The Flat tax: Economic panacea or pandora?

In Short:
Flat tax is all the talk in the new member states these days, and calls for tax cuts and simplification are also coming from elsewhere in Europe. Meanwhile, divisions remain on its merits.

Background:
Simply put, flat tax means that everyone is taxed at just one rate. In such a system, in place of a complex set of income tax brackets, the state declares a threshold above which all parties pay a fixed rate on all their income. This threshold is normally low enough to provide an incentive for the citizens to prefer paying to dodging their taxes. Such a system taxes all income once and once only, on its inception. As regards corporate taxes, the idea is similar: one bracket should fit all.

Analysts are inclined to point out that while in the first half of the 19th century the flat tax rate was the norm in the industrialising states, the first loud calls for a heavy progressive or graduated income tax came from Karl Marx in his 1848 Communist Manifesto. Eventually, however, it was the capitalist part of the world that adopted Marxs call.

Since then, the idea has been resurrected a number of times, with quite a number of countries adopting one version or another of the flat tax regime. And yet, for all the recurring debates, to date no major Western economy has switched over (or back) to a flat-rate income tax regime.
According to popular belief, taxpayers all over the world take some eight billion man-hours each year to fill out their tax returns.

The modern-day renaissance of the flat-rate income tax was initiated by Estonia in 1991, followed by Latvia (1994), Lithuania (1994), Russia (2001), Serbia (2003), Ukraine (2003), Slovakia (2003), Georgia (2004) and Romania (2005). Hungary is reportedly considering introducing a version of the flat tax regime soon.

Issues:
Although flat tax is not touted as a panacea to all economic ills, an increasing number of European countries (among them a few new EU member states) have introduced or are developing one-size-fits-all tax regimes. Most of these countries are confronted with sizeable budget deficits, and several face the need to align their economic status with the eurozone's requirements.

Flat tax is believed to:
- help reduce red tape and associated difficulties and confusion
- reduce inequity (same rate for all)
- counterbalance tax dodging and cheating
- provide incentives to work, save and invest
- generate increased tax revenue, and thus
- spark off a 'mini economic boom'

At the same time, a flat tax regime is understood to
- eliminate practically all forms of tax exemptions and allowances
- be non-progressive (at least as far as the 'marginal' rates are concerned)
- favour the wealthy at the expense of the poor
- favour share and dividend-holders since profits are taxed only once, at source (ie 'flat tax' is a consumption-based tax)

Whether the seemingly popular switch over to a flat tax system is driven by sound fiscal policy strategies or rather by a desire to somehow make the citizens pay more into the states coffers is a moot point. One key conclusion cited by several researchers is that the efficiency and success of a flat rate regime is inherently dependent on the actual level of the tax rate: the lower it is, the more efficient it tends to become.

Experts also call attention to the fact that a countrys competitiveness is determined by a number of other factors besides its tax system or the type of support the country gives to new investments. While it is generally true that lower taxes leave more money to circulate (and thus to be invested) in an economy, and that flat rates generally increase the citizens willingness to pay their taxes, lower taxes may also mean lower tax revenues, which in turn may be detrimental to the given states budgetary status.

Furthermore, some leaders of Europes stronger economies, among them German Chancellor Gerhard Schroder and Swedens Prime Minister Goran Persson have said that the Eastern transition economies can afford to cut taxes not least because any lost revenue is more than compensated by hefty subsidies from the EU. This argument has repeatedly been refuted by those transition states affected. Meanwhile, Germany, as well as Italy, Austria, Finland, Denmark and Greece have also decided to introduce tax cuts in various forms and brackets in order to boost investment and spending and spur growth.

NGOs and Think-Tanks
Centre for European Reform: Is tax competition bad?
Adam Smith Institute: Flat tax the British case (by Andrei Grecu)
Hoover Institution: The flat tax idea gains momentum (by Alvin Rabushka)
Economics.UK: Fools gold or economic miracle?
Progress Foundation: The flat tax An introduction (by Alvin Rabushka)
The Fraser Institute: Flat tax Principles and issues
National Center for Policy Analysis: Flat tax and alternative tax systems
The Brookings Institution: Flat tax (by William G. Gale)
Tax Foundation: Fundamental tax reform in Central Europe (by Martin Chren)

Source http://www.euractiv.com