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

 

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

16 Comments »

  1. very nice article and well written

    Comment by Chris | May 31, 2006 | Reply

  2. “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.”

    American proposals tend to use the word “flat tax” for “two-step” tax: a flat rate on labor income and a 0 rate on capital and real property income.

    The “income tax amendment” was required by the courts before we were allowed to extend taxes on wage income to taxes on other forms of income. The American flat tax proposals have for their primary intent, a rollback in practice of what the amendment allowed in law.

    It is the deceptive language game the American proponents are playing that gives one the impression that the goal is simply “to line the pockets of the rich”.

    A per individual flat tax on all sources of income with an exception for 2 times the poverty rate for a family of four with a rate set yearly so that receipts would cover the government’s current year budget plus last year’s deficit: this would find few opponents.

    Comment by Don | June 1, 2006 | Reply

  3. Here is another interesting article regarding Eastern European Tax Policy. It allows one to compare two nations; one who saw the opportunity to exploit the anti-business Western European tax environment, and one who didn’t. Slovakia used a low tax environment to attract businesses and jobs from the West. It is now seeing the positive effects of economic reform

    http://www.economist.com/world/europe/displaystory.cfm?story_id=7008578

    Comment by J | June 1, 2006 | Reply

  4. Well put Don.

    JPL

    Comment by JPL | June 1, 2006 | Reply

  5. Repost your original, you slumberless numbskull.

    Joe

    Comment by JPL | June 3, 2006 | Reply

  6. Hmmm. I would hate to be on the upper cut off between no tax and 25% tax, but maybe this could be solved with limited incrementalism … and to be fair this could be extended all the way up … sounds kinda familiar though.

    Comment by John | June 3, 2006 | Reply

  7. Yeah, http://www.oriolesthinktank.com. Thanks bro.

    Comment by JPL | June 4, 2006 | Reply

  8. Thanks for the comment John. Keep in mind that Eastern Europe’s motivation for enacting a flat tax is to pull much needed business from the West. Although I believe that simplification of our tax code is needed, I also believe that there are some flaws in proponents of a Flat Tax’s reasoning, especially here in America. Thanks again for reading.

    JPL

    Comment by thescreamingpen | June 6, 2006 | Reply

  9. A lot of Russia’s economic growth has to do with them cracking down on corporate tax evasion. The Lukoil example comes to mind. I think that was in 2004 or so, google it. Despite the existence of a threshold (which, amazingly enough, my liberal mind is able to process), the concept of a major corporation and an average working man paying the same % in income taxes is silly and counterintuitive.

    So, let’s see, corporations aren’t paying their income taxes. The solution? Reward them by lowering the amount they owe and raising the amount that middle-income families owe. Fucking Reaganomic bullshit. It may, after all, result in a growing economy, but the vast majority of the country will only see what trickles down (italics meant to indicate sarcasm). Gross GDP only means so much when increased economic disparity is a necessary side effect.

    Comment by Bitter in Baltimore | June 8, 2006 | Reply

  10. Thanks for the comments Mike. I think you are thinking of Yukos, although I believe Lukoil is a spinoff or subsidiary. (There is a Lukoil gas station on Eastern Ave.)

    First off, you are absolutely correct, cracking down on tax evasion has helped the Russian economy. Yukos is a prime example. The privatization process that Russia went through in the early nineties resulted in corrupt "private" companies headed by corrupt ex-communist officials and others who used connections within the government to their advantage in what was described as an "oligarchic privatization" (Thanks Prof. Loe) The corruption that resulted from the transition from a command economy to "privatization" is commonplace in Eastern Europe. This corruption makes Worldcom and Enron look like nothing. (Last year a government official was caught selling a submarine to drug smugglers)

    Yukos used certain exemptions and tax havens that were set up through shady connections to evade taxes. I think Yukos ended up owing something like $10 billion in taxes.

    The Flat Tax in Eastern Europe aims to remedy this by removing all loopholes and tax havens with a few exceptions. These loopholes, most of which applied to corporations, were replaced with a lower tax across the board sans loopholes. Increased revenue from corporations more than covered the decrease in taxes that the people saw (i believe the flat tax rate is around 24% in estonia). This holds true because personal income tax rates in most ex communist countries remained very high. This has almost solved the Eastern European tax crisis by giving corrupt corporations no excuses when it comes to paying taxes. It has resulted in a more transparent system of taxation that has increased revenues at the corporate level. Lower taxes have also attracted corporations from Western Europe (HP, Peugot), which like it or not, bring jobs.

    I'd also like to remind you that this article is about Eastern Europe, not America. In America we have one of the most transparent financial systems in the world, and while I believe in limited government and a simplified tax code, it is obvious to me that a pure flat tax would not be the best choice.

    Also, the word Gross is already included in the word GDP.

    And I apologize if there are any spelling/grammar errors, I am a busy guy.

    Also please do not include sentences like "fucking reaganomic bullshit" in posts on this blog, it adds absolutely nothing.

    Comment by JPL | June 9, 2006 | Reply

  11. I didn’t post that, so don’t preach to me.

    Comment by Mike | June 9, 2006 | Reply

  12. What?

    Comment by thescreamingpen | June 9, 2006 | Reply

  13. I sent it in an email, since you only allow people that agree with you to post on the site. Darren posted it here.

    And stop acting all high and mighty about your precious blog. You’ve done worse on mine.

    Comment by Mike | June 9, 2006 | Reply

  14. Lets change the subject. Who else thinks Vince from Entourage is a bad actor?

    Comment by JPL | June 9, 2006 | Reply

  15. He’s not as bad as the person he’s supposedly playing. Much cuter too.

    Comment by Mike | June 9, 2006 | Reply

  16. ford kansas city

    Comment by reomeclalm | June 24, 2007 | Reply


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