Our cover story this month examines the vexed question of flat taxes. The merits and demerits of the arguments are set out clearly in a well argued piece by Catherine Snowdon. Emerging states have clearly benefited from the coherence and simplicity of the system though economists across the world are less convinced of its benefits for more complex economies.
When a US-based think tank, earlier in the summer, promoted the case of Iceland in this regard its thesis was rapidly exploited by Canada's tax professionals for their own purposes. The core argument articulated by the US researchers was that Iceland was an economic basket case until it had the vision to adopt a flat tax methodology.
It is now one of the wealthiest nations on Earth by head of population. This is the type of thinking that annoys opponents of flat taxes who say that a whole range of other factors came to Iceland's aid.
The Canadians were using the study to criticise their own government. Iceland's case was endorsed by Canadian tax practitioners. They said that if their government had adopted such progressive measures Canada would be much better off.
They may have a point but the message which emerges from our cover story is that more complex economies require more detailed solutions. Flat taxes have worked in Eastern Europe, for example, because they are designed for a single purpose – to attract investment. Estonia was the pioneer. The Baltic states enjoyed significant benefits from a rapid adoption of flat taxes.
On seeing the success of Estonia, Latvia and Lithuania joined in and they too reaped investment success. The article makes a distinction between pure flat taxes – the vanilla version – and a part-flat tax system. This can be more complex and potentially more threatening.
The value in a flat tax is its simplicity. Investors generally know that a flat tax is the be all and end all of the deal. Estonia, as Snowdon's account points out, does not offer incentives for R&D which are common elsewhere. Motive is an interesting perspective. Greece's flat tax system was initiated to stop tax evasion. In practice, it has led to a growth in smaller companies.
Snowdon discusses the race to the bottom. This is the phenomenon where states which to be seen to be offering the lowest tax rate among the flat tax nations.
Flat tax is, without doubt, here to stay. It has helped to revitalise stagnant economies but it is not a fix that can be applied everywhere. It is unlikely that a straightforward flat tax would solve the problems of more complex states.
Bob Reynolds
Editor
International Tax Review
breynolds@euromoneyplc.com
+44 207 779 8789
