In response to growing concerns about national security, the Estonian Parliament adopted the Security Tax Act, planned to take effect from January 2025 onwards. Among other measures, the Act originally included a 2% Security Tax on personal income and 2% increases in VAT. The Security Tax was subsequently revised into a 2% increase in the personal income tax rate and later repealed, leaving only the VAT increase implemented to date. Separately, the government revised the basic personal income tax allowance, making it independent from taxable income. This note describes the fiscal, distributional, poverty, and inequality impacts of these reforms.
Assessing Estonia’s Security Tax Act
Abstract
Budgetary deficit. The reform package as it was known at the time of analysis would lead to an annual revenue loss of EUR 192 million (0.46% of GDP). Additional revenues from the PIT and VAT increases are outweighed by the costs of the tax allowance reform.
Lower redistribution. The higher VAT rate would mainly affect lower-income households. The higher personal income tax would negatively affect middle‑ to high-income households, but this would be offset by the more generous allowance for these income groups.
Higher poverty and inequality. The VAT and personal income tax reforms would increase post-consumption tax poverty and inequality.
In response to growing concerns about national security, the Estonian Parliament adopted the Security Tax Act in December 2024. The Act introduced a package of temporary fiscal measures to support higher defence spending. Initially planned for 2025 to 2028, the package originally included three main components: a 2% security tax on personal income, a 2% increase in the standard VAT rate, and a 2% corporate income tax on earned profits.
The Parlement revised the Act in June 2025. The revision cancelled the temporary 2% security tax on personal income and instead proposed a permanent increase in the personal income tax (PIT) rate from 22% to 24%, starting in January 2026. This change was subsequently repealed, and the PIT rate remained at 22%. By contrast, the VAT increase, originally a temporary measure, was made permanent, raising the standard rate from 22 to 24% as of July 2025. The corporate income tax increase was also repealed, though this measure falls outside the scope of this study.
Separately, the government revised the “basic” PIT allowance. Until 2025, this allowance was equal to EUR 654 per month for individuals with a taxable annual income below or equal to EUR 14 400 (65% of EU-SILC average wage). After this threshold, the allowance decreased linearly until it reached zero at EUR 25 200 (110% of the average wage) Figure 1 – blue line). From January 2026, the reform slightly increases the allowance and makes it independent of income (light blue line).
This study assesses the fiscal, distributional, poverty and inequality impacts of the measures included in Security Tax Act (June 2025 version), as well as the basic tax allowance reform. The assessments are made using the European Commission’s tax-benefit microsimulation model, EUROMOD, based on EU-SILC 2022 and HBS 2015 input data. All reforms are evaluated against a 2026 baseline reflecting updated policies and monetary variables based on the information available in January 2025.
The combined reforms lead to an annual revenue loss of EUR 192 million (0.46% of GDP in 2025) (Table 1). The permanent PIT and VAT increases generate EUR 284 and EUR 217 million, respectively. But these are outweighed by the EUR 694 million cost of the tax allowance reform.
Indirect budgetary effects are minor, due to the limited interactions within Estonia’s tax-benefit system. EUROMOD captures a slight drop in social assistance spending and a small rise in ad valorem excise revenues.
Note: The VAT reform is modelled as if it was implemented in January 2026 rather than July 2025, assuming households do not adjust their consumption behaviour (constant quantities assumption) and adjust savings accordingly.
Source: OECD calculations using the EUROMOD J1.0+ model, EU-SILC 2022 and HBS 2015 data.
The combined reforms would reduce disposable income in the bottom three deciles, while those in the middle and upper deciles would experience modest gains (Figure 2 – white markers). The highest gain would be experienced by decile 7, where disposable income would rise by 2.33%. Meanwhile, deciles 4 and 10 would experience minimal effects (0.40% and 0.36%, respectively), and deciles 1 and 2 would lose an average of 1.68% and 1.05% of their income, respectively.
Examining the impact of the individual reforms, the increase in VAT would most affect lower-income households (Figure 2 – dark blue bars), as they spend a larger proportion of their income on consumption. Conversely, the rise in the PIT rate would affect higher-income households more due to the progressive structure of the PIT schedule (light blue bars). While middle‑ and higher-income groups (deciles 4‑10) would experience a negative impact from the combined effect of the VAT and PIT increases, this would be offset by the income gained from the tax allowance reform (grey bars).
Overall, the reform package would increase post-consumption tax (CT) poverty (Table 2). The tax allowance reform would reduce pre‑CT poverty, while the PIT rate increase would increase it. Overall, the two PIT reforms would reduce pre‑CT poverty by 0.35 percentage points (p.p.). (Table 2 – row 1). However, the increase in VAT would more than offsets the impact of the PIT reforms, pushing post-CT poverty up by 0.55 p.p. (Table 2 – row 2).
Inequality would also rise (Table 2 – rows 3 and 4). The increase in the PIT rate would slightly reduce the Gini coefficient by -0.0028. In contrast, the tax allowance and VAT reforms would increase it. When assessed jointly, the reforms result in a small increase in income inequality of 0.0011 Gini point.
Note: Household disposable income is equivalised using the OECD modified equivalence scale. VAT reform is modelled as if it was implemented in January 2026 rather than July 2025, assuming households do not adjust their consumption behaviour (constant quantities assumption) and adjust savings accordingly. Anchored poverty line set at 60% of median equivalised disposable income in baseline scenario.
Source: OECD calculations using the EUROMOD J1.0+ model, EU-SILC 2022 and HBS 2015 data.
The reforms described in this note were carried out as part of the 2025 Technical Support Instrument (TSI) project “Boosting the Usage of Distributional Impact Assessments through Microsimulation”, funded by the European Commission. The beneficiary authority in Estonia was the Ministry of Finance. The reforms implemented during the project implementation, including those described in this note, were for capacity building purposes only and do not necessarily reflect the official views of the beneficiary authority.
The supplementary material compares the fiscal and distributional effects of a 2% Security tax on income versus a 2 p.p. increase in the PIT rate.
More information on the Estonia’s tax and benefit system is available in the OECD Descriptions of Tax and Benefit systems.
How do taxes and benefits affect disposable household income, benefit replacement rates, benefit adequacy, and financial work incentives? Find it out using the OECD tax-benefit web calculator.
More information on the EUROMOD microsimulation model: here.
Contact: Ella-Marie Assal (Ella-Marie.Assal@oecd.org), Daniele Pacifico (Daniele.Pacifico@oecd.org) and Sara Riscado (Sara.Riscado@oecd.org).
This work is issued under the responsibility of the Secretary-General of the OECD, and does not necessarily reflect the official views of OECD Member countries.
This document was produced with the financial assistance of the European Union. The views expressed herein can in no way be taken to reflect the official opinion of the European Union.
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