March 20, 2006
By Daniel J. Mitchell, Ph.D.
Thanks to globalization, many nations are
adopting better tax policies. Certain politicians still believe in
high tax rates, of course, but they feel compelled to move in the
opposite direction since it is now increasingly easy for labor and
capital to escape oppressive tax regimes by crossing national
This is why so many nations had to lower personal income tax rates
after the Thatcher and Reagan rate reductions - and why many
nations have been lowering tax rates on business in response to
Ireland's incredibly successful 12.5 per cent corporate tax. They
know the geese that lay the golden eggs will fly away if they
impose bad tax law.
Economists like tax competition because it leads to better tax
policy. Two of the most important rules of good tax law are low tax
rates and less double taxation of saving and investment. Fiscal
rivalry between nations leads them to adopt both.
Maximum personal income tax rates, for instance, are 23 percentage
points lower today in developed nations than they were back in
1980.Corporate income tax rates have dropped by almost 20
percentage points. And many nations, including Scandinavian
countries, are reducing tax rates on individual capital income and
lowering taxes on wealth.
All these reforms boost economic performance by lowering the
marginal tax rate on productive behavior. It is no surprise that
nations that enact these policies grow faster and create more
Governments that try to keep tax rates high, by contrast, suffer
from stagnation and joblessness. Politicians from these countries
whine about ''harmful'' tax competition from Ireland, Slovakia,
Estonia, and the United States, but they should look in the mirror
if they want to find who really deserves to be blamed.
Instead of fighting to preserve existing tax systems that punish
job creation and success, governments should make a virtue out of
necessity and adopt pro-growth tax reforms. Ideally, they should
scrap their tax codes and implement a flat tax. About a dozen
nations already have implemented this simple and fair tax code, and
the list gets longer every year - thanks to tax competition.
How would a flat tax work for individual taxpayers?
Compared to traditional tax systems, a flat tax is extremely
simple. Households get only one exemption -a generous allowance
based on family size - and then pay a low rate on any income above
They do not need to worry about reporting dividends, interest and
other forms of business/capital income. Those forms of income are
taxed at the business level, thus obviating any need to tax them at
the individual level since that would violate the principle of no
How would a flat tax work for businesses? All businesses, from the
largest multinational to a corner pub, would play by the same
rules. Companies would add up their receipts (how much revenue came
in) and then subtract their costs (salaries, cost of raw materials,
and expenses for new tools and machinery).
This would give them their taxable income, which would be taxed at
the low rate.
What are the advantages of a flat tax?
There are two principal arguments for a flat tax- growth and
fairness. Many economists are attracted to the idea because current
tax systems, with high rates and discriminatory taxation of saving
and investment, reduce growth, destroy jobs and lower income. A
flat tax would not eliminate the damaging impact of taxes
altogether, but by dramatically lowering rates and ending the tax
bias against saving and investment, it would boost an economy's
However, the most persuasive feature of a flat tax for many people
is its fairness.
The complicated documents, instruction manuals and numerous forms
that taxpayers struggle to decipher would be replaced by a brief
set of instructions. The entire tax code could be based on two
simple postcard-sized forms.
This radical reform appeals to citizens who not only resent the
time and expense consumed by filing their own tax forms, but also
suspect that the existing maze of credits, deductions and
exemptions gives a special advantage to those who wield political
power and can afford expert tax advisers.
If enacted, a flat tax would yield major benefits, including:
Faster economic growth. A flat tax would spur increased work,
saving and investment.
By increasing incentives to engage in productive economic behavior,
it would also boost the economy's long-term growth rate.
Instant wealth creation. All income-producing assets would rise in
value since the flat tax would increase the after-tax stream of
income that they generate.
Simplicity. Complexity is a hidden tax that requires
record-keeping, form preparation, lawyers, accountants and other
resources to comply with the current system.
Fairness. A flat tax would treat people equally. A wealthy taxpayer
with 1,000 times the taxable income of another taxpayer would pay
1,000 times more in taxes.
No longer would the tax code penalize success and discriminate
against citizens on the basis of income.
An end to micromanaging and political favoritism. A flat tax gets
rid of all deductions, loopholes, credits and exemptions.
Politicians would lose all ability to pick winners and losers,
reward friends and punish enemies, and use the tax code to impose
their values on the economy.
Increased civil liberties. A flat tax would eliminate almost all
sources of conflict between taxpayers and the government.
