I believe this is one of the biggest pieces of economic news ever. Milton Friedman's single-postcard flat tax idea has finally started catching on (ten Eastern European countries, with four more in Europe close to adoption). 2004 GDP growth rates there averaged a staggering 8%, well over twice the industrialized nations' average of 3.4%. Of course these flat tax rates vary widely, from 12-33%. Among the six lowest-taxed countries, growth rates are the highest: 8.6%. The lowest-taxed three have 9.5% growth.
Earlier I discussed the most successful of Milton Friedman's ideas--the volunteer military. The flat tax idea certainly has the potential to be similarly successful if democracies can summon the moral courage to resist the natural inclination to legally confiscate their wealthy neighbors' money through the coercive power of government. Note that this extraordinary success was achieved through adopting one element of economic freedom. Adopting many of these components as I have illustrated here would unleash economic energy of unprecedented proportions.
Update: Andrew Sullivan and many others have linked to this post and are debating the issue now.
Update 2 (October 11):
This topic has stimulated a large emount of blogosphere debate. The majority of criticism fits into the following categories:
?It?s easy to expand quickly when you?re small and recovering from communism. You have nowhere to go but up.?
If only this had been so obvious to the many pessimistic reporters who covered the fall of the Soviet Union.
If this claim were true we would expect to see similar growth rates among other small economies, particularly from the former Soviet Union. It may be the case that free-market reforms are so widespread in that region that the flat tax in itself makes little difference in economic growth. I will post these results later. Incidentally there is one notable exception in this list: the highly developed economy of Hong Kong.
?Cause and effect are reversed here. The overall free-market attitude which caused the flat tax to be adopted is what is driving the rapid growth.?
This is certainly a reasonable caveat of most studies involving human behavior in that cause and effect are hard to separate. The study was not prospective, i.e. the countries were not selected to have a flat tax randomly imposed. The conclusions of this study are that the flat tax should be enacted in an atmosphere of comprehensive free-market reform.
?The amount of data is too small.?
I wholeheartedly agree that this experiment needs to be carried out on a much larger scale as soon as possible. Interestingly there are reports that Germany?s new Chancellor, Merkel, supports the flat tax.
?What does the flat tax have to do with a blog on Israeli security??
Please see this FAQ.
Update 3: The critics were correct: these numbers are not compelling given that the entire area appears to be experiencing extraordinary growth. I ran the numbers on the non-flat tax countries of the former Soviet Union and there is only a slight (0.3%) advantage to the flat tax group. This difference is probably not statistically significant given the weakness of the underlying reporting mechanisms.
These results certainly appear promising, particularly for a developed country like Hong Kong. But it is too early to attribute systemic economic gains to one factor in the free-market palette.
Flat Tax: Greater Growth vs. Wealth Distribution
Should America adopt a flat tax? The appeal is simple: flat taxes are easy to understand and hard to avoid. Now there is strong evidence that flat tax countries are growing more quickly. This doesn't prove a causal relationship, but it's certainly compelling. You can read the theoretical case for flat taxes and how a flat tax can be progressive....
According to current statistics, the Fair Tax complared to the Flat Tax is the best solution as far as a change in the tax code is concerned. Those European countries that have adopted a flat tax don't have the IRS to contend with. A national consumption tax is the best alternative in the house and senate bill HR25;SB25. www.fairtax.org
The Fair tax cultist must have a network that searches out every reference to "flat tax" for the sole purpose of pretending that other countries have "no IRS".
The idea that the "fair tax" wouldn't require a massive bureacracy to administer is silly on its face. Further, the idea that lobbyists wouldn't flood the halls with similar exemptions, appeals, & cozy legislation is just as preposterous.
Though still undecided as to the best system, the religious & cult like mania with which the "fair tax" people operate is spooky.
"That choclate eclaire on the table is just like the universe with out the IRS. The fair tax will be just like desert for all three dinner courses" _
The fact is that all those countries have an "IRS." They are growing because the taxes are low (because they are flat). When will people realize that the aggregate tax take is the big ball people have to keep their eye on.
I am a liberal but very conservative on fiscal matters and I certainly find this information interesting. It does not however account for the broader issues and fluctuations of an economy, it's just one small snapshot of nations that are in a period of dramatic market liberalization anyway.
A flat tax ultimately says that very low taxation, even for the highest earners stimulates growth to the degree that it generates more gov't revenue, and while this might be able to be demonstrated as true, it is also worth considering the type of growth this stimulates, and whether the defeciencies of the market are exacerbated as a result.
Anyways, I'm certainly looking forward to the role this issue plays in the Republican 2008 primaries. It might have some then have some traction.
I am a fiscal conservative as well, and you are right to be skeptical. If you look at GDP data for countries that are similar to those that have adopted a flat tax, you will find that the ones with a flat tax are not really doing any better.
I'm also afraid you are confusing a flat tax with the Laffer Curve. A flat tax is a simplified tax system that could have any tax rate. The Laffer Curve is a theory that if you lower tax rates, you can increase long-term government revenues. Unfortunately, it is generally believed among economists that this only happens when tax rates are initially well above 50%.
Businesses add the flat tax to the cost of products causing:
a. Higher product costs
b. Fewer exports
c. Compliance (record keeping) costs
d. Unknown embedded tax
a. No work incentives
b. Underground economy, porn industry escape taxes
c. Record keeping required and discourages savings
d. Increases cost of products
e. IRS audits, harrassment
f. Taxes savings, investments, education, basic necessities.
These nations are all growing fast off a low base. High rates of eco growth are not uncommon off a low base. And many such nations have had progressive taxation regimes.
The most notable current exception to the "flat tax fast growth rate" equation is the PRC. This nation of one billion plus people has been growing at 8% + for a generation and has a steeply progressive income and land tax schedule.
The tax on an individual's income is progressive. As at 2005, an individual's income is taxed progressively at 5% - 45%.
You could at least have the intellectual rigor to get the chronology correct, i.e. cite growth rates following the adoption of the flat tax. For Georgia, the flat tax took effect just this year and growth is expected to drop to around 6%. For Romania, also adopted just this year and growth will drop to around 5-5.5%. Fact is there are no quantitative studies which show a strong correlation between flat taxes and growth. Simply too many other factors at play. For example, flat taxes have been shown to be much less effective in increasing compliance (which is the real benefit of simple tax regimes in highly corrupt post-communist enivironments) without parallel reform of payroll taxes (which are very high in these countries).
Separately, you have to look at the effective rate. The elimination of deductions can actually lead to an increase in the effective rate. In the case of Russia, the flat tax led to a 1 percentage point increase in the effective rate. Before the flat tax, 90% of taxpayers were paying the lowest tax rate of 12%.