The public finance debate (in Estonian — ed.) at Opinion Festival in Paide once again confirmed that the problem facing Estonia cannot be reduced to a simple question of whether taxes should be raised or spending cut. The question is much more fundamental: How can Estonia get its economy growing sustainably again while also putting a stop to the rapid increase in government debt?

Estonia cannot tax itself into prosperity, nor can we cut or borrow our way to prosperity. Estonia must grow its way to prosperity.

Banking tax working in Latvia and Lithuania

Estonia's economy contracted by a total of approximately 5.5 percent from the end of 2021 to the end of 2024. The economy returned to growth in 2025, but growth remained at around just 0.5 percent. This year, growth of approximately 2 percent or slightly more is forecast.

But GDP growth alone is not enough; the quality of that growth is what matters. Is Estonia's economy growing thanks to exports, productivity and private-sector investment, or because the government is spending more and consumption is increasing? The former creates long-term prosperity; the latter may give the economy a short-term boost but does not solve our structural problems.

The same applies to tax policy. We often hear that Estonia's tax burden is not high compared with the European Union average. There is some truth to this when looking at the overall tax burden: Estonia still remains below the EU average. But what matters is not only how much tax is collected, but also where it is collected from.

Estonia's tax system relies heavily on taxing consumption. Consumption taxes account for approximately 39 percent of total tax revenue in Estonia, compared with an EU average of about 27 percent. At the same time, capital taxes account for approximately 8.5 percent in Estonia, compared with an EU average of more than 20 percent. Estonia's tax system is therefore clearly tilted toward consumption.

Tax policy in recent years has tended to deepen this disparity. Just a few years ago, VAT was 20 percent; it has now risen to 24 percent. A motor vehicle tax has been introduced, while excise duties and other taxes have also been raised.

Higher consumption taxes affect everyone, but their impact is not the same for everyone. People on lower incomes spend a larger share of their income on food, housing, energy and other basic necessities. This is precisely why we have repeatedly proposed lowering VAT on staple foods. It is a matter of principle: Should the government finance its growing expenditures by increasingly taxing people's everyday shopping baskets? In my view, it should not.

That does not mean the solution is to impose higher taxes on businesses and investment. Estonia needs more private investment, not less, and any effort to rebalance the tax system must therefore distinguish between productive capital and sectors where profitability has become exceptionally high.

One option is to look to the financial sector. Latvia and Lithuania have imposed additional taxes on the banking sector. Estonia, too, needs to have an honest discussion about whether some government revenue could come from sectors that have enjoyed exceptionally high profitability in recent years. The goal should be to create a fairer tax structure that does less harm to economic growth.

Economy growing slowly, debt rapidly

An even bigger issue is the growth of government debt. In 2019, Estonia's general government debt stood at 8.6 percent of GDP. By 2025, it had risen to 24.1 percent, and according to current forecasts, we are on track to approach 40 percent by the end of the decade. Estonia's debt burden remains low by European standards and there is no reason to deny that. The main problem is the pace at which it is growing. If the economy grows slowly while debt grows rapidly, such a trajectory cannot continue indefinitely.

This points to one of the biggest contradictions in economic policy in recent years. More taxes are being collected from people and businesses, yet government debt is also rising. If the result is simultaneously higher taxes, more debt and weak economic growth, we have to ask whether the chosen policies are actually working.

We need to be honest when discussing the budget deficit. Defense accounts for a significant share of the increase in spending in the coming years. Estonia's defense spending is moving toward approximately 5 percent of GDP, and in the current security environment, I do not believe this is an area where we should make cuts to balance the budget.

That is precisely why the rest of the state budget needs to be managed better. Instead of across-the-board cuts, we need a review of the efficiency of government spending. Duplicative functions, rising administrative costs and programs and subsidies whose impact cannot be measured must be reviewed.

At the same time, we need to distinguish between current spending and investment. From an economic perspective, a euro spent on administration does not have the same value as a euro invested in infrastructure, energy security, research and development or digitalization. We need both a smaller deficit and a higher-quality state budget.

Where will economic growth come from next?

Estonia needs tax stability and investment certainty. Businesses need to know what the tax environment will look like not only next year, but also three or five years from now. Constant changes to the tax system increase uncertainty and delay investment.

We need competitive and predictable energy prices. For industry in particular, the price of energy can determine whether production takes place in Estonia or another country. Estonia must also become a more attractive place to invest. Additional investment incentives should be considered for new production facilities, automation and research and development.

We need less bureaucracy and faster permitting processes. If an investor has to wait years for a permit, the next investment may go to Lithuania, Poland or elsewhere instead of Estonia. Exports must once again become a central focus of Estonia's economic policy. A domestic market of 1.3 million people cannot on its own deliver the economic growth we need to raise living standards and fund defense, healthcare, education and social spending.

Goals for 2031

By 2031, Estonia should have reached a point where the budget deficit is significantly smaller than it is today and the growth of the debt burden has been brought under control. We should aim for a budget deficit of around 1 percent, but achieving that must be based on stronger economic growth, not on stifling the economy with new taxes. The faster the economy, investment and exports grow, the larger the government's revenue base will be.

Economic growth is one of the main prerequisites for sound public finances. When the economy and productivity grow, the tax base expands and the debt burden becomes easier to control. If the economy stagnates, every additional euro spent on defense, pensions, healthcare or education becomes increasingly difficult to finance.

We do not have to choose between sound public finances and a strong economy, because we need both. The experience of recent years should serve as sufficient warning that ever-higher taxes combined with ever-growing debt are not a sustainable economic model.

--

Follow ERR News on Facebook and X and never miss an update!