What is their new big idea? A flat tax. An idea that they say is sweeping the world, well sweeping Estonia, well a wing of the neo conservatives in Estonia
Gordon Brown, 26th September 2005
I was at the Estonian Embassy last week for a Young Fabian debate on the flat tax. Tory MP Greg Hands spoke for it, and Labour MP Andy Love spoke against. I was amazed at the paradox and irony that the flat tax continues to create, summed up by Gordon Brown's dismissive, sneering jibe quoted above. How often do you see a Conservative arguing for an optimistic policy that will lift the very poor out of income tax? How often do you see a Progressive blindly defending the status quo, offering scare stories about the intentions of their opponents, tying policy to people not ideas. Throughout the debate Greg Hands was referring to the flat tax as a real policy, implemented across Central and Eastern Europe. Andy Love went for "guilt by association" by incessantly claiming that this was Tory policy, (thereby making the debate party political). What a shame.
As Mart Laar famously quipped:
“The most left wing parties in the new Europe, from an economic policy standpoint, are more right wing than the most right wing parties from the Old Europe”
Remarks were made at the graduation ceremonies of the American Institute for Political and Economic Studies (Fund for American Studies) at Charles University, August 2, 2003
No wonder New Labour/the left feel threatened; there’s been a radical change in the political landscape, and the parties that have implemented it are traditionally deemed conservative! But the Tories needn't worry, for it's not without precedent:
“It is one of the paradoxes of Anglo-America constitutional history that proponents of radical change have regularly portrayed themselves as conservators rather than transformers…We are not transforming the Constitution, proponents of change insisted, we are returning to or preserving its original perfection”
I take a favourable view over the effects of the flat tax: public revenues rose in Estonia by 0.2% of GDP*, by over 20% in each of the first two years following Russia’s adoption**, rose in the Slovak Republic***, and rose in Romania****.
Currently in Romania (the case I know best), fears for inflation and budget deficits just haven't materialised: inflation is falling (it was over 20% in 2002, EIU forecast it will be under 5% in 2008); and the EIU believe the budget deficit target of 2.5% will be undershot this year. Lest we forget the IMF tried their utmost to prevent Romania from adopting a flat tax, fearing a fiscal nightmare - the bottom line is that most observers were far to pessimistic.
So it's no surprise that the IMF are now dousing down the flames of the flat tax momentum, recently
Discussion of these quite radical reforms has been marked, however, more by assertion and rhetoric than by analysis and evidence.
several lessons emerge: there is no sign of Laffer-type behavioral responses generating revenue increases from the tax cut elements of these reforms; their impact on compliance is theoretically ambiguous, but there is evidence for Russia that compliance did improve; the distributional effects of the flat taxes are not unambiguously regressive, and in some cases they may have increased progressivity, including through the impact on compliance; adoption of the flat tax has not resolved common challenges in taxing capital income; and it may have strengthened, not weakened, the automatic stabilizers.
Looking forward, the question is not so much whether more countries will adopt a flat tax as whether those that have will move away from it.
I accept (and have investigated) the rhetorical basis of the spread of the flat tax, and emphasise
myself that flat taxes are neither radical nor uniform (it's a flat tax on personal income that's interesting). Also, what are these "Laffer-type behavioral responses"? They're muddling the Buchanan tautology about rules and revenues, and the behavioural assumption that incentives matter. They're different things. But I can't see any evidence to support the claim that it's more likely for flat tax countries to go back to progressive rates, than new countries adopt a flat tax. I don't see any serious parties advocating a retreat from flat taxes, yet their adoption is still a very real possibility elsewhere (Greece especially).
Also, my own thesis suggests that the flat tax movement has reached a lip, but remains a feasible reform in a different region. It also suggests that should this occur (and for it to happen it must be idea-driven), it will spread throughout. From various off the record conversations I wouldn't be surprised at all if the next country to adopt a flat tax was big, non-Western, and would definately set off a new domino effect throughout their economic region. If that does indeed occur, Gordon Brown's smugness will be wiped from his face, and the claims of The Economist will win out:
The flat-tax idea is big enough and simple enough to be worth taking seriously
The Economist, 16th April 2005
I'm enamoured by the sociology of the flat tax movement because it's not an anti-soviet policy (such as privatisation or anti-corruption) -- it's a post-soviet policy. Unlike neoclassical growth thoery and unlike Fukayama this isn't about "them" catching up with "us", it's about
Western academics travelling to Tallinn not to teach, but to learn
Evans, Anthony J. (2006) "Constitutional Moments and Subjectivist Public Choice" Mercatus Center Working Paper
[These notes formed the basis of a discussion held at the Hayek Society aje_hayeksoc_ideas.pdf ]
* “The Case for Flat Taxes – Simplifying Tax Systems” The Economist 16th April 2005
** “Flat Approach Seems to Generate an Upward Curve” by Lynn, Liquid Africa, Comtex 30th November 2004
*** “High Taxes Wither Away” by Fund, New York Sun 1st March 2005
**** “The Truth about the Flat Tax” by Sorin Ionita, SAR Policy Brief No. 18, May 2006