Eastern Europe Gives Taste of Flat-Tax Paradise: Matthew Lynn
Nov. 29 (Bloomberg) -- Flat taxes are back on the world's economic agenda. In the U.S., newly re-elected President George W. Bush has talked of simplifying the tax code, words taken by some as meaning a flat tax. And in countries such as the U.K. and Germany, there have been calls for flat taxes.
Economists can debate the theory endlessly. Everyone has neat curves showing government revenue rising as taxes fall, and vice versa. Yet this debate doesn't have to be conducted in charts, or tested only in lecture halls.
Flat taxes have been introduced in several former communist countries in the past few years. So far, the evidence shows they are working.
If that success is sustained, it will give a powerful boost to the proponents of flat taxes. After all, even in tax policy, good ideas are eventually copied.
Let's take a tour of flat-tax-land. Start in tiny Estonia, which has a flat rate of tax of 26 percent for individuals. And how have government tax receipts been holding up?
According to the Bank of Estonia, government revenue for 2003 was 48 billion kroons ($4.06 billion). That compares with 42 billion kroons in 2002, and 36 billion kroons in 2001. In other words, revenue has risen steadily.
Next, head south to Slovakia. At the end of last year, the country introduced a flat tax of 19 percent for individuals and companies. The system came into effect at the start of this year.
Slovak Revenue
And how's it working out? Well, this month the government of Slovakia said tax revenue will probably exceed its forecasts for the year by 700 million koruna ($23.6 million). As a result of that, it said the budget deficit would be smaller than originally forecast.
Again, the flat tax seems to be producing higher revenue.
Now, head east to Russia.
Russian President Vladimir Putin may be an inconsistent supporter of free markets, as shown by his support for Ukraine Prime Minister Viktor Yanukovych in that country's disputed Nov. 21 presidential election. Yet in 2001, Putin introduced a flat tax of 13 percent.
So how is Russia's tax revenue doing?
Pretty well. After adjusting for inflation, personal income tax revenue increased 25.2 percent in 2001, 24.6 percent in 2002, 15.2 percent in 2003, and is predicted to total more than 16 percent in 2004, according to Andrei Grecu, who completed a study on flat taxes for the London-based Adam Smith Institute recently.
Grecu drew attention to the Russian model in advocating a flat tax for the U.K. ``Four years after the implementation of the flat personal-income tax, total real receipts from the personal income tax have more than doubled,'' Grecu wrote.
`Increased Incentives'
``This constant expansion of the government tax revenue is the result of less tax evasion and increased incentives to work, save, and invest,'' he wrote.
It's important not to get too carried away. In Russia, for example, surging oil prices play a big part in the healthy budget surplus and the booming economy. And in small, less-developed economies where the system of tax collection may be weak, low and simple taxes that people actually pay work better than high and complex taxes that they don't. In more-developed economies, with tougher tax collectors, that may not be true.
Some economists also consider that flat taxes compromise income equality by benefiting the rich more than the poor.
German Panel
In different countries, flat taxes would produce varied outcomes. Still, there is no escaping the evidence. Where they have been introduced, flat taxes are yielding impressive results.
Quite rightly, people are paying attention.
In Germany, a panel of economic experts set up by the Finance Ministry this year put forward a plan for a flat tax. The panel was headed by Wolfgang Wiegard, who also heads Chancellor Gerhard Schroeder's five-member council of economic advisers.
In Spain, Miguel Sebastian, economic adviser to the ruling Socialist Party, has advocated a flat tax. In Italy, Prime Minister Silvio Berlusconi has just secured an agreement to simplify the tax system. The number of tax brackets will be cut to four from five next year, then come down to two or three perhaps in 2006, he said. That's not a flat tax, yet it is a significant step away from a progressive tax system.
Flat taxes in countries such as Italy and Germany may seem unrealistic right now. Yet don't rule it out in the next decade or so. After all, high, complex taxes haven't delivered spectacular results. Most of the major European economies suffer from weak growth and chronic budget deficits.
Flat-Tax-Land
Flat taxes work for simple reasons. They are straightforward, thus eliminating costly collection. Because they are low, they reduce the incentive for tax evasion and complex planning (why go to all that trouble to save yourself 20 percent?). And they stimulate economic growth, making everyone better off.
The results coming through from flat-tax-land in the next few years will keep this debate very much alive. When ideas clearly work, they are copied -- even by politicians.
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