The motive for reform in the Baltics came not from the foresight of politicians but from the overriding need to increase economic growth from the low levels of the nineties. This was the driving force behind the selection of their reformed economic systems.
After the successful reforms of the Baltic states, European enlargement and the possibility of further expansion of the EU, we are faced with a changing set of circumstances, and I want to focus on a few of these new policy dilemmas.
The first dilemma is between uniformity and diversity – basically between tax competition and harmonisation. Competition is encouraged by diversity. Competition for investment and the business of firms is much higher than a decade ago. The mobility of people, and the larger groups of people with low income, is also higher. We see already from the new member states that people are choosing between countries when selecting the optimal place to work. Today they are choosing between job opportunities, but maybe some day they will be choosing between tax systems. This will only increase the need for tax competition.
Tax reduction, which we have seen in the last few years in Slovakia and Romania, is the biggest motive for tax competition. It is not just about a flat tax versus a progressive system. It is about a very low flat rate. When we imposed flat tax systems in Lithuania we were highlighted as a pioneer in Europe. Now we look like some older European countries – like France or Germany – because Lithuania still has a 33% flat tax.
Compared with 18%, 16% or 13%, this now looks outdated. In Lithuania, about 37% of household income is undeclared, which shows that a flat tax with a high rate creates more tendencies towards tax evasion than a progressive system, because with the latter you can at least hide yourself in a different tax bracket.
This is good news for those who dream about harmonisation. Harmonisation is happening, but it is not happening in the way people thought it would. It is happening in the way Hayek envisioned: via spontaneous order. Now we are moving towards harmonisation on flat and low tax systems. It has become almost unpopular to talk about tax rates higher than 20%, which shows that we are normalising at very low levels of income tax. I believe that no country that has adopted a flat tax system is discussing reverting back to the progressive model. We also have another dilemma between flat and progressive. I think that progressive taxation, although it was overwhelmingly popular some hundred years ago, and even in the last century, has totally discredited its own principles.
Now we see that the flat tax system not only generates more government revenue, but it also fulfils the major goal of the progressive system. People who earn more pay more. The socialist ideal that those with high incomes should be paying more is fulfilled within the flat tax system more efficiently than in a progressive system, which allows the rich to escape from taxation.
The last dilemma is between having a tax on profits or not. Since Estonia imposed a zero per cent profit tax, there is now a clear tendency to reduce tax on profits. Such a move is a powerful incentive for foreign firms to set up within a state, but is also a positive move for domestic firms.
Estonia demonstrates to the rest of the world that we can live without taxes on profit. It implemented its system five years ago and has not collapsed as a result. Indeed, it is growing as fast as it used to – even faster. This creates a very powerful argument for the abolition of the profit tax.
Today we have more positive news and more positive tendencies towards not only tax competition but towards dismantling existing harmonised taxes within the EU.
© Copyright; Foundation for Economic Growth and various authors. Individual authors retain their own copyright.
Top of Page
|
