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Jewish World Review Feb. 28, 2005 / 19 Adar I 5765

John H. Fund

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High Taxes Wither Away: Former communist countries lead the way in abandoning progressivity


http://www.NewsAndOpinion.com | President Bush went out of his way last week in Europe to praise the growing number of countries that have junked their complicated tax codes and adopted a flat tax.


Mr. Bush speaks for a growing number of Americans who are embracing the idea—among them Clint Eastwood, whose said few years back that the adoption of a flat tax would mean "a little old lady on a home computer [could do] the work of all these thousands of bureaucrats and accountants. Passing that would be amazing, wouldn't it?"


The bipartisan tax-reform commission Mr. Bush has appointed will no doubt look carefully at the global spread of the flat tax, a concept its supporters hail because it is simple to calculate, is harder to cheat on, encourages investment and fosters growth economic growth. Little wonder it's catching on in Eastern Europe.


In 1994, newly independent Estonia borrowed the idea of the flat tax from highly prosperous Hong Kong, which 45 years before had introduced a dual income tax system, allowing taxpayers to pay a flat rate on their gross income. (In practice, almost everyone in Hong Kong pays the flat tax.) Lithuania and Latvia quickly followed Estonia's lead. Today, all three Baltic states are booming, and, along with Slovakia, a recent convert to the flat tax, they are the least-taxed countries in the European Union.


The success of the Baltics attracted the attention of Andrei Illarionov, Russian president Vladimir Putin's economic adviser. At his suggestion, Mr. Putin implemented a 13% flat tax for individuals, along with a 15% rate for most business income. The results have been astonishing as Russia's black-marketers decided the tax was low enough and transparent enough that it wasn't worth evading.


After struggling for a decade, Russia's economy grew 5% a year after inflation in 2002 and 2003 and 7.3% last year. The flat tax has been a key reason that revenue from the country's personal income tax has grown by 150% since 2001. "This constant expansion of the government tax revenue is the result of less tax evasion and increased incentive to work, save, and invest," noted the Adam Smith Institute in London in a report on the flat tax's success.


Russia's experience set off a wave of imitators. In 2003, Serbia introduced a 14% tax on income and corporate profits along with plans to cut it further. Russia's neighbor, Ukraine then set a 13% rate, with dividends and bank interest taxed at only 5%.


Last year Slovakia junked an old tax system that included 66 exemptions, 19 sources of untaxed income and 27 items with their own specific tax rates. Instead it put in place a 19% flat tax on income and profits. In December Jan Oravec, president of Slovakia's Hayek Foundation, told me that the country's flat tax has helped sustain an economic growth rate of 4.9%, lowered unemployment and led to a surge in surge in tax revenues as people take advantage of the new opportunities to work and invest. Last year, the World Bank named Slovakia the world's top economic reformer in 2004 for improving its investment climate.


It was in Slovakia last week that Mr. Bush privately told Mr. Putin how much he admired Russia's success in implementing the flat tax. Later, in public comments, he praised his Slovakian hosts for their flat tax, which "has helped to attract capital and create economic vitality and growth."


Alvin Rabushka, a senior fellow at Stanford's Hoover Institution who consults with countries all over the world on how to design a flat tax, can barely keep up with all the new adherents. Within two weeks after taking office in December, Romania's new prime minister, Calin Popescu Tariceanu, issued an emergency edict to take effect only three days later: Companies and individuals now pay a single flat rate of 16%. Georgia also adopted the flat tax as of Jan 1.


Europe is becoming so crowded with flat-tax nations that the original proponents of the idea are having to play catch-up. Estonia has just cut its rate to 24%, and has promised to slash it to 20% over the next two years. Mr. Rabushka's book "The Flat Tax" has just been published in Chinese, with a preface by Lou Jiwei, the vice minister of finance. If China were to climb on board the flat-tax train, more than a quarter of the world's population would be filling out their taxes on the back of a postcard.


In the U.S., interest in the flat tax languished after Steve Forbes, who championed a 17% flat rate during his 1996 presidential campaign, failed to win the GOP nomination. Former House majority leader Dick Armey, a pioneer in promoting the flat tax, privately admits that Congress is unlikely to abolish tax deductions for mortgage interest and charitable contributions, but there is lots of room for President Bush's tax reform commission to propose a dramatic flattening of the income tax code.


Liberal Americans often deride the flat tax on the ground that its lower rates would starve public services and allow the rich to escape the higher taxes. But as former California governor Jerry Brown pointed out during his 1992 presidential campaign, the rich will always be able to hire experts to lobby for tax loopholes and avoid the higher rate traps set for them. "It is in everyone's interest to make sure everyone pays and that both tax loopholes and the underground economy are reduced," he told me at the time, citing studies that nearly 10% of the U.S. economy could be off of the books.


Indeed, under existing flat-tax systems the wealthy end up paying a larger share of total tax revenues. In flat-tax countries, taxpayers in the highest brackets more from consumption or tax-sheltered investments to more productive, taxable investments. Many higher earners work harder or take additional risks, rewarded by higher after-tax returns.


Despite all of its advantages, the flat tax faces enormous ideological opposition. Envy and the lust for the political control that complicated tax regimes can provide are powerful motivations to keep progressive tax systems in place. Karl Marx in "The Communist Manifesto" was among the first to call for "a heavy progressive or graduated income tax" at a time when a flat rate was the norm in advanced countries. He listed it as second in the list of priorities for a new society based on the class struggle.


It is therefore ironic that every country that has adopted the flat tax is a former communist nation—except Hong Kong, the modern originator of the concept, which has seen its new communist rulers retain the flat tax as a centerpiece of its economic policies.


Given all this, why should the U.S. allow itself to continue to see its economic potential limited by a Marxist concept that most nations that followed that path are now fleeing from?

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JWR contributor John H. Fund is author, most recently, of "Stealing Elections: How Voter Fraud Threatens Our Democracy". (Click HERE to purchase. Sales help fund JWR.)

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©2001, John H. Fund