Estonia has announced a swingeing package of tax rises and spending cuts to keep its budget deficit next year to 3% of gross domestic product (GDP), the maximum allowed under the European Union's Stability and Growth Pact, and to make room for a big planned increase in defence spending.

Starting July 1, 2025, Estonia's VAT rate will  rise by 2 percentage points, ERR.ee, the website of Estonian national broadcaster ERR, reported on September 18. From 2026 there will also be a special supplementary 2% tax on corporate profits and personal income to support the country's increasing defence expenditures. Standard personal income and corporate income tax are currently both 20%.  The existing lower rate corporate tax band of 14% will also be abolished.

Prime Minister Kristen Michal (Reform) pledged that no new taxes will be introduced until after the 2027 general election.

To address austerity, the government plans to cut around €1 billion from public sector costs, exceeding previous targets. Each ministry, along with state foundations and state-owned companies, will reduce expenses by 10% over three years: 5% in the first year, 3% in 2026, and 2% in 2027. The overall public sector cuts now total €1.3 billion.

Starting in 2026, sickness and parental benefits will be capped at two national average salaries, and the state will cease paying social tax for stay-at-home parents. Additionally, pensioners in nursing homes will lose eligibility for the single pensioner benefit from next year.

The government's goal is to lower next year's fiscal deficit from a projected 4.4% to 3% of GDP. These measures are expected to save €200 million in interest expenses over the next four years. Last year the deficit was 3.4% of GDP.

As reported by bne IntelliNews, Estonia, once a poster child among Eastern European members of the EU, has recently emerged from more than two years of recession, with GDP falling 1% y/y in the second quarter but rising a feeble 0.2% q/q.

Finance Minister Jurgen Ligi (Reform) also highlighted the challenges of balancing national defence with the current fiscal situation. Minister of Defence Hanno Pevkur said recently that spending could need to reach 5% of GDP in the future.

The government has allocated €1.6 billion over several years for ammunition needs. The Ministry of Defence has plans to purchase over €4 billion worth of munitions in the next decade.

The government also plans significant economic investments, including €402.6 billion from pollution quota sales. Two-thirds of this will fund the Rail Baltica project and a joint Elron and Rail Baltica depot. Additional funds will support apartment energy efficiency projects, road construction, and marine green technologies.

In 2026, a new investment initiative will aim to attract high-tech manufacturing, boost exports, and create high-paying jobs. The government will continue constructing ERR's new television production complex, finalize renovations of the National Library building, and begin work on the Tallinn Art Hall Gallery.

The government plans to approve the state budget bill on September 25 and Michal will present it to the Riigikogu (parliament) on September 26, ERR.ee said.