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Personal Income Tax Reform in Lithuania: Macroeconomic and Welfare Implications

Sigitas Karpavicius and Igor Vetlov
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Sigitas Karpavicius: University of New South Wales

No 2, Bank of Lithuania Working Paper Series from 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.

Keywords: fiscal policy; taxation; tax evasion; dynamic general equilibrium model (search for similar items in EconPapers)
JEL-codes: E62 H24 H25 H26 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2008-12-01
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