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Four More Years: In Central and Eastern Europe, the flat tax has proved a resounding success. Why not enact it here? By Alvin Rabushka.
Will we ever get real tax reform in the United States?
For several decades, economists, journalists,
and politicians have been discussing the pros and cons of the flat tax, sales tax, value-added tax, and other proposals
as alternatives to our current federal income tax. One commission after
another has made recommendations to overhaul the federal income tax, but
little has come of these efforts. Special
interest groups and partisan politics have blocked all efforts at reform since 1986. Every year Congress further
complicates the tax code. President Bush
established another commission, his Advisory Panel on Federal Income Tax Reform, on January 7, 2005, but it
will doubtless encounter the same obstacles. A new commission is not
needed. A better approach is simply to look around the world at a raft of
success stories. The flat tax has been adopted in eight newly independent
Central and Eastern European countries, has been proposed by political
parties in two more, and is even under consideration in China.
Estonia was first, implementing a 26 percent flat tax
in 1994. The relatively high rate was set to balance its budget, a requirement of its new
constitution. Since then, buoyed by strong
economic performance, Estonia has eliminated the
corporate tax on retained earnings, taxing only distributed profits. The
rate is scheduled to fall to 24 percent in 2005 and 20 percent in 2007.
Next to follow in 1995 was Latvia with a 25 percent
rate.
Russia is the big story. It took the tax reform world
by storm in 2000 with a 13 percent flat tax,
replacing its previous three-bracket system that topped out at 30 percent. The results have been spectacular. The economy
has enjoyed four years of sustained
growth. Real (inflation-adjusted) ruble revenue from the personal income
tax rose 25.2 percent in 2001, 24.6 percent in 2002, 15.2 percent in 2003,
and 16 percent in the first half of 2004. By year’s end, total
receipts will have more than doubled; the share of consolidated budget
revenue received from the personal income tax increased from 12.1 percent
in 2000 to 17 percent at the end of 2003.
After a pause of three years, the flat tax resumed
course. In 2003 Serbia implemented a
comprehensive 14 percent flat tax on personal and corporate income.
Taking a page from Russia’s playbook, Ukraine
implemented a 13 percent flat tax in 2004,
replacing five brackets of 10, 15, 20, 30, and 40 percent. Dividends and
interest on bank deposits will be taxed at an even lower 5 percent rate beginning in 2005. News reports suggest that
Ukrainian officials consulted with their
Russian colleagues. The advice they received was that incentives and
revenue would rise and that the underground economy and tax evasion would
decline.
In 2004 Slovakia implemented a 19 percent flat tax on
both individual and corporate income. The measure, which passed by a vote
of 85 to 48, garnered the support of some opposition deputies. The 19
percent flat tax replaced five brackets of 10, 20, 25, 35, and 38 percent
and the corporate rate of 25 percent. It greatly simplified the previous
system, which included 90 exceptions, 19 sources of income that were not
taxed, 66 items that were tax-exempt, and 27
items with their own specific tax rates (e.g., bank interest, honoraria, etc.). Once the corporate tax is paid,
dividends received by individuals are tax-free.
Georgia’s new president, Mikhail Saakashvili,
was inaugurated on January 25, 2004. Five days later he stated that one of
his new government’s top priorities was
the introduction of a flat-rate tax system. On December 22, 2004, Georgia’s parliament approved the 12 percent
flat tax effective January 1, 2005, by an
overwhelming vote of 1,071 to 11. Seven days later, on December 29, 2004, the newly elected government of Romania
implemented a 16 percent flat tax on personal
and business income, effective January 1, 2005. Opposition political
parties in the Czech Republic and Poland have
proposed a 15 percent flat tax on both personal and corporate income.
In every case, a simple flat tax replaced complicated
tax regimes with multiple rates.
In November 2003 I was invited by the Ministry of
Finance to Beijing to discuss personal income
tax reform. A Chinese translation of The Flat Tax was published in May 2003 by the China Financial & Economic
Publishing House, with the preface written
by Vice-Minister of Finance Lou Jiwei. During the past few years, several
Chinese professors of public finance have written articles on the economic
and fiscal benefits of sharply reducing China’s top personal income
tax rate of 45 percent, some suggesting a flat 20 percent rate. The
government is likely to announce some preliminary reforms of the personal
income tax in its March 2005 budget.
Better than another tax commission would be a road
trip to Central and Eastern Europe to see firsthand the success of the flat
tax.
This essay appeared in the Wall Street Journal on January 12, 2005. Available from the Hoover Press is Taxation and Economic Performance, by W. Kurt Hauser, a monograph in the Hoover Essays in Public Policy series. Also available is The Flat Tax, by Robert E. Hall and Alvin Rabushka. To order, call 800.935.2882. Alvin Rabushka is the David and Joan Traitel Senior Fellow at the Hoover Institution. He is an expert on taxation. His books and articles on the flat tax, with Hoover fellow Robert Hall, have provided the foundation for numerous tax reform bills. His book Taxation in Colonial America was just released by Princeton University Press. His other research areas are economic development in Pacific Rim countries, Israel, and the transition economies of Central and Eastern Europe, notably Russia. |
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