The Screaming Pen

Providing Global Insight, Context, and Perspective

Dude, Where’s My W-2?

Let me tell you how it will be;
There’s one for you, nineteen for me.
‘Cause I’m the taxman,
Yeah, I’m the taxman.

-The Beatles

 

A Possible Impetus For Change

Last fall, the international media focused much of its attention on European elections that promised to shake up the old European order. For those seeking real economic change in the form of market liberalization, those elections were partial letdowns. For instance, many analysts believe that a clear-cut Merkel victory in Germany could have provided the impetus necessary for much needed economic reform and market liberalization in other Western European countries. Following the formation of a grand coalition in Germany, it appears that constant compromise may prevent Angela Merkel, the new Chancellor of Germany, from carrying out her intended reforms. It is also uncertain what direction Poland’s newly elected center right coalition government will take the country. Before coming to the conclusion that all hope is lost regarding Western European change, one must consider an economic force that has been slowly moving westward, originating in the tiny nation of Estonia. The flat tax, which applies a constant rate of taxation, is exerting economic pressure in the form of tax competition on the high tax economies of Western Europe, slowly forcing economic change in those countries.

Reactionary Yet Opportunistic

From a historical perspective, it is interesting that many of the countries who have enacted constant rates are ex-communist nations who have voluntarily moved in the opposite direction of Soviet central planning, the failed communist system that attempted to control every aspect of economic activity. Much like the iron curtain before it, the flat tax movement and free market values are slowly moving westward, with Greece facing a crucial decision this year regarding the adoption of a 25% flat tax. In the recent Polish election, the pro flat tax Civic Platform Party came in a close second, and will now share power with the victorious Law and Justice party. In Germany, the early election campaign of Angela Merkel featured a proposed finance minister who was an outspoken supporter of a flat tax. Unlike the spread of communism, however, the flat tax movement is being voluntarily implemented.

Mail Order Brides are no Longer Estonia’s Chief Export

 

The flat tax system, which uses a single tax rate that is applied to wage earners and corporations that begins taxing after a certain income threshold is reached, has been successful in several nations beginning in 1994, when Estonia introduced a 24% tax rate. By attracting business from abroad, Estonia’s economy grew at double digits in 1997, and has averaged about 6% GDP growth per year since. Russia, a nation whose complicated tax code caused widespread evasion, instituted a flat tax in 2001. It is estimated that in the years leading up to the 2001 flat tax, Russia’s biggest corporations ignored 29% of their tax obligations, while 63% substituted goods or services instead of hard currency. This made Russia susceptible to debt defaults as their coffers reached record lows. In 1998 Russian government revenues were 12.4% of GDP. By implementing a simplified tax code, Russia eliminated loopholes and increased its revenues in real terms by 28% in 2001, 21% in 2002, and 31% in 2004.

Opponents of a flat tax, who believe that a flat tax is meant to line the pockets of the rich and will result in lower government revenues, fail to realize that flat tax systems do not tax earners below a certain threshold, allowing the poorest workers to be exempt from taxes. The revenue question is answered by looking at Russia, a nation who learned that the best way to get higher revenues is to give people more incentive to report their taxes by keeping tax rates low. Ideally, a low tax rate would result in more wealth creation, which could generate even greater revenue. Remember, the examples cited in this article are from countries that had an insanely restrictive, command style tax code. The flat tax is also making Western Europe increasingly uncompetitive, as businesses and investment dollars flow into Eastern Europe.

Implications

In response to widespread eastern European acceptance of a flat tax, Western Europe is beginning to consider tax reform. According to the Economist, Germany has already made plans to cut its corporate tax rate from 25% to 19%, and the in Britain, the Opposition Conservatives announced on September 7, that they would set up a panel to study a flat tax proposal. As investment dollars and businesses continue to flock to Eastern Europe from Western Europe, it will be increasingly apparent to Western Europe that in order to maintain its standard of living, it will need to make radical changes in its tax policy.

Conclusions

It will be interesting to see how the Western European nations deal with tax competition from the east. It is apparent that the increasingly uncompetitive Western European nations will need to modernize their economies in order to compete. It will also be interesting to see how the continued success of an Eastern European flat tax effects the current tax situation in America, where our own tax code has broken the nine million word mark.

-JPL

Links of Interest

http://www.washingtonpost.com/wp-dyn/content/article/2006/05/31/AR2006053102043.html

 

Advertisements

May 31, 2006 Posted by | Author: JPL, Emerging Markets, Europe, Flat Tax, Germany, Globalisation, Politics, Russia, Unemployment, World Markets | 16 Comments