Saturday, February 10, 2007


"Privatisation, strong fiscal management and responsible leadership on the part of labour unions and employers have played a major part in the successful restructuring of the Icelandic economy."

David Oddsson, former Prime Minister of Iceland

Daniel Mitchell reports that Iceland has finally joined the flat tax club. In the process of rapid economic success, the corporate tax rate was cut from 45 percent to 18 percent. The cut enabled companies to reduce their tax burden as well as to set a solid grounding for strategic growth in the market, domestically and internationally. In fact, in the period of economic stagnation and "status quo" era, the financial sector was dominated by the government which effectively controlled all major ownership stakes that firmed its dominant position in the banking and insurance sector. When the stakes were sold to private investors, the financial sector achieved tremendous success. Today, the three largest Icelandic banks are among 15 largest Nordic banks.

Keith Miles, a financial adviser to the government of Slovenia, gave Slovenian policymakers a sign of orientation where to seek examples and reform models that embody the success story of long-term economic growth and structural advancement. Iceland and Slovenia are very similar countries. They both have quite homogenous societies whose advantage is dynamic adaptability and adjustment to real competitive advantage faster than their European counterparts. Both countries have a similar (percentage) trade volume. 60 percent of all trade, in average, is flowed to the EU. In going for growth, Iceland never granted massive subsidies from the EU as Ireland did.

With the expiration of the surtax, individuals now pay 22,75 percent flat tax on the personal income. Marginal tax rates were cut from 32,80 percent in 1991 to 22,75 in 2007. A reformed tax system is not purely the verison the flat tax which was authored by Robert Hall and Alvin Rabushka. The tax rate is high, double taxation of savings and investments remains while certain tax preferences still persist. However, compared to regional and global competitors, Iceland has dramatically moved forward in a way that collects the total revenue at a minimal cost of economic distorstions without progressive tax code.

New Icelandic tax system dramatically reduced the cost burden on the productive activities. 10 years, the marginal income tax rate was set at 30,41 percent with a 5 percent surtax on higher incomes. Tax revenue was additionally collected from a local tax so that the most productive individuals paid half of their income to the government. Until recent tax reforms were implemented, the general income tax was reduced by 7 percentage points. With the combination of the local tax, which increased slightly, the total tax rate is now 36 percent. Icelandic tax system has a high tax-free threshold. Taxpayers get a credit of about $5,000 per adult and $2,000 per child. There are also additional tax preferences for housing and seaman. Employers technically pay a quite modest payroll tax of 6 percent. Icelanders also have an employer-based pension system which is based on private savings. Iceland also has a value-added tax whose rates vary between 14 and 24,5 percent.

In the area of corporate taxation, Iceland can be a model to the rest of the world. The corporate tax rate of 18 percent is one of the lowest in the industrial world. Countries such as Cyprus (11 percent), Hong Kong (17,5 percent) and Ireland (12,5 percent) have a lower rate. In Iceland, the rate was lowered dramatically throughout the last decade. It's been cut permanently from 50 percent at the end of 80s to 33 percent in the mid-90s to 18 percent by 2002. The reduction in corporate tax burden has created incredible investment incentives and boosted economic growth. The principal effect of the Laffer Curve worked once more. Corporate tax reductions did not result in a loss of government revenue but they have coincided with a rapid growth of corporate revenue.

Tax reforms, reflected in the introduction of the flat tax for businesses and individuals, presented an important part of Iceland's global economic success. Other features stimulated the economic miracle as well. Real estate tax was dropped to 5 percent, 10 percent capital income tax was made flat, turnover tax on businesses was repealed and the wealth tax was abolished.

Reforms that made Iceland the Nordic growth miracle and a roaring tiger were introduced when the economy and society were in a severe slump of economic depression. Private property is well protected in Iceland. Private property rights were created for fisheries as well. Regardless of the methodology, Iceland is now one of the wealthiest countries in the world. Unemployment, currently standing at 2 percent, almost doesn't exist. Numerous businesses and state enterprises were immediately privatized. Mr. David Oddsson, former Prime Minister and the European reform champion, addressed the American Enterprise Institute, where he underpinned the importance of privatization in Iceland's economic transformation. Impressive economic growth, averaging 4 percent in 2006, has made it one of the foremost prosperous nations in the world, and the fifth wealthiest in the OECD.

Successful tax system were created when the flat tax revolution spread throughout the globe. It began in 1994 when Estonia implemented a flat tax on individual and corporate income. In continued in the rest of Eastern Europe and reached even Kyrgyzstan and, recently, Macedonia and, of course, Iceland. It has a high rate compared to other countries which joined the flat tax, but its implementation is a remarkable success. Iceland is the very first Western country which decided not to prolong progressive and highly discriminatory tax system. As a country, Iceland incredibly prospered from radical tax reform, economic freedom and several other features, including liberalization, privatization and deregulation. We hope that policymakers in other countries will also pursue the implementation of the flat tax. Everyone would benefit.


NE said...

Well done Iceland. Your country is going to be the best ever thanks to this. Ooops maybe not...

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