Flat taxes stimulate growth and employment and, paradoxically, higher tax revenues,
says Steve Forbes
The flat tax is a powerful generator of economic growth. It is very simple: a single, ideally low, tax rate is applied to personal incomes after generous exemptions for adults and children alike. For businesses, the profits tax would also be low and businesses would be allowed to expense immediately all capital investments instead of writing the assets off over several years.
Under my plan for America, for instance, a family of four would owe no federal income tax on their first $46,000 of income and would pay just 17% on any income above that. For a family of six, the exemption would amount to more than $65,000.
There would be no tax on savings – no levies on dividends, interest and capital gains. For businesses, the profits tax would be cut from the present rate of 35% to 17%, and business investments would be written off immediately.
Once tried, never denied
Hong Kong was the first to apply a variation of the flat tax nearly 60 years ago, and it has worked magnificently. It played a key role in transforming Hong Kong from one of the poorest areas on earth to one of the most prosperous.
In recent years, 10 countries – Estonia, Latvia, Lithuania, Russia, the Ukraine, Slovakia, Georgia, Romania, Serbia and Iraq – have adopted a flat tax and it has worked well everywhere. As the prime minister of Estonia puts it: “Once you’ve tried it, you never want to go back.”
A number of other countries, including Spain, Greece, Croatia and Slovenia, are considering the flat tax. Support is also growing among policymakers in Britain and Germany. China is also examining the issue.
A critical principle to understanding why the flat tax is so potent in fuelling economic growth is that taxes are not just a means of raising revenue for the government. They are also a price and a burden.
The tax you pay on income is the price you pay for working. The tax you pay on profits is the price you pay for being successful. And the tax on capital gains is the price you pay for taking risks that work out. The concept is very simple – when you lower the price of positive things, such as productive work, risk-taking and success, you get more of them. Raise the price, and you will get less of them.
What policymakers so often cannot grasp is that reducing tax rates does not reduce tax revenues. Lowering rates increases incentives for people to start new businesses and to work more productively. This is not theory. In America, for example, every time that federal income tax rates have been cut, the American economy has got stronger and federal tax receipts have increased, rather than decreased. Employment has gone up.
It pays to work
In the 1960s, then-president John Kennedy proposed a 23% reduction across the board in American income tax rates. Critics cried that this would unacceptably reduce Washington’s tax receipts. The cuts were eventually enacted, the American economy boomed – and Washington’s tax take went up.
We saw a similar phenomenon in the 1980s when Ronald Reagan’s radical income tax rate reductions were fully enacted. During the 1980s, federal tax receipts just about doubled, even though the top tax rate dropped from 70% to 28%.
Other countries have had similar experiences. Russia enacted a flat tax in 2001 at just 13%. Russia’s income tax receipts, adjusted for inflation, more than doubled within four years.
Edward Prescott, a Nobel Prize-winning economist, has shown the effect that high taxes have on a country’s workers. Prescott asked: “Why do Americans work so much more than Europeans?”
His findings reveal that Americans work 50% more than their counterparts in France, Germany and Italy. Very high tax rates in those countries persuade people to work less. These findings also hold true for non-western cultures such as Japan.
Prescott demonstrated that, historically, when the French and others were taxed similarly to Americans, they worked the same amount of time. Europeans only began to work less as their tax rates increased, creating today’s huge disparity between American and European productivity.
The flat tax’s simplicity also means greater compliance, as the Russian experience dramatically demonstrates. Russia previously had a horrific system of unimaginable complexity that bred widespread non-compliance and rampant corruption.
One American study reported that arrears were more than a third of collections by 1997. By the following year, the tax take had fallen so far that the Russian government could not pay its creditors.
When the tax code is transparent and easy to understand, people have a hard time evading it. In fact, since the rate is so low, most people and most businesses don’t think it is worth the risk to try to evade what they lawfully owe.
Lower rates, less evasion
As you would expect, there are variations of the flat tax. Each of the countries that have adopted it has a different rate. And they have differing approaches to the taxation of consumption, profits and savings. But the concept is the same – low taxes and simplicity are a potent mix for greater prosperity.
For example, Fiscal Associates, a US-based economic consultancy, used sophisticated economic models that took into account the real-world context of tax changes and determined that, over the course of 10 years, the flat tax would create $6 trillion in new assets, $892 billion in additional payroll tax receipts and lead to nearly 3.5 million new jobs that otherwise would not exist in America. Furthermore, the flat tax would cut the tax burden on all Americans.
A tax break for the rich?
Some opponents claim that the flat tax would help only the rich. Wrong. Not only would it be a tax cut for everyone, it would also abolish all those loopholes that the rich are so good at exploiting. The flat tax would make it harder for those commanding armies of tax lawyers and lobbyists to manipulate the system.
By creating more prosperity, the flat tax gives people just starting out in life a greater opportunity to get jobs and then to move on to better- paying jobs. This has certainly been the experience of those countries where the flat tax has been implemented.
No wonder the flat-tax idea is rapidly spreading. Countries are increasingly recognizing that if they don’t adopt it, they will lose jobs and capital and ambitious entrepreneurs to growth-friendly nations. In other words, just as competition is essential for economic progress, tax competition, too, spurs more growth and opportunity.
One sees the benefit of tax competition already on the corporate side. Austria last year slashed its corporate tax rate from 34% to 25% because neighbouring central European countries had lowered rates and were attracting job-creating investments. The Netherlands recently reduced rates, and other European countries are following suit.
As the late, great, American banker Walter Wriston never tired of observing, capital – money and people – goes where it is welcome and stays where it is well-treated.
The flat tax would enormously help western Europe to come out of its economic doldrums and generate desperately-needed growth. Countries such as France and Germany are plagued with high unemployment, which leads to destabilizing social unrest.
The flat-tax movement is being recognized by media organizations that had once been sceptical. The Economist devoted an April 2005 cover to the growing worldwide support for it.
The flat tax is, indeed, an idea whose time is coming – and the global economy will benefit enormously from it.
CV Steve Forbes
Steve Forbes is the president and chief executive officer of Forbes and editor-in-chief
of Forbes magazine