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The tax system, widely seen as a cornerstone of Estonia's success to date, faces the biggest threat. A 26% flat income tax was introduced in 1994. The rate has since dropped to 23% and the official plan depending on the outcome of the next parliamentary election, in March next year is to keep lowering it by 1% per year until 2011. It was the first of two striking tax initiatives. In the late 1990s, Estonia startled the business community and many of its European neighbors with the second: the decision not to tax corporate profits at all if they are reinvested rather than paid out in dividends. "Lots of foreigners were shopping around for special tax regimes. We wanted to say that we are a country that treats everyone rather well," recalls Kersti Kaljulaid, at the time an economic-policy adviser to the government and now Estonia's representative at the E.U. court of auditors.
But Economics Minister Edgar Savisaar, an erstwhile hero of Estonia's independence movement and leader of one of the biggest political parties, wants to scrap the flat tax and use a more conventional progressive system that taxes the rich at higher rates than the less well-off. "Our system is too simple," he says. "We have too much inequality." Arguing that rural areas, old people and young families have lost out, he recently began calling for massive wage increases for all. Savisaar's reformist opponents, including those in the same coalition government, denounce his call as irresponsible demagoguery; they worry about Estonian competitiveness being harmed if wages outstrip productivity. The polarization grew particularly acute in the run-up to the recent presidential election, a bruising contest between the incumbent Arnold Rüütel, a grandfatherly former communist official who is 78 and fluent in Russian, and the challenger, Toomas Hendrik Ilves, a slick American-educated foreign-policy specialist who is 26 years Rüütel's junior and claims to speak for "the 65% of Estonians who are pro-Western and forward looking." Ilves narrowly won the vote, by electoral college.
But a bigger challenge for Estonia's future may be the past. The nation still nurses deep wounds. Ethnic Russians comprise about one-quarter of Estonia's population, many of them the families of people shipped in during the Soviet period as part of a program to tame the country's irredentism. Since Estonian independence, thousands of these Russians have passed an exam to become naturalized Estonians. But some 130,000, almost 10% of the population, haven't, and officials reckon that about half of them don't want to.
Open interethnic conflict is rare, but relations with Russia itself are uneasy; a border treaty that both sides signed last year after long negotiations remains open because Moscow now says it wants new terms. In this charged atmosphere, even small disputes sometimes assume oversized importance. Scuffles broke out at a Soviet-era war memorial in Tallinn this year on May 9, the anniversary of the end of World War II, after Russian veterans unfurled Soviet flags. That prompted an outraged reaction, including a threat by one Estonian nationalist leader to blow up the monument. The park where the memorial is situated has since been cordoned off and remains under 24-hour police guard. Ask Heiki Ahonen, director of a museum dedicated to the Nazi and Soviet occupations, how Estonia is faring as it seeks to construct an integrated society, and he snorts: "This is not nation building; it's more like putting out fires."
Perhaps the next generation will work out such tricky issues. Galja Burnakova, 29, taps the side of her head with her index finger. "The biggest problem is here," she says. She's an interior decorator who was born in the Siberian town of Abakan but has lived in Tallinn for a decade and speaks near-flawless Estonian. Like many Russian-born residents, she says she'd much rather live in Estonia than back in Russia. She's nibbling shrimp sandwiches in a hip private club called Noku with her friend Kertu Lukas, 25, the editor of an Estonian food magazine. For a while, Lukas had a Russian boyfriend. He spoke Estonian, but some of his family didn't; she speaks some Russian, but many of her friends don't. That was awkward sometimes and, she admits: "It was a problem for my father."