Learning from European Tax Reform Sucesses

October 31, 2005

As lawmakers await tomorrow’s release of proposals to overhaul the U.S. tax code, the Philadelphia Inquirer recounts a tax-reform success story Congress would do well to emulate: the rise of single-rate tax systems throughout Eastern Europe in the last decade:

Eleven years ago, when this tiny former Soviet outpost was looking to smooth its plunge into the rough seas of the free market, Estonia’s upstart leader decided to try something radical: A flat tax on personal income.

Then-Prime Minister Mart Laar, who was 32 at the time, says he really didn’t appreciate the extent to which the flat tax – one rate for everyone, with few deductions or exemptions – was lampooned in the West as a right-wing fantasy, a boon for the rich at the expense of the middle class, a throwback to the days before the affluent were expected to pay a higher tax rate on the upper levels of their earnings.

All he knew, he says, is that he had read about the idea in a book by the conservative American economist Milton Friedman, and it seemed fair to him. So, over the objections of his own finance minister and the International Monetary Fund, he pushed through parliament a single, 26 percent income-tax rate with just a handful of deductions.

These days, Estonia is booming, the flat tax gets a lot of the credit, and Laar is considered the father of a tax-simplification movement that has swept through the former communist states of Eastern Europe.

Flat-tax fever has now infected politicians in the prosperous West, and while the idea has suffered political setbacks of late, it’s clear that Eastern Europe’s success with the flat tax is squeezing Europe’s rich countries to reexamine their tax systems. (Read the full piece here.)

Most non-economists find the idea that a simpler tax code can boost economic growth abstract and implausible. Hopefully the experience of the booming Eastern European economies will help dispel that skepticism—and maybe even prompt our own lawmakers to follow Eastern Europe’s lead.


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