A Flat Tax for Costa Rica?

October 11, 2006

A number of European countries have made headlines in recent years for enacting tax reform, from Ireland’s corporate tax rate decrease to Slovakia’s flat income tax. As these countries enjoy the prosperity that resulted from their reforms, other nations are evaluating their own tax systems, not wanting to be left behind.

Enthusiasm for flat taxes is spreading, and they have become part of the political discourse even in countries where enactment does not seem likely anytime soon. Recently, Costa Rica entertained the idea. From the Wall Street Journal:

The first country in Latin America that institutes a flat-tax regime is going to make history for that region, just as history is being made by such pro-growth flat-tax regimes as Slovakia, Georgia and Estonia across Eastern Europe. The man who made it happen in Estonia is giving Costa Rica that chance. So far, they are proving they’re not up to it.

Former Estonian Prime Minister Mart Laar went to Costa Rica last month to explain the groundbreaking structural change in his own country that sparked a free-market revolution all over Eastern Europe. According to press reports, his message hit home with Costa Rican business and opinion makers. Amazingly, the Costa Rican government is already trying to close the door on Mr. Laar’s ideas. It’s hard to understand why.

Costa Rica is not the poorest country in Latin America but it’s hardly meeting its potential. Steep personal income-tax rates are the cause of a government-estimated tax evasion rate of 70%. A 30% corporate tax rate discourages investment.

Mr. Laar faced bigger challenges in post-Soviet-Estonia. In 1992 his country was running 1,000% annualized inflation and the economy had contracted 30% over two years. Today, with its zero corporate tax rate on reinvested profits, single tax rate for individuals and a fully deregulated economy, Estonia is running ahead of the European pack, attracting human and financial capital. Real GDP growth in 2006-2007 is forecast at more than 8% per year.

Although the flat tax may not be coming to Costa Rica in the very near future, at least the success of countries that have enacted fundamental tax reform is causing other nations to take notice and start scrutinizing their own tax systems.

For more on international tax reform, click here.

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