December 22, 2005


A Flat-Out Winner for Tax Reform (Daniel J. Mitchell, December 22, 2005, Washington Post)

The flat-tax revolution in Eastern Europe is particularly compelling. Nine nations from the old Soviet bloc have adopted the flat tax -- which taxes income at one rate -- and others are poised to. In an ironic twist, these countries are rejecting the class-warfare politics of yesteryear and building tax systems specifically designed to attract investment, fuel economic growth and treat all citizens fairly.

Russia, for instance, enjoys the benefits of the 13 percent flat tax it adopted in 2001. The tax quickly yielded positive results. Revenue poured into government coffers as tax evasion and avoidance became much less profitable. Inflation-adjusted personal income tax revenue has more than doubled since the flat tax was implemented.

But Russia was simply learning from its neighbors. Estonia was the first, adopting a 26 percent flat rate in 1994. Latvia and Lithuania followed in the mid-1990s, with 25 percent and 33 percent rates, respectively. Serbia was next; in 2003 it went with a 14 percent rate. Last year, it was Slovakia (19 percent) and Ukraine (13 percent). This year it's been Romania (16 percent) and Georgia, which boasts the lowest rate -- 12 percent.

Estonia has been cutting its rate: It's at 24 percent and will drop to 20 percent before the end of the decade. Lithuania also has decided to make its flat tax more competitive; the rate will go from 33 to 24 percent.

The flat tax is not a silver bullet. But combined with other market reforms, it provides a significant economic boost. All three Baltic nations are enjoying strong growth, averaging over 5 percent per year. No wonder the "Baltic Tigers" became role models for the region. This growth is generating plenty of tax revenue, in part because tax evasion has been dramatically reduced. And the rich are paying the lion's share: In Estonia, for instance, the top 10 percent are paying 41 percent of the tax.

A consumption tax is preferable, but, regardless of which you choose, if you do it by constitutional amendment and don't allow any other form of federal taxation you'd also manage to clean up politics considerably, since folks wouldn't get to lobby for special tax breaks anymore.

The Tiny Tigers: Accepted into the European Union last year, the former eastern bloc countries are the latest to capitalize on globalization. Followed by Slovenia and Slovakia, the Baltic States have set a cracking pace with their radical economic reforms. Their fervor is alarming its old-school neighbors in the West. (Marion Kraske and Jan Puhl, 12/22/05, Der Spiegel)

In no other place in Europe are entrepreneurs and consumers as optimistic as in Poland. Last year the country boosted its export volume by nearly 12 percent. The World Bank recently upgraded the "emerging" Czech Republic into a "developed" nation. Former Deputy Prime Minister Martin Jahn forecasts: "There will be fewer and fewer investments where low-cost labor plays a central role." The subtext: We can be both low-wage and high-tech.

Even remote Lithuania, the poorest country in the EU along with Latvia, is planning its offensive: "The initial upswing was driven by booming exports; most recently, domestic demand is booming," the World Bank said of the Baltic republic.

Hungary and Slovenia have been ranked the top economies of all the countries in transition by the rating agency Dun & Bradstreet. Germany is Hungary's biggest foreign investor with about €10 billion. In addition to Audi and Deutsche Telekom, the country has attracted scores of automotive suppliers. Slovenia has sewn up the Balkans as an investment destination: Slovenian companies are thriving in the countries that emerged when multi- ethnic Yugoslavia fell apart. They speak the language; they understand the mentality.

Today, low wages are but one of many selling points in these countries. They have shed layers of bureaucracy, simplified their tax systems, invested in education, and overhauled their infrastructure. A bottomless resolve to make up for all the deprivations of the socialist regime is fueling these changes. The economic creed of eastern Europe is defined by a mood of new departure. "In the next 10 years, the gap between per capita incomes in the old and new EU member states will progressively close," forecasts Andreas Polkowski of the Hamburg Institute of International Economics (HWWA). "Some regions may even overtake us." [...]

Slovakia's meteoric rise began as late as 1998 with the fall of autocratic leader Vladimír Meciar. Since then, launching a company just takes a matter of days, the national pension system is being supplemented by capital funding, and unemployment benefits are accorded only to those who actively look for work and are willing to do part-time community service - until a real job materializes. But the heart of Slovakia's reforms is a flat tax rate.

Since January 1, 2004, a uniform rate of 19 percent has applied to income, corporate and value-added taxes. The driving force behind the reforms is Deputy Prime Minister and Treasury Secretary Ivan Miklos, who considers himself a trailblazer on the European reform stage.

When he talks about the major economies in the western half of the continent, sympathy and arrogance mingle. Of course, the 45-year-old says, large countries can institute reforms, too. But they only opt to do so "when they're at the point of no return."

The Latvians are equally self-confident. Their capital of Riga has seen a major makeover in the past few years. The once cold and remote Soviet satellite has become a modern city with Scandinavian chic. The buildings in its old quarters have been renovated; luxury limousines squeeze through their narrow lanes. Porsche can't even keep up with orders for Cayennes and 911s. At least that's the word at trendy cafes such as "Sarkans."

It's the quintessential quandry: if economic liberalization works for them then what are we supposed to do?

Posted by Orrin Judd at December 22, 2005 8:59 AM

I agree that a consumption tax is superior to an income tax. But, no matter what the form of the tax, there will always be some manner in which to lobby for special tax breaks.

Posted by: Brandon at December 22, 2005 2:10 PM

I'm really not sure our economic models should be recovering former Soviet states.

Posted by: Alexander Wolfe at December 22, 2005 4:56 PM

Not even if they're doing very well economically? We should instead emulate the failing economies of the not-formerly Soviet nations of Western Europe?

Posted by: Annoying Old Guy at December 22, 2005 5:03 PM

they've a rare opportunity to avoid the failures of our social welfare phase.

Posted by: oj at December 22, 2005 5:23 PM