Siim Kallas Proved the Hard Work of Sound Tax Reform Pays Off

Recently, the world lost a true taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reformer. Siim Kallas, the former Estonian Prime Minister and European Commissioner who helped design the reforms that brought Estonian economic policy into the modern era, passed away on August 22^nd at the age of 77.

Politicians frequently fail to carry a clear vision for tax reform from concept to implementation. They talk about easy administration, flat rates, eliminating loopholes, and supporting businesses. But when it comes time to perform the difficult work of truly reforming the rules, they often find it’s easier to maintain the status quo.

Not Kallas. On tax policy, Kallas was an innovator. In 2000, after years of leadership from Kallas and others, Estonia adopted an approach to taxing business profits that exempts retained earnings. If owners wanted to use profits to continue building their business or needed cash on the balance sheet to provide liquidity for emergencies, the tax system would leave them alone.

Traditional corporate income taxes, like the US’s, can discourage investment and distort financing decisions by favoring debt over equity. Kallas’s reform addressed these challenges, and the evidence has proven him right.

The Economic Evidence

Estonian firms are generally less leveraged and have more retained earnings than comparable firms. In 2013, Estonian economists demonstrated how the tax system led to healthier balance sheets in Estonia compared to its neighbors, and data shows that non-performing loans were one-third of the levels seen in Latvia and Lithuania at the end of 2009.

Stronger balance sheets also mattered in a more recent economic shock. At a 2024 event at the Estonian Embassy in Washington, DC, the chairman of the Estonian central bank credited the healthy balance sheets of Estonian companies with limiting the harmful impacts of the COVID-era economic downturn.

Estonia’s economy is also among the most entrepreneurial and dynamic in Europe, thanks in part to its tax system. For example, Estonia leads Europe in terms of startups per capita (including “unicorns” or startups valued at $1 billion or more), venture capital funding per capita, and capital investment per capita. Since the 2000 tax reform, Estonia’s GDP per capita has grown 103 percent; for comparison, US GDP per capita has grown 40 percent, and the average among countries in the OECD has grown 36 percent.

There’s a reason Estonia has ranked first on Tax Foundation’s International Tax Competitiveness Index every year since we started measuring and comparing different countries’ tax systems in 2014. Estonia’s structure is simple: a broad-based consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or income taxes where all savings are tax-deductible., a property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. that focuses on the value of land, a roughly flat personal income tax, and the business system aimed at distributed profits. Neutrality—often the hardest of Tax Foundation’s principles for politicians to maintain—is at the heart of Estonia’s tax system.

If the US were to mimic just Estonia’s business tax reforms, we estimate it would reduce business tax compliance costs by more than $70 billion each year and expand the size of the US economy by 1.7 percent in the long run. The capital stock would increase by 3.1 percent, wages by 1.3 percent, and employment by 412,000 full-time equivalent jobs.

How to Stay Principled When Political Pressure Mounts

Reform does not come without critics, though.

Earlier this year, Kallas admitted it took seven years for his vision of corporate tax reform to come to fruition. He had to negotiate with domestic political interests, and, even after adoption, leaders in the European Union (EU) wanted Estonia to do an about-face on the reforms to join the bloc.

Kallas stood firm, stating clearly in 2002, “In our opinion, there is no need to discuss the Estonian income tax system at the accession talks.”

The pressure to unwind portions of the reform has continued into this decade. The global minimum tax threatens to take the unlimited deferral of taxes on retained earnings and shrink it to a four-year deferral. While the EU’s implementation of the global minimum tax does not currently require Estonia to adopt those rules, that status, as of now, will end at the end of 2029. The same treatment exclusion is also benefiting Latvia, Lithuania, Malta, and Slovakia.

Recent International Monetary Fund analysis is also skeptical of Kallas’s system, suggesting that a standard corporate tax system would be “less risky” than allowing the current rules to persist.

When there was a push to adopt an additional corporate tax in 2024 to fund defense build-up, Kallas called it “a mistake.” That special levy was abolished before it could be implemented.

What the US Can Learn

Kallas knew that the system he helped design was fragile, not because of unsound economics, but because politicians are tempted to wield tax rules in non-neutral ways. The global minimum tax embodies this with clear discrimination between large and small companies, and the variety of formulae and definitions that result in endless complexity.

Unfortunately, leaders like Kallas are rare. Political movements that allow them to succeed are even rarer. But if America’s leaders today want to learn how to build a lasting system on the foundation of simplicity and neutrality, they should follow the Siim Kallas blueprint.

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