This post is was originally published in the Northstack Memo, our weekly newsletter. You can sign up here.

An interesting post on new laws in Latvia made the rounds in the startup circles in Iceland last week:

The Startup Law, approved today by the Latvian Parliament will create a tax regime … that will effectively double venture capital investors’ money in young Latvian startups. This law is seen as part of a wider push to make Latvia an attractive base for startups.

“When investors decide to risk money backing a startup in Latvia, almost half of their money goes to pay social and personal income taxes …” said Andris K. Berzins, board member and co-founder at the Latvian Startup Association … “This is because in most startups there are few other costs aside from salaries. So together with the Ministry of Economics, we decided to tackle this cost directly and the result is this new tax regime.”

The law foresees two tax plans: a special flat tax regime, currently 252 euros/mo per employee … Or for more highly qualified employees with a doctors or masters degree or 5+ years of experience, a regime where all their social and personal taxes are covered by the state, and they receive full social benefits

Latvia is lifting taxes on qualifying startups, so they can make their money last longer. Nothing new, per se, in the increasing competition between countries luring promising companies in. And due to the recent technological, that make starting (and moving) a company much easier than before, this fight might get bigger (and dirtier?) in the coming years.

Other countries do similar. Canada, for example, has on several (confirmed) occasions reached out to Icelandic companies. They offer tax breaks (both personal income and corporate) to move there. The main difference here is that Latvia is blanketing this to all companies, not only companies contacted by the local economic development office. (Question: does Reykjavik have one of those?)

The most obvious reasoning for passing a law like this one, would be something similar to the following (keep in mind, I’m not an expert on Latvian econmics):

Latvia (as the other baltics) is seen as an outsourcing / offshoring nation. Western European companies outsource their software development to Latvia. The long term value in actually having the companies in Latvia is something the government there would very much like, so they subsidize startups that come to / are started in Latvia.

And I think Iceland should absolutely have the same mindset.

Nations and economies depend on the businesses that are operated in them to drive the value creation. This value generation in the end pays for everything the government does. Subsidies and other efforts to lure companies to certain places are one way of artificially creating an ecosystem, that (hopefully) drives economic growth down the line.

Some notes on this:

  • Small nations like Iceland will have a very hard time organically growing a software startup ecosystem that consistently produces medium- to high value companies. We’re simply too small.
  • Another way to get to the same result is to try to artificially create the ecosystem. While I’m not convinced that it can happen – and the government luring companies here would be a better way than actually creating them – there’s no shame in trying. I could argue that it’s better to try and fail than not try at all in these matters (isn’t that generally the case?)
  • Iceland’s tourist boom has covered up the lack of growth in the international sector, identified in the McKinsey report as essential to Iceland’s future prosperity, and pointed out again in the Chamber of Commerce’s follow up report.

Recent news and economic changes support this even more. The strengthening of the Icelandic krona makes operation of international (tech) companies in Iceland harder. As international companies, their revenues are mostly in foreign currency (99% is probably a good guess-timate). At the same time, their costs (mostly salaries) are in ISK. You don’t need an MBA to see the difficulties that arise here. This is already affecting Icelandic companies in a way that is bad for Iceland (i.e. focusing hiring to non-Iceland offices).

Iceland currently has no government, but I hope that when we will, the people at the top take these things seriously.

This post is was originally published in the Northstack Memo, our weekly newsletter. You can sign up here. Image is of Riga, capital of Latvia, from Flickr.