REAGAN'S STILL REVOLUTIONIZING EASTERN EUROPE:

The New Orthodoxy: Eastern Europeans put their faith in the flat tax. (William Underhill, 2/21/05, Newsweek International)

Romania's new prime minister knows his priorities. His country may be struggling with a massive budget deficit, but Calin Popescu Tariceanu isn't asking for painful sacrifices: he's cutting taxes. Within 48 hours of taking office, his government issued an emergency edict to take effect in time for the New Year. From last month, companies and private citizens pay tax at a single rate of just 16 percent. Cue the rejoicing among the country's top earners, previously charged at more than twice as much.

A costly bid for popularity—or the new orthodoxy? Once upon a time, the "flat tax" was just a pet cause of free-market ideologues, spurned by practical politicians. No longer. Romania joins a lengthening list of converts among the post-Communist states of Eastern Europe. Estonia began the trend back in 1994, to be followed by Latvia, Lithuania, Ukraine, Russia and Serbia. Last year Slovakia fixed a universal rate of 19 percent. Opposition parties are pressing for similar deals in Poland and the Czech Republic. Even fiscally orthodox Old Europe is taking note. "There is discussion all over the EU," says Katinka Barysch, of the Centre for European Reform in London. "People are asking, if the Slovaks can have such a beautiful and simple system then why can't we?"

Fair question. A flat-tax system is easy to set up and simple to administer—powerful attractions for any country with a weak tradition of tax collection. It also encourages the tax-paying habit. Why risk the penalties of working in the black economy when, as in Russia, the taxman wants just 13 percent of your earnings? "Set the rate low enough and it just isn't worth going criminal," says Madsen Pirie, of the Adam Smith Institute in London. The Belgian entrepreneur paying 50 percent on the top slice of his income might be tempted to hide his cash offshore; not so his Slovakian equivalent.

Best of all, the treasury needn't suffer. Whatever your intuition might say, classic economic theory predicts that establishing a low flat tax may increase—not reduce—the state's revenues.

Kind of humiliating to be more backwards than Romania.

Posted by Orrin Judd at February 15, 2005 6:31 PM