estonian tax system. But let me explain.
The reason why Ryanair can reel you in by offering you a ridiculously cheap ticket is that they broke up into several different bits what used to be sold simply as a single thing.
You might pay no more than €17 for your ticket to London — but once airport tax, fuel surcharge, the cost of your seat and luggage, and the credit card fee are paid, you’re likely looking at roughly the same kind of money you would have spent on a “proper” airline.
(Though apparently these days all airlines are no-frills airlines — I heard Finnair now weigh you to better be able to calculate how much fuel to take on. But I digress.)
The way you pay tax in Estonia is much the same. The Estonian government in the 1990s didn’t come up with a brilliant new system. All they did was move a few markers. Just like Ryanair.
Estonia’s income tax isn’t a stroke of genius. All they did is move a marker
For the sake of this exercise, let’s invent a fictitious European country. We’ll call it Doggerland. In Doggerland, your €1,000 net salary is taxed as follows:
Your employer pays you €1,672.50. Of this money, you pay €412.50 into your public social insurance fund. You pay €30 unemployment insurance, a €25 contribution to your second-pillar pension fund, and €205 income tax. You’re left with €1,000 to take home.
This is Doggerland, which runs a tax system like most of the EU member states have it. Your employer spends €1,672.50 on you, you take €1,000 home.
Now. It just so happens that Estonia applies the exact same percentages taxing its citizens as Doggerland does — but with a twist.
Like in Doggerland, in Estonia your employer spends €1,672.50 on you. But this isn’t all your money.
First off, your employer pays a contribution to the country’s social system in the form of a social tax in the amount of 412.50. Then they also pay a share of your unemployment insurance, namely €10. We arrive at your Estonian “gross salary”, namely the €1,250 that are left. Of that money, you now pay €25 into your second-pillar pension fund, €20 towards your unemployment insurance, and €205 in income tax. You take €1,000 home. The amounts are the same, but the distribution is different.
How has the marker moved?
The marker has moved in such a way that social tax and the employer’s unemployment insurance contribution are declared as tax they paid, not you. Even though it is part of the total amount of money that your employer is happy to pay for your work.
This matters because beyond VAT, Estonia doesn’t levy any kind of corporate tax. Companies pay income tax on the dividends they pay out, but both at a rate corresponding to personal income tax, and without any additional taxes to be paid on the money on the part of the recipient of the dividend. The principle is the same: while in Doggerland the company would pay out 100% of the money to the shareholder, and the state would tax the dividend as the shareholder’s personal income, Estonia again moves the marker and has the company pay income tax on the dividend. This means that while nominally the tax burden is with the company, in practice the company’s gains still haven’t been taxed.
Yet you’ll still hear plenty of businessmen (and right-of-centre parties) complain about the tax burden of companies.
Utter bollocks. Beyond VAT and the negligible unemployment insurance contribution, Estonian companies don’t pay a cent’s worth of tax. What we are looking at is nothing more than a marker that was moved because a), as it was meaningful in the 1990s, the resulting flat-rate income tax is easier to handle as taxes need to be collected only from a relatively small number of businesses rather than from hundreds of thousands of individuals, and b), as it is meaningful to the Reform Party, Pro Patria and their crowd now, companies can claim they pay tax (because legally they do) even though de facto they only pay the state the money you would otherwise pay as tax yourself.
Bottom line: beyond VAT, a company in Estonia does not pay tax. It just doesn’t. Thanks to the marker moved to just the right position, legally they do — but if we’re all being honest, and if we apply the standards used by most Western European countries, they really don’t.
A tax haven of sorts
Early in 2018, the Ukraine blacklisted Estonia as a tax haven. The measure lasted only for a very short time and was countered swiftly by a large-scale diplomatic offensive on the part of the Estonian Ministry of Foreign Affairs.
This was jokkimine (for JOKK in Estonian, juriidiliselt on kõik korrektne, legally speaking everything is proper) at the bilateral level. Because of course Estonian businesses pay tax! They pay labour tax, VAT, income tax on redistributed profits… (Shh; just don’t mention the marker.)
Forced entrepreneurship in start-up wonderland
If you believe the proponents of the current system, it is beautifully simple and brings great benefits for the economy. But as with Ryanair, stripping everything down to the bare essentials never comes without side effects.
The 30-plus percent social tax your employer pays and your “gross salary”, with a difference of a few hundred euros depending on how much you make, is the perfect means to obfuscate and diminish what an individual’s work is worth.
Your employer may suddenly tell you that they’d prefer it if you invoiced them, rather than expect them to pay you a salary.
They have a good reason to do so, because what happens now is that they’ll offer you the same hourly pay as before, say €9.50, for example. The difference with what was the case before, of course, is that if you invoice them you’ll end up paying your own social tax out of that money — while previously they paid it on top of that money. They’re saving thousands this way.
In other words, you’re worse off than you were before, but they don’t want to work with you unless you invoice them. So you’re forced to agree.
There’s a term for this: forced entrepreneurship. I don’t know of a single study on the subject in Estonia. But it’s high time someone conducted one.
Such a study may then shed some light on Estonia’s record numbers of new businesses founded every year. And if you think just a little further along those lines, you realise that quite a bit of the country’s reputation as an innovative and inventive economy may thus also be, well, bollocks.
The current system doesn’t boost the economy, but undermines it
Estonia’s economy is mainly consumer-driven. Has been for years. If you take into account how much more the basic cost of living (not to mention that you’re in fact taxed at near half of your labour’s worth) affects the disposable income of someone with a low salary than it affects that of someone who makes a lot, you quickly realise that the whole system is actually regressive. Those who earn less proportionally pay more tax than those who earn a lot.
And as the people who earn less, the majority of consumers, also carry the Estonian economy, the current system is slowly undermining everything — including the state’s finances, Estonia’s productivity, its competitiveness, you name it. In short, it doesn’t do much good.
The current government’s manipulation of the tax-deductible income has now led to a de facto progressive system, meaning that those who make the least now pay ever so slightly less tax. While the opposition (and part of the coalition) are screaming bloody murder, the sad fact is that this measure is nowhere near enough.
The 4+ percent growth predicted for this year is offsetting the negative effects for the time being. But this economy has nowhere to go so long as companies’ gains aren’t taxed, the loopholes aren’t closed that let them take millions out of the country untaxed every year, and nothing is done against the abuse of the private limited corporation (called osaühing in Estonian) as a way to circumvent tax.
A nation on the fiddle
The sad thing is that in the long term, this kind of system where both businesses as well as private individuals are constantly on the fiddle trying to save a few cents here and squeeze a few hundred euros out of their companies there is worlds away from the coveted Estonian self-image of almost Germanic efficiency and reliability.
In the current system, millions (if not billions) disappear in a bottomless pit every year because companies as well as individuals are cheating the state and each other wherever they see an opportunity.
That isn’t to say this isn’t happening elsewhere. The difference though is that in Estonia, it’s the way the system is built that actually forces people to do it. It’s not much of an extra trick in the sense of the Panama or Paradise Papers. Offshore accounts and expensive schemes aren’t what is putting the local economy at risk.
At the end of the day, it’s a matter of attitude. And if the majority of businesses remain stuck in a culture of endless wheeling and dealing, Western Europe will remain as far away as it still is.