MICROENTERPRISE TAX REGIME IN LATVIA: A FISCAL BLACK HOLE OR A JOB CREATION TOOL?

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1 MICROENTERPRISE TAX REGIME IN LATVIA: A FISCAL BLACK HOLE OR A JOB CREATION TOOL? Mihails Hazans, University of Latvia and IZA mihails.hazans@lu.lv (based on a background paper for the World Bank (2016) Latvia Tax Review ) Corruption, Tax Evasion and Institutions International Conference, SSE Riga, May 11-13, 2017

2 MICROENTERPRISE TAXATION (MET): DESIGN, COVERAGE, ISSUES MET ( ): a simplified tax regime (9% of turnover instead of CIT, PIT on earnings, & SSC) for firms or self-employed individuals with: sales volume <= EUR, <=5 employees, monthly earnings of each <=720 EUR Designed and introduced in the crisis/post-crisis environment (high unemployment, low job creation). Not time limited; not well targeted. In 2015, 9% of all employees with non-zero earnings (private sector: 13%) covered by MET Effective tax rate on microenterprise earnings (on average 13% in 2015) is much lower than effective tax rate on general regime earnings (about 48%, of which 34% is SSC) and effective tax rate on envelope wages paid from from owner s dividend income ( *(1-0.15) = 23.5%). MET workers are not socially protected (effective SSC payments about 9% instead of 34%) Costly regime (estimated costs associated with MET in terms of tax revenue foregone - 60 million EUR annually in ) Other concerns: productivity, innovation?

3 MET EARNINGS HAS BECOME IMPORTANT SOURCE OF PERSONAL INCOME Business, labor and interest income of physical persons by source, 2008 & MET earnings Million EUR Million EUR Self-empl. Income Interest income Contract work Dividends General regime earnings (right scale) Source: State Revenue Service.

4 Much of the inflow into the microenterprise regime came from the general regime, but also from non-employment or informal employment individuals who worked in microenterprises in , by work history over % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 66% 59% 55% 48% 43% 34% 23% 28% 16% 25% 21% 19% 16% 15% 8% 6% Only microenterprises Mainly microenterprises Mixed Only/mainly general regime employees Self-employment only Age 20+, no declared earnings Age 15-19, no declared earnings Age <15 Source: Calculations based on State Revenue Service Biznesa, data. vadības un

5 INFLOWS FROM INFORMALITY AND NON-EMPLOYMENT NOT NEGLIGIBLE 25% Estimated shares of MET workers without declared labor income during the previous year (Source: combined EU-SILC & SRS data) Main inflows into the MET regime in , by tax regime in the previous year (Source: SRS data) NE -MET GEN - MIX GEN - MET MIX-MET MET-MIX SE - MET (right scale) % 15% 10% 7% 5% 7% 3% only informal income no labor income % 14% 14% 9% 9% %

6 Most sectors with high MET share in private employment are service sectors with highly qualified workforce (=>high burden of labor taxes) Piezīmes. Šis skaitlis atspoguļo tādu strādājošo vidējo skaitu gadā, kuriem mikrouzņēmumos ir pozitīvi ienākumi. Tas aptver nozares ar vairāk nekā 1000 mikrouzņēmumos strādājošo. Avots: Latvijas Valsts ieņēmumu dienesta dati, CSB dati un darbinieku skaita aprēķini. Mikrouzņēmumu režīmā strādājošo īpatsvars privātajā sektorā, %

7 Sectoral determinants of MET share among employers and private sector workers, 2015 Sectors that faced higher effective tax rates on labor and profit in 2010 feature larger MET shares among employers and private sector employees in 2015 Estimated effects Descriptives Employees (mean=0.163, s.d.=0.227) Employers (mean=0.275, s.d.=0.180) Explanatory variables mean s.d. Beta (s.e.) Sig. Beta * s.d.(x) Beta (s.e.) Sig. Beta * s.d.(x) Taxes on labor, * * (as a share of turnover) (0.215) (0.347) Taxes on profit, 2010 (as a share of turnover) Share of zero-earnings employees, 2010 Sectoral dummies * * (0.989) (1.404) * * (0.265) (0.271) Education & social work * X (NACE 85 & 88) (0.048) Arts & entertainment * (NACE 90) (0.032) (0.051) High-tech X * (NACE 21 & 26) (0.038) R-squared Root MSE N obs

8 Sectors with larger shares of MET-only workers in 2014 have seen larger cuts (or smaller increases) in the burden of main taxes between 2010 and 2014 Dependent variable: Change in tax burden (as a share of 2010 turnover) Explanatory variables Share of MET-only workers, 2014 Share of mixed workers, 2014 VAT returned, 2010 mean s.d Estimated coefficients Beta*s.d.(x) * (0.068) * (0.127) * (0.177) (as a share of Sectoral dummies Construction * (0.068) Manufacturing * electronic & optical (0.003) Arts & entertainment * (0.003) * Employment activities (0.003) R-squared Root MSE N obs

9 Sectors with higher shares of microenterprise workers in 2014 feature smaller growth of real labor productivity & larger growth of nominal unit labor costs. 9 Dependent variables: Growth between 2010 and 2014 Labor cost per Labor productivity measured as Full-time equivalent (FTE) 1 euro of output Value added a per FTE mean s.d Value added a per employed Explanatory variables Estimated coefficients (robust s.e. in italic below) Share of all MET workers, 2014 b * * * Labor cost per full-time worker, * X X 2010 (1000 EUR), log Sectoral dummy Manufacturing of basic metals * X * * Constant * * R-squared Root MSE b N obs

10 Econometric analysis of earnings The Figure in the next slide reports the results from (log) annual earnings regressions controlling for: the year; gender; education; total work experience; age; living with a partner; presence of children below age of 15; ethnicity and citizenship; limitations in daily activities; chronic illness; region and level of urbanization; number of months worked full-time and part-time; presence of self-employment income; tax regime as employee during the income reference year (only general, mixed, only MET or informal); being informal, MET-only or mixed employee in another year; size (7 categories) and economic activity (23 categories) of local unit the main job; contract type; occupation (2-digit ISCO code); supervisory responsibilities; job change since the previous year. For each year, the sample consists of all individuals whose gross annuals earnings were no less than one monthly minimum wage, excluding those who received part of the income reference year earnings abroad. N obs is between 12 and 13 thousand, while R-squared varies from 0.65 to * and refer to coefficients significant at 5% and 1% level, respectively

11 Analysis of earnings suggests that microenterprise-only workers have lower productivity than other workers (and are overpaid) Informal Was or will be informal Was or will be MET-only Mixed MET-only 50% % 30% Effects on earnings 20% 10% 0% -10% -20% -30% * * net earnings gross earnings

12 Main findings on the MET regime Main inflows: from the general regime, non-employment, and informality Sectors with higher shares of MET workers feature smaller growth of real labor productivity Analysis of earnings suggests that MET-only workers have lower productivity than other workers and are over-paid Sectors that faced higher effective tax rates on labor and profit in 2010 feature larger MET shares among workers and employers in 2015 Sectors with larger shares of MET-only workers in 2014 have seen larger cuts (or smaller increases) in the burden of main taxes (labor taxes, profit taxes, VAT, and MET) between 2010 and 2014 => firms switched to MET to reduce tax burden and succeeded

13 THANK YOU!

Labor Force Participation and the Wage Gap Detailed Notes and Code Econometrics 113 Spring 2014

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