In Struggling European Countries,
Momentum Is Building
For (Gasp!) the Flat Tax
By G. THOMAS SIMS
Staff Reporter of THE WALL STREET JOURNAL
October 3, 2005; Page A2
FRANKFURT -- It is, for many Western Europeans and Americans, a public-policy heresy: the flat tax, a single rate all taxpayers, rich or poor, pay on income. But across the struggling economies of Europe, momentum is building for flat taxes, or at the very least, lower and simpler taxes.
Last week, advisers to the Dutch Parliament recommended a flat tax on personal income to boost growth and get more people working. In Italy, weathering a public-debt crisis and a flailing economy, Prime Minister Silvio Berlusconi's chief economic adviser advocates a flat tax to increase revenue and fight tax evasion by abolishing tricky exemptions and loopholes and reducing off-the-book employment that can result when taxes are too high. Opposition parties in the Czech Republic and the United Kingdom are pushing similar ideas, while Spain and Greece have already offered plans to simplify and cut.
[country comparisons]
"Tax competition is clearly at play here," says Erik Nielsen, economist with Goldman Sachs in London, referring to the game of trying to lure businesses by setting tax rates lower than neighboring countries. "But I also think the drive reflects a general shift in Europe towards less acceptance of high tax rates."
The flat-tax movement is led by Eastern European nations that are making the transition from communism and from the progressive tax system championed by Karl Marx, who in his 1848 Communist Manifesto called for a person to pay taxes "according to his means." The rationale behind progressive taxation is that the wealthiest people have a larger share of a nation's income and therefore should pay more in taxes than people with less income. Before Marx's views took hold, taxes had been flat in the industrializing world. Despite its Marxist origins, many Americans and Western Europeans to this day consider a progressive tax fair and just.
But to countries trying to build their economies after years of crippling communism, progressive taxation is increasingly viewed as the problem. A low flat tax, in contrast, is considered the solution. Lower taxes free up money for spending on consumer goods, investment and new jobs; and flatter taxes help draw foreign investment by making the system easy to understand by foreign companies. In at least one place where flat taxes have been the norm for decades, Hong Kong, growth over the years has been strong.
Estonia was the first European nation to adopt a flat tax, in 1994, quickly followed by Latvia and Lithuania. Last year Slovakia and this year Romania have adopted low flat-tax rates that are helping them grow quickly and undercut so-called Old Europe economies. Estonia's gross domestic product, for example, grew 6.3% on average in the three years after it made the move, compared with shrinking 8.4% in the three years before. With many of these countries now in the European Union, it is putting pressure on the more-established, more-sluggish western European economies to rethink their tax systems: even if it doesn't result in a full-fledged pure flat tax, these countries are at least headed in this direction.
Under a flat tax, all income is taxed at the same rate. Proponents argue that flat taxes eliminate complexities, such as brackets and exemptions, and the administrative burden of managing taxes disappears, freeing up resources for more productive parts of the economy. Opponents say it hits the low and middle-income earners and would initially drive up deficits.
The challenge is to come up with a rate that is low enough to be politically palatable but high enough to keep the government running. In the U.S., the idea doesn't have the backing in Congress that it did in the mid 1990s, when presidential candidate Steve Forbes gave it a high profile, because of how high the rate would have to be. But Europe has more room to simplify its tax system and reduce the overall tax burden. Most nations have multiple brackets and numerous obscure exemptions. And in the EU, tax revenues are about 40% of gross domestic product, compared with 25% in the U.S.
The debate played out in Poland's elections last week The EU's most populous new member suffers from 18% unemployment and is losing new jobs to its neighbors. The probusiness Civic Platform party promised a flat 15% tax -- not only for incomes but also for businesses -- to stimulate the economy. For individuals the tax rate currently varies, and for companies it is 19%.
The Civic Platform rival, Law and Justice, launched a last-minute campaign playing on fears it would hurt the poor. In one television spot, a woman opens a full refrigerator, but the onions, lettuce, and other foods begin to vanish one by one. That cost Civic Platform its lead, but the party will still govern with the victorious Law and Justice, which agrees that taxes need to be cut and simplified. "We're absolutely sure that we need to lower taxes for the Polish economy to move forward," said party head Jaroslaw Kaczynski, who may be the next prime minister.
Slovakia managed to overcome objections by creating an exemption for low-income people, making their tax a bit less flat but seen as fairer. It had immediate effects: South Korea's Kia Motors quickly moved to invest nearly €1 billion in a plant, which is also attracting other suppliers. Slovakia's stock index is up 170% over the last two years. Slovakia received kudos from President Bush, as well as Japanese Prime Minister Junichiro Koizumi, who is struggling to enact his own reforms.
The latest country to move to a flat tax was Romania. Last month[September], Standard & Poor's raised the nation's credit rating from junk to investment grade, expressing confidence in the health of finances after the tax reform. That will help Romania borrow at a lower cost and attract investment. Just days later, Romanian President Traian Basescu was in Detroit to make a sales pitch to Ford Motor Co.
But the flat tax still carries a taint in some countries, including Karl Marx's homeland. In Germany, Angela Merkel, a Christian Democrat, saw her lead in the polls diminish ahead of Sept. 18 elections when she named a flat-tax advocate, the nonpartisan professor Paul Kirchhof, as her designated finance minister. Her party didn't directly advocate a flat tax, and Mr. Kirchhof even said he wouldn't push for it anytime soon.
Chancellor Gerhard Schröder seized on the issue, saying at one rally the German Volk couldn't become a guinea pig for an unjust tax experiment. Ms. Merkel lost support and Mr. Kirchhof quit the day after the election. And Germany still hasn't picked a new government. |
