Life's Persistent Questions

Today's EU is not yesterday's EU.

I got into an argument with someone recently over the idea of flat tax. Long story short, it comes down to a couple of simple questions. One, whether flat tax hurts low income families. Two, whether it will increase overall tax revenue by removing the incentive to evade taxation by people with higher income. My initial attraction to flat tax was based mainly on my speed reading of Bruce Bartlett's article. Now a little more digging on the net shows that any flat tax proposal has come with it a threshold (under which the person pays no tax) and deduction for individuals and spouses and dependents. This is clearly an attempt to protect the people trying to keep their heads above water. Whether that's enough, I don't know, but will keep it in mind.

However the nagging feeling that has been growing in my stomach has been the question at the other end of the spectrum. Does flat tax increase government revenue? The evidence at first glance suggest so. Bartlett pointed to half dozen or so EU members and Russia that have seen increasing tax revenue after the implementation of a flat tax. Sounds great, until I realized all the EU countries in question are in fact in eastern Europe, and like Russia, have immature economies. Flat tax is pro-growth, which is usually synonymous with pro-business, no one denies that. In fact, the developed countries such as GB, France and Germany, which has highly progressive tax rates, are furious at these countries. In the end, I think Bartlett is highly disingenuous to use countries like Georgia and Estonia as examples of benefits of flat tax. I believe the increase revenue has as much to do with increased foreign investment and economic growth as better compliance with tax collection. In fact in the conclusion of the IMF work paper cited by Bartlett, p40, it clearly stated:

a key lesson must be that tax-cutting reforms of this kind should not be expected to pay for themselves by greater work effort and improved compliance. Our analysis suggests that the strength of PIT revenues in Russia over this period was largely driven by an increase in real wage rates unrelated to the reform. This may have been associated with the strong energy prices, wider structural reforms, or simply a return to more normal trend levels, and in any event a full understanding is likely to hinge on features of Russian labor markets.

Look, I am for simplifying the tax code. I also have some moral ambivalence toward the idea of progressive tax on the successful. But considering that the most developed, wealthiest countries in the world had held on to the progressive tax, I am relectant to throw my hat behind a new system whose best supporting evidence comes from countries barely crawling out the shadow of their communist past.

posted by hedgehog @ 5:02 PM