Saturday, July 22, 2006

TAX POLICY FOR PROSPERITY: WHY IS THE FLAT TAX GOOD FOR SLOVENIA?

Flat tax represents a simplification of the tax liabilities. In many countries there are different rates of tax for different levels of income, and sometimes the rates vary depending on how the income was earned. Usually there is a list of allowable exemptions from tax, and deductions from tax, as well as tax allowances. Flat tax changes all that by introducing a constant tax rate for all income above the threshold starting level. It abolishes most of the exemptions, deductions and allowances. It represents a different attitude to taxation, and sweeps away the clutter of the years, like spring-cleaning a house from the debris which piled up over the winter.

Streaming to the future, flat tax is inevitable for Slovenia if this country once wants to be the most competitive "Central European Tiger" with impressive economic growth, rapid job creation and highly protective system of private property. To maximize its economic growth, create jobs, raise incomes, and provide the government with sufficient revenue to finance the essential limited tasks of government Slovenia must sooner or later move forward towards simplified and non-discriminatory system of flat tax. Several examples in Eastern Europe have shown that the system of flat tax works perfectly well, since there are no double taxation laws, dividends taxations and where citizens of certain country are not forced to spend their entire time on filling out tax return for months. Instead, they would fill-out the tax return on a small postcard-sized form in matter of minutes.

Today Slovenia faces an immensely exposed challenge. One of its long-term objectives must be to devise a tax system that will help boost economic growth and total factor productivity so the Slovenians will easily overcome their inherited crippling legacy of socialist mismanagement which has moved Slovenia away from prosperity and benefits of free market economy. However, the new tax system must be made attractive to foreign investors. This is being extremely important because of integral globalization which awards nations with low tax-rates and non-discriminatory environment for foreign investment. Essentially, foreign investment is one of the foremost drivers of economic growth. Yet, the tax system in Slovenia needs flat tax. It must raise its revenue to finance the needs of hopefully limited government with rare spending habits. The flat tax is a good solution for Slovenia to become prosperous, competitive and successful small tiger in the heart of Europe.

Nearly every economic theorist and expert for public finance prefers flat tax. It holds low tax rates where people have a strong incentive to work and a little reason to hide their money from the government. After getting rid of many specific forms of taxation, flat tax does not impose bias against saving and investment. It also completely eliminates all forms of different tax treatment, preferences and penalties so that consumers' decisions are based on economic merit rather than on tax consideration. In case of certain fundamental or incremental tax reform, Slovenian leaders will face a never-ending number of obstacles towards implementing the flat tax. Unfortunately, international bureaucracies are very likely to be a part of that problem. The EU and OECD, for instance, strongly represent interests of high-tax nations, such as Germany and France. Those and many others area of extreme and discriminatory taxations have already been very upset that some Eastern European nations are moving ahead and implement the flat tax. The bureaucrats apparently don’t understand that higher tax rates simultaneously discourage work, saving, and investment and encourage tax evasion and tax avoidance.

The IMF may be even more dangerous than the OECD and EU since it uses its large budget to bribe nations to follow its advice. Slovenian leaders should reject the bad advises of international bureaucracies immediately. There's no other choice if Slovenia really wants to become a bite-roaring economic tiger or "Singapore of Central Europe". If tax rates will remain too high, people will keep hiding the money away from the government. Even worse, foreign investors will rather choose another country to build production factories and create jobs. Indeed, this is why it is so important to be radical and reject harmfully bad advises of international bureaucrats from EU and OECD against tax competition.

If Slovenia doesn't lower tax rates and reform its rigid tax system, it will have very little chance of successfully competing with other nations in the region that have made these changes. Foreign investors will have plenty of options left to choose where to build high-tech production parks. They will rather choose Slovakia with 19% corporate tax, Romania with 15% corporate tax rate. Why should Nokia build a factory in Slovenia, when it can benefit from Hungary's 16% flat rate on corporate income. Simply told, Slovenia must compete or perish.

It must become a leading innovation free market nation and create competitive, free and friendly investors' business environment like no other nation before. Continually, it must improve its score on regulation, banking system, pension reform, labor market flexibility and private property rights in order to climb to the top. And if the IMF (or even the World Bank) argues that tax reform and tax rate reductions will deprive the government of too much revenue, Slovenia's leaders should point to what has happened in other nations. In Russia, for instance, income tax revenues have nearly doubled since President Putin shifted from a 30 percent “progressive” tax to a 13 percent flat tax. Estonia rejected IMF's advice to implement strongly progressive tax system back in 1994 and had moved towards the flat tax. The results of implementing it were of course impressive. Other Eastern European nations have seen similar results because of faster growth and less evasion. More than 40 years ago, American president John Fitzgerald Kennedy implemented congratulating reductions in tax rates. His opponents made the same arguments as the ones we hear from international bureaucratic monsters such as EU and OECD today. But President Kennedy had a vision and preserved. He told critics that:

"Our true choice is not between tax reduction, on the one hand, and the avoidance of large Federal deficits on the other. It is increasingly clear that no matter what party is in power, so long as our national security needs keep rising, an economy hampered by restrictive tax rates will never produce enough revenues to balance our budget just as it will never produce enough jobs or enough profits… In short, it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now."

Slovenia should follow this highly sensible advice. American economy boomed after Kennedy's tax cuts in the 1960s and it sky-rocketed again when Ronald Reagan cut corporate and personal income tax rates in the 1980s. Slovenia should do the same. If enacted, let Slovenia cut its extremely high tax rates and let it reform the tax system. I hope that Slovenian policymakers will not listen to bureaucratic monsters who represent crippling, backward and damaging thinking of high-tax welfare states such as France, Germany, Sweden, Italy etc. Slovenian lawmakers should eliminate the evil called progressive taxation and finally implement the flat tax in order to let its economy moving upward with high rates of economic growth, rapid job creation, privatized economy, strong protection of property rights and new way of thinking how to become the most competitive small tiger in the global economy.