Moreover, infringements on freedom and privacy would fall
dramatically, since the government would no longer need to know the
intimate details of each taxpayer's financial assets.
Global competitiveness. In a remarkable development, former
communist nations are leading a global tax reform revolution.
Estonia was the first to adopt a flat tax, implementing a 26 per
cent rate in 1994, just a few years after the collapse of the
Soviet Union. The other two Baltic republics of the former Soviet
Union enacted flat taxes in the mid-1990s, with Latvia choosing a
25 per cent rate and Lithuania picking 33 per cent. Along with
other free-market reforms, the flat tax significantly improved
economic growth, and the 'Baltic Tigers' became role models for the
region. Learning from its neighbors, Russia stunned the world by
adopting a 13 per cent flat tax, which went into effect in
The Russian flat tax quickly yielded positive results: the economy
prospered and revenues poured into government coffers since tax
evasion and avoidance became much less profitable. The flat tax
then spread to Serbia, which in 2003 chose a 14 per cent rate.
Slovakia hopped on the bandwagon the following year with a 19 per
cent flat tax, as did Ukraine, which chose a 13per cent rate.
Earlier this year, Romania joined the flat tax revolution with a 16
per cent tax rate, and Georgia adopted a 12per cent rate. This
year, Kyrgyzstan adopted a 10 per cent flat tax, giving it the
honor, at least temporarily, of having the lowest rate in the
The flat tax revolution has been so successful that Estonia is
lowering its rate to keep pace with other nations: it is now down
to 24 per cent and will drop to 20 per cent by 2007.Lithuania is in
the process of lowering its 33 per cent flat tax to a more
reasonable 24 per cent, and the Latvian government wants to reduce
its tax rate from 25 per cent to 15 per cent.
Lawmakers in Croatia, Slovenia, Bulgaria and Hungary are also
considering tax reform. Last but not least, the opposition parties
in the Czech Republic have promised to implement a 15 per cent flat
tax regime if they win the upcoming elections.
No discussion of the flat tax is complete without a mention of Hong
Kong. After World War II, Hong Kong was one of the poorest places
on the planet. But a flat tax was adopted in 1947, and this system
- combined with other free-market policies - led to dramatic
increases in economic performance. Today, Hong Kong's optional flat
tax (taxpayers can choose to participate in a so-called progressive
scheme) should serve as a role model for other jurisdictions.
Traditional income tax systems punish the economy, impose heavy
compliance costs on taxpayers, reward special interests and make a
nation less competitive. A flat tax would dramatically reduce these
More importantly, it would reduce government power over the lives
of taxpayers and get it out of the business of trying to
micromanage the economy.
There will never be a tax that is good for the economy. But the
flat tax moves the system much closer to where it should be -
raising the revenues that government demands, but in the least
destructive and least intrusive way possible.
Mitchell is McKenna senior fellow in political economy
at The Heritage Foundation.
First appeared in the Sunday Business Post (Ireland)
Thanks to globalisation, many nations are adopting better tax policies. Certain politicians still believe in high tax rates, of course, but they feel compelled to move in the opposite direction since it is now increasingly easy for labour and capital to escape oppressive tax regimes by crossing national borders.
Daniel J. Mitchell, Ph.D.
McKenna Senior Fellow in Political Economy
Read More >>
Heritage's daily Morning Bell e-mail keeps you updated on the ongoing policy battles in Washington and around the country.
The subscription is free and delivers you the latest conservative policy perspectives on the news each weekday--straight from Heritage experts.
The Morning Bell is your daily wake-up call offering a fresh, conservative analysis of the news.
More than 200,000 Americans rely on Heritage's Morning Bell to stay up to date on the policy battles that affect them.
Rush Limbaugh says "The Heritage Foundation's Morning Bell is just terrific!"
Rep. Peter Roskam (R-IL) says it's "a great way to start the day for any conservative who wants to get America back on track."
Sign up to start your free subscription today!
The Heritage Foundation is the nation’s most broadly supported public policy research institute, with hundreds of thousands of individual, foundation and corporate donors. Heritage, founded in February 1973, has a staff of 275 and an annual expense budget of $82.4 million.
Our mission is to formulate and promote conservative public policies based on the principles of free enterprise, limited government, individual freedom, traditional American values, and a strong national defense. Read More
© 2014, The Heritage Foundation Conservative policy research since 1973