Latvia should consider lowering its value-added tax rate in the second half of the year to keep inflation within the range needed to adopt the euro, said central bank Governor Ilmars Rimsevics.
“The government would need to consider the possibility to not raise VAT, but the opposite, to lower VAT” if rising consumer prices threaten the country’s euro-adoption goal and receipts are adequate, Rimsevics told reporters in Riga today. “The second half of the year would be the latest that it could be done.”
The Baltic country, which completed a 7.5 billion euro ($9.8 billion) loan program from a group led by the European Union and the International Monetary Fund in December, plans to adopt the euro in 2014. Inflation will have to below the average of the three lowest rates in the European Union plus 1.5 percentage points to qualify for the currency.
The central bank forecasts inflation of 2.4 percent this year; the rate last month was 3.4 percent, the lowest since December 2010. The VAT rate on most items is 22 percent.
“This will definitely stop growth in prices, of course the government would have to follow whether businesses and traders wouldn’t use the lower VAT for their own interests,” said Rimsevics today.
Latvia wouldn’t be the first country to use tax policy to adopt the euro, said Guntram Wolff, deputy director of Bruegel, the Brussels-based research institute, by telephone.
“I think this has been done in a number of countries before the euro was launched,” he said.
Lithuania’s application to adopt the euro in 2007 was rejected by the European Commission after the country missed the inflation target by 0.1 percentage point.
“The current inflation criteria are completely nonsensical” since we could end up with an inflation reference rate close to zero due recessions in some countries, Wolff said. “It’s going to be a very tough criteria to meet” for Latvia.
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