Friday, July 01, 2005

Arguments for Flat Tax

This is my second "flat" post on this blog. I first talked about flat tax when discussiong The Economist article on this same subject. Now, I had the pleasure of listening to Dr. Madsen Pirie which presented at the Danish CEPOS flat tax conference the Adam Smith Institutes arguments for flat tax in the UK. According to Madsen Pirie the flat tax broadens the tax base in 3 ways: (i) Less motivation for tax avoidance; (ii) Less black economy; (iii) Economic expansion.

A flat tax is a system that taxes all entities in a class (either individuals or companies) at the same rate, as opposed to a graduated or progressive scheme. The term flat tax is most often discussed in the context of income taxes. The flat tax is currently used very rarely in the developed world, standing in contrast to the more widely used progressive income tax. The Baltic countries of Estonia and Latvia have had flat taxes of 24% and 25% respectively with a tax exempt amount, since the mid-1990s. On 1 January 2001, a 13 percent flat tax on personal income took effect in Russia. Ukraine followed Russia with a 13% flat tax in 2003. Slovakia introduced a 19% flat tax in 2004. More recently, Romania introduced a 16% flat tax on personal income and corporate profit on January 1, 2005. Now the issue is being considered in more countries, from Denmark to the UK and even in the US there have been tentative discussions on the consequences and arguments of a flat tax.

According to Madsen Pirie, “flat tax came to new Europe first because it is politically easier to do there, not because it is more appropriate economically. The Eastern states do not have the long history of entrenched interest groups influencing the democratic process. Politicians in countries with a longer democratic tradition have to be careful in taking on groups, which perceive benefits to themselves from the progressive tax system. Some see advantages in the exemptions and allowances which characterize such systems, and fear they might lose out”. Nevertheless, he considers that the incentive boost to economic activity underlying the enactment of a flat tax would be probably higher in a more developed economy.

We all agree that flat tax becomes politically easier as more countries introduce it but we also have to agree (or disagree) that the discussion is still in its infancy and that the economic impact of such measures should be measured in more detail. Nevertheless, I am supportive in principle to any measure that not only simplifies but also flattens the operation of a tax system.

Click here if you would like to listen to Dr. Madsen Pirie presentation at the CEPOS flat tax conference.


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