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Flat approach seems to generate an upward curve

Flat approach seems to generate an upward curve < News < Bet On Markets

Flat taxes are back on the world’s economic agenda. In the US newly re-elected President George W Bush has talked of simplifying the tax code, words taken by some as meaning a flat tax. And there have been calls for flat taxes in countries such as the UK and Germany.

Economists can debate the theory endlessly. Everyone has neat curves showing government revenue rising as taxes fall, and vice versa. Yet this debate does not have to be conducted on charts, or tested only in lecture halls.

Flat taxes have been introduced in several former communist countries in the past few years. So far, the evidence shows they are working.

If that success is sustained it will give a powerful boost to the proponents of flat taxes. After all, even in tax policy, good ideas are eventually copied.

Estonia has a flat rate of tax of 26 percent for individuals. According to the Bank of Estonia, government revenue for 2003 was 48 billion kroons (R24 billion). That compares with 42 billion kroons in 2002, and 36 billion kroons in 2001. Revenue has risen steadily.

Slovakia introduced a flat tax of 19 percent for individuals and companies at the end of last year, and the system came into effect at the start of this year. This month the government of Slovakia said tax revenue would probably exceed its forecasts for the year by 700 million koruna (R139 million).

As a result of that, it said the budget deficit would be smaller than originally forecast. Again, the flat tax seems to be producing higher revenue.

Russian President Vladimir Putin might be an inconsistent supporter of free markets, as shown by his support for Ukraine Prime Minister Viktor Yanukovych in that country’s disputed presidential election. Yet in 2001, Putin introduced a flat tax of 13 percent.

After adjusting for inflation, personal income tax revenue increased 25.2 percent in 2001, 24.6 percent in 2002 and 15.2 percent in 2003. It is predicted to rise more than 16 percent in 2004, according to Andrei Grecu, who completed a study on flat taxes for the London-based Adam Smith Institute recently.

Grecu drew attention to the Russian model in advocating a flat tax for the UK. «Four years after the implementation of the flat personal income tax, total real receipts from personal income tax have more than doubled,» Grecu wrote.

It is important not to get too carried away. In Russia, for example, surging oil prices play a big part in the healthy budget surplus and the booming economy. And in small, less developed economies, where the system of tax collection might be weak, low and simple taxes that people actually pay work better than high and complex taxes they do not.

In more developed economies, with tougher tax collectors, that might not be true.

Some economists also consider that flat taxes compromise income equality by benefiting the rich more than the poor. In different countries, flat taxes would produce varied outcomes.

Still, there is no escaping the evidence. Where they have been introduced, flat taxes are yielding impressive results.

Quite rightly, people are paying attention.

In Germany a panel of economic experts set up by the finance ministry this year put forward a plan for a flat tax.

In Spain, Miguel Sebastian, economic adviser to the ruling Socialist Party, has advocated a flat tax. In Italy, Prime Minister Silvio Berlusconi has secured an agreement to simplify the tax system.

Flat taxes in countries such as Italy and Germany might seem unrealistic right now. Yet do not rule them out in the next decade or so. After all, high, complex taxes have not delivered spectacular results. Most of the major European economies suffer from weak growth and chronic budget deficits.

Flat taxes work for simple reasons. They are straightforward, eliminating costly collection. Because they are low they reduce the incentive for tax evasion and complex planning — and they stimulate economic growth, making everyone better off.

By Matthew Lynn

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