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Personal Income Tax Reform in Lithuania: Macroeconomic and Welfare Implications

Author

Listed:
  • Sigitas Karpavicius

    (University of New South Wales)

  • Igor Vetlov

    () (Bank of Lithuania)

Abstract

In this paper, the economic impact of the 2006–2008 personal income tax (PIT) reform in Lithuania is analyzed applying model-based simulations. We find that the undertaken PIT reform is unsustainable as it leads to permanent government budget deficits and ever increasing public debt. This result holds even allowing for endogenous reduction in tax evasion. After introducing permanent compensatory fiscal measures ensuring long-term sustainability of the PIT reduction, we demonstrate that the lower PIT produces higher output and lower prices in the long run. Higher domestic spending is supported by higher employment and after-tax wages. Moreover, following a reduction in the marginal production costs, producer prices fall enhancing economy’s international competitiveness and boosting domestic exports. Pre-announcement of the tax reform implies early macroeconomic reaction, and thus in most cases smoother adjustment of the economy to the tax change.

Suggested Citation

  • Sigitas Karpavicius & Igor Vetlov, 2008. "Personal Income Tax Reform in Lithuania: Macroeconomic and Welfare Implications," Bank of Lithuania Working Paper Series 2, Bank of Lithuania.
    • Handle: RePEc:lie:wpaper:2
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    File URL: http://www.lb.lt/en/publications/no-2-personal-income-tax-reform-in-lithuania-macroeconomic-and-welfare-implications
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Sigitas Karpavicius, 2009. "The Effects of Fiscal Instruments on the Economy of Lithuania," Bank of Lithuania Working Paper Series 4, Bank of Lithuania.

    More about this item

    Keywords

    fiscal policy; taxation; tax evasion; dynamic general equilibrium model;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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