A sign of Europe’s troubled times? Lithuania brings in tax reforms to boost defence spending
- Written by Karl Matikonis, Assistant Professor, University College Dublin
Lithuania is entering 2026 with a tax shift that brings its system closer to countries like Ireland and the UK. From January 1, the long-standing flat 15% personal income-tax rate for self-employed people is being abolished for higher earners. These workers will now be integrated into the same new progressive bands that apply to employment income.
On the surface, it’s a technical adjustment. But politically, economically and symbolically it captures a moment in Europe’s history. That is to say, higher defence spending[1], shrinking fiscal space, EU rules that tie funding to progress on reforms and a public mood swinging towards the idea of “fairness”[2].
That’s why this small Baltic reform is being watched far beyond Lithuania’s capital Vilnius.
Security is now a direct fiscal driver. Lithuania, positioned on Nato’s eastern frontier, has tied parts of its tax package to defence funding. A new 10% security contribution[3] on insurance premiums (excluding life insurance) makes that link explicit.
As budgets tighten, ageing populations, higher borrowing costs and the legacy of COVID spending leave governments with far less room to maintain tax preferences, especially those that create visible distributional gaps.
This is not only an EU dynamic. The UK’s recent budget[4], which pushes the overall tax burden to its highest level in decades, reflects similar constraints in the financial picture.
EU funding conditions are also prompting reform. Lithuania’s disbursements under its €3.8 billion[5] (£3.32 billion) plan are linked to progress on income tax, property-tax changes and digital administration. The 2026 package addresses several of these milestones.
In other words, Lithuania didn’t just change taxes. It read the room.
For nearly three decades, lightening the load for freelancers made sense. As my new research shows[6], Lithuania emerged from the Soviet system with limited administrative capacity. Most citizens had never filed a tax return, and the state needed to grow a private sector rapidly.
Flat, low-tax self-employment acted as a tool to build markets, encourage people to move out of the informal, cash-only economy and secure quasi-voluntary compliance in a state still developing its enforcement capacity.
But that era is over. Lithuania now operates one of the EU’s more digitised tax administrations. Returns are largely pre-populated, third-party reporting is extensive and the country’s tax inspectorate uses real-time and automated risk analysis. Under these conditions, the original administrative justification for maintaining a separate and significantly more generous freelancer regime has weakened.
In June 2025, Lithuania’s Seimas (parliament) approved a fiscal package to come into force on January 1 2026. The core principle is alignment: employees and the self-employed with comparable earnings now face broadly similar and more progressive income tax rates.
Until the end of 2025, freelancers paid a flat 15% income tax. But now this is replaced by a progressive regime of 20%, 25% and 32%. Lower-income sole traders are protected by a structured tax credit on the first €20,000 of income, which tapers out up to €42,500.
Above the taper threshold, employment and self-employment income will now be subject to the same income tax bands.
Several other measures[7] are taking effect, including corporation tax increases from 16% to 17%; rising real estate tax; a new excise duty on sugary drinks and the 10% “national defence contribution” applied to non-life insurance premiums.
As the figure below (which is based on my analysis[8]) shows, the reform narrows though does not eliminate the gap between freelancers and employees. But symbolically and structurally, it marks a clear shift.
Lithuania is confronting a challenge faced by many European states. Countries with sizeable gaps between the taxation of employees and the self-employed, including Italy[9], the Netherlands[10] and Czech Republic[11], are grappling with the same pressures: rising defence budgets, tighter EU fiscal governance and labour markets where workers move easily between employment, contracting and the gig economy.
In these settings, systems designed in the 1990s no longer reflect how income is generated. Lithuania’s reform is one of the clearest recent examples of a broader shift towards taxing different forms of income in a more similar way.
There is also a subtler change under way. For many years, Lithuania’s flat freelancer tax was justified as a means of supporting entrepreneurship. Today, the public conversation has shifted. With digital administration lowering compliance barriers, fairness is increasingly defined as parity rather than privilege. Compliance tends to rise when taxpayers believe the system treats comparable earners even-handedly[12].
And in 2026’s security climate, linking part of the reform to defence spending has turned taxation into something closer to civic participation.
Lithuania’s reform is not radical; it is normalisation. But the direction of this change indicates where many European systems are heading: towards higher defence expenditure, closer EU fiscal oversight and tax structures that tolerate fewer discrepancies between different forms of work.
In that sense, this small Baltic state may simply have moved early, partly because of its geopolitical position. But others are likely to follow.
References
- ^ higher defence spending (theconversation.com)
- ^ of “fairness” (theconversation.com)
- ^ 10% security contribution (global.lockton.com)
- ^ recent budget (theconversation.com)
- ^ €3.8 billion (ec.europa.eu)
- ^ new research shows (www.ibfd.org)
- ^ Several other measures (www.ibfd.org)
- ^ my analysis (www.ibfd.org)
- ^ Italy (www.expatica.com)
- ^ the Netherlands (www.oecd.org)
- ^ Czech Republic (dostupnyadvokat.cz)
- ^ comparable earners even-handedly (doi.org)
- ^ Michele Ursi/Shutterstock (www.shutterstock.com)
