The Introduction of a 19 per Cent Flat Tax Has Helped Slovakia Boost Economic Growth, Attract Foreign Direct Investment and Reduce Tax Evasion. the Politicians of Western Europe Should Muster the Courage to Follow Suit
Miklos, Ivan, European Business Forum
The biggest European economies have been suffering from relatively low economic growth for more than a decade. The real cause of this under performance is well known: sluggish activity due to a lack of structural reform. Several years ago, the Slovak government had been facing a similar challenge. It urgently needed to accelerate economic growth: the GDP per capita in Slovakia was more than 50 per cent lower than the average of the original 15 EU member states.
A variety of structural reforms covering virtually all areas of economic and social policy were needed, spanning pensions, the labour market, the social welfare system, healthcare and taxation. Yet, in many important respects, the policies that we introduced were neither dramatically new nor complex. In every single reform we simply tried to respect basic economic principles and theories that you find in any introductory economic textbook. Where appropriate, we followed well-known policy proposals long promoted by respected international organisations, such as the OECD.
Our fundamental tax reform, which included the introduction of flat tax, has become the most well known, not least due to the strident criticism it has received from some European leaders. Unfortunately, its basic aspects and results have often been grossly misrepresented. As a result, flat tax is often viewed as a threat rather than an opportunity for Europe. Yet the Slovak experience shows that the flat tax can be implemented in a way that both boosts economic performance and strengthens traditional European values. It combines increased efficiency with increased fairness.
Elementary economic theory says that an optimal tax system should be as simple and non-distortive as possible, with low rates and a broad base. Most European tax systems are, however, quite complex with relatively high rates and narrow bases. They are supposed to be progressive, taxing the rich relatively more than the poor. In addition, traditional tax systems contain many different types of taxes and a plethora of deductions, exemptions and special regimes. These are generally established with various non-fiscal goals is mind, for instance in the domain of social policy.
The actual effects of these traditional tax systems are often quite different from those intended. High direct tax rates are one of the key culprits that distort and stymie economic activity. They discourage investment and employment, thereby decreasing productivity and growth. High taxation of personal income often motivates the most productive locals to seek residence elsewhere and certainly does not help to attract the most educated and skilled people from the rest of the world.
Moreover, most deductions, exemptions, special regimes and rates rarely fulfil their intended goals and instead create economic distortions. They also mean administrative costs for honest, small and medium-sized companies, while providing others-mainly large entities with significant resources with the ability to find legal ways of avoiding paying taxes at all. This also applies to extremely wealthy individuals: they simply need to hire good accountants and tax advisors. It is important to stress that tax avoidance is not just a problem in less developed countries. No matter how developed the country is, its affluent citizens will always find a way to use complex tax systems to their advantage and to avoid paying taxes. Even though they apparently face very high tax rates, quite often they actually pay less than the middle class.
If combined with several other changes, the introduction of flat tax can remove most of these problems.
First, the broader tax reform in which it should be embedded should aim to simplify the tax system as much as possible. Ideally, it should cancel all exceptions, exemptions, deductions and special rates. This increases the simplicity of the system while broadening the base. …