notably among middle and lower income earners. In 2009, Estonia continued to simplify the tax system by extending the standard VAT rate to more goods and services, which were previously taxed at the reduced rate. Furthermore, the reduced VAT rate was increased from 5 percent to 9 percent.

52. The lowering of the overall tax burden also contributed to combating undeclared work by reducing incentives to evade tax (direct effect) and contributing to higher growth and employment (indirect effect). During 2000-2007, the overall tax burden (as measured by tax revenue as a percentage of GDP) was on average around 31 percent of GDP, down from above 36 percent in 1995. The lowering of the overall tax burden was the result of lower labor taxes (4 percentage points of GDP), and – to a lesser degree – lower capital taxation (by around 1 percentage point of GDP), while taxes on consumption remained broadly constant.

53. Estonia has – together with Slovakia – the lowest labor tax wedge among the NM-EU countries. But low-income earners who are most vulnerable to undeclared work are facing a somewhat higher labor tax wedge than the OECD average, although it is lower than the EU15 average and lower than in most other NM-EU countries. The labor tax wedge is relatively flat, increasing from around 37 percent of labor costs for lower wages (67 percent of average wage) to around 38 percent for average wages, and around 39 percent for higher wages (167 percent of average wage). Social security contributions (the so-called social tax) are the largest component of the labor tax wedge and therefore tend to reduce (formal) employment more than the personal income tax. But the size of this effect also depends to what degree workers perceive these contributions as taxes or as savings (insurance premiums); in the latter case, workers would not respond by reducing labor participation.

54. Due to the various benefit reforms the link between contributions and benefits has been strengthened, which should in principle have raised the awareness of the positive effects of social security contributions, thus reducing incentives to underdeclare earnings. To this end a three-pillar pension system was introduced and unemployment insurance was reformed. The pension reform implies that future pension benefits are linked to lifetime social contributions so that part of social contributions are no longer taxes (according to the classical definition) but (forced) savings to an insurance system. Furthermore, individuals (including self-employed) only receive public health insurance if a minimum social contribution (social tax) has been paid; exceptions are pensioners, pregnant women, individuals under 19 years old, students, and dependent spouses of an insured person. Maternity allowances are also linked to previous earnings.

55. Tax collection, which is under the authority of the Estonian Tax and Customs Board (EMTA), is perhaps the most modern of all EU countries. It has been facilitated by the simplification of the tax system, administrative reforms, and the prevalence of e-government. Estonia ́s rate of electronic filing (personal income tax - 85 percent in 2007, corporate income tax - 88 percent, and VAT - 90 percent) is not only the highest among the NM-EU countries but also among the highest in the world. As a result, Estonia belongs to a group of countries with relatively low costs of tax compliance, as measured by the time spent preparing, filing, and paying taxes. EMTA collects all general taxes, custom duties, and (since 1999) social security contributions. This modernization of tax collection allowed EMTA to shift resources towards areas that help to ensure better compliance. In order to improve tax compliance, public procurement should only be carried out with those firms who do not have tax arrears. EMTA is working closely with the Estonian Labor Inspectorate to exchange risk analysis, and conduct joint operations, as well as cooperating with the Cititenship and Migration Board.

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