Like Estonia, Slovenia should champion private property rights through privatization and pursue tax competition via flat tax.

Taking amazing geographical location, privatization launch, competitive strength and free trade into account, Slovenia has excellent potential for being the tiger of hope, the child of brave and the champion of economic freedom.

7 comments:

romunov said...

As for me, if I earned 100k a month, I wouldn't want to pay 50% in taxes. Now if you tax a rich fat guy @ 50%, you gonna see some heavy cash rolling in.

Foreign inverstments do diddly squat for the region. All the profits go back to the country of origin, what's left here is some low wages who are spent on holidays in... Croatia. :rolleyes: Or the manegement buys the newest BMW...

Want money and jobs? Legalise drugs. It's funny how noone ever mentions that option, even though the .nl is very successful at it.

Rocks said...

If the monthly income of the rich guy will be taxed on 50% progressive rate, I think this guy would have a plenty of reasons to hide his money from the government and on the long-run government revenues would fall down rapidly since it favors progressive taxation. If an investor decides to build a new high-tech park in certain country, than he would put his profit in this country because its tax system in non-discriminatory. Since Slovakia has become a magnet for foreign investment the real wages rapidly increased. But it's not just Slovakia. There're many other economies paving its road to prosperity by making a room for a friendly environment for foreign investors. Competition automatically forces them to invest in infrastructure, new production technology and his promotion. And the fact is that the key to long-term prosperity is total factor productivity which directly leades to an increase of real wages since agents on the market recognize how profitable it is to engage in productive behavior.
But as a matter of fact, reforming the tax system is only one way to make a bright future. There are several other components to be reformed. Without them even low tax regime wouldn't function as usually well. There's an institutional environment underpinning friendly behavior towards establishing new firms. There's a trade policy based upon the principles of free trade. There's a need to improve judicial system and provide inviolable protection of private property rights. And finally there's the most important card. Public spending. My opinion is that even 30% of government spending is way too much. What government wants, needs to collect through taxes. And finally, in case of transition economies, government must quit actively-boosted participating in real economy. Estonia and Slovakia have done it quickly.

Beside very friendly tax system certain economy needs very favorable, small but efficient institutions not be a burden to entrepreneurs but a "friend" of rapid development, providing a flexible framework for a functioning economy.

romunov said...

In your opinion, how muck do you think cheap labour serves as a "magnet" for big firmes? China with their near slave wages comes to mind.

Rocks said...

Talking about benefits of cheap labor demands rather microeconomic analysis based upon the observations of the firm. If a firm seeks to maximize its growth it is required to search for new opportunities on the global market. But of course, pioneering fro growth requires skilled and well-educated labor force. Here Investors often face troubles since cheap labor means unskilled labor. But Chinese market is moving upward from that "ground zero". Annually, Chinese students are offering perfect education in fields where investors look for the potential of their firm (IT, engineering). According to Deloitte, 70% American businesses investing in China place "staff supply" on top of their priority list when making a decision to launch an investment in China. And there are two other extremely important factors left. The first is of course the size of the market. Larger it is, more opportunities can pioneer. Larger market also requires more broadly branded marketing which could be translated into increased overall operation costs. And second, there's an institutional environment which is perhaps slightly less accountable but still of the greater importance. If the judicial system is functioning well, if contract enforcement is relatively flexible and quick, if administrative procedures is fast and can be done online, if banking and financial system is supportable to entrepreneurs' demands, if hiring and firing workers is easy and without heavy compliance and finally if investors are legislatively well protected and if tax system is non-discriminatory than a certain economy could become a great hotting magnet for big and medium-sized firms when they take upon decision to expand themselves into large and full of opportunities global market such as India and China. Of course, infrastructure plays a partial role in this process. Political and Economic stability either.And even good traffic connections. But I underpin the fact that the size of the market and the opportunities' potential are often the key factor when a relatively large firm decides to boost its investment in foreign global environment.

romunov said...

I've read that India and China produce about 500.000 graduates a year, compared to about 15.000 in the USA. It's understandable that these two countries have far superior thinking power, which is also why some of the US (and probably from Europe and other places) are moving to Asia theater - cheaper and better skilled workers. Which spells beans for us.

Rocks said...

It's not just about U.S. companies it's about "making China your second home". The number of fresh graduates doesn't tell us much about the size of them in terms of percentage. We need an international comparison to draw a line and see where technological study pioneering really rallies. I once talked to a Chinese student of computer engineering in Montreal who has told me that in average he studies more than 10 hours a day without putting Saturdays and Sundays away from regular studying schedule. By December 2005 China has taken the lead of being the largest exporter in Information Technology products. Remember it's not the matter "if" Chinese GDP per capita will slash European one, the question is only "when will this happen." As an student of Economics I can tell that "cheaper labor force doesn't also mean productive labor force." This results that foreign investors must intensively invest into improvement of education of those "cheap workers" The costs of this transformation are often enormous but Chinese market has faced that challenge by producing numerous fresh-brained IT graduates that can offer equally good or perhaps even better knowledge than their European mates.

The fact that China is still lagging behind other world economic superpowers is political. The enlargement of economic freedom claims equally worth improvement in political and personal freedom. Those three branches of liberty are always and everywhere the preconditional requirement for the achievment of economic miracle, entrepreneurial welfare and long-term free-market prosperity.

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