There is a rising crescendo in the US regarding a flat tax system – a policy of income tax which in principle assesses a single rate of tax for all – where pundits are criticising this exercise for its apparent flaw that it increases tax on the less privileged to reduce tax on the relatively wealthy. However, what we should analyse is that if flat tax was really a bad idea, then why is it that so many nations across the globe have worked to embrace it?
When studied in detail, most countries that have managed the flat tax regime mainly in post communist countries of Eastern Europe, along with micro states across the globe, suggest that there are three fundamental reasons for their success. Firstly some states are relatively poor with negligible domestic capital, therefore they choose to drop rates mostly as a tool to attract foreign investors. Other countries are small and inefficient at raising revenue, therefore they cannot afford to employ a progressive tax regime. Lastly, some countries have battled with corruption and therefore give the rich a rate cut to induce them to pay any taxes at all.
None of these conditions exist for the United States, therefore it is not clear why a flat tax rate is really needed. Those countries from the post communist era that adopted the flat tax regime including Estonia, Latvia, Lithuania, Macedonia, Ukraine amongst others, were lacking in investment capital. In these countries that are competing rigorously for foreign investment, a flat tax regime is a signal to investors that they are welcome, that they will be allowed to retain their wealth and earnings.
According to an IMF report, flat tax is consequently less effective in countries that have a record of inward investment and abundance of capital. Therefore, when making an analysis of developed countries that we use as comparison, the flat tax regime has not been adopted by any and China is no exception in this case either.
Other countries that have adopted the flat tax regime are micro states, including Seychelles, Jamaica, Tuvalu, Mauritius and others. The only exception to the micro states in this aspect is the state of Paraguay which adopted a flat tax system last year. Therefore, the analysis one can make from these cases is that in places where an effective progressive tax system cannot evolve owing to administrative limitations, as is the case with these micro states, a flat tax regime might actually make sense. Countries and states that are larger in size have the ability to design more equitable ways of raising tax revenues.
Lastly, as mentioned before, if public institutions of a particular country are suffering the rot where oligarchs have made a habit of stealing with impunity, then a good way for the government to induce the rich to pay taxes would be to introduce the flat tax regime. Therefore in the year 2001, the Russians became the first nation to induce the flat tax system to overcome the crises of corruption and tax evasion.
What can be understood when studied in detail is that almost in all countries that have adopted the flat tax, government revenues from income tax have relatively decreased. That is why the adoption of the flat tax is simultaneously coupled with an increase in value added tax rates, something that was implemented by Eastern European countries.
Most importantly, it needs to be understood that republican presidential candidate Herman Cain’s “9-9-9” plan is demanding the implementation of a nine per cent rate of personal and corporate tax, along with nine per cent national sales tax. What we can decipher from this is – something the gods have suspected for a long time now while hoping it was not true – that America is now like a school boy who has run out of luck and pocket money, broke, struggling for inward investment, ill governed, and run by a bunch of self interested oligarchic bourgeoisie.
The writer is a seasoned banker with more than 30 years of experience and is currently chief manager SME bank.
