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Flat success

There a lot of ongoing debates about the taxation system all over the world, especially in Europe and the US. The classic example of an effective tax system is usually associated with progressive scale. However, more and more debates are going towards changing the system towards different strategy. One of the possibilities is a flat tax rate implementation.

Flat tax rate implementation took place in former Soviet bloc countries. Throughout the 1990s and early 2000s, six former Soviet republics and three other Eastern European countries flattened their income-tax rates. Some countries, like Estonia and Slovakia, instituted a flat tax on personal and corporate income.

Russia is an example of adopting a flat personal income tax, while keeping a different rate for corporate income at the same time and was the fourth country in implementing “flat strategy”. In 2001, Russia switched from a system of 12, 20 and 30 percent tax rates to a 13 percent flat income tax. This was a huge step – the tax is four percentage points lower than the supposedly “radical” plan for the United States espoused by Steve Forbes.

Adjusted for inflation, revenue from Russia’s personal income tax increased by 26 percent in the year after a flat tax was implemented, and by nearly one-fifth as a percentage of GDP. Russia also saw strong GDP growth throughout the 2000s, ranging from 6 to 8[1].

But what are the lessons that can be taken:

1)      In the former Soviet bloc, most of the countries that enacted flat taxes gained revenue as people who had worked in the shadow economy began reporting their income and paying taxes. It was no longer worth running the risk of breaking the law for the former tax dodgers. Moscow saw its income tax revenues more than double in real terms from 2000 to 2004[2].

2)      Though proponents of a flat income tax speculate that a lower consistent tax rate would motivate people to work harder, the 2005 IMF study[3] also found that that was not the case in Russia: “Based on what we found there has been very little effect on actual work effort”.

3)      There is no statistical evidence that the rate reduction had any strong incentive effect. What can be found in the data is a significant reduction in the relative gross wage rates of those most affected by the reform. All this is consistent with, for instance, the elasticity of supply of higher-paid labor being low relative to that of labor demand[4].

The main outcome of the reform had mainly the behavioral effect rather than labor supply improvement. However that was a right decision for the time of shadow economy domination and remains efficient, due to the taxation payment efficiency.

Sergey Shashkov 1451

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Author: studentnovasbe

Master student in Nova Sbe

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